[Senate Hearing 112-385]
[From the U.S. Government Publishing Office]
S. Hrg. 112-385
CONSUMER PROTECTION AND MIDDLE-CLASS WEALTH BUILDING IN AN AGE OF
GROWING HOUSEHOLD DEBT
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
FINANCIAL INSTITUTIONS AND CONSUMER PROTECTION
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
EXAMINING CONSUMER PROTECTION AND MIDDLE-CLASS WEALTH BUILDING
__________
OCTOBER 4, 2011
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.fdsys.gov /
----------
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Washington, DC 20402-0001
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia MARK KIRK, Illinois
JEFF MERKLEY, Oregon JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
Dwight Fettig, Staff Director
William D. Duhnke, Republican Staff Director
Dawn Ratliff, Chief Clerk
Riker Vermilye, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Financial Institutions and Consumer Protection
SHERROD BROWN, Ohio, Chairman
BOB CORKER, Tennessee, Ranking Republican Member
JACK REED, Rhode Island JERRY MORAN, Kansas
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey MIKE JOHANNS, Nebraska
DANIEL K. AKAKA, Hawaii PATRICK J. TOOMEY, Pennsylvania
JON TESTER, Montana JIM DeMINT, South Carolina
HERB KOHL, Wisconsin DAVID VITTER, Louisiana
JEFF MERKLEY, Oregon
KAY HAGAN, North Carolina
Graham Steele, Subcommittee Staff Director
Michael Bright, Republican Subcommittee Staff Director
(ii)
C O N T E N T S
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TUESDAY, OCTOBER 4, 2011
Page
Opening statement of Chairman Brown.............................. 1
Opening statements, comments, or prepared statements of:
Senator Corker............................................... 3
WITNESSES
Atif Mian, Associate Professor of Economics and Finance, Haas
School of Business and Department of Economics, University of
California, Berkeley........................................... 5
Prepared statement........................................... 30
Katherine Porter, Professor of Law, University of California
Irvine School of Law........................................... 6
Prepared statement........................................... 37
Robert M. Lawless, Professor of Law, University of Illinois
College of Law................................................. 8
Prepared statement........................................... 44
Ray Boshara, Senior Advisor, Federal Reserve Bank of St. Louis... 9
Prepared statement........................................... 49
G. Michael Flores, Chief Executive Officer, Bretton Woods, Inc... 11
Prepared statement........................................... 54
Douglas Fecher, President and Chief Executive Officer, Wright-
Patterson Federal Credit Union, Fairborn, Ohio................. 13
Prepared statement........................................... 58
Ida Rademacher, Vice President for Policy and Research,
Corporation for Enterprise Development......................... 15
Prepared statement........................................... 61
Susan K. Weinstock, Director, Safe Checking Project, Pew Health
Group, The Pew Charitable Trusts............................... 17
Prepared statement........................................... 68
(iii)
CONSUMER PROTECTION AND MIDDLE-CLASS WEALTH BUILDING IN AN AGE OF
GROWING HOUSEHOLD DEBT
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TUESDAY, OCTOBER 4, 2011
U.S. Senate,
Subcommittee on Financial Institutions and
Consumer Protection,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met at 3:10 p.m., in room SD-538, Dirksen
Senate Office Building, Hon. Sherrod Brown, Chairman of the
Subcommittee, presiding.
OPENING STATEMENT OF CHAIRMAN SHERROD BROWN
Chairman Brown. The Committee will come to order. Thank you
all for joining us. I apologize. I thank Senator Corker for
actually being on time, and I apologize for being late. We were
trying to work through some details on the currency bill on the
Senate floor. Senator Corker spoke against it; then I spoke for
it; and then the two leaders were working out some details, as
they are wont to do. And I needed to stay to start to manage
the bill, but thank you, all of you, for joining us. I thank
Senator Merkley and Senator Hagan also for joining us.
With our economy still recovering from the financial
crisis, it is critical to understand how excessive household
debt remains a burden to our Nation's full recovery,
understanding that we can better put our Nation back on the
road to prosperity. Credit can be undeniably a good thing. It
allows people to borrow against their future earnings to
purchase essential goods and services. It allows families to
buy homes and students to go to college. It helps people pay
for food and clothing.
It also can cause irreparable harm when those future
earnings never materialize due to job loss or stagnant wages.
It can undermine our economy when it is offered on terms
designed to take advantage of consumers rather than to help
their wealth grow. It is that capacity for wealth to grow that
makes America a stable and prosperous country. It is that
capacity to generate wealth and pass it down to future
generations that really has created and preserved our middle
class.
But over the last three decades, in the last decade in
several years in particular, the pathway to a strong economy
and a strong middle class has been more and more difficult to
travel. From 2000 to 2010, median income for working-age
households fell by more than 10 percent. In that same decade,
poverty increased overall by almost 4 percent. These are merely
averages. The statistics, as we know, are far worse for
Hispanic and African American households than they on the
average in white households.
Behind the statistics are stories of Americans forced to
try to borrow as a substitute for stagnant wages and declining
household value assets, and some were preyed upon by a
burgeoning predatory lending industry. Cities like Cleveland
and Dayton, here Doug is from, are clear examples of this
devastating combination. In Cleveland, the same year that the
LTV steel plant was filing for bankruptcy, Cuyahoga County
officials were begging the Federal Reserve to crack down on
predatory mortgage lending practices.
Likewise, in Dayton, as Mr. Fecher knows all too well, we
lost GM's Moraine plant, a large assembly plant, at the same
time that groups like the Miami Valley Fair Housing Coalition
were going door to door educating the West Dayton community
about the dangers of predatory refinancing schemes. The growing
reliance on debt led to a vicious cycle. Our declining
manufacturing base contributed to the dangerous growth of the
financial sector.
Financial services industry output went from 15 percent of
U.S. gross domestic product in 1980 to 21 percent of GDP in
2010. Over that same period, manufacturing declined from about
21 percent of GDP to not much over 11 percent of GDP.
Encouraged by predatory lending practices and flawed Government
policies, including financial deregulation and free trade
agreements, household debt reached 133 percent of household
income by 2007, the highest level since the beginning of the
Great Depression. The ensuing financial crisis exposed failures
throughout the financial sector. It continues to affect
families across Ohio and the Nation who have been hurt by the
tremendous destruction of jobs and wealth and assets. Just this
week we learned that household incomes dropped during the month
of August.
But we had good news that the manufacturing sector
expanded. Wages actually declined in manufacturing and services
and goods-producing industries, and Americans were forced to
tap their savings to cover those losses.
The need to address these issues could not be clearer. I
hope we can find some areas of agreement today because I know
that Senator Corker shares some of my concerns about our
indebtedness.
I remember in our hearing in February Senator Corker
wondered whether new rules for debit card fees would push
consumers from checking accounts that are backed by a
consumer's assets into credit cards that are debt instruments.
We did not ultimately agree on the swipe fee issue, but I
understand and appreciate his concerns from that.
Professor Porter notes in her testimony that while Wall
Street is too big to fail, American families are too small to
save. And from reading the first chapter of your book, it is
almost that American families were also too small to be noticed
by policy makers.
It is important to remember that excessive household debt
is dangerous to individual families but also is a problem for
all of us.
Professor Mian estimates that the deleveraging process
caused 4 million of the 6.2 million jobs lost between March of
2007 and March of 2009. I wear a canary pin on my lapel
signifying many things, one of them the canary in the mine the
mine workers took down to the mines, where the mine worker had
no protection of a union that was strong enough or a Government
that cared enough in those days, and the mine worker was on his
own. The canary--in many ways household debt in this country is
the coal mine of our economic security.
If you think that indebtedness will not cause greater
problems for society, I would tell you to look at what is
happening in cities across the country now--thousands of people
in the streets protesting, among other things, illegal
foreclosures, excessive student loan debts. Their activism
reminds us that we ignore these issues at our own peril and the
peril of the futures of our children and grandchildren.
I look forward to exploring ways that policy makers can
encourage responsible borrowing and sensible consumer
protections. I am confident that the new Consumer Financial
Protection Bureau will be a tool to help American families
rebuild some of the wealth that they have lost over the last
decade. I look forward to a vote in this Committee, I believe
perhaps as early as Thursday, on whether to confirm former Ohio
Attorney General Richard Cordray as the first Director. I think
that would be good for American families and good for the
American economy.
Senator Corker.
STATEMENT OF SENATOR BOB CORKER
Senator Corker. Thank you, Mr. Chairman, and I thank each
of you. I will be very brief. I think one of you actually has a
flight to catch, and I do not usually make long comments
anyway.
I will say that I am looking forward to your testimony. I
probably more than anybody on our side of the aisle spent a
great deal of time trying to negotiate a consumer protection
bureau and really think that we should have one. It is my hope
that the Administration will try to institutionalize and not
cause it to be something that is personality-based where one
person that is a know-all is setting the landscape for the
entire financial industry, but instead of that there will be
some appropriate checks and balances. And I think if that
occurs ever, we will actually end up having someone leading the
consumer protection agency with the appropriate type of
institutional checks and balances.
I will also say that while I very much agree with my friend
regarding some of the concerns that I have with consumers,
sometimes we as policy makers create policies that have
unintended consequences. And, you know, it is pretty
interesting to see the senior Senator from Illinois on the
floor sort of apologizing to everybody in some ways that in
creating the Durbin amendment we basically shifted money out of
the pockets of consumers into the bottom line of Walmart and
Target and other entities. So unintended consequences do occur.
Whether you agree or disagree with what I just said, the
fact is we need to be careful as policy makers, and I look
forward to your help in making sure that we make prudent
decisions. So thank you for being here.
Chairman Brown. Thank you, Senator Corker.
Senator Merkley, do you have an opening statement? Senator
Hagan, an opening statement? OK. Thank you.
I will introduce the panel with brief introductions, then
go from left to right. And, Ms. Porter, thank you for being
here, and if you have to leave, certainly we will be mostly
concluded, perhaps entirely concluded by then.
Atif Mian is an associate professor of economics and
finance at the Haas School of Business at the University of
California at Berkeley. His recent work is centered on
understanding the origins of the global financial crisis, the
political economy of Government intervention in financial
markets, and the link between asset prices, household
borrowing, and consumption.
Katherine Porter is a professor of law at U.C.-Irvine where
she teaches courses on consumer bankruptcy and consumer law.
She is a regular contributor to Credit Slips, a blog that
discusses issues related to credit and finance and bankruptcy.
She is the editor of the forthcoming book, ``Broke: How Debt
Bankrupts the Middle Class.''
Robert Lawless is a professor of law at the University of
Illinois College of Law, codirector of the program on law,
behavior, and social science. He is a regular contributor to
the blog Credit Slips. From January to May of 2000, he was a
visiting professor at the Ohio State University's College of
Law. I am sure that he still regrets leaving to this very day.
Ray Boshara, also an Ohio native, is senior advisor at the
Federal Reserve Bank of St. Louis. His work at the Fed focuses
on household financial stability with an emphasis on
strengthening the balance sheets of American families, how that
contributes to economic growth. He served as an advisor the
Clinton, George W. Bush, and Obama administrations. He is a
graduate of Ohio State. No more comment on that.
Michael Flores is president and CEO of Bretton Woods, Inc.,
a specialty management consulting firm serving financial
institutions, with 30 years of financial institution experience
through his employment in banking as well as consulting.
Welcome.
Douglas Fecher is president and CEO of Ohio's largest
credit union, Wright-Patterson Credit Union, a credit union
with $1.5 billion in assets. He worked his way up from a teller
to become the CEO, a position he has held for almost 11 years.
He is past director and chairman of the Ohio Credit Union
League.
IDA Rademacher is the vice president for policy and
research at the Corporation for Enterprise Development. She
leads its policy and research team in their efforts to advance
comprehensive research and policy agendas that expand asset-
and wealth-building opportunities for all Americans.
Last, Susan Weinstock is the project director for the Pew
Charitable Trusts' Safe Checking in the Electronic Age Project.
Previously she was the financial reform campaign director at
the Consumer Federation of America. Prior to joining them in
2009, she worked on a number of different positions at AARP.
Professor Mian, if you would begin. Thank you all for
joining us.
STATEMENT OF ATIF MIAN, ASSOCIATE PROFESSOR OF ECONOMICS AND
FINANCE, HAAS SCHOOL OF BUSINESS AND DEPARTMENT OF ECONOMICS,
UNIVERSITY OF CALIFORNIA, BERKELEY
Mr. Mian. Thank you, Chairman Brown and Senator Corker, for
inviting me. I am going to talk about the role of household
leverage in the current economic crisis and the importance of
household balance sheets in explaining macroeconomic
fluctuations. My comments today are based on research that my
coauthor Amir Sufi and I have done over the years.
In order to understand the role of household balance sheets
in the current economic slump, we must begin from the
unprecedented and staggering increase in household debt during
the 2000s. The sharp expansion in the supply of mortgage credit
in the U.S. resulted in U.S. household debt doubling from $7
trillion in 2001 to $14 trillion in 2007. This massive
accumulation of debt by households with largely stagnant real
wages was not sustainable. Correspondingly, toward the second
half of 2006, mortgage delinquencies started to creep up, and
about five quarters later the U.S. enters into a full-blown
recession.
Our research shows quite conclusively that the main reason
for the U.S. economic collapse was a process referred to as
``deleveraging'' of household balance sheets. That is, faced
with reduced net worth, highly leveraged households sharply cut
back on consumption to conserve debt capacity and pay back
existing debt.
For example, we find that consumption such as the sale of
new automobiles drops significantly more in areas with highly
leveraged households. This drop in consumption severely
impacted job losses as well. For example, job losses in the
nontradable sectors, such as retail where businesses must
depend on local demand to survive, job losses in such sectors
were much higher in highly indebted counties. Extending these
job losses over the entire economy, we find that we can
conservatively attribute 4 million of the 6.2 million jobs lost
between March of 2007 and March of 2009 to this process of
deleveraging. In other words, 65 percent of total jobs lost in
the U.S. are due to this deleveraging, and the drop in
aggregate demand as a result of it.
Policy choices in the face of extremely damaging effects of
deleveraging and aggregate demand cycle are somewhat obvious.
We must do more to facilitate principal debt reduction for
highly indebted and underwater homeowners. The economy can
neither afford to foreclose these homes nor bear the costs
associated with reduced aggregate demand. Despite almost 4
years since the start of the deleveraging cycle, only $1
trillion out of the $7 trillion of debt accumulated over 2001
to 2007 has either been paid down or written off.
The dilemma for efforts to reduce household indebtedness is
that from a lender's perspective it is not in their interest to
write down debt that continues to be serviced on time. But as
my analysis highlights, the collective consequences of such
individually rational actions are quite unpleasant. If a large
number of financially distressed homeowners cut back on
consumption in order to protect their homes and continue paying
their mortgages, the aggregate demand and employment
consequences hurt everyone. Therefore, I repeat, we must do
more to facilitate principal debt reduction for highly indebted
and underwater homeowners.
In the long run, it is important to keep in mind that the
relationship between high household leverage and long economic
slumps is not limited to our current experience. In his seminal
paper, Irving Fisher in 1933 described the role that high
household indebtedness played in deepening and perpetuating the
Great Depression. In order to prevent such episodes from
happening again, we need to reevaluate our financial structure.
In particular, I would submit that we need to put in place
contingencies that will automatically write down the value of
outstanding debt if the overall economic environment is
sufficiently negative.
For example, mortgage principal can be automatically
written down if the local house price index falls below a
certain threshold. If we had such contingencies in place in the
current mortgage contracts, we could have avoided the extreme
economic pain due to the negative deleveraging and aggregate
demand cycle.
I thank you very much for your time and consideration.
Chairman Brown. Thank you, Dr. Mian.
Dr. Porter, Ms. Porter, thank you.
STATEMENT OF KATHERINE PORTER, PROFESSOR OF LAW, UNIVERSITY OF
CALIFORNIA IRVINE SCHOOL OF LAW
Ms. Porter. I appreciate the opportunity to talk to you
today about the reasons that thoughtful consumer protection is
a vital necessity to our country's future economic health. The
decade of increases in consumer debt has reshaped the prospects
of American families, and the recovery from the recession
presents challenges for families trying to make prudent
financial decisions and navigate this difficult economy. These
challenges mean that consumer credit law will be a major
determinant of the well-being of families for decades to come.
Before the recession, for decades families added debt. In
the mid-1980s, the ratio of debt to personal income, personal
disposable income was 65 percent. By 2007, that U.S. household
leverage ratio had more than doubled, reaching an all-time high
of 133 percent. Unfortunately for families, the debt binge was
not accompanied by meaningful increases in disposable income.
While income crept up, debt jumped up.
The growth in debt also outstripped the appreciation of
assets, eroding the wealth of families. As far back as 1995,
the amount of mortgage debt began to increase faster than house
values, and between 2001 and 2004, a period of relative
prosperity, the typical household's wealth actually declined.
This expansion in borrowing spanned social classes, racial
groups, sexes, and generations. Every age group except those 75
years or older took on increased debt between 1998 and 2007.
African Americans, Hispanics, and non-Hispanic whites all
become more indebted in this same period.
People who lack a high school diploma and families headed
by households over age 65, between 65 and 74, had particularly
sharp increases in debt. By 2007, when those debt burdens
peaked, 77 percent of households had some type of outstanding
consumer debt. Consumer debt has become one of the most common
shared qualities of the middle class, higher than the fraction
of the population that owns a home, is married, has graduated
from college, or attends church regularly. And as that debt
increased, so, too, did the risk of financial failure.
Today millions of Americans are struggling to avoid
financial collapse. We all hope that the worst of the financial
crisis is over. Subprime lenders have gone bankrupt. Most
subprime and nontraditional mortgage products were eliminated
by the market and later, for good measure, by the Federal
Reserve and the Dodd-Frank Act. In the aggregate, families are
dialing down their debt loads, and lenders have changed their
practices.
Some may use this credit retrenchment to argue against
consumer protection laws or to justify reconfiguring the
Consumer Financial Protection Bureau. In my opinion, these
efforts are misguided. They fundamentally misunderstand the
nature of the consumer debt overhang that is harming families
and the overall economy. It is precisely in today's turbulent,
difficult economy that an energetic and dedicated consumer
protection regulator is needed to aid families. Why?
First, a regulator is needed because consumer debt remains
at a level that would have been unthinkable a generation or two
ago. Overindebtedness was not a temporary feature of the U.S.
economy, and it is not a problem of the distant past cured by
the recession, Government stimulus programs, or Dodd-Frank.
Second, consumer protection is crucial because default
rates remain very high. Foreclosures are a well-known story,
but other worrisome trends exist, including significant
increases in student loan default rates and a 28-percent
increase last year in complaints to the FTC about debt
collectors. Debt collection and default are not isolated
experiences. They are now a routine and painful part of what it
means to be middle class in the United States.
Third, credit retrenchment, which has begun, will be a long
and painful process. For many families it will mean lost homes,
repossessed cars, second jobs, and dunning from debt
collectors. Changes in credit standards and fears about taking
on credit make it harder for families to hang onto the rung on
the economic ladder where they are or to climb up it.
Fourth, a Consumer Financial Protection Bureau can help
ease anxiety about the turbulent economy. Americans' appetite
for risk reflects in part the insecurity that they face because
of their debt loads. Americans are frustrated with the lack of
an effective and sustained Government response to their
hardships. Asked in 2010 whom Government had helped a great
deal during the recession, 53 percent said banks, 44 percent
fingered large corporations, and just 2 percent thought
economic policies had helped the middle class. The banks may
have been too big to fail, but families seem to have been too
small to save. Middle-class Americans feel abandoned and that
the Government's response to the financial crisis missed their
pain.
Today families are in uncharted territory, facing risks in
the job market, declines in Government service, and uncertain
access to credit. It is precisely in this environment that
consumer protection law can help families regain confidence in
the American economy and make informed and smart decisions to
rebuild their wealth. In this economy, the Consumer Financial
Protection Bureau, which is charged with monitoring the
functioning of the credit markets, can be of use to develop
outreach and education initiatives and provide technical
expertise to lawmakers.
I urge the Committee to move forward with the Consumer
Financial Protection Bureau, confirming a Director so that its
important work can begin.
Chairman Brown. Thank you, Professor Porter.
Professor Lawless, welcome.
STATEMENT OF ROBERT M. LAWLESS, PROFESSOR OF LAW, UNIVERSITY OF
ILLINOIS COLLEGE OF LAW
Mr. Lawless. Thank you, and thank you for inviting. In your
invitation letter, you asked me to address household debt and
the trends in household debt and how those trends affect in the
extreme bankruptcy filings. But before I get into that, I want
to talk a little bit about the subtext of what is, I think, in
everybody's mind as we're talking here--this new financial
regulator that is about to come on board.
One of the things that I think people have forgotten is
that in the lead-up to Dodd-Frank, in the wake of the financial
crisis, there was a lot of discussion about what should happen.
Then there are people like me. I am a believer that there are
some products out there that people just cannot possibly
afford. And I think the best solution to fixing those products
is to ban them altogether.
Now, I understand that is a controversial position. Not
everyone is going to agree with that. But people of good faith
and good judgment can differ over those type of policy
outcomes.
I think one of the things that has been forgotten in
today's debates and with the heated rhetoric is that one of the
reasons the Consumer Financial Protection Bureau was so popular
at the time of Dodd-Frank was that it was in many ways a
compromise solution between those who would go further and
those who felt that not a lot needed to be done.
I would hope that, as we begin to discuss what the shape of
the Consumer Financial Protection Bureau will look like going
forward, we will remember that it was, again, in many ways a
compromise solution.
What you asked me here today mainly to talk about was about
trends in household debt, and, Senator Brown, in your opening
statement, you have already discussed some of this. I will not
belabor the point. But one thing I would like to highlight that
is in my written testimony is comparing the United States to
other countries.
You talked about the tremendous run-up in household debt
over the past generations, and it is absolutely correct. In
preparing for this testimony, I ran some numbers. Consumer debt
in this country, even after you adjust for population growth
and inflation, has increased 46 percent in the past 25 years,
106 percent in the past 50 years. That is not counting
mortgages. If you put mortgages into that calculation, private
household debt is 220 percent more than it was 25 years ago,
and 374 percent more than it was 50 years ago--almost 4 times
as much.
