Credit

The Debate over Negative Returns on Savings

Jamie Zimmerman — Mon, 23 Jun 2008 19:36:00 -0400

Our newly released report on thrift in the United States has gotten some good play in the media but has also sparked internal and external debate, domestically and internationally, on the importance of savings and thrift relative to credit and consumption. The report advocates a culture of thrift and a renewed focus on savings (as opposed to our current focus on credit and culture of indebtedness). As a team, the Asset Building program promotes these goals and others heavily in our domestic work as well as internationally through the Global Assets Project.

In recent weeks we've received a lot of feedback (from within our organization and among practitioners and policymakers in microfinance and related fields) wondering if, in a time of higher inflation, we're advocating irrational behavior among our target populations. For instance, Sherle Schwenninger, the director of the Global Economic Growth program here at New America, challenged the asset building team's focus on pushing people to save when typical interest rates on savings accounts are lower than the rate of inflation. That basically means that people are losing money on their savings, instead of gaining interest over the long run on their deferred consumption. On popular microfinance listservs like MicroFinancePractice and DevFinance, the report sparked similar debates over encouraging thrift in developing or emerging economies, which are typically less stable than advanced economies. In India, many savers are earning 1% interest or less on their savings in an 8% inflation climate. In Zimbabwe's hyper-inflation, money not used today is tomorrow's fire kindling. But that is an extreme example. Essentially, the argument is that, in the absence of better products, we are irrationally encouraging people to save up, but to nothing.

Or so it seems, if you don't look at the bigger picture:

Yes, the poor, low and moderate income populations, particularly those traditionally excluded from low-cost, appropriate and mainstream financial services do indeed need and deserve access to more attractive savings and investment options, one's that do not deteriorate their financial assets, but protect and build them.
However, in the U.S. but most especially in many parts of the developing world, the poor lack access to a safe place to put away their savings in the first place. Experience in the micro-savings field has shown that the poor are quite often willing to pay a fee to have someone or some institution safely hold their savings, as it's a much safer prospect than stashing the money under the mattress. They are much less concerned with making a return on their savings than the prospect of loss or mismanagement that comes with not having it safely locked away until needed. Where these options don't exist, you face a potentially tumultuous and threatening environment where even small lump sums are not safe. This isn't just a problem in the developing world. Here in the United States, unbanked Latino immigrants are increasingly targeted for robbery, as because of their undocumented status, they are often paid in cash and lack access to a bank account to store their money.
And for those among this population who do have access to basic savings products, the fact of the matter is that the vast majority are not saving with the intent to make a return on those savings. They need lump sums to pay for certain expenditures like marriage, education, property and even funerals; they need a nest egg to protect them against economic and environmental shocks to which they are disproportionately more vulnerable.

Losing money on savings is very much a bad thing and seems an irrational choice. But then again we must consider all the options from which certain populations get to choose. I mentioned negative return on savings in India, a sad case that turns ever sadder when considering that over 50% of India's population has absolutely no access to formal savings products in the first place, something the government in India is aggressively trying to change.

While designing and offering short and medium-term higher-yield savings products for the poor and underserved around the world is important work and an ultimate goal, it will be of little value until we 1) can provide effective access to banking services and 2) increase understanding of the value of savings and thrift for long-term financial growth and asset building for those populations who have for too-long gone underserved and excluded.

I'm glad that this new report on thrift is forcing us to acknowledge these realities and to think more deeply on how to get people not only into, but benefiting from, formal financial systems.

The Color of Credit Turns Grey

Reid Cramer — Mon, 23 Jun 2008 15:07:00 -0400

A curious piece ran today on the Washington Post's opinion page.

President of the Southern Christian Leadership Conference Charles Steele Jr. wrote an article called the "The Color of Credit" which noted the racial disaprity of wealth in America. Good, that's a fact that needs some more attention. It highlights the history of housing discrimination, policy efforts to address it, and the rise in minority homeownership rates since the mid-90s. Fine, that's a story worth knowing. It then discusses how recent declines in the housing and mortgages market will erode these gains. Great, that's an essential perspective to have right now, especially as we think about crafting future policy interventions. It takes issue with proposed restrictions on credit providers that would cap their fees. Wait a minute, what's going on here?

Steele calls out a specific piece of legislation, something called the Credit Cardholders' Bill of Rights Act and even gives the bill number (HR 5244). It is being sponsored by Representative Carol Maloney (D-NY) who claims it will stop abusive practives by the credit card lending industry. He claims that passing this will force some subprime credit providers out of the market. For him, that's a bad thing. For me, I'm not is sure.

