TPM Cafe: Opinion

Does “middle” sound mushy? dull? ho-hum? Do you know that nothing really heart-racing happens to the middle? Are you sure it is strong, that it will always be there?

Think again.

The middle class is being carved up as the main dish in a corporate feast. Strugging with flat incomes and rising costs for housing, health care, transportation, child care and taxes (yes, taxes), these folks are under a lot of financial strain. And big corporate interests, led by the consumer finance industry, are devouring families and spitting out the bones.

That’s what I want to talk about. How about you?


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Nowadays politicians’ favorite mantra seems to be “lower taxes.” Corporate taxes. Estate taxes. Taxes on millionaires. Taxes on working folks. The We-Hate-Taxes leadership in Washington says “cut ‘em all.”

This “No New Taxes” routine (with a little “No Old Taxes, Either” tacked on) has one glaring exception: A big tax increase on folks who are broke. The Bankruptcy Bill President Bush signed into law last week raised the fees on every family that files from $155 to $200.

What, you thought no one below median income would suffer? The new taxes, like almost every other provision in the bill, apply to everyone — no matter how low their income.

The (public) reason was to pay for 28 new judgeships created by the bill, but the numbers are a little off. The government estimates the five-year cost of the new judges at $25 million, but the government puts the five-year net revenues (from the fee increase alone) at about $150 million.

So will the fee be lowered? Of course not. That money will go where taxes usually go — straight to the general revenue coffers — fresh from the hides of people in desperate financial trouble.

Congress has kicked these families when they are down by passing a harsh new bankruptcy bill, and then kicked them again with a tax to fatten general revenues. Get sick? Lose your job? Trying to save your house? Boy, have we got a tax for you.

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President Bush at the bankruptcy bill signing ceremony:

Under the new law, Americans who have the ability to pay will be required to pay back at least a portion of their debts. Those who fall behind their state’s median income will not be required to pay back their debts.

The President’s comment is simply not true. Let me count just some of the ways:

1) Under current law, everyone pays back taxes, child support, alimony and student loans, and if they want to keep the house or the car, they have to pay those loans too. This bill expands the list of non-dischargeable debts for EVERYONE, regardless of income, and it expands the amounts that they have to pay for cars and other assets. To say that people leave bankruptcy and “don’t have to pay back their debts” is just plain wrong.

2) The means test will require EVERYONE who files bankruptcy — regardless of income — to file new forms, detailed budgets, tax returns and new affidavits. If the person cannot afford the higher lawyers’ fees to manage this new work or if the person trips over one of the requirements, then she is tossed out of bankruptcy — regardless of whether she is above or below median income. In some places, the means test bites above-median and below-median debtors differently, but it bites everyone.

3) The dozens and dozens of other provisions in the bill that are aimed at consumers have no income test. They apply to everyone, regardless of income.

4) The millionaires’ loopholes remain open. To say that those with above-median income will pay something is true only for the common folk. The millionaires can still slide through. This bill has always suffered from a truth-in-advertising problem. The proponents say the bill does one thing, while the reality is very different. Evidently that problem persists even as the President describes what he is signing.

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The House passed the bankruptcy bill, and now we’re down to the last minutes before President Bush signs it into law.

I should be depressed, but I’m not.

Eight years ago the proponents said it was a speeding train that could not be stopped. It was written by a lobbyist and shopped to a friendly Congressman. The financial services industry was giving big money, and there was no one in the way to stop it. We slowed it down. In the meantime, more than 12 million families got some relief when they were overwhelmed with debts following job losses, illnesses, or family break ups. With all the money on just one side in the debate, that’s pretty amazing. Even now, the bill that came from the Senate to the House had a few small adjustments that will help keep the door open for more families in desperate trouble. Not bad.

But the part that makes me feel better is that this time around we finally got the message out. Even after the horse race was over and it was clear the bill would pass, the press continued to write about the bankruptcy bill — and the stories weren’t pretty. The politicians who thought this would be a free vote discovered they were wrong. The middle class is beginning to rumble, and those rumbles will change things.

I’m also glad to see the old conservative-liberal dichotomy break down over bankruptcy. Both conservative and liberal bloggers exposed the rotten foundations of this bill, particularly the imperfect credit markets and the influence of money on politics. Could alliances shift over economic issues aimed at middle class families?