We live in a very different time than our parents and our
grandparents. Today, people coming of age can expect to be
indebted for most of their adult lives.
The United States, according to statistics from the
Organization for Economic Cooperation and Development, leads
the world in short-term debt. We owe $9,663 per capita in
short-term debt, things like credit cards and payday loans.
These are the types of loans that are most likely to be taken
out on short notice, most likely to be taken out under
pressure, most likely to be taken out without full information,
and most likely to be subject to abuse.
Moreover, household debt is undoubtedly linked to
bankruptcy. Indeed, I think it is a common fiction that what
drives bankruptcy filings in this country are the ups and downs
of the economy. That turns out not to be true. It is
outstanding household debt. Debt creates conditions for
bankruptcy in the long run. In the short run, decreasing
availability of credit puts people who might otherwise be able
to stave off the day of reckoning into bankruptcy. You can
actually have increased bankruptcy filing rates in economic
boom times, like the 1990s, when high consumer borrowing in the
early part of the decade laid the conditions for people to need
bankruptcy and then some lesser availability of consumer credit
drove them into the bankruptcy courthouse.
You can also have decreased bankruptcy filing rates in
economic busts, as is going to happen this year when bankruptcy
filing rates will be down about 10 percent. Why? In the
immediate aftermath of the 2007-08 financial crisis, people
were less able to borrow, creating less need for bankruptcy
today. And according to the Federal Reserve, consumer credit is
now slightly easier to get than it was at this time last year.
People are able to use borrowing to stave off the day of
reckoning.
So it is not the economy, which, again, I think people
mistakenly blame for bankruptcy rates. They think that layoffs
or unemployment is what is driving bankruptcy. Statistically,
it turns out to be the amount of household debt.
Now, the Consumer Financial Protection Bureau, of course,
was not created to stop debt. As Senator Brown noted,
responsible borrowing is good. People borrow to finance their
houses, to finance automobiles, to finance their education. But
what the Consumer Financial Protection Bureau is there to do is
to stop the abuses that place individual households at risk of
things like bankruptcy and to act as a check on runaway lending
practices that place our whole economy at risk, as Professor
Mian indicated.
Thank you again for inviting me.
Chairman Brown. Thank you very much, Mr. Lawless.
Mr. Boshara, proceed. Thank you.
STATEMENT OF RAY BOSHARA, SENIOR ADVISOR, FEDERAL RESERVE BANK
OF ST. LOUIS
Mr. Boshara. Well, I am not only a proud graduate of OSU,
but Revere High School in Akron, Ohio, and I worked for
Congressman Tony Hall for many years, so plenty of Ohio
credentials here.
I need to say that, of course, these are my own views and
not necessarily the views of the Federal Reserve Bank of St.
Louis or the Board of Governors of the Federal Reserve System.
I was asked to talk about solutions more on the other side
of the balance sheet: How do you help families build up savings
and assets? Let me get right to my punch line.
Looking back, we have seen the damage to families,
communities, and the broader economy derived from three severe
balance sheet shortcomings:
First, we as a Nation let debt levels rise to damaging
levels.
Second, we did not help families buildup their savings.
And, third, we failed to help families diversify their
assets beyond housing.
Going forward, we must address, proactively, each of these
shortcomings. We need adequate savings, good wealth-building
debt, and a diversity of assets. In other words, we need to
look at the entire balance sheet, especially of low- and
moderate-income families.
When we build up net worth, we will see two things:
First, we are going to see a stronger economy. Several
people have identified weak balance sheets at the core of the
economic downturn. The IMF, the Bank for International
Settlements, others on this panel. If we strengthen balance
sheets, we can turn that around and help revive the economy.
Second, when we buildup net worth, we are going to see
stronger families and better economic mobility outcomes. What
researchers have done over the last several years is isolate
what is called the ``asset effect.'' What do you get from asset
ownership, independent of income, education, and a whole other
series of factors? What do you get when you own assets that you
do not otherwise get? You get more mobility. You get better
health outcomes, and better child outcomes, better educational
outcomes. So building assets gets you better financial
security, and a better society as well.
I have five ideas in my written testimony, but first let me
say something that unifies my recommendations. Building assets
is not a new idea. The Federal Government is already very
generously in the asset-building business. Through tax breaks
for retirement, home ownership, college savings, investment,
and business ownership, we have very generously encouraged
better-off families, the upper half of the population, to build
savings and wealth. I, therefore, think that the core policy
challenge is to take this great policy that we have for
building wealth for better-off Americans and make it work for
those in the bottom half. How do we extend the savings
mechanisms and incentives so that they work for people below
median income? We need to ``bundle'' savings and investment
opportunities for the lower half just as we have for the upper
half. So it is not a new idea here; we just have to extend what
we are doing already.
So what are my five ideas? First, build assets early in
life. As I mentioned, when one has assets, the better he or she
will do. It turns out that the earlier in life you have assets,
the better you are going to do. The best idea that I know of is
to establish savings accounts at birth for every child born in
America with greater resources directed at lower-wealth
families. And I am pleased to recognize the leadership of two
Members of the Subcommittee for their work on this issue:
Senator Schumer and Senator DeMint. If we cannot achieve such
an ambitious policy, I would encourage us to think about
something like a ``Kid's Roth'' or a ``Young Savers Account''
or a ``Roth at Birth''--a voluntary account that would let kids
start saving for some kind of a long-term asset.
Second, we need to build assets at tax time. The IRS now
has a ``split refunds'' form, which lets you take your refund
and send it to three separate accounts. We can do a lot with
that infrastructure. We also can improve the Federal Saver's
Credit, which Senator Menendez has provided leadership on.
Third, we can build assets at the workplace. I benefit,
many of the folks in this room benefit, from the Federal Thrift
Savings Plan. That and other kinds of retirement plans have
built enormous pension wealth in this country. We can use that
infrastructure to build other kinds of wealth as well for low-
income families.
Fourth, build unrestricted savings. You know, this is a
``sweet spot.'' Families with unrestricted savings get better
wealth-building financial services, better debt, and the
ability to purchase long-term assets.
And fifth, think about the 529 college savings platform as
an opportunity to build savings and wealth. In Oklahoma, they
are testing the idea of giving every child a 529 savings
account at birth. And in the city of San Francisco, they are
testing the idea of giving every kindergartner a college
savings account. We can learn from these innovations.
Finally, let me close by saying that we do not necessarily
have to spend new money to move forward on this agenda to build
assets for the bottom half of the population, for two reasons:
First, we can imagine a more efficient allocation of
current asset-building subsidies. We should strive to subsidize
economic activity that would not otherwise occur, which is the
case for the bottom half of the population.
And, second, we can tweak existing products, forms, and
systems. As a matter of fact, ``auto 401(k)s,'' ``split
refunds,'' my proposed ``Kid's Roth,''--none of these have or
would cost the Federal Government any money but could generate
literally millions and billions of dollars of new savings and
assets by the poor.
Thank you.
Chairman Brown. Thank you, Mr. Boshara.
Mr. Flores.
STATEMENT OF G. MICHAEL FLORES, CHIEF EXECUTIVE OFFICER,
BRETTON WOODS, INC.
Mr. Flores. Good afternoon. Thank you, Mr. Chairman,
Senator Corker, Senator Merkley. I appreciate the opportunity
to be here today.
I take a little bit different approach to this. As you
noted in my bio, I have been in the financial services industry
for 30 years. Actually, I have been consulting for 30 years. I
started in banking about 7 years before that. I have seen a lot
of changes in the industry, and what I want to focus on today
is the impacts, as Senator Corker had mentioned, on unintended
consequences of regulations, some that we are seeing right now,
and then relate that to the CFPB and some concerns that I have
there, not that I do not agree that we need a CFPB, it is how
it is structured, how it is implemented.
First of all, let me talk about the banking business model
and why we are having less access to the middle class, the
people we are talking about are starting to be marginalized out
of traditional mainstream banking. The banking model is a 20th
century banking model. The commercial banking system has not
figured out the 21st century model yet, and it is for good
reason.
They have two sets of customers. They have their legacy
customers, and I hate to say baby boomers, but the older
customers that still want the branch, still deal with checks,
still use cash, and still go to the teller line. Then you have
the Gen Y customers that will probably never step into a branch
and do everything off their PDA. This is their bank.
The bank has to support both those cost structures right
now, so there is extreme pressure on their earnings. Banks have
had margin compression for the last 15 years. What do they do
to address that? They try to get more to a fee model. How do
they do that?
Well, overdrafts were the first shot at that, and I am a
guilty party. I helped install some of those overdraft
programs. But we did it for checks because that was a service
to the consumer. If you returned the check, you are going to
pay two to three times more than if you paid that check in the
overdraft originally. Where we went off the rails with this
thing is opening it up to debit card transactions. There was no
value in that $3 plus $35 cup of coffee that everybody talks
about.
Then we ended up with interchange fees, and interchange was
not driven initially as a source of fee income. It was driven
to push people to a new service delivery model. Use that debit
card. Stop writing checks. Get rid of the paper out of the
system. Reduce reliance on cash. Use that debit card. People
started using the debit card. The income started rising, so
this is a great deal. Then we have regulation that addressed
that and has reduced both overdraft income as well as
interchange income.
Expenses--we have increased interest expense in banks by
fee regulating, Reg Q, and allowing payment of interest on
business accounts.
And finally, and all my clients talk about this, are
compliance costs. Banks under $1 billion, one, do not know if
they have the money to afford good compliance officers, and
two, where are they going to find good compliance officers?
They are few and far between and it is an extreme cost that is
being added.
So the bank is being squeezed from revenue, on the expense
side, and what needs to be done, then, to address this? Why are
banks not offering the services to the middle class? Service
charge income--you have read in the last two or 3 days the new
service charges going in, and as you had said, we have now had
a transfer of wealth from the consumer through the bank to the
merchant, which was not the intended consequence of the
original legislation.
Alternatives to checking accounts--with these high rates,
people are going to start dropping checking accounts. What is
the alternative? Right now, it is the general purpose
reloadable prepaid card. Well, there are some restrictions in
that that say if you allow the consumer as a service to pay
their bills with that card, then we are going to not allow the
exemption for the prepaid cards on interchange.
And so the providers are faced with, do we cut service or
do we cut our revenues, and that is yet to be determined what
is going to happen.
Finally, let me talk about the CFPB for a moment. As I said
earlier, I think it is needed. My concern is there is a
concentration of power the way it is currently structured, and
I am concerned about accountability. I think my opinion is it
should be accountable to Congress.
And finally, I believe the Director ought to report to a
board, and let me tell you why. I think that board ought to be
representative of prudential regulators and members of the
industry. That way, when regulations are proposed, all those
people can deal with--the prudential regulators can deal with
safety and soundness issues, because right now we separate
safety and soundness from consumer protection. And members of
the industry can make their point of what is the potential
unintended consequences of the proposed regulation.
So what are the options that are available out there right
now? Well, overdrafts are still there for checks, and I still
maintain that is a valuable service to the consumer. The other
option for credit are what some of the larger banks are
testing, deposit advance products, which our next member of the
panel will talk about his product. Yes, they are expensive, but
they are in demand. And it is interesting when you talk about
demand. With Reg E, you are requiring the consumer to opt in
for debit card transactions, which I thought would be very low
because I did not see the value. It has turned out to be an
extraordinarily high opt in. Why? I do not understand. It is
the consumer acting, saying they want that service. So I think
we need to strike a balance, consumer needs, consumer-driven,
market-driven solutions versus strictly regulatory-driven
solutions.
I will be happy to answer any questions. Thank you.
Chairman Brown. Thank you, Mr. Flores.
Mr. Fecher, welcome.
STATEMENT OF DOUGLAS FECHER, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, WRIGHT-PATTERSON FEDERAL CREDIT UNION, FAIRBORN, OHIO
Mr. Fecher. Thank you. Thank you, Mr. Chairman. We have
spent a lot of time talking about consumer balance sheets, and
I am with Wright-Patterson Credit Union and we are in the
business of fixing consumer balance sheets. We are in Dayton,
Ohio, as you noted. We are a community hard hit by this
economy. In the last 3 years, we have lost 33,000 jobs in
Dayton. Our members are facing an uncertain financial future.
I have a lot of the same statistics some of the other
witnesses had on the incredible rise in consumer debt over the
years, the drop in their savings rates, which at one point even
became negative, the drop in their home prices, and the one
that is most alarming to me, household net worth is $5.5
trillion less today than it was at the beginning of the
financial crisis.
But I am the one on the street trying to serve these folks
who come in that are overloaded with debt. They cannot afford
to make their next car payment. They are worried about their
house. They do not know what to do next and they come to see me
at the credit union and our staff.
Clearly, the need for our affordable financial services
have never been greater, and that is where I think the
cooperative credit union model comes into play. Our mission is
simply this. We help folks achieve financial freedom for
themselves and their families.
Specific to debt, this whole issue of debt, the way you
make good loans is you make them up front in a way that they
can afford to be repaid and you know that going in. You make
them for provident and productive purposes, not speculative
purposes. You tell the members exactly what their loans are
going to cost. You make sure they know every single fee that
they might be faced with in the future. You take every
opportunity to advise the member on how to increase their
savings accounts, even when they are taking out a loan. And if
they do happen to fall behind, you treat them with dignity and
respect and work with them on a plan to bring them back to
financial health, if that includes modification, adjusting
their rate, or whatever it takes to get them back to financial
health, although I do not agree that reducing principal
balances ultimately will just shift the cost somewhere else in
the economy.
These principles are the foundation of the way Wright-
Patterson Credit Union lends money. We try to create an
environment where we help people change their lives. In my
written testimony, you will see several stories of how we serve
members through mortgage modifications, credit cards that are
not designed to tempt people to spend money but designed to
help them pay down their debt. We have emergency payday loan
products that are affordable for a borrower who runs into a
short-term need of emergency cash.
We educate. We serve the airmen and airwomen of Wright-
Patterson Air Force Base and we find them in great need of
first-time car buyer loans, but they have never borrowed money
before and they do not know how. So we teach them how to do
that through our financial counseling and education services,
just to name a few of the things that we have done.
We are proud of the way we help our members save because we
can see the impact it makes on their lives, but I have to take
the other side on some parts of this. Like all smaller
financial institutions--we are under about $2 billion in
assets--we face challenges that make it harder for us to do
this stuff. Since 2008, we have been given more than 160 new
rules and regulations from some 27 different financial
agencies, or Federal agencies, despite the fact that our
Nation's credit unions had nothing to do with the financial
crisis.
While we would rather hire loan advisors, the people that
can meet with our members to teach them how to make better use
of their own money, we find ourselves trying to hire compliance
officers, and that is the truth. It is not a statement other
than the truth. And all we really do with those compliance
officers is demonstrate that we have always tried to do the
right thing. The fact is, our Nation's community-based
financial institutions, as I sit here today, are worried that,
ultimately, if you are under a billion dollars in assets, you
could be regulated out of business. This country does not need
fewer small institutions, it needs more of them.
I would also like to comment briefly on the CFPB. I have to
admit, we are a little concerned that it might create another
level of regulation for us to follow, but we support the goals
of the agency. There are abuses going on that need to be
curtailed. I note that we have a branch in an area of town next
to a pawn shop, next to a payday lender, and the only one there
that is regulated is us. The CFPB needs to address that fact.
I also think that the greater transparency in the
simplified disclosures that a new agency such as this would
require would highlight the way credit unions have always done
business. I can also talk about Richard Cordray. He has
outstanding qualifications and he understands the unique role
of credit unions and what they do in the lives of consumers.
But I have to say this. We hope the agency empowers credit
unions and other lenders to do their jobs of helping consumers
to save and make better use of their loans without adding an
excessive regulatory cost. And we hope Congress will ensure the
Bureau fulfills its mandate to address unnecessary and
burdensome regulation.
I will close quickly with an email I received just last
week from a member who personifies the typical financial
challenge faced by our membership. I quote, ``I am writing you
today to inform you of the difference your company has made in
my life. My previous car payment was $348, and with my rent
being $699 a month, including my other household bills, I could
barely make ends meet. Some weeks, I could not feed myself due
to the strain of having this enormous car payment. Just 2 weeks
ago, your credit union approved me for a car payment of $192.
You guys saved me $156 each month. My interest rate went from
24 percent to 8 percent. You guys helped me keep food on the
table.''
I get emails like this all the time and it affirms to me
that we are doing exactly what you want us to do. We are taking
care of consumers, helping them improve their financial
situation, putting money back in their pockets. In fact, this
year alone at Wright-Patterson Credit Union, we have saved our
members more than $10 million in loan interest costs by
refinancing their high-interest loans to lower rates.
To conclude, I believe in the power of America's
cooperative credit unions. We have always been here for
consumers, often when they have had nowhere else to go, in good
times and bad. A credit union cannot be bought and it cannot be
sold. If Congress strengthens and empowers credit unions,
credit unions will do even more to help people keep more of
their hard-earned money.
I will be happy to take any questions that you have. Thank
you.
Chairman Brown. Thank you, Mr. Fecher.
Ms. Rademacher.
STATEMENT OF IDA RADEMACHER, VICE PRESIDENT FOR POLICY AND
RESEARCH, CORPORATION FOR ENTERPRISE DEVELOPMENT
Ms. Rademacher. Thank you. Good afternoon, Chairman Brown
and Ranking Member Corker and also Senator Merkley. I commend
you for devoting a hearing to the issue of building middle-
class wealth at a time when our collective and individual
balance sheets are very much in the red, as we have been
hearing about.
Some would argue that in the current economic climate, it
is not realistic to focus on saving and wealth building, but
saving is exactly the right issue to focus on. It is critical
for low, moderate, and middle-income households precisely
because these are the families most vulnerable to income shocks
from job loss, medical emergencies, and other costs which can
knock them totally off course financially. And borrowing one's
way out of one emergency often sets up a downward spiral of
debt that can be extremely difficult to recover from.
The need for short-term credit can also be understood as a
need for liquidity and for savings. Research from the Urban
Institute shows that a relatively small nest egg of about
$4,000 provides as much protection against material hardship in
the face of an economic shock as being in the next highest
third of the income distribution.
The middle-class squeeze in America is more pronounced and
more consequential than at any time in modern history.
Regarding savings, over half the population does not have that
$4,000 nest egg I just mentioned. And regarding wealth, the
latest report from the Pew Hispanic Center found that the
median household wealth for Hispanics fell 66 percent from 2005
to 2009, 53 percent for African Americans, and 16 percent for
white households. The net worth of white families now stands at
18 to 20 times that of Hispanic and black households in
America, the largest gap in 25 years.
Regarding credit and debt, I will not go over all of the
statistics my colleagues here have already talked about. I
would say that over half of consumers in the U.S. have what can
be considered subprime credit scores at the moment.
The recession has clearly exacerbated financial problems,
but at another level, these problems reflect years of
Government policy decisions that disproportionately, if
unintentionally, help high-income households build assets while
virtually ignoring the needs of middle-class and explicitly
penalizing efforts by low-income households to save and to
invest.
Last year, CFED and the Annie E. Casey Foundation published
a report called ``Upside Down'' which showed the Federal
Government spends upwards of $400 billion a year to encourage
Americans to save and to build assets. But the policies are
primarily embedded in the tax code, and as a result, they are
overwhelmingly inaccessible to middle- and lower-income
households who do not itemize and who have a limited tax
liability.
In the study, we found that taxpayers making $1 million or
more in 2009 received a tax break of about $95,000, which is
enough to help finance a pretty good college education for one
of their kids. Tax filers making less than $20,000 got a break
worth about $5, which is enough to pay for 2 days of school
lunch. This expensive, ineffective, and skewed allocation of
tax subsidies has been relatively ineffective at generating new
net savings and has added to both the Federal deficit and the
growing wealth gap.
Without adequate savings, without adequate income, or
without adequate product options, the real financial choices of
millions of Americans are limited. I would urge Members of the
Subcommittee to take the following actions to improve the
financial security of all Americans.
First, confirm a Director to lead the CFPB. One of the main
goals of Dodd-Frank was to unify the entire financial services
marketplace under one set of clear, transparent rules with
consumer financial well-being in mind. Without a Director, the
CFPB is limited in its ability to regulate in many sectors of
the market, including nonbank financial institutions, payday
lenders, private education lenders, consumer credit rating
agencies, and mortgage servicers.
Congress should also encourage the CFPB to focus on
improving disclosures for all consumer financial products and
on helping consumers build their credit scores by ensuring the
accuracy of credit reports and by expanding the amount of
information reported to consumer credit rating agencies that
could help build the credit files of thin and no-file
consumers.
Beyond the CFPB, Congress can do much more to support the
goals of wealth building in low and moderate-income families.
Specifically, Congress should remove penalties in our safety
net programs for developing savings that can help families move
beyond--move into financial independence. Congress should
follow the lead of States like Ohio that have eliminated asset
tests in their TANF program. Congress could also consider
reforming the asset test in the SSI program, following the
trend of asset limit reform occurring at the State level for
TANF, SNAP, and Medicaid programs.
By expanding the savers' credit and making the credit
refundable, Congress could provide a powerful, easy, safe
incentive to as many as 50 million lower-income tax filers who
desperately need to build savings. Congress additionally
enacting the automatic IRA would enable the 78 million workers
who lack access to employer-sponsored retirement plans to use
payroll reductions to open and fund IRAs with minimum effort.
Congress should reauthorize the Assets for Independence
Act, which supports one of the few programs geared specifically
to low-income families that helps to support wealth building
and financial education to help these households get ahead.
And Congress could also support, as my colleague raised,
the creation of child savings accounts to greatly expand the
economic mobility of millions of children.
Taken together, these policies cost a small fraction of the
billions of dollars the Federal Government currently spends to
subsidize asset building, and they could easily be funded by
capping some of the existing and exclusive tax breaks now in
place. More importantly, they would begin to address some of
the long-term inequities that contribute to the wealth gap, and
they would help millions of families build a more secure
economic future. Thank you.
Chairman Brown. Thank you, Ms. Rademacher.
Ms. Weinstock, welcome.