According to the good folks at Credit Slips, a blog run by respectable academic types interested in credit and bankruptcy issues, this bill takes aim at some of the most troubling and odious practices of the card industry. They provide a pretty good summary of the bill and its constructive provisions. Seems like the providers it will force out are ones we want out. Could it be that Steel has been unduly influenced by his partnership with credit card issuer CompuCredit? They announced a "partnership for economic security" last summer.

But this summer, just two weeks ago in fact, CompuCredit was accused by the feds (FDIC and Federal Trade Commission) of deceptive practices that trapped their customers into debt. It is one of the largest actions of its kind apparently and they are asking for $217 million in restitution and fines.

So, yes, I agree with Steele that access to credit is an important element of wealth creation and disparities should be considered as civil rights issues. But no, economic justice is not served by letting this industry police itself. Federal regulatory efforts can be troubling but it seems like Representative Maloney and her co-sponsors are heading in the right direction.

Going after Unfair and Deceptive Practices: It's About Time

Ellen Seidman — Thu, 01 May 2008 23:00:00 -0400

Credit is a critical element to asset building, but credit that is badly structured, difficult to understand, or abusive generally results in the destruction of assets, not their creation. Credit cards and overdraft protection programs have often shared these characteristics-and the asset stripping results.

On Friday, bank regulators will release proposed regulations under Section 18 of the Federal Trade Commission Act concerning unfair and deceptive acts and practices (UDAP). The proposal will apparently be a joint release by the three agencies that have jurisdiction to write rules under the Act, the Federal Reserve, the Office of Thrift Supervision, and the National Credit Union Administration. This will be a rare instance of the agencies exercising rule-making, in contrast to enforcement, authority under the statute.

The proposal, which is expected to cover both credit cards and bounce protection, would require major improvements in practices, including generally limiting credit card interest rate increases to new balances, requiring opportunities to opt out of bounce protection, and prohibiting overdraft and overlimit fees that arise because of holds on debit or credit card purchases. While there will be objections from both the industry-asserting the proposed rules stifle competition-and consumer advocates-arguing that they do not go far enough-this is an extremely welcome development, one long overdue. The agencies have said they intend to make the rules final by the end of the year.

The 75-day comment period will coincide with both Congressional and electoral activity. And of course, year end will be a time of transition no matter who wins the election. It has taken a very long time to get this far; it's important that the regulators finish the job, and finish it strongly.

College Grads Crippled by Credit Card Debt

Karen Murrell — Mon, 28 Apr 2008 13:25:00 -0400

Many experts have predicted that our economy is moving into a recession and as the economy declines, it will become even more important for college students to graduate with as little credit card debt as possible to enable them weather tough times. A recent article in the Washington Post stated that college students can least afford to graduate with debt these days with an unstable job market. Many college students are crippled with debt. They graduate with credit card debt as well as student loan debt and in today's economy they may not be able to find a job immediately upon graduation. In spite of these facts, research shows that college students continue to accumulate credit card debt.

A recent study by the US PIRG Education Fund showed that nearly two thirds of students reported that they had at least one credit card. Seniors reported carrying more than $2,500 of credit card debt. This debt was incurred to pay for college expenses as well as living expenses. Students reported using credit cards for "day-to-day" expenses (55%) and books (55%). The next highest categories reported were "weekends and pizza" and emergencies.

As college costs continue to soar, college students are increasingly turning to credit cards to cover costs. The US PIRG survey showed that nearly 25% reported that they used their credit cards to pay for tuition. Last week two major financial institutions announced plans to curb private student loans and this move will likely force even more students to turn to credit to finance their college education.

In spite of the dire situation, there are efforts to help college students escape the credit trap. Financial education coupled with sound policy and less credit card marketing on campuses could help college students avoid the credit card trap.

Many consumer advocates believe that financial education is important because students often don't understand the obligations and long-term impact of credit cards and as a result, some universities are beginning to incorporate financial education into their freshman orientation.

Credit card issuers are exploring ways to educate college students who apply for credit to help reduce the number who ultimately fall into trouble. The Center for Financial Services Innovation documented the results of a pilot program of three credit card issuers--Target Financial Services, U.S. Bank, and Wells Fargo. The results showed that although engaging cardholders in educational activities was challenging, early intervention seems to hold some promise for improving credit behavior and reducing delinquency.

Recently several policy makers are taking steps to address this issue. Senator Robert Menendez (D-NJ) introduced a bill that requires consumers under age 21 to "opt in" before they could be the target of credit card solicitations. Carolyn Maloney (D-NY) and Barney Frank (D-MA) have introduced a similar bill in the House that addresses complaints that card issuers manipulate their mail to result in late payments even when consumers pay on time.

Additionally, universities are stepping in to ban credit card marketing on their campuses. College students are frequently enticed to open credit card accounts on campus with the lure of free gifts. The US PIRG study shows that 76 percent of students stopped at tables on campus to apply for a credit card and nearly one-third were offered a free gift. Increasingly, college campuses are banning these practices.