Finally, it ain’t over. The rumors are already all over Washington that a “technical amendments” bill will be passed during the 180 days before the bankruptcy law becomes effective. Several new stand-alone bankruptcy amendments are already in the hopper in the Senate and House, including a bill to sew up the millionaires’ loophole and a bill to stop corporate forum shopping in bankruptcy.

And it ain’t over in a bigger sense either. The point of this whole conversation is that bankruptcy isn’t an isolated issue. Bankruptcy is about job losses and health care finance; it is about credit card practices and predatory lending. Bankruptcy is just one way to measure the financial health of the middle class.

Josh has asked us to hang around, and particularly to continue talking about the shifting economic scene for the middle class. We think maybe there will be something to blog about even after the President has signed the bill.

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Judge Richard Posner and economist Gary Becker have joined the ranks of academic bloggers that have turned their considerable intellects to the topic of bankruptcy reform. I expected a real treat, but their recent comments on the pending bankruptcy bill are so out of touch (and out of date) that I was amazed to see them advanced. Posner and Becker’s entire discussion rests on the standard chestnut that the bankruptcy bill will benefit consumers because it will reduce creditors’ risk and therefore cut interest rates. That argument not only ignores twenty years of data; it also perpetuates a plodding “perfect markets” model of consumer credit that most theorists have long since abandoned.

Start with a brief look at the data. Bankruptcy write offs represent about half of the total bad debt writes, which would suggest that they ranged from 1% in 1985 to 2.5% in 1992. Much larger is the cost of funds, which is the amount companies must pay to borrow the money they lend out. From 1980 to 1992, that cost fell from 13.4% to 3.5%, a stunning decrease in costs. What happened to the interest rates the companies charged? In the same time period, the average credit card interest rate rose from 17.3% to 17.8%. Move the clock forward a bit. When the cost of funds dropped nine times in 2001, instead of passing along the cost savings, the credit card companies pocketed a windfall of $10 billion in a single year. So much for the idea that the credit card companies are lined up to pass savings along to the customers.

Posner and Becker imagine a credit card market that simply does not exist. A WSJ piece by Mitchell Pacelle described a changing market:

Until the early 1990s, most banks offered one main credit-card product. It typically carried an annual interest rate of about 18 percent and an annual fee of $25. Cardholders who paid late or strayed over their credit limit were charged modest fees. Profits from good customers covered losses from those who defaulted.
Then card issuers, in an effort to grab market share, began scrapping annual fees and vying to offer the lowest annual interest rates. They junked simple pricing models in favor of complex ones they say were tailored to cardholders’ risk and behavior.

According to the WSJ, a typical credit card contract was “little more than a page 20 years ago [but runs] to 30 pages or more of small print today.” Universal default, undisclosed penalty rates, arbitration clauses, undisclosed amortization rates — the combination of complex language and missing terms makes the contracts indecipherable even for those who have secret decoder rings. The credit card companies have fought like tigers to avoid telling customers the basics — if you make the minimum monthly payment, you’ll pay $xx in interest and it will take you xx years to pay it off. This non-closure is so that credit card companies can compete to lower fees?

A number of younger economists have explored credit card pricing, developing a much more nuanced theory of how it exploits lack of consumer information and systematic cognitive errors. Oren Bar-Gill penned a detailed analysis of how credit card companies use dozens of tricks in their contracts to encourage customers to underestimate costs and overestimate their repayment schedules. He shows that even in a competitive market, these pracrices can lead to welfare losses. Lawrence Ausubel has demonstrated that, while people will shop for introductory interest rates, they are far less likely to re-shop when new fees and penalty rates are imposed on them. A recent article in the Quarterly Journal of Economics by Stefan Della Vigna and Ulrike Malmendier examines pricing strategies in various consumer markets and concludes, “for all types of goods firms introduce switching costs and charge back-loaded fees. The contractual design targets consumer misperception of future consumption and underestimation of the renewal probability. The predictions of the theory match the empirical contract design in the credit card, gambling, health club, life insurance, mail order, mobile phone, and vacation time-sharing industries.” The lesson is clear: credit card companies can maximize profits by pricing introductory rates competitively and then hitting customers hard later on with fees and penalties. And that model certainly seems to fit the data on revenues. Today, credit card fees and late charges amount to $50 billion — about half of all credit card revenues.