STATEMENT OF SUSAN K. WEINSTOCK, DIRECTOR, SAFE CHECKING
PROJECT, PEW HEALTH GROUP, THE PEW CHARITABLE TRUSTS
Ms. Weinstock. Thank you. Thank you for the opportunity to
discuss Pew's research on the importance of transparent and
fair financial products and services as well as their use as a
means to build and sustain wealth. Based on research and
critical analysis, the Pew Health Group seeks to improve the
health and well-being of all Americans, an important component
of which is consumer financial product safety.
The most common of these products is the checking account,
which 9 out of 10 Americans have. In October 2010, the Pew
Health Group's Safe Checking Project began a study of more than
250 types of checking accounts offered online by the 10 largest
banks in the U.S. which held nearly 60 percent of deposits
nationwide. Through this research, we identified a number of
practices that put consumers at financial risk, potentially
exposing them to high costs for little benefit.
I would like to highlight three of our policy
recommendations. Number one is the need for a disclosure box
laying out account terms, conditions, and fees. Number two is
complete disclosure of overdraft options. And number three is
prohibition of transaction reordering that maximizes overdraft
fees.
First, 111 pages. That is the median length of disclosure
documents from the 10 largest banks in the United States. I
think we all can agree that disclosures are critical for
consumers to make informed decisions, but the information needs
to be presented in a format that is clear and understandable.
Obviously, with 111 pages, the checking accounts in our study
did not meet this transparency standard. These documents are
not user friendly, with highly technical and legalistic text.
For this reason, we developed a model disclosure box to provide
relevant information to checking account customers which is
included in my written statement.
In developing a disclosure box, we tested drafts with
consumers in three cities. Participants thought the box would
be useful if they wanted to investigate a bank's offerings and/
or compare multiple banks on the basis of fees. As a follow-up,
in July of 2011, we commissioned a national survey of U.S.
checking account holders. Seventy-eight percent of account
holders believe it would be a positive change to require banks
to provide a one-page summary of information about checking
accounts' terms, conditions, and fees, while only 4 percent
think this would be negative.
Our second research finding concerned overdraft options.
Currently, there are two main categories of overdraft products.
We define overdraft penalty plans as short-term advances made
for a fee by the bank to cover an overdraft, the median cost of
which is $35. Overdraft transfer plans involve a transfer from
another account, either a savings account, a credit card, or a
line of credit, with a median cost of $10.
As of August 15, 2010, new Federal Reserve rules required
that customers must opt into an overdraft penalty plan that
covers debit card transactions at points of sale and ATMs. If a
customer does not opt in, any debit card transactions that
overdraw the account will be denied and no fee will be charged.
While Pew supports this rule, we would have preferred for the
Fed to also require that comprehensive information about all
available overdraft options, including fee amount, be provided
to consumers who need to understand that they have three
overdraft options and what each costs: Not opting in, which is
free; overdraft transfer plans; and overdraft penalty plans.
Now that these rules have transferred to the Consumer
Financial Protection Bureau, we believe that the CFPB should
amend the overdraft rules to ensure that overdraft policy
disclosures are clear and comprehensive. They should require
full disclosure of all three overdraft options prior to opt in
and as part of the disclosure box.
Americans strongly support this added disclosure. In our
July survey, 83 percent of account holders said they want banks
to be required to provide a summary of information about
overdraft options, while only 2 percent said this would be a
negative change.
An additional research finding is on bank processing of
deposits and withdrawals. Banks' reorderings of transactions
can greatly impact the overdraft fees that consumers incur. At
the time of our study, all banks and all accounts reserved the
right to process all debits presented in a given day from
highest to lowest dollar amount. Since that time, Wells Fargo,
Chase, and Citibank disclosed that they will no longer reorder
certain types of transactions for at least a portion of their
accounts.
Posting orders that maximize overdraft fees, especially
those that post withdrawals from largest to smallest, continue
to be the subject of court challenges. A Federal judge in
California ruled against a bank on this practice and stated in
his summary of the case, quote, ``The essence of this case is
that Wells Fargo has devised a bookkeeping device to turn what
would ordinarily be one overdraft into as many as 10
overdrafts, thereby dramatically multiplying the number of fees
the bank can extract from a single mistake.''
Depository institutions should be required to post deposits
and withdrawals in a fully disclosed, objective, and neutral
manner that does not maximize overdraft fees, such as
chronological order. Our July survey shows that 70 percent of
checking account holders agree.
Finally, this month, we will release a longitudinal study
of 2,000 low-income Los Angeles area households. We found, not
surprisingly, that between 2009 and 2010, a time of great
economic turmoil, the ranks of those without a bank account
increased, with more families leaving banking than opening
accounts. But what was surprising was the most common reason
these households cited for leaving banking was unexpected or
unexplained fees, not the loss of a job or a decrease in
salary. We also found in times of economic decline, consumers
with a bank account fared better and were more likely to be
able to pay bills and also save for the future.
Our research demonstrates the central role that bank
policies and practices have in allowing consumers to understand
the terms and conditions of their bank accounts. Making this
marketplace fairer would allow consumers to manage their money
responsibly. Providing information in a clear, concise
disclosure box will enhance competition and make the market
more efficient.
In addition, practices that maximize fees, like transaction
reordering, should be prohibited. Transactions should be
processed in a predictable, objective, and neutral manner that
responsible consumers can follow. These changes will allow
consumers to build and sustain wealth by removing much of the
hidden risk currently found in checking accounts. Thank you.
Chairman Brown. Thank you, Ms. Weinstock. Thank you all.
Mr. Boshara noted in his testimony that family wealth has
been concentrated in home ownership, which he said, quote,
``has contributed to the stability and upward mobility of
millions of families in this country.'' Well, we know the
effects of the housing crisis, including both predatory
mortgages and foreclosure fraud, on middle-class wealth
building. Let me ask a specific question that all eight of you,
I would like to answer. Be as brief and as concise and
prescriptive as you can.
What can consumer protection do to promote home ownership
as a vehicle for saving? And you, unfortunately, Professor
Mian, had the least time to think about the answer, but I will
start with you. What can consumer protection do to promote home
ownership as a vehicle for saving in the sort of traditional
ways that we used to or have in this country, and many people
still are able to?
Mr. Mian. I think that the main problem, at least in
hindsight and from our historical experience, has been that
even when these kind of policies are successful, sometimes they
may be too successful in the sort run, like we saw in the 2000s
when the home ownership rate increased by a lot, and that, in
turn, can lead to a boom or a bubble in house prices, as well.
So as we think about incentivizing people to build value in
their houses, we should also think about what if the economy as
a whole makes a mistake and things turn south. Do we have the
protection, the downside protection, that is, and that is
something I was emphasizing in my initial remarks, as well. We
also need to think about downward protection. And that is why I
was talking about we should--when we put these regulations in
place, we should also think about circumstances. How will the
regulated and the economy react in case house prices fall by 20
percent and we have to reallocate the savings and debt across
the economy?
That is the fundamental problem that we are facing right
now, and I would just urge lawmakers to think about those
scenarios, as well, and not just expanding or helping
homeowners with more access, but in circumstances when things
turn south, how will the economy react, or will we force people
to go into foreclosure and things like that.
Chairman Brown. Professor Porter.
Ms. Porter. I think one answer is that buying a house is
one of the biggest financial decisions people will make and it
is an opportunity for them to have conversations with
thoughtful, concerned financial institutions like the community
financial institution that Mr. Fecher works for, about their
overall financial profile.
So one of the things we have already seen the Consumer
Financial Protection do is respond to its mandate in Dodd-Frank
to simplify disclosures and create a combined Truth in Lending
and RESPA disclosure. So go from multiple disclosures enforced
by multiple regulators to one disclosure enforced by one
regulator. That kind of simplification and the kinds of
financial education that the Consumer Financial Protection
Bureau is doing, that conversation about purchasing a home
needs to be seen as part of a larger financial strategy, not as
a one-off decision that is a sure bet in the economy, because
as Professor Mian says, it may not be.
So I think part of it is to continue to emphasize
counseling, purchasing, disclosures, and to think about home
ownership as one step toward building a financial future rather
than as the only step or as a sure bet financial strategy for
middle-class families. We have too many families who put all of
their savings eggs in the housing basket, and I think the
financial education role of the Bureau and the initiatives they
have already rolled out in this regard, their ``Know Before You
Owe'' initiative is a good example of how to combat some of
that.
Chairman Brown. Thank you.
Professor Lawless.
Mr. Lawless. Yes. I will try to be really brief, because I
think there is consensus here, and I think this is a consensus
in the academy that there has been too much of an overreliance
on home ownership as a way to build wealth rather than focusing
on housing as an item of consumption.
So, Senator, with all due respect, I would somewhat argue
the question. I do not think that we ought to use home
ownership as a wealth-building strategy, although I do agree
home ownership is something that many people will aspire to and
something that we ought to encourage. But I would encourage us
to think about housing costs rather than home ownership, and as
Professor Porter and Professor Mian said, have home ownership
just be part of a much bigger financial picture.
Chairman Brown. Thank you.
Mr. Boshara.
Mr. Boshara. Well, I agree very much, of course, with the
recommendation to diversify a family's assets beyond their
homes, as I have mentioned. I think that is the most important
thing.
Second, we need to be clear that home ownership is
something that is not for everybody. We have to balance risks
and rewards and be smart about how we do home ownership going
forward.
Specifically, though, to generate savings, there are a
couple of ideas. One is that we could escrow savings, just like
we escrow mortgages, mortgage insurance and property taxes, so
that when you make your payment, a portion of your payment goes
automatically into a savings account and you just buildup this
savings account without thinking about it, and so that when the
roof breaks or you have some sort of emergency, you have a
stock of savings already generated. So, you know, I would think
about building in that savings product into the payment itself.
The other thing I would think about is thinking of ways to
let families capture the upside of wealth accumulation through
their homes, which is what we want, and then, therefore, using
that equity for other asset building purposes, but to pool the
risk of a down market. You know, is there a way to somehow
socialize the risk of price decreases. Professor--I wrote down
his name and do not have it here--you know, there are proposals
out there right now to basically pool the risk of a down market
so more homeowners can reap the upside of a good housing
market.
Chairman Brown. Thank you, Mr. Boshara.
Mr. Flores.
Mr. Flores. I think we are getting there. I think banks are
getting back to the traditional underwriting requiring 20
percent down. That is going to say a lot of people are not
going to qualify for home at this point in time. If they save
and get to that 20 percent down, then they will.
The next issue, and I take a little bit different tack than
my colleague over here is home equity lines of credit. Over the
last 10 years, it has been a piggy-bank for consumption and
that is eaten--even if we did not have a down economy, that has
eaten up their equity. That economy just exacerbate it.
So I think if somebody has that, if they have got the
equity, if they are going to go in for a home equity line, then
certainly counseling about what is the impact, what are the
appropriate purposes of home equity should suffice, and this
all boils down to financial literacy. Whatever form that takes,
whoever provides it, it is a need in this country.
Most people do not understand how to handle money. They do
not understand the basics of banking. And then when we get into
these high dollar credits that they are involved in, they need
some assistance in understanding that.
Chairman Brown. Mr. Fecher.
Mr. Fecher. Thank you, Senator. I would agree with some of
the previous commenters, that we need to be careful to think
that just owning a home is a way to build wealth. In some cases
it is; in very many cases it is not. If I were advising a
member, I would make sure that they have a savings account set
up and get in the habit of putting money into it before they
ever thought about building wealth through a home, because when
the downside hits the housing market, it hits hard, as we have
seen, and it can wipe out every bit of wealth that a moderate
income person might have.
So I think as part of the bigger financial picture, just as
has been discussed on the disclosure side of it, I agree. We
need a shorter way to tell members what, or consumers, what a
mortgage loan is going to cost them and their family, what the
consequences of future events might be, for example, if it is a
variable rate loan, not what the first payment is going to be,
but what the highest payment of the loan might be so that they
do not spend money they do not have to spend on a loan that
they can put back toward their health.
So it is a complex answer, but it is part of a bigger
financial picture and it takes sitting down with the member and
showing them what is best for them, and each situation is
different.
Chairman Brown. Thank you, Mr. Fecher. Ms. Rademacher.
Ms. Rademacher. Thanks. I think it is important to think
about saving as both something that has to do with the product
and the protections, and when you think about a house, in terms
of the product and what it takes to get the right product,
consumer education, specifically home purchase education and
the home prepurchase counseling is critical.
Also, the types of disclosures that are available so that
somebody can understand the kind of product they are
purchasing. It is a very important piece of the mix. In terms
of protections, I think that the CFPB is already looking into
this in pretty expensive ways.
I would say that one of the studies we did a couple of
years ago when we looked at home owners who had purchased
homes, low-income homeowners who had purchased with an IDA,
compared to other low-income homeowners in those same
communities that had purchased homes at the same time, that IDA
gave them prepurchase counseling and ensured that they had
savings and skin in the game when they went into that.
When we looked at long-term rates of home ownership and
long-term foreclosure rates, we found that if you compared the
low-income homeowners from the IDA study with other low-income
homeowners in that area, less than 1 percent of the IDA
purchasers used a subprime loan versus 20 percent in the larger
market, and the foreclosure rate was about three times less.
So I would say that home ownership is still a value for us
to think about in terms of a way for low-income communities to
build wealth. It has to be done very clearly, concisely, with
the kinds of inputs and the kinds of education and the kinds of
protection others have talked about. Thanks.
Chairman Brown. Thank you. Ms. Weinstock.
Ms. Weinstock. I should first say that Pew is a data-driven
organization and we really have not looked at housing per se,
but I also want to say that I think it is very important that
people be banked, and that the research that we did in Los
Angeles proved that.
Forty-seven percent of the banked said that they saved when
they could, and one-third of all banked used an automatic
savings feature to move money regularly into a savings account.
And also, I think the savings part is the first step to moving
on to greater purchases or whatever.
Chairman Brown. Thank you. Senator Corker.
Senator Corker. Thank you, Mr. Chairman, and again, thank
each of you for your testimony. As I look at the panel, sort of
Mr. Boshara over, I think most of the witnesses have talked
about solutions and ways of moving ahead. I look at the first
three witnesses as more talking about consumers as victims. And
it has really been interesting to sort of have that dichotomy
here on the panel.
It seems to me that western democracies in general,
governments have over-levered, consumers have over-levered. I
mean, it has been sort of the culture, if you will, of western
democracies in many ways, not every one of them, but certainly
in our country, and Senator Brown and I were talking and I
certainly could not blame Democrats for all of this occurring.
There have been some policies that they have pursued. I
certainly could not say that Republicans were to blame. It just
seems to me that as a society, what we have done over the last
20 years or so is really move toward people consuming a lot
more and taking on more credit, and much of what we are seeing
happen today is just a result of our culture.
I wonder if the first three witnesses, in any way, would
respond to that briefly.
Mr. Mian. Thank you, Senator. Yes, I think that is a
question that I analyze almost on a daily basis. I apologize if
my speech kind of sounds more like an academic or an economist,
but that is just the nature of how things are.
Any economy has two kinds of people, borrowers and those
who lend them money, the lenders and the savings, and that is
true for the U.S. and that is true everywhere. That is number
one, that is basic fact number one.
Basic fact number two is economies overall are going to
make mistakes. Things are going to go up and sometimes things
are going to come down, house prices, other kinds of assets and
so on. The problem that we are having in the U.S. and, indeed,
the problem that we having globally is the following: We had a
big bubble, let us assume that happened, in the housing market,
for example.
As things come down, we have to distribute losses across
the population. That is just a fact of how the things are. And
the question is, how are those losses distributed across the
population? Under the way our financial system is structured,
which is largely a debt-based financial system, debt is the
losses.
The first person to get hit with those losses is the
borrower. That is just the nature of those contracts, and that
is fine. I think at the individual level that is fine. We can
say each person is responsible for how much they borrow. But
none of us individually control the macroenvironment.
So when the macro environment turns negative, the losses
are disproportionately shifted on one segment of the economy.
So internationally that happens to be Greece. Within the U.S.
that happens to be underwater homeowners and the borrowers.
And the big question is, what do they do in response to
that financial pressure that is being shoved in one segment of
the economy? This is what I talked about in my opening remarks.
They are cutting back. Many of them are still paying back their
mortgages and so on, but they are cutting back drastically on
their consumption, which is affecting aggregate economy and
total output and employment.
The big question is, that problem can be solved if people
who are the lenders and the savers correspondingly increase
their consumption. But interest rates have fallen to zero and
they are still trying to save. That is why interest rates are
zero, because they still want to save more and more.
So there is this dichotomy that on the one side, the savers
and those without the wealth, they actually are still trying to
save a lot more when they should be reallocating their money
back into society in goods and services. But they are not being
convinced to boost their consumption and their investment.
And that is the misbalance that we have had, because of
this over-leveraging of the economy in the household sector for
the U.S., and also more globally with the sovereign debt
problem. And we have to realign this tension, this dichotomy
between the saving class and the borrowing class, and part of
it has to be that we have to distribute losses more equitably.
That is a challenge for the financial system as a whole.
Senator Corker. I find your solution really odd. I mean,
you have got 9 out of 10 borrowers who are current on their
mortgages. You have got 1 out of 10 that are not, and what you
have really thrown out is the bank creating a partnership with
the borrower so that when things are all good, the borrower
bears the fruits of--or has the fruits of home equity, but when
things go bad, then the principal amount goes down as far as
what the bank is owed. That is really strange.
And what that does, I think, is drive up everybody else's
borrowing cost within the system. So I have to say, that is one
of the oddest proposals I have ever heard and really goes
against the grain of those people who are responsible being
able to get lower rates to borrow their loans because they are
responsible. Those people that are irresponsible, in essence,
are creating a burden for every other borrower. And you think
that is the way we should solve this problem?
Mr. Mian. I think partly one can argue that it is true that
the cost of credit was too cheap or too low. So to the extent
that we put part of the perceived burden looking forward back
on the lenders so they price these costs in, it might actually
be useful to limit the over-leveraging of the sector.
So just the fact that the cost of credit goes up, it is not
always good for the cost of credit to go down if people do not
take into account these macroeconomic costs, or extranalities
as they are sometimes referred to. That is number one.
But I think that the broader principle is that one can
design these contracts in a way that you can also give some of
the upside to the lender so as to minimize the cost up front.
And certainly, if someone comes in with enough of a
downpayment, it will actually build into the downpayment
requirement as well.
If someone comes in with enough of a downpayment, then you
do not have to worry about the bank absorbing too much of the
down side.
Senator Corker. Obviously during the Dodd-Frank debate, I
tried to cause there to be a minimum downpayment. I think what
you are actually arguing is what many folks on my side of the
aisle have argued for years, and that is that people ought to
have a reasonable downpayment.
I think Mr. Flores alluded to that and I think Mr. Fecher
agrees with that. People ought to have a downpayment and we
should not subsidize the interest rates for housing. They ought
to be based on fair market values, and that is something that
many of us have been arguing for years. Hopefully we will get
to that point.
But I have to say, the idea of basically creating a
partnership whereby if things go good, one side wins. If things
go bad, the lender loses. It is really odd and I doubt that
will make it into the mainstay here. But do you want to go
ahead, Mrs. Porter, and respond?
Ms. Porter. So you hypothesize that--you said that you
think it has been sort of the culture of democracies to over-
lever?
Senator Corker. The culture recently in many western
democracies has been over-consumption, by Government, by
individuals, by--you know, it has just been an over-spending
type of arrangement. And I find many of these solutions,
solutions that are being created to sort of cause people's
culture to overcome the culture that has been created, when
maybe the real solution is just causing people to not consume
as much and not borrow as much.
I mean, what really happened was, it seems to me that
financial institutions were meeting the needs of consumers.
Consumers wanted to be able to borrow more and they did. There
is no doubt there are products that were out there that were
tricky, and I understand all that, and I am all for disclosure.
I myself, I feel like I am fairly sophisticated, but have a
difficult time reading some of these disclosure forms. I am all
for that, but the fact is, it seems like many of the solutions
or many of the things that you all talked about was people
being victims when, in essence, it is kind of way society has
been in general over the last 20 or so years.
Ms. Porter. OK. So I do not think of consumers as victims
and I do not think I used that word. What I do think is that
there have been decades of taking on increased debt. Part of
that increased debt reflects stagnation in wages and
difficulties in keeping up with levels of consumption.
So we have had very sharp increased costs in health care,
sharp rises in tuition costs, a run-up in the housing market
which in part was fed by cheap credit in the housing market. So
some of the costs of treading water have been met by borrowing.
I think that one of the major justifications for getting
the Bureau put to work quickly is I think we have gone from, as
you said, cultures of over-levering to just sort of cultures of
panic. And so we see families who really do not know what to do
in today's economy. Should I still buy a home? Is buying a home
still safe? If it is, what kinds of products are out there? How
should I navigate in this economy?
And I think that having the Bureau fully operational with a
confirmed director, it lets the financial institutions know
where to take their questions and concerns. It lets families
know where to take their questions and concerns. So I think it
is finding that new culture going forward. We need certainty in
order to do that.
And so, I think that part of this cultural change is we
know consumers are dialing down on consumer debt and that
consumer debt is dropping. What they do not always know, as
some of the other panelists have talked about, is where to put
that money if they are not going to consume it, how to save it
properly.
And so, I think the CFPB, the Bureau, is a very important
part of rethinking our culture and engaging in conversations
with financial institutions about their role and engaging in
conversations with families and bringing those two parties
together for conversation. I think right now you just have
uncertainty about the future of the Bureau.
Senator Corker. This Bureau is going to have an even more
expanded role than I thought in causing culture to change. Let
me ask you this. I mean, would it be detrimental, do you think,
to this new Bureau to have a board of directors that this new
person who is doing all these things you just mentioned could
bounce off decisions? I mean, would that be something that you
think might be helpful to someone who might be heading this
Bureau?
Ms. Porter. I think there already are procedures in place
in the design of the Bureau that Congress enacted.
Senator Corker. But would a board be harmful?
Ms. Porter. I think a board could be harmful, yes. I think
that the procedures that are there, like the normal
Administrative Procedures Act rulemaking provide a well-known,
long-standing mechanism.
Senator Corker. What kind of organization do you have? What
is the name of your organization?
Ms. Porter. Oh, sorry. Who I work for?