These efforts are all important steps to help college students avoid the credit-card trap and enable them to graduate without a debt load that will certainly burden them and threaten their financial future.

'Sub Sub Sub Subprime' Borrowers 100 Million Strong Worldwide and Growing

Jamie Zimmerman — Thu, 17 Apr 2008 12:00:00 -0400

It's all we hear about these days: The U.S. subprime mortgage bubble -- created by poor and at times predatory lending practices and lax banking regulation and creative investment products -- has burst. Of the approximately 7.7 million subprime loans outstanding, over 2 million are at risk of foreclosure and 600,000 borrowers are expected to lose their homes this year. The majority of us are left in shock as we watch the devastation unfold, the bubbles aftermath wreaking havoc on the U.S. (and increasingly global) economy, ensuing fears of recession and economic pain to come, and leaving politicians, economists, and regulators all scrambling to pick up the pieces.
However, in the meantime, the 2006 Nobel Peace Prize winner on Tuesday proudly hailed microfinance -- the innovation of providing small loans to poor, traditionally financial excluded individuals, mainly women -- as "sub sub sub subprime" lending. That means that globally, more than 3300 microfinance institutions provide such "super-subprime" loans to over 100 million clients and growing. Just to be clear: I'm a huge fan of microfinance. However, I'm left perplexed by this dichotomy: How can a lending practice that is almost singlehandedly dragging the whole of the U.S. economy in to a hole simultaneously and sustainably end third world poverty?

Well according to Yunus, the answer is simple - the U.S. subprime crisis was fueled by "sloppy business practices" and complex product, which simply don't exist in the microfinance industry. Finding ways to extend access to credit and financial services to those with less than stellar or no credit or financial history, if done properly, can provide asset-building opportunities to those traditionally excluded and economically disadvantaged. In that sense (and this may come as a shock to those who only know of subprime as it related to the current crisis), subprime lending is not inherently a bad thing.

However, when discussing this issue last night at a CGAP cocktail reception, the answer seemed to be about as complicated as a 5/1 balloon ARM disclosure. Expert discussants, considering the similarities and differences between these sub-prime markets, concluded that microfinance products and services are indeed different from the complex mortgages and bundled securities of the U.S. mortgage market. However, they all cautioned the microfinance industry to take a close look at how certain similarities - the perverse incentives for quantity over quality; the potential of similar "irrational exuberance" of both clients and lenders; the growing influx of new players, products and dis-intermediated capital that could lead to predatory products and practices; similarly, competition among providers that could lead to "race to the bottom" practices and products; the risk of information asymmetries and moral hazard created by increase in disintermediation (which creates distance between borrowers and lenders), and finally, the lack of regulation in many markets -- indeed mirrors characteristics of the sub-prime mortgage market in the United States.

So, my original question remains unanswered, but these new insights beg related, and perhaps more pertinent questions. In our haste to extend the power of micro-credit to the millions living in poverty around the world, how much, if at all, should we head the warnings derived from the subprime crisis? Can light-touch regulation and more concerted efforts enhance consumer awareness provide the balance between providing as much access as quickly as possible to as many as possible and quality of products and practices? Would putting such regulatory brakes on this exploding industry help us to avoid the possibility of a global sub-prime bubble or just deprive the needy of access to finance?

If some predictions are right, then the tightening of capital in the global financial markets -- essentially the effect of failing to address these issues U.S. until it was too late - may inadvertently apply those brakes before we get the chance to answer the question. But with others predicting the opposite (even more capital being diverted into more lucrative, global markets (i.e., microfinance investment)) then we may need to look at these issues more closely, ASAP.

Global Economic Snapshot: Depth of the Credit Crunch

Sam Sherraden — Mon, 11 Feb 2008 00:00:00 -0500

The credit crunch currently constraining consumers and financial institutions threatens to spread to high-grade corporate bonds, according to analysts. Defaults on corporate bonds are at an all-time low at 1%, but more corporate bonds may default in 2008. Moody’s predicts default rates to rise to 10% in 2008, well above the historical average of 5%. Constrained corporate credit may may be another signal of the looming recession.

Financial Times – Default rates fail to detect cold front approaching
Financial Times - Default rates ‘to surge from 26-year low’
Bloomberg – CDO Losses Driving Credit-Default Swaps to Record, Analysts Say
Wall Street Journal – New Hitches In Markets May Widen Credit Woes
Wall Street Journal – Credit Jitters Hit Leveraged Loans
Bloomberg – Junk Bond Default Rate to Rise Ninefold, Altman Says
Fitch Ratings (free login) – Developments in the US Leveraged Loan and CLO Markets