If Posner and Becker wanted to put their simple model to good use describing a perfect market, then why didn’t they question why the proposed changes in the bankruptcy laws would apply to all outstanding debt? Existing credit card debt was priced based on current laws. Billions of dollars are outstanding in fixed-term loans. The bankruptcy bill would change the terms of those loans by limiting the availability of the bankruptcy discharge — a nice windfall for the creditors who face lower risks. If the law isn’t designed to be a give-away to the creditors, why not make the new rules applicable only to loans made after the effective date of any amendments — when those new, low Posner-Becker interest rates will be in effect?

The credit card companies didn’t spend tens of millions of dollars for campaign contributions and high-dollar lobbyists so that they could pass legislation to save money for their customers. They paid for a law that will let them squeeze ordinary working folks harder. They want a law that will maximize profits from their richest source — those who stumble. And if that law put more people directly in the line of file when they lose their jobs or get sick or get called up to military duty, that’s just the way it works when the companies have the power to write the laws. The credit card companies want a law that will give people caught in 35.99% hell no chance to escape, no matter what.

Posner and Becker talk at length about debtors’ willingness to incur credit, but nothing in the bankruptcy bill distinguishes credit issued for a fabulous vacation and credit issued to cover hospital bills or put food on the table during a long spell of unemployment. It is all treated the same, which undercuts the Posner-Becker notion that consumers have their fate in their own hands every time they sign a credit slip. Europeans have universal health insurance, better unemployment protection, and tougher bankruptcy laws; to make the bankruptcy laws in the U.S. tougher when shrinking health insurance coverage and growing unemployment and outsourcing tear away at middle class families is simply to ignore facts that don’t fit the model.

I know that it is fun to think of every market in terms of simple “if I had a nickel and you had a banana” models, but when Congress is on the verge of passing a massive give-away to credit card companies, a little more realism seems called for.

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My coauthors and I have been doing research on families in bankruptcy for more than twenty years. I never really wanted a role in politics, but like many things in life, when the bankruptcy bill came thundering down the tracks, there wasn’t really much choice. Supporters of the bankruptcy bill railed on about irresponsibility and fraud. Our research was one of the few pieces of hard data about what was going on. It offered a very different picture of families in desperate financial trouble.

In a remarkable piece of timing (the article had been submitted for publication more than a year earlier, but academic journals are very slow), our recent study on medical bankruptcies was published in Health Affairs, the premier health policy journal, just a week before the Senate took up the bankruptcy bill again. As a result, people committed on the political question took after the study. So here’s a quick Q&A; with my students that might be useful:

1) What is the study you report on in Health Affairs?

The overall project involves five law professors, the dean of a law school, two medical school professors, two sociologists and a finance professor. Their areas of expertise include law, medicine, demography and housing. The universities represented are University of California at Los Angeles, Harvard University Medical School, Harvard University Law School, University of Iowa, University of Las Vegas at Nevada, Ohio University, University of Pennsylvania, and the University of Texas. The Ford Foundation and the Robert Wood Johnson Foundation did most of the funding. The study has gone through various forms of peer review and human subjects approval, and the medical study was blind review (the gold standard for academic research). The medical bankruptcy portion was the work of two Harvard doctors, an Ohio U. sociologist and me.

2) What did you say in the study?

There were many ways to measure medical bankruptcy, from the family that was crushed by massive medical bills (medical debt) to the person whose bills were picked up by insurance but who was flatted by eight weeks with no income (job loss) to the family that paid off huge medical bills by putting a second mortgage on the house and who now can’t manage the mortgage and all their other bills (migrating debt). We said that reasonable people could make the count different ways, but that the data suggested that about 44.2%-54.5% of the families filing bankruptcy could fairly be classified as medical bankrupts. We extrapolated those numbers, which would mean about 750,000 households filing for bankruptcy, or about 1 million people (counting husbands and wives who file together). Once the children, the elderly dependent parents, and the non-filing spouses are counted, the total rises to about 2 million.

These families were mostly middle class, with good educations and decent jobs. About three-quarters of them had health insurance at the onset of the illness or accident that eventually bankrupted them.

3) Is it true that you included drug addiction and gambling in the definition of medical bankruptcy?