Senator Corker. Yes.
Ms. Porter. I am a law professor.
Senator Corker. OK. And does the school that you work with,
do they have a board of directors?
Ms. Porter. We have regents, but we also have a president
that wields an enormous amount of power.
Senator Corker. And does he have a board of trustees?
Ms. Porter. We have regents. That is what they are called.
Senator Corker. So board of regents.
Ms. Porter. They do not have control over everything and
they are different than Federal regulators. Most Federal
agencies, the Department of Transportation, the Department of
Agriculture, they have single secretaries that are headed by
single institutions, single people, and we have chosen that
structure for the vast majority of Government organizations for
a reason.
Our financial regulators, like the Office of the
Comptroller of the Currency, the Office of Thrift Supervision,
the FDIC are headed by single people. So I think the Bureau has
important checks built into it and I support those checks.
The fact that they have to go through the rulemaking
process and allow for rules to have public comment, the fact
that the Financial Stability Oversight Council has a role in
looking at what the Bureau is doing, and if necessary, in their
belief, to serve this financial system, vetoing those rules.
So I strongly support the checks that are there. I think
Congress thought very hard about them just 1 year ago. But I
would not restructure the entire Bureau. And I think this
threat of restructuring is delaying the Bureau from beginning
its really important work. I think families need that work to
start. They are tired of waiting.
Senator Corker. Well, look, I do not think I have been as
constructive today, Senator Brown. I apologize. I want to say
to all of you who have testified, from Mr. Boshara over, that I
really appreciate the comments you have made. I know our staff
has made notes and I think there have been a lot of
constructive comments made.
I do think as it relates to the Bureau, that it is
unlikely, based on just reading the tea leaves, that there will
be a Bureau head unless there are appropriate checks and
balances, and it is my hope, very soon, I know that I have
reached out to the Administration, I know others have.
I hope that very soon those types of checks and balances,
just having a board and an appropriate veto process, will
actually occur. I do not think that that is an end-all by any
stretch solution to many of the problems that have been laid
out.
I do want to thank the panelists on this side for many of
the solutions that you have laid out and the input that you
have given today, and certainly, Mr. Fecher, the proactive
activities that are taking place within your organization, and
certainly the savings issues that you brought forth, Mr.
Boshara.
Chairman Brown. Thank you. Now, Ms. Porter, I know that you
need to leave at 4:30. It is 4:30. We are not asking you to
leave because you disagreed with Senator Corker because you
actually agreed with me or I agreed with you. But thank you.
I have one question, two more questions, and then if
Senator Corker wants to go again he certainly can too. Any of
you can answer, any or all of you. Ms. Rademacher said
something, she pointed out in her written testimony, consumers
accumulated $18-plus billion in new credit card debt in the
second quarter of 2011, a 66 percent increase over the same
quarter in 2010.
What do any of you make of that? Anybody want to answer
that? Do not feel obligated, but if any of you want, I would
like to hear any thoughts.
Mr. Flores. I think you are operating from a much lower
base. From 2007 to 2008, credit card lines were cut
significantly. Balances were reduced significantly. So when you
look at the growth, that percentage is from a smaller base than
we have dealt with historically.
Chairman Brown. Anybody else? Ms. Rademacher.
Ms. Rademacher. I would agree. I think, especially if you
look 2 years past, the growth from 2 years ago was 368 percent.
So I do think there is a rebound. People in the last couple of
years have gotten comfortable with the credit available again
and are becoming--moving more toward the use of credit in the
ways that we had seen it before. So I agree that it was a shock
that had dipped credit use and then it is actually building
again.
Chairman Brown. OK. Professor Lawless.
Mr. Lawless. Yes, I just wanted to add that this
illustrates the falsity of the idea that somehow we are now in
a changed society, that we had this big run-up in consumer
credit and now, with the financial crisis, subprime lending is
gone, we are going to be in a different society going forward.
I think that is just a falsehood and I think the recent
statistics probably indicate that.
Chairman Brown. OK. Thank you. One more question. In an
August Subcommittee hearing, I asked the minority's witness
about the lack of a permanent director at the Consumer Bureau.
He said, quote, The anomaly of not confirming Mr. Cordray is
there will be imposition of the banking sector of consumer
rules, not a bad thing, but there will not be an imposition of
those rules in the nonbank financial sector, the shadow banking
system not a good thing.
Mr. Fecher, your discussion of the credit union that you
recently opened to members Center and West Dayton and the
Wright-Dunbar area of Dayton, what does the lack of a full-time
director mean for your credit union in relation to who your
competitors are in that neighborhood?
Mr. Fecher. Well, I think it is exactly as you just said.
The fact of the matter, I am the most regulated financial
service provider in that neighborhood. The least regulated are
the payday lenders and the pawn shops that are right next door
to me.
It is difficult on the consumers. It is difficult on us. We
support the CFPB and what it tries to do, but the first place I
would put them is at the unregulated financial service
provider, the shadow banks and so forth that you talked about
because that is where the real abuses are taking place. They
are not taking place in the typical banking sector for the most
part, in my opinion.
Chairman Brown. You talked in your testimony, Mr. Fecher,
about the increasing number of regulations. Can the Consumer
Bureau help you streamline those regulations and small
institutions generally?
Mr. Fecher. I certainly hope so. I certainly hope so. The
burden--when I first got into this business back in '80s, to
make a first mortgage loan took a handful of pieces of paper to
disclose the loan to the borrower. Today the package can be 100
pages or even 200 pages long.
When I think of 200 pages that we have to print, train our
employees how to understand, how to explain them, I just see
dollar signs adding up. And here is the twist to it. It has
gotten so complex, I think as Ms. Weinstock said, people do not
read them. They do not understand them. They do not even try
because it is a daunting task to look at this stack of pieces
of paper.
So what I would like to see the CFPB do is just make it
easier on the consumer to understand the cost of what they are
doing in a page or two, if possible, and we need to get rid of
these entire stacks of disclosures that just confuse everybody.
Chairman Brown. Thanks. Mr. Flores, last comment.
Mr. Flores. I would just like to make one comment on the
shadow banking system. I have done research in the alternative
financial services space, and yes, payday loans are not
legislated or regulated at a Federal level, but they certainly
are at a State level, and in some States, rather significantly
just like State-chartered banks are.
So I think it is a bit misleading saying they are
unregulated.
Chairman Brown. OK, thank you. I found Senator Corker's
comments interesting and we have discussed briefly, and he
expanded on it, the culture of sort of borrowing and spending
in this society. I think it is exacerbated. I think that is
part of the story and I agree with him on that. I think it is
exacerbated by how we have seen incomes go up at the top and
incomes pretty stagnant for most Americans.
There was an interesting piece in the Washington Post, a
front page piece today about CEO pay and how it is not really
paying for performance anymore, and I was recently at a
company--well, I will not go into that. But I have just seen
that there is not the more spouses working, the decline in
wages, how hard it is for somebody in the middle class now.
Anyone that wants to make additional comments may submit
anything in writing in the next week. Appreciate Senator Corker
being here always, and thank you, all seven of you, for your
patience and your testimony and your insight and your public
service. The Subcommittee is adjourned.
[Whereupon, at 4:37 p.m., the hearing was adjourned.]
[Prepared statements supplied for the record follow:]
PREPARED STATEMENT OF ATIF MIAN
Associate Professor of Economics and Finance, Haas School of Business
and Department of Economics, University of California, Berkeley
October 4, 2011
I thank the Senate Subcommittee on Financial Institutions and
Consumer Protection for inviting me to talk about the role of household
leverage in the current economic crisis and the importance of household
balance sheets in explaining macroeconomic fluctuations. My discussion
on this topic--which is based on my research over the years with Amir
Sufi of University of Chicago Booth School of Business--is divided into
three parts.
First, I discuss the magnitude and nature of household debt
accumulation in the U.S. over the past decade. Second, I show how the
timing and severity of the current economic collapse is closely related
to the deleveraging of U.S. household balance sheets in the aftermath
of the housing market downturn. Deleveraging by highly indebted
households forces them to cut back on consumption. The resulting loss
in aggregate demand is responsible for a majority of the jobs lost
during the 2007-09 recession. Finally, I discuss the type of reforms
needed to resolve the U.S. household leverage crisis and put the
economy back on track.
Section 1: The Accumulation of U.S. Household Debt
The increase in household leverage prior to the recession was
stunning by any historical comparison. From 2001 to 2007, household
debt doubled from $7 trillion to $14 trillion (see, Figure 1). The
household debt to income ratio increased by more during these 6 years
than it had increased in the 45 years prior. In fact, the household
debt to income ratio in 2007 was higher than at any point since 1929.
Recent data suggest that over a quarter of mortgaged homes in the U.S.
are underwater relative to their mortgage value.
Why did U.S. households borrow so much and in such a short span of
time? What kind of households borrowed the most? I explore this
question in a couple of papers with Amir Sufi (Mian and Sufi 2009 and
2011a). Our explanation for the increase in household debt begins with
the dramatic expansion in mortgage originations to low credit quality
households from 2002 to 2007. Mortgage-related debt makes up 70 to 75
percent of household debt and was primarily responsible for the overall
increase in household debt.
We argue that the primary explanation behind the dramatic increase
in mortgage debt was a securitization-driven shift in the supply of
mortgage credit. The fraction of home purchase mortgages that were
securitized by non-GSE institutions rose from 3 percent to almost 20
percent from 2002 to 2005, before collapsing completely by 2008.
Moreover, non-GSE securitization primarily targeted zip codes that had
a large share of subprime borrowers. In these zip codes, mortgage
denial rates dropped dramatically and debt to income ratios
skyrocketed.
An important lesson regarding mortgage expansion during the 2000s,
is that the expansion does not reflect productivity or permanent income
improvements for new borrowers. In particular, mortgage credit growth
and income growth were negatively correlated at the zip code level from
2002 to 2005, despite being positively correlated in every other time
period back to 1990. Mortgage credit flowed into areas with declining
incomes at a faster pace.
One consequence of the rapid increase in supply of mortgage credit
was its impact on house prices. As credit became more easily available
to households that were historically rationed out of the credit market,
house prices began to rise. Moreover, the increase in house prices was
not uniform across the U.S. House price appreciated faster in areas
that had difficult-to-build terrain, i.e., where housing supply was
inelastic. While this mechanism does not explain all of the cross-
sectional variation in house price growth across the U.S., it does
explain a major proportion of it. \1\
---------------------------------------------------------------------------
\1\ In particular, cities in Arizona and Nevada are important
outliers. See, Mian and Sufi (2009 and 2011a) for more details.
---------------------------------------------------------------------------
The increase in house prices had a large impact on further
encouraging the accumulation of debt by households. In Mian and Sufi
(2011a) we focus on the feedback effect from house prices to household
borrowing by analyzing individual level borrowing data on U.S.
household that already owned their homes in 1997 before mortgage credit
expanded. We find that existing homeowners borrowed 25 to 30 cents
against the rising value of their home equity from 2002 to 2006.
The home equity-based borrowing channel is strongest for low credit
quality borrowers, borrowers with high credit card utilization rate,
and younger borrowers. Moreover, home-equity borrowing was not used to
purchase new properties or to pay down expensive credit card balances,
implying that the new debt was likely used for real outlays such as
home improvement and consumption. Overall, we estimate that the home-
equity based borrowing channel can explain 50 percent of the overall
increase in debt among homeowners from 2002 to 2006.
To summarize, rapid increase in the supply of securitization-driven
mortgage credit in early 2000s induced U.S. households particularly
those in subprime neighborhoods to accumulate debt. The expansion in
credit supply also fueled a remarkable increase in house prices and
U.S. homeowners borrowed aggressively against the rising value of their
houses. While overall debt increased by 7 trillion dollars, the
increase was not uniform across the U.S. Household leverage growth was
concentrated in areas with relatively inelastic housing supply, and
among younger households and households with low credit scores.
Section 2: Household Deleveraging, Aggregate Demand, and Unemployment
A. The Beginnings of the Crisis
The accumulation of debt by households with largely stagnant real
wages was not sustainable. Markets began to realize this towards the
second half of 2006 as mortgage delinquencies crept up. In fact many of
the first set of borrowers to default were those who could not even
afford to carry their first few months of mortgage payments. Unable to
refinance or sell their homes at a higher price, many homeowners began
defaulting on their loan obligations.
Figure 2 plots the quarterly change in mortgage defaults and
unemployment, and shows that default rates kept increasing for five
straight quarters before there was an increase in the unemployment rate
in the second quarter of 2007. This evidence is suggestive of the
causal role that high household leverage and a weak housing market
played in generating employment and output declines (see, Mian and Sufi
2010 for details). The next section shows more direct evidence of this
channel.
B. Deleveraging and Aggregate Demand
How has the sharp rise in household debt from 2002 to 2007 affected
economic recovery? When a large class of consumers see the value of
their houses decline and realize that they can no longer rely on
further borrowing to sustain their standard of living, they go into a
``deleveraging mode''. Deleveraging refers to the process where
consumers stop relying on more credit for consumption and start making
efforts to pay down existing debt to more manageable level. The scale
of this problem can be judged from a recent study by Core Logic that
reports that almost a quarter of homeowners who are current on their
mortgages are underwater.
Once a large fraction of homeowners start cutting back on
consumption as a result of deleveraging, there is a reduction in
aggregate demand and the economy goes into a recession. Interest rates
fall to help slowdown the fall in consumption and output. However,
whether interest rate drop is sufficient to halt aggregate demand
decline depends critically on the extent to which lenders (i.e.,
savers) increase their consumption in response to declining interest
rates. If--as has been the case in the current slump--even an interest
rate of zero fails to boost consumption sufficiently for the lending
class, aggregate demand will fall and the economy goes into a
recession.
I explain below how this deleveraging--aggregate demand channel is
responsible for the large drop in U.S. output and employment. As noted
earlier, the accumulation of leverage across the U.S. differed widely,
depending in part on the elasticity of housing supply in an area. There
are thus important differences across the U.S. in the extent to which a
given area has suffered from the deleveraging shock. These differences
are illustrated in Figure 3 that comes from Mian and Sufi (2011c).
Figure 3 splits U.S. counties into four quartiles based on the debt
to income ratio as of 2006. High (low) household leverage counties are
counties in the top (bottom) quartile of the 2006 debt to income
distribution. The top left panel shows that high household leverage
counties experienced much more severe house price declines during the
recession and afterward. House prices declined from 2006 to 2010 by 40
percent in these areas.
The decline in house prices represented a severe credit shock to
households. As the top left panel shows, home equity limits from 2007
to 2010 declined by 25 percent in high leverage counties. The shock to
credit availability translated into lower household borrowing. From
2007 to 2010, debt in these counties dropped by 15 percent, which
translates into $600 billion.
The deleveraging shock also translates into aggregate demand. The
lower right panel shows that consumption--as proxied by sale of new
automobiles--drops significantly more in high leverage counties. High
household leverage counties experienced a drop in auto sales of 50
percent from 2006 to 2009, with only a slight recovery in 2010. Mian,
Rao, and Sufi (2011) show that the pattern in auto sales in Figure 3
also holds for consumption across other goods, including furniture,
appliances, grocery, and restaurant spending. Moreover, within high
leverage counties, the drop in auto sales is significantly higher in
more subprime neighborhoods that are hit larger by the deleveraging
shock.
The magnitude of the drop in these variables is far smaller in
counties with low household leverage before the recession. As of 2010,
house prices were down only 10 percent, home equity limits had dropped
only 8 percent, and household borrowing was down only slightly relative
to the 2008 peak. Auto sales dropped sharply even in low leverage
counties, but the drop was much less severe and the recovery in 2010 is
stronger.
C. Deleveraging and Unemployment
Figure 3 shows evidence of weak consumer demand for durable goods
in high household debt counties. How does the sharp decline in
consumption in high leverage areas affect aggregate unemployment?
Answering this question with geographical variation has been difficult
given an obvious barrier: the goods consumed in one part of the country
are not necessarily produced in that area. For example, if Californians
sharply reduce auto purchases because of excessive leverage, the
decline in auto purchases will likely reduce employment in Michigan.
Given this one only examines job losses in high leverage areas such as
California.
However job losses in goods and services that are nontradable and
hence must be produced in the city where they are consumed do not
suffer from this problem. We therefore split consumption goods into
those consumed locally (nontradable) and those consumed nationally
(tradable), and use the impact of deleveraging shock on local
nontradable employment to back out the total effect of deleveraging and
reduced aggregate demand on employment (see, Mian and Sufi 2011c for
details).
The central insight of our approach is that one can estimate the
aggregate effect of household deleveraging on unemployment by examining
how nontradable employment varies across counties with varying degrees
of deleveraging shocks. We classify industries as nontradable if they
are focused in the retail or restaurant business. Given that high
leverage counties are those with a large boom and bust in residential
investment, we explicitly remove construction from the nontradable
sector. In other words, our nontradable industry category does not
include construction or any other real estate related business.
The first step of the empirical methodology is to estimate the
effect of deleveraging on employment in industries producing
nontradable goods. The left panel of Figure 4 show a very strong and
quantitatively large relation between household leverage measured as of
2006 and employment declines in nontradable industries from 2007 to
2009. For example, going from the 10th to the 90th percentile of county
distribution by leverage increase job loss as a fraction of total
employment in the county by 4.4 percentage points.
The right panel of Figure 4 repeats the analysis for employment
losses in the tradable sector and shows that there is no relationship
between county deleveraging shock and job loss in the tradable sector.
The reason for this is that losses in the tradable sector are
distributed equally across the U.S. as mentioned earlier. However, we
can use the relationship between job losses and deleveraging shock in
the nontradable sector to back out the number of nationwide jobs that
have been lost in the tradable sector due to the deleveraging shock and
resulting decline in demand.
We do this calculation carefully in Mian and Sufi (2011c) and
perform a number of checks to ensure that the number we compute is
driven by the deleveraging--aggregate demand phenomena and not any
alternative explanation. The total number of job losses that we can
conservatively attribute to the deleveraging--aggregate demand channel
is staggering. We estimate that deleveraging of the household sector
accounts for 4 million of the 6.2 million jobs lost between March 2007
and March 2009 in our sample. In other words, 65 percent of total jobs
lost in the U.S. are due to deleveraging and the drop in aggregate
demand as a result of it.
Section 3: Policy Choices
The analysis above identifies the deleveraging--aggregate demand
channel as the most important mechanism responsible for economic
downturn and job losses in the American economy. The sharp drop in
consumer demand in areas that accumulated the most leverage and large
employment losses associated with the drop in consumer demand highlight
the economic importance of the deleveraging--aggregate demand channel.
Unfortunately the current deleveraging cycle in the U.S. is
painfully slow. How long will this cycle last? Despite more than 3
years since the start of this cycle, the amount of debt paid off or
written down remains stubbornly small. Out of the 7 trillion dollars
accumulated over 2001-2007, only about one trillion has been paid down
or written off. U.S. household balance sheets remain highly levered by
historical standards. The most recent monthly auto sales data also
continue to show significant weakness in consumer demand among high
leverage counties.
In the face of the very slow deleveraging process and its high
economic cost, we urgently need policies that help reduce leverage for
highly indebted households without forcing them into costly actions
such as bankruptcy and foreclosures. \2\ The threat of foreclosure and
losing one's home may force many underwater homeowners to continue
paying their mortgage bills but the resulting drop in aggregate demand
hurts everyone. Indeed most recent data from Core Logic suggests that a
quarter of U.S. homeowners owe more than their house is worth, and yet
continue to make mortgage payments.
---------------------------------------------------------------------------
\2\ Foreclosures is a very costly mechanism to reduce
indebtedness, especially in the current environment. In a recent paper,
Mian, Sufi, and Trebbi (2011), we show that foreclosures significantly
reduce the value of homes in the neighborhood of foreclosed home and
lower house prices have a negative feedback effect on local consumption
and investment.
---------------------------------------------------------------------------
The dilemma for efforts to reduce household indebtedness is that
from a lender's perspective it is not in their interest to write down
debt that continues to be serviced on time. But as my analysis
highlights, the collective consequences of such ``individually
rational'' actions are quite unpleasant. If a large number of
financially distressed homeowners cut back on consumption in order to
protect their homes and continue paying their mortgages, the aggregate
demand and employment consequences hurt everyone.
An obvious policy proposal to facilitate leverage reduction is
principal write-down on underwater mortgages. While the Government did
initiate some related programs in the past, they have been largely
ineffective in achieving the desired goal. To be sure, there are
complicated legal issues pertaining to mortgage debt restructuring.
Similarly any orderly mechanism of debt restructuring should minimize
unwanted disruptions in the banking and financial system. These are
difficult and complex problems, but not impossible to address and
require collective regulatory and legislative action.
While the focus of my discussion has been the recent U.S. economic
downturn, the relationship between high household leverage and long
economic slumps is not limited to our current experience. In his
seminal paper, Irving Fisher (1933) described the role that high
household indebtedness and the process of deleveraging played in
perpetuating the Great Depression. More recent empirical work by
scholars such as Mishkin (1978), Olney (1999), and Eichengreen and
Mitchener (2003) further supports this view of the Great Depression.
Evidence from Japanese and European recessions (e.g., King 1994) also
highlights problems associated with leverage.
Our collective experience from historical recessions as well as the
most recent global slump point to a fundamental weakness in the modern
financial system: its inability to distribute downside risk equitably
and efficiently across the population. The tendency to rely too much on
debt-financed economic activity implies that in the event of a negative
economywide shock, most of the financial pain is pushed on a particular
segment of the population (i.e., the borrowing class). As the recent
U.S. experience reminds us, pushing most of the downside risk on one
segment of the population is seriously damaging for the overall
economy.
Going forward, in order to avoid deep economic slumps resulting
from an over-levered household sector, we need to put in place
contingencies that will automatically write down the value of
outstanding debt if the overall economic environment is sufficiently
negative. There is a lot to think through here before implementing a
particular policy. However, it is practically feasible to redesign debt
covenants by introducing contingencies for economic downturns.
