Friday, March 11, 2005

Populist/Leftist Ramblings: Credit Reform

It occurs to me that people may appreciate this blog more for generic politics but from what perspective I can give it, than single focus on the issue of constitutional reform. . We’ll see.

Inspired by the discussion over at EconLog about bankruptcy reform, I’ve had a number of thoughts along the line. If you’re looking for solid economic and pragmatic opposition to credit card reform, besides the rhetoric Paul Krugman has to use on the NYTimes page or how many numbers Brad DeLong uses, try this cup of joe.

The central premise for anyone beginning is this: if you are in debt (mortgage or credit card debt or bills paid via those) and can’t possibly pay, you can declare bankruptcy at personal loss to you, but in such a way that you can’t be charged for eternity. The legal and personal costs to achieve this are high, and economically speaking, the bill would raise them. Now banks and credit card companies know people might default on their debt, and so when they loan you money, the risk of you defaulting is part of the cost and premiums. By making it harder for people to default, this risk is reduced. The economic hope there is that lower risk rates of debtors defaulting will increase profits for the industry, and also pass on lower premiums to high risk borrowers through competition.

1. The bill is an explicit gift to the credit card industry, when without grandfather clauses. This is not that changing rates will be better necessarily only for the credit card industry. But, any high risk person who has already borrowed for mortgage or credit, at rates calculated using previous rules about bankruptcy, now is lower risk (and cost) to the industry but with the same rates charged to them. That surplus alone is huge motivation for credit card companies to push this bill. In contrast, anyone who borrowed money as a high-risk person, is paying premiums that include that risk, but doesn’t have the protection it assumed. (And if you think any bill that would make bankruptcy easier wouldn’t grandfather exception the people who had lower rates beforehand, ha.)

2. Low risk people aren’t affected. Drinking the Kool Aid about the free market and assuming that the lending industry responds to these incentives (something many would believe they don’t) is the only way to assume this is a good thing. Well if the lending market is competitive, low-risk borrowers already get charged rates independent from the risk by high rate borrowers (since a firm could set up shop that just serves low risk lenders).

This is only true for the degree that low risk and high risk people can be separated out. But the lending industry has gotten pretty good at that. So this bill is largely being sold to the American public saying that they will reap surplus from this, but it in fact won’t affect most people monetarily.

3. This does not affect the overclass. If you are dealing with sufficiently large amounts of money, there are ways to make bankruptcy easier, protect certain funds from bankruptcy, and evade debtors. Much of the country is cynical about how accountable rich people are in cases like this, and this bill is partially being sold as a way to stop people who are “gaming the system”. That is a lie, and the bill explicitly leaves open loop-holes for such asset protection. Now, there may be good economic reasons for loopholes – but it still isn’t doing anything to stop those people with the most money from gaming the system.

4. Most bankruptcies in the middle class are because of catastrophic losses. Divorces gone awry, medical losses, etc. These people are not gaming the system, and the bill is going to hurt them the most.


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