Yes, we reported data on addition and gambling—but it made very little difference on the overall numbers. About 2.5% families described the costs of dealing with addiction and 1.2% reported uncontrolled gambling. Many of those families had other medical problems—children with serious illnesses, car accidents, a terminal illness in the family, etc. If all of these families were somehow disqualified from consideration as medical bankruptcies, then the top range of the estimate of medical bankruptcies would drop from 54.5% to 50.8%.

4) Why include these people at all? Isn’t this their own fault?

My physician coauthors felt strongly that a family driven to bankruptcy to pay for drug rehab treatments for a teen-aged son should be included in medical bankruptcies. They also thought that a family that lost everything when an out-of-control husband ran up hundreds of thousands of dollars in debts at casinos should be included. If a family described their reason for filing as addiction or uncontrolled gambling we reported it, but we also gave the exact percentages so that anyone who wanted to exclude these people could do so—and could see that it wouldn’t change the overall finding.

5) What about everyone who had more than $1000 in out-of-pocket medical costs?

We reported on those people, and we noted that the median out-of-pocket medical costs were $11,854.

6) Why include these people?

Most of them had much higher debts, and they were included because they also described medical problems had pushed them into bankruptcy. But even the lowest possible number—$1000 in out-of-pocket costs—was a real burden for these people. The average income when they filed for Chapter 7 bankruptcy was $19,188, which means that even the minimum out-of-pocket medical cost was more than 5% of their annual income.

7) What would change if you left them out?

Again, the difference would be modest. In the published report, we didn’t have the room to run every possible permutation, but if we exclude as a medical bankruptcy anyone who was classified only because they put a second mortgage on the house to pay medical bills AND anyone who lost more than two weeks of income because of an illness or accident AND anyone who had medical bills at the $1000 or higher level, we would still be left with 47.3% of the sample describing their medically-related bankruptcies. In other words, even if several criteria are taken out, there are still nearly 1 million people filing for bankruptcy in the aftermath of a medical problem.

8) Is yours the only study that finds medical bankruptcies?

No. A month before our study was published, the Salt Lake City Tribune (go here, here, here, here, here, and here) analyzed 1,053 randomly selected cases filed in 2003-04 in Utah. They found 60% of the cases involved medical debts, a point they discussed at length. Another academic study in which I participated [link] pointed in that same direction based on 1999 data. A new study in progress from the Commonwealth Fund is reported to find that 29 million Americans—14% of all adults—are in serious medical debt, which means they have put large medical bills on their credit cards, taken out second mortgages on their homes or are in a payment plan with their hospital or other provider.

9) So what’s the bottom line?

Over the past decade, millions of Americans families have turned to the bankruptcy system to deal with the financial fallout from serious health problem. Some of them have come forward to tell their stories. The bankruptcy bill speeding through Congress treats every one of them exactly the same way it treats a person who took expensive vacations or who went to the mall too many times.
Several amendments were introduced to the bankruptcy bill to cut a break for the families laid low by medical problems, but each one was voted down. According to this bill, they are all deadbeats who need to be squeezed harder.

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I’m going to be standing by my mailbox, waiting for my $400 back from the credit card industry. Industry representatives told me, in the news and in testimony before Congress, that the cost of bankruptcies filed by people who can afford to pay their debts, was $400 for every man, woman and child in America.

Now that they’ve obtained passage of the Bankruptcy Reform Act, I know that I’m going to be getting that money back!

Okay, maybe they won’t send me a check. But surely the interest rate on my credit card will be going down. After all, I am a very good credit risk. Since 9% is about the lowest rate right I can find now, I bet I’m going to get a bunch of offers for credit cards at 6%.

If the Fed Funds rate is 2.5%, and expected inflation is about the same, then credit card companies need to make 5% to come out even. Add 1% for operational costs, and that means I should pay 6% on my card. Seven percent, tops. After all, there isn’t much risk in lending to me now.

Since I make above the median income in my area, under the new bill, I won’t be able to discharge my debts. Instead, I will be required to pay them back over time, in a bankruptcy proceeding called a Chapter 13. That means that credit card losses due to non-payment should be going down dramatically.

So, if I don’t get my $400 back, and my cost of credit doesn’t go down to account for the lower risk, I’ll know . . . .

Gee, is it possible the credit card companies are going to keep that money?