For example, mortgage principal can be automatically written down
if the local house price index falls beyond a certain threshold. Since
such contingencies are written on aggregate states of nature, they do
not suffer from the standard moral hazard criticism. Lenders will
obviously price such contingencies in before extending credit, but it
is a price that benefits borrowers and the economy in the long run. If
we had such contingencies present in the current mortgage contracts, we
could have avoided the extreme economic pain due to the negative
deleveraging--aggregate demand cycle.
Bibliography
Barry Eichengreen and Kris Mitchener, ``The Great Depression as a
Credit Boom Gone Wrong'', BIS Working Paper 137, September, 2003.
Irving Fisher, ``The Debt-Deflation Theory of Great Depressions'',
Econometrica, 337-357, 1933.
Mervyn King, ``Debt Deflation: Theory and Evidence,'' European Economic
Review, 38: 419-445, 1994.
Atif R. Mian and Amir Sufir, ``The Consequences of Mortgage Credit
Expansion: Evidence From the U.S. Mortgage Default Crisis'',
Quarterly Journal of Economics 124: 1449-1496, 2009.
Atif R. Mian and Amir Sufir, ``Household Leverage and the Recession of
2007 to 2009'', IMF Economic Review, 58: 74-117, 2010.
Atif R. Mian and Amir Sufir, ``House Prices, Home Equity-Based
Borrowing, and the U.S. Household Leverage Crisis'', American
Economic Review, August, 2011a.
Atif R. Mian and Amir Sufir, ``Consumers and the Economy, Part II:
Household Debt and the Weak U.S. Recovery'', FRBSF Economic Letter,
January 18, 2011, 2011b.
Atif R. Mian and Amir Sufir, ``What Explains High Unemployment? The
Deleveraging--Aggregate Demand Hypothesis'', Working Paper, 2011c.
Atif R. Mian, Kamalesh Rao, and Amir Sufi, ``Deleveraging, Consumption,
and the Economic Slump'', Working Paper, 2011.
Atif R. Mian, Amir Sufi, and Francesco Trebbi, ``Foreclosures, House
Prices and the Real Economy'', NBER Working Paper # 16685, 2011.
Frederic S. Mishkin, ``The Household Balance Sheet and the Great
Depression'', Journal of Economic History, 38: 918-937, 1978.
Martha Olney, ``Avoiding Default: The Role of Credit in the Consumption
Collapse of 1930'', Quarterly Journal of Economics, 114: 319-335,
1999.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF KATHERINE PORTER
Professor of Law, University of California Irvine School of Law
October 4, 2011
Introduction
My testimony addresses the reasons that thoughtful consumer
protection is a vital necessity to our country's future economic
health. In the last two generations, increases in household borrowing
and changes in consumer financial services have reshaped the economy.
The result is that consumer credit law will be a major determinant of
the well-being of middle-class families for decades to come. To monitor
this marketplace and its role in family economic security and the
entire economy, lawmakers need the expertise and energy of a dedicated
regulator on consumer credit such as the Consumer Financial Protection
Bureau.
I am Professor of Law at the University of California, Irvine,
School of Law. I have worked at several leading law schools, including
Harvard Law School and the University of California, Berkeley, School
of Law. I have conducted research on household economic security and
consumer debt since 2001. My empirical research on abuses in the
mortgage servicing industry was among the first efforts to document
misbehaviors in foreclosure and bankruptcy cases that violate the rule
of law. I am a principal investigator of the 2007 Consumer Bankruptcy
Project, the Nation's largest study of families that file bankruptcy. I
am the author of more than a dozen law review articles on consumer
credit issues and am the editor of a forthcoming book, Broke: How Debt
Bankrupts the Middle Class (Stanford Univ. Press, 2011).
Debt: The New Middle-Class Marker
The middle class is a powerful concept. Historically, the size and
prosperity of the American middle class has been heralded as a great
social and economic achievement. Membership in the middle class is
associated with home ownership, educational opportunity, comfortable
retirement, access to health care, and last but certainly not least, an
appetite for consumer goods. \1\ The middle class also has political
appeal, as demonstrated by President Obama's decision during his very
first week in office to establish a Middle-Class Task Force. \2\ As
chair of the task force, Vice President Biden explained that middle-
class life is the ``old-fashioned notion of the American Dream'' and
that he and the President ``have long believed that you can't have a
strong America without a growing middle class. It's that simple. It's
that basic.'' \3\ The task force has focused its energy on job
creation, retirement security, work-family issues, and higher
education. \4\
---------------------------------------------------------------------------
\1\ Homi Kharas, ``The Emerging Middle Class in Developing
Countries'', Working Paper no. 285 at 7, Organisation for Economic Co-
operation and Development Centre, Washington, DC, 2010. http://
www.oecd.org/dataoecd/12/52/44457738.pdf
\2\ White House, ``White House Announces Middle Class Task
Force'', Press Release, January 30, 2009. http://www.whitehouse.gov/
the-press-office/obama-announces-middle-class-task-force
\3\ White House, ``Remarks by the President and Vice President at
Middle Class Task Force Meeting'', Press Release, January 25, 2010.
http://www.whitehouse.gov/the-press-office/remarks-president-and-vice-
president-middle-class-task-force-meeting
\4\ Joseph I. Biden, ``Annual Report of the White House Task Force
on the Middle Class'', Washington, DC: Office of the Vice President of
the United States, 2010. Accessed August 16, 2010. http://
www.whitehouse.gov/sites/default/files/microsites/100226-annual-report-
middle-class.pdf
---------------------------------------------------------------------------
But the task force has largely ignored a revolutionary change in
the lives of middle class Americans: the increase in household debt. In
the mid-1980s, the ratio of debt to personal disposable income for
American households was 65 percent. During the next two decades, U.S.
household leverage more than doubled, reaching an all-time high of 133
percent in 2007. \5\ Measured in the aggregate, the ratio of household
debt to GDP reached its highest level since the onset of the Great
Depression. \6\ This record debt burden, which crested just as the
financial crisis began, set up families to suffer deeply as
foreclosures, unemployment, and wage stagnation set in for the years to
follow.
---------------------------------------------------------------------------
\5\ Federal Reserve Bank of San Francisco, ``U.S. Household
Deleveraging and Future Consumption Growth'', FRBSF Economic Letter 1,
no. 2009-16 (May 15, 2009). Accessed October 2, 2011. http:// http://
www.frbsf.org/publications/economics/letter/2009/el2009-16.pdf
\6\ Atif R. Mian and Amir Sufi. ``Household Leverage and the
Recession of 2007 to 2009'', Working Paper 15896 at 1, National Bureau
of Economic Research, Cambridge, MA, 2010. http://www.nber.org/papers/
w15896
---------------------------------------------------------------------------
The consumer debt overhang, however, began long before the
financial crisis and recession. Exhortations about subprime mortgages
reflect only a relatively minor piece of a much broader recalibration
in the balance sheets of middle-class families. Debt began to climb
steeply around 1985, with its growth accelerating in nearly every
subsequent year until the onset of the recession. The run-up in
consumer debt coincided with a period of deregulation of financial
institutions and the preemption of State consumer protection laws and
State usury laws that regulated interest rates. Unfortunately for
American families, the debt binge was not accompanied by meaningful
increases in disposable income. While income crept up, debt shot up, as
Figure 1 illustrates. As debt grows relative to income, families must
stretch their dollars further to pay for current consumption, while
keeping up with debt payments. At some point, income simply becomes
insufficient, and families must either curtail spending or default on
debt. We are suffering these consequences now, as consumer spending
stagnates and families shed debt through foreclosures and default.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The growth in debt outstripped the appreciation of assets during
the last several decades. In other words, increases in liabilities--
mortgage debt, home equity lines of credit, student loans, and credit
cards--collectively grew faster than increases in assets--houses, cars,
stocks, or cash savings. Edward Wolff of the Levy Economics Institute
has calculated that as far back as 1995, the amount of mortgage debt
began to increase faster than house values. \7\ The result of the
increased borrowing was to constrain or retard growth in household
wealth. Indeed, between 2001 and 2004, the typical (median) American
household's wealth actually declined. \8\ This was an unprecedented
event because the wealth decline occurred during a period of overall
economic expansion.
---------------------------------------------------------------------------
\7\ Edward N. Wolff, ``Recent Trends in Household Wealth in the
United States: Rising Debt and the Middle-Class Squeeze--An Update to
2007'', Working Paper no. 589 at 34, Levy Economics Institute, Bard
College, Annandale-on-Hudson, NY, 2010. http://www.levyinstitute.org/
pubs/wp_589.pdf
\8\ Ibid., 47, table 5.
---------------------------------------------------------------------------
For the middle class, household debt outstripped household asset
accumulation. For households with wealth between the 20th and 80th
percentiles of the entire distribution, the debt-equity ratio climbed
from 37.4 in 1983 to 51.3 in 1998, and then topped off at 61 percent in
2004 and 2007. \9\ Whether assessed against income or assets, debt grew
in proportion to other changes in families' balance sheets. What looked
like a boom economy in the first half of the 2000s actually produced an
increase in financial risk for families by loading them with
unsustainable debt.
---------------------------------------------------------------------------
\9\ Ibid., 50, table 8.
---------------------------------------------------------------------------
The expansion in borrowing spanned social classes, racial and
ethnic groups, sexes, and generations. Every age group, except those 75
years or older, had increased leverage ratios between 1998 and 2007.
\10\ Similarly, African Americans, Hispanics, and non-Hispanic Whites
all saw their leverage ratios grow from 2001 to 2007. \11\ This is not
to suggest that the debt explosion was equally distributed. For
example, between 2004 and 2007, typical people who lacked a high school
diploma and typical households headed by a person between ages 65 and
74 had particularly sharp increases in their debt burdens. \12\ In
particular periods, some groups saw modest declines in consumer debt,
but the overwhelming trend was increased amounts of debt among nearly
every type of family. By 2007, when debt burdens peaked, 77 percent of
American households had some type of outstanding debt. \13\ Consumer
debt has become one of the most common shared qualities of middle-class
Americans, usurping the fraction of the population that owns their
home, is married, has graduated from college, or attends church
regularly. \14\
---------------------------------------------------------------------------
\10\ Brian K. Bucks, Arthur B. Kennickell, Traci L. Mach, and
Kevin B. Moore. ``Changes in U.S. Family Finances From 2004 to 2007:
Evidence from the Survey of Consumer Finances'', Federal Reserve
Bulletin 95, A37, table 12 (February 2009).
\11\ Wolff, ``Recent Trends in Household Wealth in the United
States'', 26.
\12\ Bucks et al., ``Changes in U.S. Family Finances'', A42.
\13\ Ibid., p. A37.
\14\ In 2007, the U.S. home ownership rate was 68.1 percent.
United States Census Bureau. ``Housing Vacancies and Homeownership
(CPS/HVS) Annual Statistics: 2007''. Last revised February 20, 2008.
http://www.census.gov/hhes/www/housing/hvs/annual07/ann07t12.html. As
of 2007, 54.7 percent of American men and 51.2 percent of American
women were married. United States Census Bureau. ``America's Families
and Living Arrangements: 2007''. Accessed January 2, 2011. http://
www.census.gov/population/www/socdemo/hh-fam/cps2007.html. In 2007, 27
percent of adults aged 25 or older reported having at least a
bachelor's degree. Sarah R. Crissey. Educational Attainment in the
United States: 2007. Washington, DC: U.S. Census Bureau, 2009. Accessed
August 16, 2010. http://www.census.gov/prod/2009pubs/p20-560.pdf. A
2007 Gallup survey found that more than 40 percent of Americans claimed
to attend church or synagogue regularly. Frank Newport. ``Just Why Do
Americans Attend Church?'' Gallup, April 6, 2007. Accessed January 24,
2011. http://www.gallup.com/poll/27124/Just-Why-Americans-Attend-
Church.aspx.
---------------------------------------------------------------------------
Too Big to Fail and Too Small To Save: Families in the Recession
As debt increases, so too does the risk of financial failure. This
is as true for American families as it is for large corporations, where
the catchy phrase ``highly leveraged'' captures a profound tilt into
the red on a balance sheet. The staples of middle-class life--going to
college, buying a house, starting a small business--carried with them
more financial risk in recent decades because they required more
borrowing and new riskier forms of borrowing. The escalation in debt
turned the smart financial decisions of the prior generation, such as
purchasing a home or taking on student loans, into high-stakes economic
gambles for middle-class families. Today, millions of Americans are
losing those bets, struggling to avoid financial collapse.
One place to see the pain of overindebtedness is in the experience
of bankrupt families. Over the long haul, increases in consumer debt
seem to explain a significant portion of the increased numbers of
consumer bankruptcies. \15\ This year approximately 1.4 million
families will file bankruptcy. \16\ They will publicly ``fall from
grace,'' skidding down the economic spectrum. \17\ These families'
aspirations of middle-class security evaporated under pressure from
debt collectors, looming foreclosures, and the loss of hope of earning
their way out of their financial problems. At least for now, their
version of the American Dream has been replaced by a desperate hope
that things do not get even worse. Driven by debt, these families are
at rock bottom.
---------------------------------------------------------------------------
\15\ Robert M. Lawless, ``The Paradox of Consumer Credit'',
University of Illinois Law Review 2007 no. 1 361-362 (2007).
\16\ Robert M. Lawless, ``Bankruptcy Filings Dropping More Rapidly
Than Expected'', Credit Slips: A Discussion on Credit, Finance, and
Bankruptcy (blog), September 9, 2011. http://www.creditslips.org/
creditslips/2011/09/bankruptcy-filings-dropping-more-rapidly-than-
expected.html#more
\17\ Katherine Newman, ``Falling From Grace 9'', New York: Free
Press, 1988.
---------------------------------------------------------------------------
Households that file bankruptcy have typically struggled seriously
with their debts for the previous 1 to 2 years. In fact, many
households spent months simply scraping together the money and
paperwork needed to file a bankruptcy petition. Nearly all of these
families will remember their few minutes with the bankruptcy trustee as
one of the most painful moments of their lives. Bankruptcy is a head-on
encounter with promises to pay that cannot be honored and privations
suffered trying fruitlessly to make ends meet.
Millions of families suffer serious financial hardship but do not
file bankruptcy. The number of foreclosures outstrips bankruptcy
filings by nearly a two-to-one margin. \18\ The Department of Education
reported last month a Federal student loan default rate of 8.8 percent
in fiscal 2009, and increase from 7 percent the previous year. \19\
Last year, 140,000 people complained to the Federal Trade Commission
about the tactics used by debt collectors, an increase of 28 percent
from 2009. \20\ A survey by RAND researchers found that between
November 2008 and April 2010 39 percent of families had experienced one
or more indicators of financial distress: unemployment, negative equity
in their home, or being 2 months behind on their mortgage or in
foreclosure. \21\ Debt collection and default are not isolated
experiences; they are becoming a routine part of the middle-class
experience, albeit a painful one. The ``new normal'' of the U.S.
economy--a world of layoffs and job losses, cuts in social programs,
and continued housing depreciation--only means that more people will
find themselves collapsing under the weight of debts incurred in
brighter economic times. \22\
---------------------------------------------------------------------------
\18\ In 2010, Americans filed just over 1.5 million nonbusiness
bankruptcies, compared to nearly 2.9 million foreclosure filings.
Leslie E. Linfield, 2010 ``Annual Consumer Bankruptcy Demographics
Report: A Five Year Perspective of the American Debtor'', 7n10,
Institute for Financial Literacy. (September 2011) Accessed October 1,
2011. http://www.financiallit.org/PDF/2010_Demographics_Report.pdf;
Julie Schmit ``Joblessness Drove Foreclosures in 2010'', USA Today, p.
6A (January 27, 2011).
\19\ The default rate represents the percentage of student loans
that fell into default among those whose payments were first due in the
prior fiscal year. Kevin Helliker, ``Student-Loan Defaults on the
Rise'', The Wall Street Journal, p. A2 (September 13, 2011).
\20\ Federal Trade Commission, ``Annual Report 2011: Fair Debt
Collection Practices Act'', 5 (March 2011). http://www.ftc.gov/os/2011/
03/110321fairdebtcollectreport.pdf.
\21\ Michael Hurd and Susan Rohwedder, ``Effects of the Financial
Crisis and Great Recession on American Households'', Working Paper WR-
810 at 27. RAND Corporation, Santa Monica, CA, 2010. http://
www.rand.org/pubs/working_papers/WR810.html
\22\ Nelson D. Schwartz, ``Jobless and Staying That Way'', New
York Times, WK1, August 8, 2010. Accessed February 4, 2011. http://
www.nytimes.com/2010/08/08/weekinreview/08schwartz.html
---------------------------------------------------------------------------
The experiences that are so evident in the wake of the recession
highlight the fact that some people will lose the borrowing game that
has become the American economy. The consumer spending that drove the
economy at the end of the 20th century was not costless. It was bought
and paid for with interest charges, late fees, increased stress about
making ends meet, and sometimes, with the humiliation of bankruptcy.
Increased consumption was largely financed by debt, rather than by
increases in wages or appreciation of assets. Heavy household debt
burdens ratchet up risk and reduce the security of the middle-class
families.
The consumer debt phenomenon is not a temporary one; it will be a
defining feature of American society for decades. It is a fact that
consumer debt levels are going down. The ``deleveraging'' process of
paying down debt and increasing savings that began in late 2007 has
lasted 4 years and shows no signs of reversing. The Federal Reserve
Board calculates the household debt service ratio for each quarter.
This is an estimate of the ratio of debt payments on outstanding
mortgages and consumer debt to disposable personal income. In 2011, the
ratio declined to levels not seen since the late 1990s. \23\ But these
levels still remain far beyond those of the prior decades.
Overindebtedness is declining but it is not a problem of the distant
past, cured by the recession, Government stimulus programs, or the
enactment of the Dodd-Frank financial reform law.
---------------------------------------------------------------------------
\23\ Federal Reserve Board, ``Household Debt Service and Financial
Obligations Ratios'', Last Updated September 20, 2011. http://
www.federalreserve.gov/releases/housedebt/
---------------------------------------------------------------------------
Retrenchment has been and will be painful--both for families and
for lenders. For many families, it has meant homes lost to foreclosure,
cars taken in repossession, trade-offs in family time for second jobs,
and dunning from debt collectors. Opportunities to launch a new
business, attend college, or start a family have been foregone. Changes
in credit standards and fears about the consequences of credit have
pushed many families further down the economic ladder, reducing assets
and consumer confidence. Credit retrenchment, just like the increases
in consumer credit in years before, dramatically reshapes the well-
being of the middle class.
Consumer confidence is critically affected by consumer debt. The
lack of access to credit that is a consequence of the financial crisis
is making Americans pessimistic about their futures. In a September
2010 poll, only half of Americans agreed that ``the American Dream--
that if you work hard you'll get ahead--still holds true''; more than 4
in 10 said it no longer did. \24\ This middle-class discontent runs
deep and retards efforts to stimulate economic growth. Americans are
famously opportunity loving, but even back in 2005 during a robust
economy, 62 percent favored the ``stability of knowing your present
sources of income are protected over concern with the opportunity to
make money in the future,'' which attracted 29 percent of respondents.
\25\ Problems in managing consumer debt have increased economic
anxiety.
---------------------------------------------------------------------------
\24\ Holly Bailey, ``ABC News/Yahoo! News Poll: People Are Losing
Faith in the American Dream'', Yahoo! News, September 21, 2010.
Accessed January 30, 2011. http://news.yahoo.com/s/yblog_upshot/abc-
newsyahoo-news-poll-people-are-losing-faith-in-the-american-dream
\25\ Jacob S. Hacker, in Katherine Porter (ed.), ``Broke: How Debt
Bankrupts the Middle Class, 227'', Stanford University Press, 2011
(citing The Tarrance Group and Lake Snell Perry Mermin and Associates,
Battleground XXVII, 29. Washington, DC: George Washington University,
2006. http:/www.lakeresearch.com/polls/pdf/bg305/charts.pdf).
---------------------------------------------------------------------------
Americans' appetite for risk and the aspirations of the middle
class reflect in part the financial insecurity of consumer debt levels.
With this type of uncertainty, the middle-class struggles to hang on,
rather than propelling itself forward.
At a conference that I attended, someone quipped that while banks
were ``too big to fail,'' families were ``too small to save.'' In part,
this comment reflects the powerful importance of the risk frame in
public policy, and that small incidences of harm rarely receive the
attention of large ones--even if the accumulation of small harms dwarfs
the single large harm. This preference to prioritize single large
events over multiple smaller ones shortchanges middle-class families.
For example, the Treasury's bold intervention in the capital markets is
a stark contrast to its anemic response to foreclosures at the family
level. Neither the Home Affordable Modification Program, nor the
Government's most recent effort, the Emergency Homeowners' Loan
Program, delivered on its promises, with delays in program roll-out and
problems in administration. Overall, an estimated less than 1 million
Americans have received a mortgage modification, refinance, or loan
from these programs. In that same period, since 2007, over 2 million
foreclosures have been completed. Today, estimates are that more than 6
million homeowners are delinquent on their mortgages and 16 million
homeowners have no equity in their homes.
Americans are frustrated with the lack of an effective and
sustained Government response to their financial hardships. Asked in
mid-2010 whom Government had helped ``a great deal'' during the
downturn, 53 percent of Americans said banks and financial
institutions; 44 percent fingered large corporations. Just 2 percent
thought economic policies had helped the middle class a great deal.
\26\ Middle-class Americans feel abandoned. Although their reactions
range from anti-Government rhetoric to calls for more intervention,
people are united across the political spectrum in feeling that
Government's response to the financial crisis missed the mark. The lack
of a Government regulator focused on consumer credit, including home
ownership markets, is a likely contributor to the feeling that families
are too often an afterthought in the design of economic policy.
---------------------------------------------------------------------------
\26\ Hacker, Broke, supra n25, at 230.
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From Subprime to Safe? Changing Financial Services
The debt loads that are commonplace among today's families would
have been simply unthinkable a generation or two ago. While the
recession that began in mid-2007 has widened the scope of the financial
pain caused by overindebtedness, the problem predated the large-scale
economic meltdown that captured headlines. Put another way, the
bursting of the housing bubble and subprime loans are not the problem,
or certainly not the entire problem, to be solved by consumer
protection. The rising levels of household debt and the burdens they
impose on families are not about a few bad actors or a couple of
innovative loan products gone awry. Certainly, subprime loans and that
market are poster children for the need for better oversight of
consumer credit. However, they are only one part of a larger revolution
in our economy that imposes more debt and more financial risk on
families.
