Preventing Financial Marginalization of Consumers in the US
The recent recession in the United States has exposed and aggravated the extent to which many families struggle to just keep up financially, and how a significant number of families are falling into a financial abyss from which there is little recovery. This financial marginalization not only locks families into financial despair, it impairs their capacity to support and grow the overall economy.
As discussed by Gabriel Davel in a CGAP Focus Note, as well as by others in this series on policy options to deal with debt stress, irresponsible lending to families of modest means affects their family situation as well as the overall economy. From my years of experience in the US, I strongly support his call for policy makers to monitor household debt and stop abusive lending practices.
In the US, mortgage lending was a core trigger of the recession, and it unnecessarily destroyed the long-term prospects of many families. Unsustainable lending and borrower over-indebtedness produced over 4 million foreclosures, with likely that many more yet to come. Why was the US hit so hard? Like many other countries, it had a deflating housing bubble. But another powerful factor here was that the underlying mortgages were very poorly underwritten.
Photo credit: Pauline Habel
Many borrowers were unable to afford their loan payments, instead relying on temporary low introductory payments and frequent refinances to stay in their homes. This could last only as long as housing prices grew at a fast clip. When housing prices fell, millions of families found themselves with loans they could not afford and that exceeded the value of their homes (today one in five home mortgages is still “underwater”).
You did not have to even have a mortgage much less have trouble paying it, to be deeply affected by the fallout. Research by the Center for Responsible Lending found that foreclosures directly reduced other neighborhood home values by $2 trillion, and depressed housing pushed the whole economy into deep recession. Although home construction has typically played a key role in pulling the US out of a recession, new construction fell to a 70-year low and the post-crash housing industry instead has been a major drag on the overall economy. Foreclosure not only stripped families of the equity in their homes -it also damaged their credit ratings for the next seven years, making it harder to advance once they are back on their feet.
For African-American and Hispanic families in the US, this impact was devastating. The so-called wealth gap between families of color and white families in the US had been slowly declining from its ten-to-one ratio in the 1980’s. Now it is again at historically high levels. The wealth of the current family of color is only one twentieth that of the average white family, translating into less opportunity for them and the overall economy. The success of the aging US economy depends on improved education and productivity of the new workers entering the workforce. The huge disparities in family wealth profoundly affect these prospects.
Recent investigations by the new US Consumer Financial Protection Bureau (CFPB) demonstrate other areas where irresponsible lending is exacerbating financial marginalization. Its recently released study on payday lending found that millions of families are trapped in loans with interest rates of 400%, that are flipped by the lender over and over. Another recent study documented how these payday lenders are also a significant drain on local economies. By capturing so much of these households’ income, payday lending diverts it from uses that would support and build the local economy.
The CFPB is also investigating student lending, where debt to finance post-secondary education has now hit $1 trillion. As in the subprime mortgage market, lenders and schools push these loans with little regard for affordability. Students and their parents, who often cosign the loans, are struggling under this high debt, particularly with diminished job prospects due to the recession.
Nearly a third of the 20 million borrowers making payments on student loans are seriously delinquent. Since recent pro-lender changes in the US bankruptcy code make most of this debt non dischargeable, many families will have this financial millstone around their necks for life. It will limit their options and ability to join an improving economy.
For example, a recent Federal Reserve study linked substantial student debt to delayed investments such as home purchase.
Finally, other “zombie debt” is haunting many families and destroying their futures. Companies are buying old debt claims that are rife with errors for pennies on the dollar. They then file questionable court claims that few can afford to hire a lawyer to contest. The resulting court judgments result in wage garnishments and long term liens that keep these families locked in debt and unable to advance.
So, as the CFPB and other financial regulators proceed with their work, they are protecting not only the consumers directly engaged with lenders and other financial companies, they are ensuring an economy that works well for both those families and for the full economy.
----- The author is President of the Center For Responsible Lending, a nonpartisan, nonprofit policy and research organization that works to support responsible lending practices.