I’ll be standing by the mailbox, waiting to find out.

Corinne Cooper is a professor emerita of law, and a consultant in Tucson, Arizona.

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So the bankruptcy bill moves forward, speeding toward inevitable passage in the Senate and the House. That’s good news for credit card companies, particularly those that are loading their cards up with surprise interest rate jumps and a dozen other tricks and traps. Good news for payday lenders, for banks raking in profits on overdraft accounts, and for car lenders that focus on no-credit-check lending. Good news for all of those who squeeze the American family when someone loses a job, gets sick, or otherwise falls behind in a tough economy.

But there is good news on other fronts too. This bankruptcy bill was largely written by a credit industry lobbyist and, as he put it, shopped to a friendly Congressman. From the outset, the bill was supposed to be an easy push, “assured of passage,” something that would stay below the radar screen.

But you changed all that.

And that is good news. This isn’t the first time that special interests have gone to Congress with a complex, hard-to-understand bill that would profit them while it increased costs or risks for all the rest of us. But you pushed up the cost. You made it obvious that Joe Biden isn’t there for working families. You highlighted the fact that Dick Durbin fought like a tiger for military families. You exposed how Tom Carper cares more about credit card companies than families. You cheered when Russ Feingold, Patrick Leahy and Mark Dayton tried to make things better. You watched Senator Feinstein speak with courage. You highlighted how Ted Kennedy, once again, forced a tough fight that others wanted to duck.

Because of this fight, there will be no quiet, smooth passage for this bill. Instead, folks are now on record: 58 voted against giving just a little protection for military families set upon by predatory lenders. 74 voted against a 30% usury cap, saying the credit card companies are free to take whatever they can get. 58 voted against treating families beset by cancer and diabetes differently from those that run up bills on fancy vacations and over-priced nonsense.

We’ve got two or three more days on this bill. Let’s show them what we can do: more facts, more discussion, more debate, more amendments. And let’s drown them in emails, faxes, phone calls and letters. There is no point in going quietly now.

And while we’re at it, let’s plot our next strategy. Families don’t have to cower before credit card companies and second mortgage lenders. They can fight back right where it hurts—in the company profits.

I have never blogged before, and once the votes are final on bankruptcy, I may never do it again. But in the meantime, I know I have been blessed. My Harvard Law students (Michael Negron, Jason Spitalnick and Ryan Spear) have been great teammates; I’d be proud to fight alongside them anytime. Josh Marshall introduced me to a new form of participatory democracy that is starting to transform the world. But most important of all is what I learned from you: I am not alone with this fearsome anger; there are thousands of people who want to change things as much as I do. You give me hope.

Folks, it is a pleasure to blog with you.

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Some thoughts on credit card fraud from a fellow academic, Corinne Cooper:

Interest rates are made up of three things:
1. The cost of money (interest goes up and down based, in part, on the supply of and demand for money, just like any commodity.)
2. The expected inflation rate (so the lender gets back its money in constant dollars)
3. A risk premium.

If I apply for a credit card (and I get an average of 5 solicitations a week), the rate that I qualify for is around 9%. Given a fed funds rate of 2.5% (the “cost” of money) and relatively low inflation projections (let’s assume 2%), the difference is . . . (drum roll) THE RISK PREMIUM. For the best borrowers, the credit card companies collect over 4% to account for the risk of non-payment.

For riskier borrowers, the credit card interest rate is much higher, often as high as 29%: that’s a 24% risk premium.

Think of it as the premium that you pay to insure the bank against your non-payment.

Here’s what’ so strange: The credit card companies collect this risk premium, year in and year out. But when the risk actually happens and the borrower cannot pay, the lenders want the Federal government to intervene to force the debtor to pay, by passing a law prohibiting them from filing bankruptcy and discharging the debts. It’s as if a life insurance company took premium payments for years and then asked the government to pass a law prohibiting death! Bankruptcy is credit death, and if this bill passes, the courts will be clogged with credit “zombies”: consumers who can never pay back their debt, and never get rid of it.

Why, then, shouldn’t the debtor be able to recover all that extra interest paid to cover risk??

There is massive credit card fraud, but it’s by the credit card issuers, not the users.

Corinne Cooper is a retired law professor and communication consultant in Tucson, Arizona.

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