The receding financial crisis and the elimination of a subprime
mortgage market do not mean that families today enjoy the economic
security that traditionally characterized the middle class. Indeed,
families today face a level of uncertainty about jobs, taxes,
Government services, and credit access that leave them in uncharted
territory. It is precisely in such an environment that consumer
protection law can help families regain confidence in the American
economy and make informed and smart financial decisions to build and
protect their wealth.
A few examples illustrate the point. In the 1990s and first half of
2000s, home equity loans provided a solution for families who had
unexpected expenses or a temporary loss of income. Those products are
unavailable to homeowners who are underwater or who have limited
equity. This reduction in home wealth leads families to look for other
options, such as taking on increased student loans to pay for college
rather than refinancing a house to pay tuition. Yet this alternative
has its own risks; the generation graduating today and in upcoming
years is more likely to have student loans and owe thousands of dollars
more than their predecessors. This growing student loan market needs
sustained attention and monitoring from the Government. Parents and
children need financial education on these products and their
consequences, and innovative in this market needs monitoring to protect
against unfair or deceptive practices.
Another example of ongoing consumer protection issues is changes in
retail banking and payment systems. Well before the effective date of
the CARD Act in 2010, \27\ younger people were more likely to prefer
debit cards to credit cards. \28\ The industry is rolling out new fees
for debit cards, and mobile payments are growing in popularity. These
changes mean consumers will have new choices and questions.
---------------------------------------------------------------------------
\27\ Credit Card Accountability Responsibility and Disclosure Act
of 2009, Pub. L. No. 111-24, 123 Stat. 1734 (2010).
\28\ Ronald J. Mann, ``Adopting, Using, and Discarding Paper and
Electronic Payment Instruments: Variation by Age and Race'', May 2011.
Fig. 7.14 (finding that consumers over the age of 45 appear
significantly less likely to use debit cards, controlling for race,
household status, income, and education).
---------------------------------------------------------------------------
Similarly, the growth in debt among older Americans, combined with
longer lifespans, mean that retirement is no longer synonymous with
economic stability. Millions of seniors owe money on their mortgages,
and this group is particularly likely to make use of credit cards. They
are also targeted repeatedly in financial scams. As the baby boomers
age and they enter retirement in financial positions quite different
from the Greatest Generation, their behaviors and needs will change the
financial profile of the middle class. These older Americans will look
to the Government for education about consumer credit and will count on
consumer protection laws to shield them from abusive practices that
prey on older Americans.
In 2010, Congress created the Consumer Financial Protection Bureau
(the ``Bureau''). \29\ It is specifically charged with monitoring the
functioning of the consumer credit markets. Already, the Bureau has
developed outreach and education initiatives, perhaps most notably its
work on servicemembers and their families. These efforts need to
continue and accelerate to help families rebuild after the financial
crisis. The Bureau may well have been effective in guarding against the
harms of subprime lending but the bankruptcy of subprime lenders and
the atrophy of the mortgage market does not eliminate the need for the
Bureau. To the contrary, it is precisely in today's uncertain climate
that families need a single, visible place to look for financial
education.
---------------------------------------------------------------------------
\29\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Pub. L. No. 111-203, 124 Stat. 1376, 1001 (2010).
---------------------------------------------------------------------------
In its lawmaking functions, the need is similar. Dozens of
financial products, including credit cards, debit cards, and student
loans are in transition in the wake of the recession and its aftermath.
While Congress in Dodd-Frank and the Federal Reserve in its rulemaking
have addressed some aspects of the mortgage market, the future of home
ownership remains unsettled. We do not know if the 30-year fixed loan
will emerge as the sole mortgage product or if a variety of products
will proliferate; the market and the regulation of the market will work
together to determine these answers. The lesson of the subprime loan
market is that there is a grave danger that the Federal Government will
pay insufficient attention to consumer credit markets without a
dedicated regulator, and that families and the entire economy can
suffer as a result. Families need a powerful voice in these
conversations that focus on their well-being; the checks and balances
that Congress built into the Bureau's design ensure that financial
institutions--and their traditional regulators--will also have a voice
in determining the future of consumer credit law. That is entirely
proper in my opinion. We should guard against weakening the Bureau now
that the worst of the financial crisis may be against us. The
uncertainty of the future makes the Bureau even more necessary than
during the height of the financial crisis when policy makers were
focused on acute problems. Government needs to continue to engage in
monitoring and regulating consumer credit to help the economy recover
and rebuild middle-class wealth.
Protecting Middle-Class Prosperity
Today, millions of middle-class families are experiencing deep
economic pain. Consumer debt is not the only reason for the increasing
financial vulnerability of Americans; stagnant wages, increased
volatility in the labor market, health care and college costs that
outpace inflation, and longer life spans that strain retirement savings
all play a role. Consumer debt is a powerful force that affects middle-
class prosperity, however, because in the last two decades debt was the
crutch of families wounded by other economic harms. Debt smoothes
consumption over time; for example, it can ease the uneven income that
characterizes the rising cadre of temporary and contract workers in
America. Debt substitutes for cost controls in markets gone astray; for
example, people increasingly must finance medical bills because they
overwhelm their monthly budgets. Debt fills gaps in making ends meet
when social programs erode; for example, people may borrow from a
payday lender to cover utility bills as local governments eliminate
energy subsidy programs.
These functions for debt are not inherently bad. To the contrary,
debt has long been a lynchpin of opportunity in our society. But too
many Americans have borrowed too much and that they taken on debts that
worsened, rather than improved, their financial situations. In
bankruptcies, foreclosures, economic anxiety, and joblessness, we see
the harms of consumer debt. The cost of debt is not just the annual
percentage rate charged to a family. It is also the social costs of
some borrowers becoming hopelessly mired in debt and the macroeconomic
effect of overleveraged households. Those costs are being paid by
today's middle-class families during the recession and will likely
continue to be paid in the upcoming decade. Economic models show that
lowering the debt-to-income ratios of households in the next decade and
beyond will have significant changes on the macroeconomy and its
ability to grow through increased consumption. \30\ The cumulative
result of households' debt burdens is to create a drag on economic
growth for the entire Nation.
---------------------------------------------------------------------------
\30\ Federal Reserve Bank of San Francisco, ``U.S. Household
Deleveraging'', supra n5, at 3.
---------------------------------------------------------------------------
America's relationship with borrowing is at a turning point.
Lenders have tightened underwriting standards, and households are
reducing their spending and saving more of their incomes. The open
question is whether this retrenchment will endure or accelerate. Will
America reverse more than two decades of reliance on consumer borrowing
and gradually work its way back to debt burdens of the post-War period
of prosperity? Or will the borrowing habit return in a few years as the
recession recedes, with another boom in borrowing replacing the last
few years of bust? The choice between those paths has profound
consequences for the economic security of America's middle class.
Congress continues to consider ways to help families with bills
such as the Foreclosure Fraud and Homeowner Abuse Prevention Act of
2011, but it should not have to act alone. The executive branch needs
to contribute expertise and administrative support. The Bureau is a
crucial part of helping to navigate the future of our economy. Through
research, rulemaking, and education, the Bureau will provide a roadmap
for legislative activity and consumer decision making. It can respond
nimbly to the rapid changes that are common in today's turbulent
economy and it can help consumers stay informed of changes to markets
and laws that could aid them in rebuilding and maintaining wealth.
The Bureau's central mission is to nurture the marketplace for
consumer credit, and it's time to allow it to begin its work in earnest
by confirming a permanent director and putting to rest efforts to
redesign the carefully crafted structure of the Bureau that Congress
approved only a year ago. The uncertainty about credit markets is
worsened by efforts to dismantle or defang the Bureau. Institutions and
industry need a clear path forward, and they need a place to bring
concerns about the future of consumer protection regulation. A fully
operational Bureau allows families and institutions to adapt and to
begin to recover in the wake of the recession and new pressures on
families' financial well-being.
Conclusion
Going forward, our Nation cannot afford to adopt a blind belief
that consumer credit markets require little attention. The unmanageable
debt burdens that pushed us into a recession and are hampering our
recovery powerfully demonstrate that more debt does not equal more
prosperity. We cannot sustain national economic prosperity while
unmanageable borrowing undermines the prosperity of American families.
But neither can we afford to limit opportunity and shunt upward
mobility for the middle class by buying into fear that all borrowing is
bad or accepting an endless downward spiral of consumer credit. The
challenge is to figure out how to calibrate consumer credit markets to
balance the harms of borrowing against its benefits. The Consumer
Financial Protection Bureau is a critical aspect of meeting that
challenge. Its vitality will help our economy recover and flourish, and
its vigilance in the future will safeguard the well-being of American
families as consumer debt markets change.
______
PREPARED STATEMENT OF ROBERT M. LAWLESS
Professor of Law, University of Illinois College of Law
October 4, 2011
Congress created the Consumer Financial Protection Bureau (CFPB) to
put an end to lending practices that rely on consumer confusion to
create profits for the lenders. Although the CFPB has now come into
existence, partisan politics have hampered the CFPB's ability to fully
vindicate its statutory mandate. The Senate has yet to act on the
confirmation of a permanent director, and some members of Congress have
vowed to scale back the agency's powers. Thank you for inviting me here
today. In my testimony, I will describe the problems that led Congress
to create the CFPB in the first place and how these problems continue
to plague American consumers.
I am a professor of law and codirector of the Illinois Program on
Law, Behavior and Social Science at the University of Illinois College
of Law. In my courses and research, I study the problems that lead both
consumers and businesses into financial distress and how we as a
society react to financial distress. Along with seven other scholars,
including copanelist Professor Katherine Porter, I regularly contribute
to Credit Slips (http://www.creditslips.org), a blog that discusses
issues related to credit, finance, and bankruptcy. My testimony today
draws on what I have learned as a scholar and teacher of lending and
bankruptcy. The views I am expressing are my own and not necessarily
the views of my university or any other organization with which I am
affiliated.
A Middle-of-the-Road Agency
I am here today as someone who was skeptical about the creation of
a consumer financial agency. \1\ My skepticism stemmed not from the
oft-repeated concerns over an agency that has too much authority.
Rather, my concern was that a consumer financial agency did not go far
enough. Professor Warren framed her proposal for a consumer financial
agency largely in terms of informational problems between consumers and
lenders. \2\ Under this vision, plain English disclosures would
ameliorate many of the most abusive lending practices. In Professor
Warren's words, ``the basic premise of a market is full information.''
The agency would stand in the middle between consumers and lenders to
ensure consumers were acting with full information.
---------------------------------------------------------------------------
\1\ The Limits of Contract as Product, 157 U. Pa. L. Rev.
PENNumbra 160 (2009) (available at http://www.pennumbra.com/responses/
02-2009/Lawless.pdf).
\2\ Oren Bar-Gill and Elizabeth Warren, ``Making Credit Safer'',
157 U. Pa. L. Rev. 1 (2008); Elizabeth Warren, ``Unsafe at Any Rate'',
Democracy: A Journal of Ideas, Summer 2007, at p. 8.
---------------------------------------------------------------------------
Although providing consumers with more information is a laudable
goal, many consumer lending transactions simply transfer wealth away
from persons living at the economic margins of society and put this
wealth in the pockets of large financial institutions. If we decide as
a society that these wealth transfers are intolerable, the answer is
not to surround these transactions with more information but to ban
these transactions altogether. Vigorous and effective usury caps would
put an end to predatory lending at rates approaching a 300 percent or
400 percent APR. If, for example, consumers systematically make
mistakes to choose credit cards with low teaser rates but higher long-
term costs, then the answer is to limit the use of teaser rates.
At the time of Dodd-Frank, people of good judgment and good faith
differed on what Congress should do to prevent a repeat of the consumer
lending abuses that played a role in creating the financial crisis. In
the heated rhetoric that often surrounds any discussion of the CFPB, it
has been forgotten that the agency in many ways was a compromise
solution between those who wanted to go further and those who thought
no little or new regulation was necessary.
My other reason for skepticism was the problem of regulatory
capture. In legal and political science scholarship, ``regulatory
capture'' describes a situation where an administrative agency becomes
beholden to the interests it regulates. The agency begins to act on
behalf of those interests instead of the citizenry. Regulatory capture
can happen for institutional reasons such as the fact that the
regulated companies often have the greatest incentive to monitor and
lobby the administrative agency. Cultural forces also play a role as
agencies often draw their employees from the same labor pool as do the
companies they regulate or as agency employees come to know their
counterparts in the regulated industry.
In financial regulation, regulatory capture has been particularly
acute. The Office of the Comptroller of the Currency (OCC) draws its
budgets from the fees of the banks it regulates. Many observers have
noted the OCC often seems to act in ways that attract regulatory
business and hence higher fees and bigger budgets. \3\ Commentators
made similar observations about the Office of Thrift Supervision (OTS),
an agency eliminated by Dodd-Frank. \4\ In their article proposing a
consumer financial agency, Professors Bar-Gill and Warren described a
broad failure across a number of agencies to regulate on the behalf of
consumers: the Federal Reserve, the OCC, the OTS, the Federal Deposit
Insurance Corporation, the National Credit Union Administration, and
the Federal Trade Commission. \5\
---------------------------------------------------------------------------
\3\ Adam Levitin, ``Why the OCC Can't Be Relied on for Consumer
Protection'', Credit Slips (Aug. 21, 2008) (http://www.creditslips.org/
creditslips/2008/08/why-the-occ-can.html); Stephanie Mencimer, ``No
Account: The Nefarious Bureaucrat Who's Helping Banks Rip You Off'',
The New Republic, Aug. 27, 2007, at 14 (http://www.tnr.com/article/no-
account); Alan White, ``OCC Findings: Illegal Foreclosures, Critical
Deficiencies'', Credit Slips (Feb. 17, 2011) (http://
www.creditslips.org/creditslips/2011/02/occ-finds-illegal-foreclosures-
critical-deficiencies.html).
\4\ U.S. Senate Permanent Subcommittee on Investigations, Staff
Report, ``Wall Street and the Financial Crisis: Anatomy of a Financial
Collapse'', pp. 161-242 (Apr. 13, 2011) (http://hsgac.senate.gov/
public/_files/Financial_Crisis/FinancialCrisisReport.pdf); Robert
Cyran, ``The Downfall of a Regulator'', N.Y. Times, Apr. 8, 2009, at B2
(http://www.nytimes.com/2009/04/09/business/09views.html).
\5\ Oren Bar-Gill and Elizabeth Warren, ``Making Credit Safer'',
157 U. Pa. L. Rev. 1, 86-97 (2008).
---------------------------------------------------------------------------
To minimize the risk of regulatory capture in an area that had
proven so susceptible to it, Congress tried to insulate the CFPB from
political influences. As the Subcommittee is undoubtedly aware, there
have been innumerable proposals to tear down the structures that
protect the CFPB from interest-group politics. Efforts to replace the
one-person director of the CFPB with a commission or place the CFPB's
budget under the immediate control of Congress are steps in the wrong
direction. Indeed, the very existence of these efforts, largely
centered in the financial services industry, demonstrates the need for
vigilance in keeping the CFPB a truly independent agency. In an era of
permanently indebted private households and complex financial
instruments that provide opportunities for abuse at the expense of
everyday Americans, we need an effective CFPB that will not be the hand
maiden of the industries it needs to regulate.
An Indebted Society
Congress did not design the CFPB as an ``anti-debt'' agency. Used
properly, borrowing can be an effective financial strategy for many
consumers. Many Americans pay for their homes, their cars, and their
educations through well-considered decisions to borrow money.
Individually, many of these borrowing decisions undoubtedly made sense.
In the aggregate, however, these individual decisions have made America
an indebted society with remarkably high levels of household debt. The
rush by financial institutions to supply this debt played a role, if
not the major role, in creating our current financial crisis. An
effective CFPB not only can minimize the systemic risk that comes from
high levels of household debt but also act to minimize the harm that
can befall individual borrowers when they enter into borrowing
decisions they do not understand or cannot possibly afford.
Without question, the financial crisis has reduced the amount of
outstanding consumer debt. According to the Federal Reserve, consumer
debt has shrunk by 4.2 percent since the beginning of 2008 to July 2011
(the most recent data available). \6\ This small reduction in consumer
debt is a drop in the bucket compared to the massive run-up during the
past several generations. Even after adjusting for inflation and
population growth, consumer debt has risen 46 percent in the past 25
years and 106 percent in the past 50 years. When mortgages are
considered, private household debt has increased 220 percent in the
past 25 years and a staggering 374 percent in the past 50 years. Many
Americans now spend most of the adult lives owing debts to some
financial institution.
---------------------------------------------------------------------------
\6\ Federal Reserve Statistical Release G.19 (July 2011). The term
``consumer debt'' does not include mortgages.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Compared to other countries, Americans are a deeply indebted
people. According to the most recent data from the Organization for
Economic Co-operation and Development (OECD), Americans had total
household debt of $44,041 for every man, woman, and child in the
country, the fifth highest among all OECD countries as illustrated by
Figure 1. Adjusting for population allows for comparison across
borders. Using per capita figures, however, understates the true debt
burden because not every man, woman, or (especially) child has
outstanding debt. For the average person carrying debt, the burden is
much higher than $44,041.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
When considering just short-term household debt, the United States
leads all OECD countries with $9,663 owed per capita. The OECD defines
short-term debt as any debt loaned for less than 1 year. Long-term debt
is debt loaned for periods of greater than 1 year with the biggest
components of long-term debt being home mortgages and automobile loans.
Short-term debt is typified by credit card debt and payday lending.
Thus, consumers are much more likely to be using short-term debt for
immediate consumption. It is exactly these types of borrowing decisions
where consumers are more likely to act quickly, perhaps under some
pressure and without careful shopping among different lenders. It is
exactly these types of borrowing decision where lenders can exploit
consumer confusion and lack of information. It is exactly these types
of borrowing decision where the CFPB can be most effective. And, it is
exactly these types of borrowing decision in which Americans lead the
world.
Household Debt, Bankruptcy, and the CFPB's Role in Research
In its invitation, the Subcommittee asked for my views on ``the
role of consumer financial products in contributing to excessive
household indebtedness and, in the extreme, bankruptcy.'' Part of that
question is easy to answer, and part of that question is much more
difficult to answer. After explaining the easier part of the answer, I
will turn to how the CFPB would be incredibly helpful in answering the
more difficult part of the question.
The easier part of the answer is that excessive household
indebtedness clearly has a link to bankruptcy filings. \7\ In the short
run, the link is counterintuitive. As consumer debt increases,
bankruptcy filings generally decline in the short-term. When consumer
debt is more readily available, households can stave off the day of
reckoning by borrowing to pay for rent, medical expenses, groceries,
and the other necessities of daily life. A tightening of consumer debt
generally has the opposite effect, driving more people into bankruptcy
in the short term. When its effects are measured over a long run,
however, consumer debt does lead to increased bankruptcy rates. Because
of its relationship to consumer debt, the bankruptcy filing rate can
rise even during economic boom times such as the 1990s when earlier
increases in debt created long-term conditions conducive to bankruptcy
filings that then spiked when credit markets became more difficult for
consumers to access. Another example is this year, where bankruptcy
filings will fall about 10 percent even amidst a dire economy. The
dearth of new consumer debt in the immediate wake of the financial
crisis in 2007 and 2008 created a situation where there would be less
long-term need for bankruptcy. As consumers have found it slightly
easier to borrow this year, the conditions have been created for a
decline in this year's bankruptcy filing rate. Thus, contrary to
popular wisdom, it is consumer indebtedness, not the Nation's overall
economy that plays the major role in driving the Nation's bankruptcy
filing rate.
---------------------------------------------------------------------------
\7\ This discussion is based on my findings in Robert M. Lawless,
``The Paradox of Consumer Credit'', 2007 U. Ill. L. Rev. 347. Further
discussion appears at Bob Lawless, ``One More Time With Feeling'',
Credit Slips (Aug. 22, 2011) (http://www.creditslips.org/creditslips/
2011/08/one-more-time-with-feeling.html) and Bob Lawless, ``Debt Causes
Bankruptcy (But Sometimes in Counter-Intuitive Ways)'', Credit Slips
(Jan. 7, 2011) (http://www.creditslips.org/creditslips/2011/01/debt-
causes-bankruptcy-but-sometimes-in-counter-intuitive-ways.html).
---------------------------------------------------------------------------
The more difficult part of the Committee's question is the role
particular consumer financial products play in creating excessive
household indebtedness. Once a consumer gets to bankruptcy court, the
fact of the bankruptcy filing and the consumer's circumstances become a
matter of public record. Researchers can use this information to
understand the relationship between indebtedness and bankruptcy, as we
have done, for example, in documenting how Americans are arriving in
bankruptcy much further in debt than they did 30 years ago. \8\ As to
how people become overindebted in the first place, we have a much
poorer understanding. For example, is overindebtedness often due to
exogenous shocks like illness or job loss, or are poor purchasing
decisions and overconsumption the primary driver? To what extent does
culture or other attitudes drive overindebtedness? Are particular
consumer financial products more likely to lead to overindebtedness?
Are some consumer financial products inherently abusive in that they
cost far more than any conceivable benefit they could be giving the
borrower? The data that would provide some insight into these questions
generally is private and beyond the ability of independent researchers
to investigate.
---------------------------------------------------------------------------
\8\ Robert M. Lawless, Angela Littwin, Katherine Porter, John
Pottow, Deborah Thorne, and Elizabeth Warren, ``Did Bankruptcy Reform
Fail? An Empirical Study of Consumer Debtors'', 82 Am. Bankr. L. J. 349
(2008).
---------------------------------------------------------------------------
Often lost in the debates over the CFPB is the research function
Congress directed it to have. Following the statutory directive given
by its enabling legislation, the CFPB now has a research unit that
investigates the following issues:
A. Developments in markets for consumer financial products or
services, including market areas of alternative consumer
financial products or services with high growth rates and areas
of risk to consumers;
B. Access to fair and affordable credit for traditionally
underserved communities;
C. Consumer awareness, understanding, and use of disclosures and
communications regarding consumer financial products or
services;
D. Consumer awareness and understanding of costs, risks, and
benefits of consumer financial products or services;
E. Consumer behavior with respect to consumer financial products or
services, including performance on mortgage loans; and
F. Experiences of traditionally underserved consumers, including un-
banked and under-banked consumers. \9\
---------------------------------------------------------------------------
\9\ 12 U.S.C. 5493(b)(1).
