Posted on Thursday, March 11, 2010
Welcome to our foreclosure nation. This may be the first time you've realized you're a resident of the nation, even if you never personality bought into the current real estate, mortgage, and financial Market mess, and that can be a bit of a shock. Understanding what a foreclosure nation is is easier when you have an understanding of the culture that created it, namely, our culture of credit.
REDEFINING THE AMERICAN DREAM
For most of us, the "dream" in American Dream is about money and the lifestyle it buys. Making the dream uniquely American is the promise that ours is a country in which anyone can achieve that dream. But what happens when we want the dream and don't have the money to afford it? Let's see how we've come to arrive at this dichotomy in the first place.
Our Grandparents' Definition of the Dream
The phrase "American Dream" was coined by and about turn-of-the-century European immigrants, an industrious group who arrived on our nation's shores with little more than the clothes on their backs. In this country, through hard work and perseverance, they had the opportunity to transcend financial and lifestyle barriers that were insurmountable in their respective homelands. Their core values, including financial values, are precisely what we'd expect from a generation struggling with two world wars, a Great Depression, a polio epidemic, and other woes. Their reward was not merely a new car, a house, jewelry, or the latest clothes. After living under monarchs and dictators, success in the land of plenty was more internal. Their desire to reap the benefits of their own efforts and control their own financial future was precious to them. They strove to create a better life for their children. Their firmly established work ethic, self-sufficiency, perseverance, practicality, and devotion to saving for a rainy day defined turn-of-the-century immigrants.
Baby Boomers' Interpretation of the Dream
The children of these immigrants are our baby boomers, optimistic kids who grew up on the crest of a postwar wave. Although their early years were marked by a predisposition toward cautious sprinklings of peace and love, boomers at once modeled the work ethic exemplified by their parents while relaxing the emphasis on saving. They chose instead to exchange some of their parents' seemingly endless sacrifice for the security and control of a big stash of cash in favor of life's little luxuries: a weekend cabin by the lake, a European vacation or maybe a cute convertible. As products of a newly emerged American world military power, boomers quickly rose as economic market leaders, their boundless optimism further empowering our country's collective relationship with money and, in turn, unwittingly initiating an important shift in Americans' core financial values. Boomers worked, in part, to get a piece of the pie, their "fair share" of material things. That they were entitled to benefit from their efforts to control their own financial future and to take their families to the next socioeconomic level (at least in the more external, material sense) was a given. True to the boomer version of the American Dream, the US government implemented a succession of programs that ensured future generations easier access to that signature dream lifestyle. Veterans Affairs (VA) and Federal Housing Authority (FHA) home loans were born, and we no longer had to work quite as hard or persevere quite as long to buy a house. Workforce protections, welfare benefits, and similar programs aimed at ensuring equal access to the dream for one and all rendered self-sufficiency a less critical factor in how we defined success.
The American Dream: Twenty-first Century Style
Fast forward fifty years to the boomers' children and grandchildren, post-postwar immigrants, and their progeny-a generation raised on home loans, car loans, and the litany of guaranteed government jump-start programs that followed: student loans, employment benefits, food stamps, and, perhaps most significantly, credit cards. We seem to have inherited the drive for the external rewards our parents and grandparents earned, but not the internal pride and motivation in earning them. Certain aspects of our modern economy actually make it more difficult for us to control our financial destinies, to get ahead the way former generations did. It used to be that we paid our dues and worked our way up the ladder, but today that's not necessarily the case. Young, newly minted MBAs trump years of work experience. Less expensive, fresh workforces replace existing workers who have become expensive and expendable. In response, some experts claim, we've acquired a form of learned helplessness that places material things we think we can control or we think make us appear rich, hip, and successful in a more important position. The psychology of material things and their priority for so many Americans makes for an interesting debate. Whether it's learned helplessness, instant gratification, or a feeling of entitlement, the outcome is the same: our grandparents' work ethic, self-sufficiency, perseverance, practicality, and penchant to save are viewed as quaint, comical, and even absurd to many modem-day Americans who have come to expect the dream lifestyle but reflect a growing lack of responsibility for personal financial well-being. Our primary career motivator is not building value, wealth, and security, but acquiring things-or, more aptly, covering the minimum monthly payments for things we've already acquired. Generations X and Y have replaced working hard with "working smart," which is often subjectively equated with working as little as possible.