The CFPB's resources and access to data will make its research
division a hub for top-flight independent scholars who are trying to
work together to understand how and why consumers become overindebted.
Although good consumer finance research is happening in some Federal
agencies, most notably the Federal Reserve, these research departments
understandably exist to serve the important regulatory aims of their
sponsoring unit such as banking regulation. In contrast, the research
arm of the CFPB works within an organization whose mission it is to
further consumer protection. Instead of research that focuses on how
consumer finance might affect other regulated systems, the CFPB will
produce research that understands how consumer finance affects
consumers. In a few years, we should have a much better understanding
of whether particular financial products are most likely to lead to
overindebtedness.
More Than Just Outstanding Consumer Debt
It was not just rising consumer debt that led Congress to create
the CFPB. Committees such as this one had heard Americans complain for
years about abusive practices in mortgage lending, credit card lending,
arbitration, debt collection, mortgage servicing, payday loans, and
many other industries. The financial crisis of 2008 created a climate
in which the political will finally existed to protect consumers from
practices where companies profited, not by providing a better product,
but by deception, confusion, and lack of information. With the collapse
of the subprime lending market, it is tempting to think that abusive
practices around consumer financial products have disappeared and that
the need for an organization like the CFPB has diminished. Since the
CFPB was created, new problems have appeared, and old problems have
become salient in new ways. At the risk of creating the misimpression
that the challenges are limited by mentioning only a few specific
problems, I will list three current areas of concern in which an
effective CFPB could play a role.
Reverse mortgages allow older persons to draw on equity they have
in their homes and receive a stream of payments to help with expenses
in their retirement years. To make an informed decision on a reverse
mortgage, a consumer needs a good understanding of the value of the
home, life expectancy, and a competitive interest rate. All of these
pieces of information require estimation. Moreover, we can expect
consumers to display bias in making these estimates such as
overestimating the value of the home or life expectancy. In addition,
persons contemplating a reverse mortgage often have liquidity
constraints that create pressure to agree to the reverse mortgage. Some
of the same players in the subprime lending market have moved into
reverse mortgages, leading to complaints from consumer advocates that
were similar to the complaints about subprime lending. Reports of high
fees and financial products inappropriate for the consumer are becoming
more and more frequent in the reverse mortgage industry, which seems
poised to become the next big consumer lending problem area.
Mortgage servicing problems have dominated the news. Borrowers and
even their attorneys are unable to reach a person at mortgage servicers
who can negotiate a reasonable solution. Paperwork mailed to servicers
gets lost or goes unacknowledged. Court affidavits have been mass-
produced and signed by persons with little knowledge over the facts
alleged in the affidavit, a problem now known as ``robo-signing.''
Community-based foreclosure mediation programs founder for want of
funds and participation by both borrower and lender. Foreclosed
properties, wanted neither by the bank or the homeowner, sit vacant and
become a blight on the urban landscape.
Finally, debt collection abuses appear to be becoming more
prevalent. Credit card collections may have replicated the robo-signing
problems in the mortgage servicing industry. Indeed, given that many of
the same players are involved and that credit card debt is sold in ways
that is similar to mortgage debt, it would be surprising if the debt
collection industry did not have robo-signing problems. Other debt
collectors have left families who have lost relatives with the
incorrect impression that the family is legally responsible for the
debts of their deceased loved one. In some areas, reports have surfaced
that creditors act in concert with local courts to abuse procedures
known as ``body attachments'' where a debtor can be arrested for
failure to answer interrogatories related to a debt collection. When
called into court, the technical nicety of being arrested for failure
to answer interrogatories, as opposed to nonpayment of the debt, is
lost on the debtor. Instead, the creditor or the court will tell the
debtor he or she can go free if the debtor starts making payments on
the debt.
Abuses in reverse mortgages, mortgage servicing, and debt
collection are just a few of the current problems that demonstrate how
a comprehensive Federal regulator can help protect consumers.
Responsible companies in these industries should welcome the oversight
of the CFPB to rid the industries of bad actors. Three years into the
financial crisis, it can be easy to forget the conditions that led to
the creation of the CFPB. It is important that short political memories
not hobble an important tool for American consumers just after it
starts.
______
PREPARED STATEMENT OF RAY BOSHARA
Senior Advisor, Federal Reserve Bank of St. Louis
October 4, 2011
Chairman Brown, Ranking Member Corker, and Members of the
Subcommittee, thank you for the invitation to appear before you today.
My name is Ray Boshara, and I am a senior advisor at the Federal
Reserve Bank of St. Louis. Let me state that the views expressed here
today are my own views, and not necessarily the views of the Federal
Reserve Bank of St. Louis or the Board of Governors of the Federal
Reserve System.
At the Federal Reserve Bank of St. Louis, I am organizing a new
effort to study mechanisms that promote household financial stability,
with a particular emphasis on rebuilding the balance sheets and net
worth of American households. My work is focused on families hardest
hit by the financial crisis and the economic downturn, those who have
experienced significant losses of employment, income, and wealth. We
know that balance sheets matter because financially healthy families
spend, save, and invest more, and thereby contribute to economic
growth.
My testimony is in two parts. In the first part, I discuss why a
focus on household balance sheets is necessary. And in the second part,
I offer some policy recommendations, based on my own work, to help
rebuild the balance sheets of struggling families.
Why Balance Sheets Are Important
Balance sheets, by which I mean the savings, assets and debts of
households, merit attention for three reasons. First, over the past few
years we have all seen the damage to families, communities, and the
broader economy derived from balance sheet challenges. For too many
years, household debt levels rose, eventually to dangerous levels,
while little was done to build up household savings and to diversify
family assets beyond housing. When the housing bubble burst, the wealth
of many households plunged, leaving balance sheets, according to some
economists, at a historic low. \1\ For instance, Mian and Sufi report
that both household debt-to-income and household debt-to-assets ratios
reached their highest points since 1950, with the debt-to-income ratio
skyrocketing from 2001 to 2007 by more than it had in the prior 45
years. \2\
---------------------------------------------------------------------------
\1\ Atif Mian and Amir Sufi, ``Household Leverage and the
Recession of 2007-09'', IMF Economic Review, vol. 58 (1), pp. 74-117,
2010. www.palgrave-journals.com/imfer/journal/v58/n1/pdf/
imfer20102a.pdf
\2\ Mian and Sufi, ``Household Leverage and the Recession of 2007-
2009''.
---------------------------------------------------------------------------
While balance sheets have improved somewhat in the last couple of
years, financial instability remains severe among the poor and persons
of color, and reaches into the middle class. Consider these points:
Three-fifths or more of families across all income groups,
according to the 2009 Survey of Consumer Finances (SCF) of the
Federal Reserve, reported a decline in wealth between 2007 and
2009, and the typical household lost nearly one-fifth of its
wealth, regardless of income group. \3\
---------------------------------------------------------------------------
\3\ Jesse Bricker, Brian Bucks, Arthur Kennickell, Traci Mach, and
Kevin Moore, ``Surveying the Aftermath of the Storm: Changes in Family
Finances from 2007 to 2009'', Finance and Economics Discussion Series
2011-17 (Washington: Board of Governors of the Federal Reserve System),
2011. www.federalreserve.gov/pubs/feds/2011/201117/201117abs.html
The Pew Research Center finds that, in 2009, typical net
worth stood at $5,677 for blacks, $6,325 for Hispanics, and
$113,149 for whites. About a third of black and Hispanic
households had zero or negative net worth that year, compared
with 15 percent of white households. \4\
---------------------------------------------------------------------------
\4\ Rakesh Kochhar, Richard Fry, and Paul Taylor, ``Wealth Gaps
Rise to Record Highs Between Whites, Blacks, Hispanics'', (Washington,
DC: Pew Research Center, July), 2011. http://pewsocialtrends.org/files/
2011/07/SDT-Wealth-Report_7-26-11_FINAL.pdf
Almost half of all households surveyed in the 2009 SCF had
less than $3,000 in liquid savings, and 20 percent had less
than $3,000 in broader savings. \5\
---------------------------------------------------------------------------
\5\ Bricker, Bucks, Kennickell, Mach, and Moore, ``Surveying the
Aftermath of the Storm: Changes in Family Finances from 2007 to 2009''.
---------------------------------------------------------------------------
Nearly half of all Americans consider themselves
financially fragile, meaning that they would ``probably'' (22.2
percent) or ``certainly'' (27.9 percent) be unable to come up
with $2,000 in 30 days to cope with a financial emergency. \6\
Similarly, almost half of all Americans report having trouble
making ends meet. \7\
\6\ Annamaria Lusardi, Daniel Schneider, and Peter Tufano,
``Financially Fragile Households: Evidence and Implications'',
Brookings Papers on Economic Activity (Washington, DC: Brookings
Institution, Spring), 2011. www.brookings.edu//media/Files/Programs/ES/
BPEA/2011_spring_bpea_papers/2011_spring_bpea_conference_lusardi.pdf
\7\ Annamaria Lusardi, ``Americans' Financial Capability'', report
prepared for the Financial Crisis Inquiry Commission, 2011. http://
fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0226-
Lusardi.pdf
In a survey by Holtz, Van Horn, and Zukin on the effects of
unemployment and the recession, 70 percent of workers reported
withdrawing funds saved in college and retirement accounts in
order to make ends meet, \8\ likely leading to losses of wealth
in future years.
---------------------------------------------------------------------------
\8\ Debbie Borie-Holtz, Carl Van Horn, and Cliff Zukin, No End in
Sight: The Agony of Prolonged Unemployment, (New Brunswick, NJ: John J.
Heldrich Center for Workforce Development, Rutgers University, May),
2010. www.heldrich.rutgers.edu/sites/default/files/content/
Work_Trends_May_2010_0.pdf
Second, weak balance sheets impact economic growth. Weak balance
sheets--especially due to lower household wealth--have had negative
``wealth effects'' on the economy. Case, Quigley, and Shiller state
that ``the results indicate that increases in housing market wealth
have had positive effects upon household consumption, but declines in
housing market wealth have had negative and somewhat larger effects
upon consumption.'' \9\ In addition, Mian and Sufi show that
``household leverage as of 2006 is a powerful statistical predictor of
the severity of the 2007-2009 recession across U.S. counties. Those
counties that experienced a large increase in household leverage from
2002 to 2006 showed a sharp relative decline in durable consumption
starting in the third quarter of 2006--a full year before the official
beginning of the recession in the fourth quarter of 2007.'' \10\ Many
others, including the Bank for International Settlements and the
International Monetary Fund, have recently identified weak household
balance sheets as one of the key factors inhibiting economic growth.
---------------------------------------------------------------------------
\9\ Karl E. Case, John M. Quigley, and Robert J. Shiller, ``Wealth
Effects Revisited 1978-2009'', Cowles Foundation Discussion Paper No.
1784 (New Haven, CT: Cowles Foundation for Research in Economics, Yale
University, February), 2011. http://cowles.econ.yale.edu/P/cd/d17b/
d1784.pdf
\10\ Mian and Sufi, ``Household Leverage and the Recession of
2007-2009''.
---------------------------------------------------------------------------
And third, a growing body of evidence indicates that families with
assets generally do better in life than those without, and generally
experience better social, behavioral, and educational outcomes. Conley,
using intergenerational data, showed that ``parental education and
parental assets are the single best predictor of educational (and other
socioeconomic) success for blacks and whites. Parental wealth proves so
powerful, in fact, that when added to statistical models, parental
income, occupation and race no longer appear to matter. That is, while
race, income, job status and net worth all tend to vary hand-in-hand,
careful statistical parsing shows that it is really net worth that
drives opportunity for the next generation.'' \11\ Moreover, Cooper and
Luengo-Prado found that among adults who were in the bottom income
quartile from 1984-1989, 34 percent left the bottom by 2003-2005 if
their initial savings were low, compared with 55 percent who left the
bottom if their initial savings were high--that is, 21 percent more
adults moved out of the bottom quartile because they had higher
savings. \12\ And Butler, Beach, and Winfree found that financial
capital, along with family structure and educational attainment, are
the three strongest predictors of economic mobility in America. \13\
---------------------------------------------------------------------------
\11\ Dalton Conley, ``Savings, Responsibility, and Opportunity in
America'', Policy Paper (Washington: New America Foundation, April),
2009. http://newamerica.net/publications/policy/
savings_responsibility_and_opportunity_america
\12\ Daniel Cooper and Maria Luengo-Prado, ``Savings and Economic
Mobility'', in Reid Cramer, Rourke O'Brien, Daniel Cooper, and Maria
Luengo-Prado, eds., A Penny Saved Is Mobility Earned: Advancing
Economic Mobility Through Savings (Washington: Pew Charitable Trusts,
Economic Mobility Project, November), 2009. www.economicmobility.org/
assets/pdfs/EMP_Savings_Report.pdf
\13\ Stuart M. Butler, William W. Beach, and Paul L. Winfree,
Pathways to Economic Mobility: Key Indicators (Washington: Pew
Charitable Trusts, Economic Mobility Project), 2008. www.pewtrusts.org/
uploadedFiles/wwwpewtrustsorg/Reports/Economic_Mobility/
PEW_EMP_Chartbook_12.pdf
---------------------------------------------------------------------------
Further evidence suggests that the earlier in life one has assets,
the better that person will do. For example, Cooper and Luengo-Prado
found that children of low-saving, low-income parents are significantly
less likely to be upwardly mobile than children of high-saving, low-
income parents. Specifically, they found that 71 percent of children
born to high-saving, low-income parents move up from the bottom income
quartile over a generation, compared to only 50 percent of children of
low-saving, low-income parents. \14\ Elliot and Beverly discovered
that, remarkably, youth with any kind of a bank account, as long as the
account was in the youth's name, are seven times more likely to attend
college than those lacking accounts. \15\ Similarly, Zhan and Sherraden
found that, after controlling for family income and other parent and
child characteristics, financial and nonfinancial assets are positively
related to, and unsecured debt is negatively related to, children's
college completion. \16\ And Shapiro, combining data analysis and in-
person interviews with a demographically wide range of families, found
that the presence of even small amounts of wealth at the right times
can have a ``transformative'' effect on the life course. \17\
---------------------------------------------------------------------------
\14\ Cooper and Luengo-Prado, ``Savings and Economic Mobility''.
\15\ William Elliot III and Sondra Beverly, ``The Role of Savings
and Wealth in Reducing `Wilt' between Expectations and College
Attendance'', Research Brief (St. Louis: Center for Social Development,
Washington University, January), 2010. http://csd.wustl.edu/
Publications/Documents/RB10-04.pdf
\16\ Min Zhan and Michael Sherraden, ``Assets and Liabilities,
Race/Ethnicity, and Children's College Education'', Research Brief (St.
Louis: Center for Social Development, Washington University, February),
2009. http://csd.wustl.edu/Publications/Documents/RB10-09.pdf
\17\ Thomas M. Shapiro, The Hidden Cost of Being African American:
How Wealth Perpetuates Inequality (New York: Oxford University Press),
2004.
---------------------------------------------------------------------------
Policy Ideas for Rebuilding Balance Sheets
For families, reducing their debts and rebuilding their savings--or
deleveraging--is already, painfully and slowly, underway. The household
savings rate has now reached around 5 percent, which is significantly
down from the 9 percent average in the 1980s, on course with the 5
percent average in the 1990s, but well above the nearly zero rates the
U.S. fell to in the first part of this century. \18\
---------------------------------------------------------------------------
\18\ Bureau of Economic Analysis, www.bea.gov/newsreleases/
national/pi/pinewsrelease.htm; Federal Reserve Bank of St. Louis,
http://research.stlouisfed.org/fred2/series/PSAVERT; and Massimo
Guidolin and Elizabeth A. La Jeunesse, ``The Decline in the U.S.
Personal Saving Rate: Is It Real and Is It a Puzzle?'' Federal Reserve
Bank of St. Louis Review, vol. 89(6), pp. 491-514, 2007.
---------------------------------------------------------------------------
Yet millions of families need to delever even more, although, not
surprisingly, economists do not agree on ideal or sustainable levels of
household savings and debt. Most agree, however, that rebuilding
balance sheets and igniting the economy require continuing measures to
resolve the housing and foreclosure crisis. Roughly three-quarters of
total household debt is mortgage debt, and nearly one-quarter of
homeowners nationwide have negative equity. \19\ Specific
recommendations to resolve the housing crisis are beyond the scope of
my expertise and testimony, so I will focus on other ideas to help
families build savings and wealth. However, before doing so, I would
like to observe that, historically, home ownership has been an
effective route to wealth accumulation for generations of families,
including for low- and moderate-income families; accordingly, going
forward, policy makers and researchers should continue to study
responsible paths to home ownership for those who are ready and
qualified, with all stakeholders balancing both risks and the rewards.
---------------------------------------------------------------------------
\19\ Board of Governors of the Federal Reserve System, Statistical
Release Z.1, ``Flow of Funds Accounts of the United States'' (September
16), 2011. www.federalreserve.gov/releases/z1/current/z1.pdf; and
CoreLogic, ``New CoreLogic Data Shows Slight Decrease in Negative
Equity'', news release, June 7, 2011. www.corelogic.com/about-us/news/
new-corelogic-data-shows-slight-decrease-in-negative-equity.aspx
---------------------------------------------------------------------------
While several ideas could be offered, let me suggest five savings-
based recommendations to rebuild balance sheets that I think hold
particular promise. \20\ I would like to note that these
recommendations are informed by a key insight gleaned from savings
experiments in the U.S. and around the world. The most interesting
question among researchers is no longer whether low-income families can
save, but how they save and what difference it makes. That is, income
is not the most important predictor of who saves. Instead, what matters
more is who has access to structured savings mechanisms--whether
through the workplace, schools, financial institutions, tax returns,
community-based organizations, and others. A well-funded asset-building
policy, one that includes several billion dollars in tax incentives, is
already reaching middle- and upper-income households in the United
States, \21\ making it easier for them to accumulate savings and
wealth; the core policy challenge, then, is to extend those savings
mechanisms and incentives to families whose earnings fall below median
income.
---------------------------------------------------------------------------
\20\ For this testimony, I will focus on savings-based approaches
to building balance sheets, which have many advantages, although I well
recognize that other important approaches exist to help low-resource
families build assets, including Pell Grants, microenterprise programs,
defined-benefit pension programs, various home ownership and rental
assistance programs, public safety net programs, and many others.
\21\ Butler, Beach, and Winfree, ``Pathways to Economic Mobility:
Key Indicators''; Reid Cramer and Rachel Black, ``The Assets Report
2011: An Assessment of Federal Policies and Proposals To Promote Asset-
Building Opportunities'' (Washington: New America Foundation, June),
2011.http://assets.newamerica.net/sites/newamerica.net/files/
policydocs/AssetsReport2011.pdf; and ``Corporation for Enterprise
Development'', ``Upside Down: The $400 Billion Federal Asset-Building
Budget'' (Washington: CFED), 2010. http://cfed.org/assets/pdfs/
UpsideDown_final.pdf
---------------------------------------------------------------------------
First, build assets as early in life as possible. As discussed
earlier, the evidence thus far suggests that children in homes with
assets, or children with assets, do better in life than those lacking
assets. Policies that automatically create a savings account at birth
for every child born in America, with greater resources available for
lower-wealth families, hold promise to expand opportunity and build a
stronger middle class over time. Such a policy would, if schools
structured financial education classes around the accounts, likely have
a significant effect on building financial skills for children and
youth--some studies show that financial know-how is the result of
regular saving, not the source. If such an ambitious policy cannot be
achieved in the near term, then I would suggest the creation of a
``Kids Roth'' or ``Roth at Birth'' or ``Young Savers Account''--a
slightly modified Roth Individual Retirement Account (IRA) that,
voluntarily, permits children to open and make contributions to a life-
long, tax-benefited account that can also be used for post-secondary
education and home ownership (as current Roth IRAs allow). The creation
of such a nationally sanctioned product directed at kids would likely
spur further experimentation around child savings accounts, which has
been hampered by product-related challenges over the last several
years.
Second, build assets and reduce debts at tax time. Income tax
refunds averaged $2,700 in 2008, while about 24 million Earned Income
Tax Credit (EITC) recipients received refunds as large as $4,824. \22\
These refunds, and the broad reach of the tax system, offer good
opportunities to repair or rebuild balance sheets. The IRS's form 8888,
which enables all taxpayers to deposit their refunds automatically in
up to three separate accounts, holds great promise in leveraging tax
refunds into savings and debt reduction. For example, savings bonds, in
many ways an ideal product for small savers, can now be purchased
directly at tax time. Other interesting pilots, including the ``Refund
to Savings'' Initiative, are under way. To further facilitate savings
at tax time, the Savers Credit, which encourages retirement savings
among low-income taxpayers, could be improved and made available for
contributions to college savings accounts, the purchase of savings
bonds, and other preretirement assets. Third, build assets at the
workplace. The workplace has always been and remains a fulcrum for
building savings and assets. In fact, the vast majority of pension
wealth in the U.S. is structured through employers. Experiments, such
as those testing ``Auto401(k)s'' and the ``Save More Tomorrow''
concept, have generated encouraging results, including for low-income
workers, and the Pension Protection Act of 1996 has removed many of the
barriers to further expansion of those efforts. To generate more
employer-based savings, policy makers could consider proposals to set
up automatic payroll deductions into retirement and unrestricted
savings accounts outside the workplace, informed by the ``AutoIRA'' and
``AutoSave'' concepts currently under discussion. Employers could also
encourage direct deposit of paychecks, which appears to lead to better
financial inclusion outcomes. Finally, one could also imagine automatic
payroll deductions for other assets, such as savings for college or
home ownership, with possible incentives to encourage further saving by
lower-income workers.