With help from Madison Avenue, positioning materialism as an entitlement and telling us we all deserve the best of everything, we've grown to believe our own rhetoric. We believe, for example, that because we're stressed out, or have been extra understanding or good about something, or maybe just because our neighbor has one, we've earned and can afford whatever it is we want at the moment as a "reward." For the majority of Americans, there is no reason to wait for anything. They view Benjamin Franklin's famous quote "A penny saved is a penny earned" as virtually meaningless, since a penny is worthless now anyway, right? Fast food, drive-thru banks and dry cleaners, instant download digital photos, text messaging, and the Internet reinforce the expectation that we can have everything now. Our worldwide reputation as Americans is for a love of flashy, material things. In short, the capitalism that defined our grandparents' generation-and indeed built our country's economy has, over time, inadvertently bred a mentality of immediate material entitlement in which the end justifies the means. The view from the fast track to achieving the dream lifestyle is quite different from our grandparents' more traditional ride, when so much pride was experienced in the journey itself.
The Solution? Credit!
So we want lots of stuff, but we don't want to have to work and wait for it. It doesn't take a rocket scientist to see that the math just doesn't work. Unfortunately, for most of us, winning the lottery or having a rich uncle leave us millions is not likely. Enter the credit card: our fast-track ticket to the dream lifestyle. One often ignored reality is the fact-that credit itself has become big business. Like most businesses, its goal is to sell, sell, sell, and make money, preferably as much money as possible. To do this, credit card companies have, over time, consciously aided in altering our society's core financial values.
There's nothing new about the concept of credit itself. It's a common thread throughout history. Some of our great-great-great-great-grandparents owed debt to lords and kings, and found themselves living as serfs in fiefdoms until the obligation was repaid. Seventeenth-century Americans regularly owed money to the blacksmith, the town doctor, or the banker. Why, then, is credit different for our generation?
For starters, look at who is granted credit today. Common sense tells us that credit card companies should lend money to those who can afford to repay it-and then, only as much money as they can comfortably repay. We tend to think that because a bank offers us credit, it must have verified in advance that we'll be able to pay back the debt. After all, banks are the experts at determining such complicated things. But that's not how modern credit works. The majority of credit cards today are sent unsolicited. In our grandparents' day, it was the other way around: When Grandpa wanted credit, he went to the bank in his Sunday best, presented his case, and basically begged for a loan. Often the banker decided that Grandpa may not be able to repay the loan on time and turned him away empty-handed. Arguably, this system unfairly favored people of means. Theoretically, some folks who would have repaid their debts were denied the opportunity to better themselves. But lots of people who would have eventually found themselves in debtors' prison had they been granted the loan were spared the heartache of their own folly by prudent bankers.
OUTSMARTED BY CREDIT CARD COMPANIES
Today our senses are dulled by a constant barrage of mailings, televisions ads, and phone calls offering us credit. The average household currently has as many as thirteen credit cards, and most of these cards were issued without the cardholder having to 'prove even a modicum of personal worth or income. We don't need to have a job or demonstrate we're worthy of a loan to get a credit card. Only a fraction of credit card companies insist on any kind of background check, and a whopping two-thirds don't bother to see if we're employed. In fact, the credit card companies actually prefer when we don't pay our credit card balances in full. The industry's most profitable consumers are "revolvers," those people who carry a monthly balance. And credit card companies love late payments, since that translates to more profit in the form of substantial late fees.
Credit card companies are very much aware of human behaviors that influence us and generate more profits for them. Advertising is everywhere, suggesting that actual money is not really involved and equating spending with achieving favorable outcomes and emotions, like love and happiness. There is even an aura of respectability that comes with using credit cards and reaching the level of a "Gold" or "Platinum" card, even though we know in reality these cards are offered based on how much money we spend, not how much we earn or can afford to pay back. Who is not impressed when someone pulls out a "Black" card?
The credit card companies know that many of us associate "credit" with "free." They know we find "debt" distasteful, but "charging" is chic. Sadly, we aren't nearly as aware of our own behaviors as the credit card companies are. Some ads appeal to our desire for convenience: "Sign and drive. Leave your cash at home." .Others appeal to a lack of accountability: "No Credit? Bad Credit? No problem!" What they don't say is that the reason it's no problem is that those cardholders with bad credit will pay the credit card company more by way of a much higher interest rate. A 2006 promotion for a credit line from the now-defunct Washington Mutual asked, "Just Can't Wait to Have It?"1 But what is really so important to own that we can't wait for it, and is it really worth paying an extra 25 percent in interest to have it now? What would our grandparents have done? It's no wonder that the number of banks issuing credit cards increased by 68 percent in 2007. According to Federal Reserve statistics, of the total number of cards issued, more than 20 million in each system carry a balance forward each month, meaning we can't afford to repay what we've borrowed?2
LIFE, LIBERTY, AND THE PURSUIT OF GOOD CREDIT SCORES
Instead of approving or denying credit based on our true financial strength, today's borrowers' financial strength is evaluated in terms of a credit rating and our credit rating is used as a pricing mechanism.
Credit reporting originated more than a hundred years ago when small retail merchants started comparing financial information about their customers. This eventually evolved into localized credit associations that eventually consolidated into a few larger ones. Standardized credit-scoring systems were born in the 1960s. It was also during this time that controversy enveloped credit-rating associations, which were using credit information to deny services and opportunities to certain profiled populations. For example, credit reports tended to include only negative information and lifestyle factors such as sexual orientation. Credit reports weren't available to the public, so no one even knew what negative information their own credit report contained, nor could an individual contest and correct erroneous entries. In the early 1970s we gained the right to see, dispute, and correct our credit reports.
The advent of modern credit scoring propelled the credit industry forward by enabling companies to filter us into groups based on risk assessment, or the likelihood that we will pay our bills on time. This grouping provides the rationale credit card companies use to justify charging some of us more or less interest than others. Credit card companies believe those who are less likely to pay constitute more of a risk, and in return for taking this risk, the companies charge those individuals a higher interest rate. Today, creditors wanting access to the more than 1 billion US consumer credit reports issued annually must submit information about their own customers each month reflecting payment history and current unpaid balances to the Fair Issac Corporation (FICO). FICO uses this information in a formula that predicts the creditworthiness of each and every borrower, and awards each of us a corresponding score that ranges from a low of 300 to a high of 850. The median score is 725, and those who score above 770 usually get the best interest rates (meaning the lowest interest rates). A FICO score below 600 is subprime, meaning those borrowers will pay higher interest rates.
Amazingly, only 2 percent of us know our own credit scores, and even fewer of us take steps to improve our credit scores.3 We'll drive miles out of our way to save money at a sale and spend hours clipping coupons, but only a very few hardy souls take the time to study and improve credit scores that may be costing tens of thousands of dollars in interest charges year after year. The same thing can be said of the manner in which we treat our credit card agreements and monthly statements. Surveys have shown that fewer than 10 percent of us review our credit card statements for accuracy. Errors have led to a plethora of other challenges, since such errors may lead to higher payments or denied credit. Among consumers with the lowest credit scores, almost 8 percent have credit reports containing errors. Twenty-five percent of these errors could result in credit denial. More than 50 percent contain outdated information or information belonging to someone else. Resources like FICO.com and annualcreditreport.com are important consumer protection tools available to all of us.4 Credit scores will become increasingly important over the coming years as more and more companies make decisions about us-for example, our insurance rates, cell phone fees, rental car costs, and rental apartment lease approvals – based on this all-important number.
From time to time the US government has stepped in and forced the credit card companies to accept changes geared toward disclosing things more clearly to us or behaving in a manner that might be considered more fair. Judging by recent congressional hearings, we can expect to see a new series of credit card regulations soon. The challenge is balancing consumer protection with the fact that in our capitalist economy, credit card companies, like other businesses, are entitled to make money – theoretically as much as possible. In fact, they have an obligation to their investors to do so. So how can we logically expect a credit card company to earn less than top dollar? Certainly if we were the investors we wouldn't want to hear that our dividends had been cut so the company could give away credit! Some argue that credit card companies cross an ethical line with what they describe in the confusing fine print of the lending agreement, with misleading advertising, and with an overall lack of transparency. The credit card debt collection industry generates more complaints than any other business.5 And industry insiders allege that some reporting agencies even deliberately include incorrect or incomplete information in our credit scoring so their competitors won't want to pursue us as customers.
Playing the Blame Game
The credit-debt blame game is a common waste of time some of us engage in with our credit card companies. It goes something like this: The credit companies tempt us with a variety of advertising and unsolicited offers into carrying more debt than our income justifies. When we drown in the debt, the house of cards crumbles. The credit card companies hit us with high penalties and collection fees. The companies claim they have to pressure us to collect the debt quickly, since once a debt is in default it becomes a riskier investment. With higher penalties and fees than we expected and the pressure to pay it all now, we cannot pay the companies back and place the blame on them. Clearly the game begins when we accept the credit card and begin to spend more than we can afford to repay. The credit industry is using every tool it can to tempt us into spending, but it's certainly not forcing us to buy things.
At the end of the day, America loves credit. Our economy has grown to need it, which is one reason the government is so hesitant to intervene. Credit keeps us all pumping money into the economy, even if we can't afford to pay it back. In our consumption-driven economy, all of us are pressed to spend if America's economy is to grow and flourish. On occasion it is almost presented as ones patriotic duty. We'll talk more about this later. For now, a timeline (pages 26-27) illustrating how the modern credit card industry evolved will give you a better idea of how our nation has progressed toward reliance upon the daily use of credit and show the common patterns in government intervention and deregulation, which, as you will see, also apply to how the subprime crisis was created and has been handled by our government.
Appropriate versus Inappropriate Use of Credit
No doubt life, including its financial components, is more complicated for us than it was for our grandparents. Let's face it: We have infinitely more spending opportunities and decisions than they did. Back then, someone could only use so many horseshoes, and I doubt any of them were Gucci. Which brings us to what is perhaps the most important controllable distinction between credit use then and now: necessity versus luxury.
Using credit cards is, hands down, far more convenient than using cash. (The same may be said of using debit cards, but at issue is our use of credit, not the fact that it can be accessed using a portable plastic card.) The magical convenience of plastic money is central to our famously compulsive consumer economy, an instrument of social as much as economic change. "Don't leave home without it" is not just a choice, it's a necessity. We can't rent a car or book a hotel room without a credit card. Our creditability has become our identity. Over time, this has led to an unrealistic comfort level with plastic that is not necessarily always in our best interest. We're comfortable using cards to finance unneeded luxuries or to buy daily necessities in between paychecks. In 2003 a residential developer named the Related Companies teamed with American Express to allow tenants to pay their rent using credit cards as landlords vied for ways to lure people away from home ownership and into rental properties. In 2007 American Express expanded the concept to allow the use of credit cards to pay mortgages. In some states we can now even use credit cards to pay our income taxes! It's easy, automatic, and convenient. Credit has become less a discretionary purchasing tool and more a financial management tool. In contrast to cars or real estate, most of our credit card purchases tend to be non-necessity depreciating assets, or things that lose their value over time, such as a television, in comparison to investing in an IRA, 401(k), or something intended to appreciate in value over time. There's no time frame for repayment and, in fact, at the time we make our credit card expenditures, many of us have no idea how long it will take us to repay the debt.
In a sense, a credit card is an instantaneous loan we issue to ourselves. The credit card companies don't ask what we will be buying. It's entirely up to us to use our credit cards in an appropriate manner. For the cash savvy, credit card incentives can be a windfall, allowing users to rack up reward points that translate to free trips and other perks. But for those less adept at financial restraint, it can spell disaster. With so many people living off credit, the growing question has been: What will happen when we finally have to pay the piper?
Credit on Steroids
With more than $1.5 trillion of total consumer spending each year, $800 billion more than what we earn, the US economy has clearly gone plastic. The only way we can collectively spend so much more than we earn is by using credit cards. Like everything else, we're super-sizing our credit card debt. Our household debt has grown from $680 billion in the mid-1970s to $14 trillion today, doubling since only 2001!7 The credit card industry is earning record profits, more than $30 billion a year. One-third of US families in bankruptcy in 2007 owed more than a year's salary on their credit cards! Seventy-eight percent of us roll over a balance each month, paying an average 1.5 percent service charge on top of other fees. According to the Federal Reserve, the total amount of outstanding revolving consumer credit exceeds $374 billion, nearly nine times the amount owed just twenty years ago.8
In the United States, annual outstanding credit card balances are now increasing at twice the rate of prior years. This indicates that people are either using their credit cards more often or using them for bigger expenses like mortgage and rent payments. Studies show that carrying so much debt is taking its toll on our lives. Seventy percent of us admit the debt we are carrying is making us unhappy, yet, as the Nike ad says, we "Just Do It." What most of us don't know is that our migration toward credit cards actually influences the way we spend money. That's right: Credit cards encourage spending. According to a research study conducted at MIT's Sloan School of Management, people who have more credit cards make larger purchases per store visit and are likely to underestimate or even entirely forget the amount spent on recent purchases. We overspend by an average of 20 percent when we use credit cards instead of cash.9
AMERICANS ARE IN DEBT DENIAL
Like many things in life, when it comes to credit card use there's a big gap between what we say and what we do. Seventy-five percent of us say we would not make a purchase we could not pay for, but the facts show more than 75 percent of us can't pay for what we buy each month. We are a nation in debt denial. Studies show that we prefer to talk about our age, weight, and even annual income than disclose the amount of credit card debt we owe. Our thought processes where credit is concerned defy common sense. Many of us put credit card debt on the psychological back burner because it can be paid back tomorrow. Some of us actually believe an incredible occurrence will happen like winning the lottery or getting a huge bonus at work-that will make repaying the debt a cinch. Most of us don't even review our monthly statements.10 Perhaps debt frustration and its related sense of hopelessness can keep us from connecting to our financial reality, while others cite a link between our country's overall aversion to numbers and mathematics, as reflected in student test scores. Or maybe online banking has removed us one step further from our money. How many of us still balance checkbooks or follow the regular monthly ritual of paying bills, as our grandparents once did?
Just when credit went from being a convenience to being a problem is hard to gauge, and debt denial compounds matters. Why we spend is a topic for another book. The 2007 Cadillac advertisement suggesting that after an exciting holiday season, as depression settles in, we should all buy new Cadillacs says it all. Automotive and other forms of "retail therapy" have become a, normal way we all deal with life's daily challenges. Likewise, a trip to the mall has become a way we entertain ourselves and our kids. .
Of course even when there's nothing we need, we seldom walk out empty-handed. Maybe just being aware of these behaviors is a first step in learning to keep them in check. Or maybe we'll decide that the time has come to really change our nation's cultural attitudes about credit, debt, and spending.
We often only truly address a problem when it's out of control. Most of us didn't give a second thought to global warming until Al Gore's An Inconvenient Truth hit movie theaters and captured audiences' attention. Terrorism officially became a problem only after 9/11. So it may be that only now, the buck will stop here with us, the consumers. Now that our debt denial has reached critical levels and America has become a full-fledged foreclosure nation, perhaps we can finally expect to see some changes. Experts at the not-for-profit Center for a New American Dream agree that changing our credit habits can make us a happier country. Current surveys show 90 percent of Americans want to take their financial power back. According to New American Dream executive director Lisa Wise, Americans are rethinking their priorities or what really matters to us. "Even before the crisis, it was obvious that the traditional American Dream had been displaced by a `more is better' focus that promotes not quality of life, but rather the unbridled production and consumption of stuff. There was never any chance that could continue indefinitely."11 A first step would be using cash more and our credit cards less, lending new meaning to the phrase "going green."
WHAT DOES ALL THIS MEAN TO YOU?
With the conclusion of this chapter, you have a bit more insight into how credit and debt have woven their way into our nation's fiber. If you're like most Americans, you have your own unique tales of the good, the bad, and the ugly that comes from having credit and debt in your life. But this is only the first chapter in the story of our foreclosure nation. In the next. chapter, I will explain how credit and debt have infiltrated our homes.
1. Washington Mutual branch promotion sign, February 2008.
2. Board of Governors of the Federal Reserve System, http://www.federal reserve.gov/releases/gl9/20071207 (accessed January 1, 2008).
3. PBS, "Secret History of the Credit Card," Frontline, http://www.pbs.org/ wgbh/pages/frontline/shows/credit (accessed February 3, 2008); "The Big Lie about Credit Card Debt," July 30, 2007, http://articles.moneycentral.msn.com/Banking/CreditCardSmarts/ TheBigLieAboutCreditCardDebt.aspx.
5. Ibid.; Chris Arnold, "Credit Card Companies Abuse the Unwitting," National Public Radio Morning Edition, November 6, 2007.
*6. [Note 6 is at the last entry of the Table on pp. 26-27 in the scanned pages from the book; I was told not to include the table for this scan].
"Discount Dining: How to Save Money When You Eat Out," Today Show, November 16, 2008; Liz Pulliam Weston, ""The Truth about Credit Card Debt," MSN Money, http://moneycentral.msn.com/content/Bankingtcreditcardsmarts/ P74808.asp (accessed February 26, 2008).
7. Weston, "The Truth about Credit Card Debt."
8. Arnold, "Credit Card Companies Abuse the Unwitting."
9. "Discount Dining: How to Save When You Eat Out"; Weston, "The Truth about Credit Card Debt."
10. Weston, "The Truth about Credit Card Debt."
11. Center for a New American Dream, http:/newdream.org/about/pdfs/ Economy-9-24.pdf.