---------------------------------------------------------------------------
\22\ David Newville, ``The Saver's Bonus: Encouraging and
Facilitating Savings by Families at Tax Time'', Policy Paper
(Washington: New America Foundation, June), 2009.www.newamerica.net/
files/nafmigration/Savers_Bonus_Two_Pager_FINAL_070209.pdf
---------------------------------------------------------------------------
Fourth, build unrestricted savings, which are savings that can be
used for emergencies or precautionary purposes and which remain in very
high demand by low- and moderate-income consumers. \23\ Those with
sufficient levels of unrestricted savings are more likely to be banked,
more likely to pay down and secure better loans, and more likely to
acquire a longer-term asset such as higher education, a small business,
or a home. And they do better: The Consumer Federation of America found
that low-income families with $500 in emergency savings had better
financial outcomes than moderate-income families with lower savings. In
addition, McKernan, Ratcliffe, and Vinopal found that households that
are ``liquid-asset poor'' are two to three times more likely than those
with liquid assets to experience ``material hardship'' after a job
loss, health emergency, death in the family, or other adverse event.
\24\ Policy makers could consider several measures to boost
unrestricted savings, including (1) expanding the EITC; (2) further
studying and testing prepaid cards, which often include a savings
``bucket" in addition to transaction services; and (3) promoting
reasonably priced small-dollar lending and small-dollar savings
programs among financial institutions, nonprofits, and others.
---------------------------------------------------------------------------
\23\ Stephanie Chase, Leah Gjertson, and J. Michael Collins,
``Coming Up with Cash in a Pinch: Emergency Savings and Its
Alternatives'', CFS Issue Brief 6.1 (Madison, WI: Center for Financial
Security, University of Wisconsin), 2011. www.cfs.wisc.edu/
Publications-Briefs/
Coming_Up_with_Cash_in_a_Pinch_Emergency_Savings_and_Its_Alternatives.pd
f
\24\ Signe-Mary McKernan, Caroline Ratcliffe, and Katie Vinopal,
``Do Assets Help Families Cope with Adverse Events?'' Brief 10
(Washington: The Urban Institute, November), 2009. www.urban.org/
UploadedPDF/411994_help_family_cope.pdf
---------------------------------------------------------------------------
And finally, consider supporting innovations to State-based 529
college savings plans and other ways to generate savings earmarked for
college. Many studies have documented the role that a good education,
especially completion of a post-secondary degree, has on one's future
earning and wealth, and how the lack of an education and skills are
among the strongest predictors of downward mobility. Promising
innovations to learn from include (1) the ``SEED for Oklahoma Kids''
experiment, which is testing 529s established at birth; (2) the
``Kindergarten to College'' initiative in San Francisco, which is
setting up college saving accounts for all of the city's
kindergartners; and (3) the ``Early Pells'' proposal by the College
Board, which would enable a Pell-eligible family to receive a child's
Pell Grant earlier in life as a deposit to a 529 account.
As implied in the recommendations above, there is a great need to
diversify the savings and assets of families, especially those below
median income. The wealth of these families has been concentrated in
home ownership, which has contributed to the stability and upward
mobility of millions of families over time--but which, especially when
not acquired responsibly, or because of price fluctuations, ended up
being a risky asset for too many families. Home ownership, as mentioned
earlier, clearly carries both potential risks and rewards that must be
carefully weighed. It is wise, therefore, for families to have access
to a range of savings products--short- and longer-term, restricted and
unrestricted--that lead to as broad a range of financial assets (such
as investments and retirement accounts) and productive assets (such as
a home, land, post-secondary education, reliable car, or small
business) as possible. As Federal Reserve Board Vice Chair Janet Yellen
has said, ``In light of this experience [with collapsing housing
prices], it makes sense to think about the development of wealth-
building vehicles for low- and moderate-income households that have
some of the desirable qualities of home ownership as an investment, but
perhaps have less of the risk. Such instruments should be simple and
transparent and might include a savings commitment component. Although
households will likely need to take on some risk in order to accumulate
wealth, the risk should not have the potential to destroy a household's
financial security. Continued research in this area is badly needed.''
\25\
---------------------------------------------------------------------------
\25\ Janet Yellen, ``Housing Market Developments and Their Effects
on Low- and Moderate-Income Neighborhoods'', speech delivered the 2011
Federal Reserve Bank of Cleveland Policy Summit, June 9,
2011.www.federalreserve.gov/newsevents/speech/yellen20110609a.htm
---------------------------------------------------------------------------
Conclusion
Mr. Chairman, I commend you for convening this hearing today to
look at high levels of household debt, consumer protection, and
rebuilding the middle class. We know that household debt is both
weighing down millions of families and stifling economic growth.
Thankfully, we have compelling evidence, some of it presented here,
suggesting that rebuilding balance sheets and net worth will help hard-
hit families and the broader economy move forward. I hope to make a
modest contribution to this critical challenge, and I would be pleased
to answer any questions that you might have.
______
PREPARED STATEMENT OF G. MICHAEL FLORES
Chief Executive Officer, Bretton Woods, Inc.
October 4, 2011
Overview
Chairman Brown and Members of the Committee, my name is Michael
Flores and I am CEO of Bretton Woods, Inc., an advisory firm in the
financial services industry.
My firm is in the initial stages of a new study on the impact to
the middle class's access to bank payments and credit facilities. We
have completed studies over the last 10 years on overdraft issues as
well as the emergence of prepaid cards.
We demonstrated in the early 2000s that the cost of an overdraft
was significantly higher that other sources of low dollar, short term
credit. We have also shown that the prepaid card issuers with the most
significant market share were on a par with basic checking accounts but
are now a less expensive option available to the consumer.
Almost every day there is a news release of banks increasing their
fees to consumers. At the same time we are hearing that banks have
plenty of money to lend but are refraining from doing so.
The results of many studies over the last 10 years, including our
own studies, \1\ indicate that the majority of overdrafts were incurred
by the segment of the consumer base that used free checking. Now that
free checking is going away, consumers are closing their checking
accounts and, as a result, losing access to this form of short term
credit.
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\1\ http://bretton-woods.com/71501/index.html
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Our contention is that most banks are operating under a 20th
century business model and have yet to adequately devise a 21st century
model. Some of the issues involve the net interest margin squeeze banks
have endured for the past 15 years as well as recent regulatory changes
that have significantly impacted banks' fee income sources. Those
primary sources are overdraft fees and interchange fees. Other issues
include the quickening pace of technology, the need to meet the
expectations of the young consumers while still providing a service
model with which the older customers are comfortable.
This is what we refer to as the banks' legacy cost structure of
delivering services in an analog world while building the
infrastructure for a digital world.
Banks cannot profitably originate and underwrite individual small
dollar loans. Our analysis indicates that $1,500 in the break-even
point using data from the FDIC Small Dollar Loan Program.
I have included a model in my written testimony for the Committee's
review.
Market driven entrants are able to leap frog the old model and
build a cost structure to effectively deliver these services at
competitive prices. We support the ability of banks and alternative
service providers to have the ability to develop strategic partnerships
or acquisitions to allow legacy banks be more competitive with
entrepreneurial and market driven solutions
A key premise of this hearing is Consumer Protection. I am a true
supporter of clear and concise disclosures so the consumer can make an
informed decision. However, it is becoming apparent that the law of
unintended consequences is alive and well. For example, the reduction
in interchange fees to benefit the consumer, which was basically a
business to business financial issue between the banks and the
merchants, has inadvertently created a significant income
redistribution from the consumers to the merchants in the form of
higher bank fees to the consumer to lower costs/higher margins for the
merchant.
Given this observation, the following are my concerns with the
CFPB:
Concentration of authority with, in my opinion, limited
accountability. I believe that the bureau should be accountable
to Congress as a check and balance, similar to other agencies.
I see inherent problems in separating safety and soundness
with consumer protection. Limitations on products or pricing
beyond market constraints can potentially produce limitations
of credit and access to mainstream banking that we are now
starting to see. Further reductions in income sources to banks
can have a significant impact to safety and soundness.
Furthermore, the cost of compliance is increasing to a
point where many small banks (under $1 billion assets) are
limited in their ability to hire the professionals required.
Finally, I believe the director should report to a board
with a broad representation of the interested parties.
Thank you and I look forward to answering your questions.
Supplemental Data
History of Banking Overdraft Fees
In the 1980s, we advised banks to pay all checks from low dollar to
high dollar so the bookkeepers would have fewer items to process. Fee
income was not the factor it became in the late 1990s. During this
time, banks were experiencing interest margin compression, traditional
finance companies were exiting the business of offering small dollar,
short term credits products (for which the demand did not subside) and
technology became available to process checks presented against
insufficient funds in an automated process. The result was the
development of Courtesy Overdraft Programs that automated the decision
process bank bookkeepers and branch managers have manually made for
decades.
Given this new technology, banks started offering free checking.
The amount of NSF and Overdraft items increased due to the limited
options available for short-term/low dollar credit but the costs to
handle these items were significantly less. Accounts that banks would
not open in the past, they could now do so profitably.
We also changed the presentment order to pay large dollar checks
first before the small dollar items. This was established was as a
customer service. Paying the mortgage payment or rent or car payment
first saved charges and embarrassment of ``bouncing'' those items.
Secondly, when deciding to pay a check into overdraft was limited to
checks (before debit cards and ACH became as prominent as they are
today), this actually saved the customer money. When a bank returns a
check unpaid, it charges the same fee as paying the check into
overdraft. The depositing customer typically redeposits that check that
may result in another NSF fee plus any merchant fees or late fees or
utility reconnect charges. In essence, paying a check into overdraft
can be one-third the ultimate cost of returning the check.
When banks extended the Courtesy Overdraft Program to low dollar
debit card transactions, the customer ceased to receive value.
The Case for Short-Term Credit Advance Loans
The point with the brief history of overdrafts is that when a
customer opens a basic checking account, the bank will still make the
pay or return decision on checks presented against insufficient funds
(even if the customer ``opts-out'' of debit card and ATM overdrafts)
and charge the fee, regardless of the decision. The result of many
studies over the last 10 years, including our own studies, \2\
indicates that the majority of NSF/OD charges were incurred by the
segment of the consumer base that used free checking.
---------------------------------------------------------------------------
\2\ http://bretton-woods.com/71501/index.html
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With the changing landscape of increasing checking account fees,
many consumers of free checking are leaving banking for alternatives,
including prepaid cards. The fact that some these consumers are out of
mainstream banking while others are now paying more for checking
accounts does not diminish the demand for low dollar short term credit.
Additionally with several State initiatives and the imposition of
Regulation E (opt in requirement) to inhibit access to short term
credit, consumers are still in need for this credit facility. The
reason banks have started offering deposit advance loans is that
individually underwriting small dollar loans is not economically
feasible. As a practice, our firm has advised banks since the early
1990s to not originate loans under certain solar limits. The minimum
limit found at many banks is now $1,000 for a consumer loan.
Bretton Woods conducted a cost analysis to originate a small dollar
loan based on the FDIC Small Dollar Loan Program. Our finding, as
indicated in the following chart, show that the minimum loan amount is
approximately $1,500 to breakeven.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Interviews with participants of the SDL program indicate that these
loans are unprofitable. An excerpt from the FDIC report \3\ shows:
---------------------------------------------------------------------------
\3\ http://www.fdic.gov/bank/analytical/quarterly/2010_vol4_2/
FDIC_Quarterly_Vol4No2_SmallDollar.pdf
``Nevertheless, as a general guideline, pilot bankers
indicated that costs related to launching and marketing small-
dollar loan programs and originating and servicing small-dollar
loans are similar to other loans. However, given the small size
of SDLs and to a lesser extent NSDLs, the interest and fees
generated are not always sufficient to achieve robust short-
term profitability (emphasis added). Rather, most pilot bankers
sought to generate long-term profitability through volume and
by using small-dollar loans to cross-sell additional
---------------------------------------------------------------------------
products.''
The average loan amount for short term credit is approximately $300
\4\ according the Center for Responsible Lending.
---------------------------------------------------------------------------
\4\ http://www.responsiblelending.org/payday-lending/research-
analysis/payday-loan-inc.pdf
---------------------------------------------------------------------------
Given the average FDIC Small Dollar Loan program loan amount is
$724 and our estimate that it takes a minimum $1,500 for a bank to
break even on a consumer loan and the demand for a short term loan is
$300, what are the options available to this consumer?
The market currently has options for unanticipated short-term
credit needs in the form of Overdrafts. There are also banks, credit
unions and Alternative Financial Services providers that have product
for anticipated short term credit needs.
As with all products, features need to be weighed against price.
The typical bank or credit union product has a slightly lower price
point for a low dollar loan but require the applicant be a customer for
a period from 1 month to 4 months and have no other delinquencies with
existing credit products. Many consumers who have a need for this
credit may not qualify for a checking account because of previous
issues and reporting to Chex Systems. Others with existing accounts
have or are considering closing their checking account due to higher
fees being assessed.
A recent article from Money Magazine, ``Get a Fair Shake, Not a
Shake-down'', dated September, 2011, depicts the reasons for this trend
in bank fees:
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Our own analyses of the cost of checking accounts compared to
prepaid cards and check cashing using the Consumers Union standard
transaction profile \5\ in August of this year shows:
---------------------------------------------------------------------------
\5\ http://www.consumersunion.org/pub/core_financial_services/
014300.html
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The bank costs are now understated given the recent news from Bank
of America and Citibank.
______
PREPARED STATEMENT OF DOUGLAS FECHER
President and Chief Executive Officer, Wright-Patterson Federal Credit
Union, Fairborn, Ohio
October 4, 2011
Mr. Chairman and Members of the Committee, thank you for the
opportunity to speak to you about responsible consumer lending
practices.
My name is Doug Fecher, and I am President and CEO of Wright-Patt
Credit Union, a $2.1 billion financial cooperative serving more than
210,000 members in Dayton, Ohio, a community hit hard by a challenging
economy. In the last 3 years, Dayton has lost thousands of jobs,
leaving many of our credit union members to face an uncertain financial
future.
Attached to my testimony are several alarming statistics that put
the struggles of the typical consumer into perspective.
A decade ago, the ratio of household debt to disposable
income was roughly 80 percent, which, proportionally, allowed
people to effectively manage their debt. Today, that ratio is
closer to 120 percent, leaving the typical consumer with little
safety margin to help them cope in difficult times.
Consumer savings rates have plummeted. Two decades ago,
consumers saved nearly 12 percent of their disposable income;
today they save less than 5 percent.
Home prices have dropped dramatically in the last 5 years,
decreasing in value more than 13 percent in 2008 and 5 percent
so far this year.
Clearly, the need for affordable financial services has never been
greater.
This is precisely where credit unions like Wright-Patt excel. To
some, our Nation's credit unions, as not-for-profit, democratically
controlled cooperatives--are anachronisms in our modern financial
system. But credit unions are different by design with an intensely
local focus that has paid enormous dividends during this time of
financial crisis and slow economic growth. The numbers speak for
themselves:
Every year of the past four (2007-2010) our Nation's 7,300-
plus credit unions have granted over $250 billion in loans;
Credit union members have over 45 million loans
outstanding;
Credit union loan quality is the strongest of all insured
financial institutions, with 60-day delinquency of just 1.6
percent, compared to bank 90-day delinquency of 4.4 percent;
Credit union net charge-offs peaked in 2009 at 1.22 percent
of all loans and are now below 1.0 percent;
Credit union auto loan market share reached its peak of
22.7 percent when the auto market was at its most difficult
point ever during the Great Recession (and in many cases credit
unions were the only active lenders in their communities);
When home prices were failing at the greatest rate, credit
unions achieved 5.8 percent market share in mortgage
originations, its highest ever; and
Credit union real estate loan modifications total over $10
billion helping nearly 60,000 members stay in their homes.
Indeed, credit unions in the United States support over 900,000
jobs. We have tripled our mortgage-lending market share in 3 years and
become the Nation's #1 manufactured housing lender. And we've restarted
a moribund private student market--at affordable rates--so far making
more than $1 billion in student loans that have enabled more than
220,000 students advance their education.
And we've done these things by being true to our core values of
helping America's consumers make smart money choices with organizations
they can trust to help them gain a sense of financial stability in an
otherwise difficult environment.
Here's how this plays out at Wright-Patt Credit Union. Our mission
is to help folks achieve financial freedom for themselves and their
families. Specific to members' use of debt we follow four commonsense
principles:
1. Wright-Patt only makes affordable loans members will be able to
repay;
2. We tell members exactly what their loans will cost without hidden
fees or penalties;
3. We take every opportunity to advise members on how to increase
their savings even when they are taking out a loan; and
4. We treat those who fall behind with dignity and respect, and we
work closely with members to develop reasonable plans--
including modification when appropriate--to return them to
sound financial health.
These principles are the foundation of the way we lend. They create
an environment where we get to help people change their lives. Here are
just a few examples.
Mortgage Modification: Wright-Patt Credit Union makes mortgage
loans to help members enjoy affordable long-term home ownership. One
member--typical of many--recently found herself in a predatory mortgage
loan with a rate and payment she couldn't afford. She was faced with
losing her home. Thanks to WPCU's partnership with Miami Valley Fair
Housing, she came to Wright-Patt Credit Union. After a lot of hard work
by our staff and by the borrower herself, we were able to find a
mortgage that lowered her payment and reduced the loan term to 15
years. Had it not been for her credit union, our member would have lost
her home through sheriff's sale. Now she gets to keep her house with a
payment she can afford and a loan that will help her build equity.
Credit Cards: We also lend for credit cards differently than most.
The Nation's largest banks offer credit cards that are designed to get
consumers to spend more in the hopes of receiving rewards or cash-back
on their purchases. Interest rates on these cards routinely exceed 20
percent. At Wright-Patt, we think credit cards are a convenient payment
mechanism, and not a temptation to run up debt. Our credit card does
not feature rewards that entice more spending, and we charge a rate
starting at just 6.25 percent so members have a reasonable chance of
paying their card in full in a manageable period of time.
Emergency ``Payday'' Loans: Wright-Patt Credit Union also offers a
small-dollar loan product called StretchPay so members aren't tempted
to visit payday lenders when they run low on cash. StretchPay is now
being offered by 51 other credit unions in Ohio, eight other States,
and the District of Columbia. StretchPay is a ``payday loan
alternative,'' and does three things for members:
1. It offers an emergency line of credit up of $250 at an interest
rate of 18 percent and an annual fee of $35. With no new
advances until paid in full, we help members avoid a ``circle
of debt'';
2. It improves credit ratings since, unlike payday lenders, we
report payments to credit bureaus with the ultimate goal of
qualifying members for even lower-cost loans on the strength of
a new repayment history; and
3. It helps members start a savings account and provide free
financial education to teach them how to build savings rather
than use high cost loans to deal with cash emergencies.
First-Time Car Buyers: WPCU serves the airmen and airwomen of
Wright-Patterson Air Force Base. Many of these young service men and
women come to base straight from high school with little or no
financial education. To help them gain reliable transportation without
visiting ``buy-here, pay-here'' lots, we help them locate an affordable
car, have it examined by a certified mechanic, and offer a loan rate
and payment that fits their financial profile.
Savings Rates: Our credit union's responsibilities to members don't
end with lending products. We also incorporate savings programs that
encourage members to become financially stronger by building up safety
reserves. Every member receives a 5 percent dividend rate on the first
$500 they are able to save in their WPCU primary membership account. We
use the 5 percent dividend in a time when average rates are less than
0.5 percent as incentive to save. We pay this rate even on accounts
with balances as low as $5 so that every member has the opportunity to
earn a decent rate on whatever they're able to save.
The Savings Race: Wright-Patt Credit Union, in conjunction with a
local television station, plays ``The Savings Race'' with five local
families from October through June. The game plays out on local
newscasts and is a contest to see which of the five families is able to
improve their net worth the most over the 8 months of the contest. (The
game is similar to ``The Biggest Loser'' on network television which is
devoted to losing weight; in our version we improve net worth.) Using
WPCU employees as coaches, in 3 years our families have improved their
net worth by a combined $389,623 of savings growth and debt reduction--
that's an improvement in net worth of more than $25,000 per family. The
next season of ``The Savings Race--Home Edition'' starts October 6.
Financial Education: Financial education is important at Wright-
Patt Credit Union. Much of this education is around helping members
know how much their loans actually cost and, if we can help them save
money, bring their loans to the credit union.
In March, 2011, we challenged members to save at least $50 on high-
interest loans by refinancing with Wright-Patt. If we couldn't save at
least $50 on their loans, we'd pay them $50. Part of the deal was
letting us review their credit report alongside them in detail--an act
which opens more than a few eyes to just how much more money folks are
spending than they need to. In just 6 months of the credit review
program we've helped thousands of members reduce interest payments on
existing debt by more than $10 million dollars.
Free Financial Counseling: WPCU provides free budget and debt
counseling to members at no cost from their credit union. Our
counselors will help negotiate lower payments and settlements so
members have a better chance of financial recovery.
Total Savings: In the last 3 years Wright-Patt Credit Union
programs have put more than $23 million dollars back in consumers'
pockets. Across Ohio, credit unions have put direct financial benefits
of $132 million back into the pockets of Ohio's 2.68 million credit
union members. Nationwide, credit union members have saved almost $6.5
billion by using credit unions.
We are proud of how much we've helped members save. But, like all
smaller financial institutions, we face challenges that hinder our
ability to spend time helping consumers.
Since 2008 we've been given more than 160 new rules and regulations
from some 27 different Federal agencies. While credit unions would
rather hire loan advisors and financial counselors to help consumers
improve their financial situation, we're instead hiring compliance
offers to deal with the new rules. The largest banks have armies of
attorneys to deal with these regulations--we don't. It is not an
exaggeration to say our Nation's small, community-based financial
institutions are exposed to a situation where they ultimately may be
regulated out of business. This should concern us all.
I'd also like to comment briefly on the new Consumer Financial
Protection Bureau. Credit unions are generally in support of the
bureau's goals; to us, the greater transparency and consumer disclosure
required by the new agency simply highlights the way credit unions have
always done business. Richard Cordray, a fellow-Ohioan who has been
nominated as the agency's director, has outstanding qualifications and
understands the unique role credit unions play in the lives of
consumers. We hope the agency empowers credit unions to do their jobs
of helping consumers make smart use of credit without creating even
higher regulatory costs.
Let me close with an email I received just last week from a member
who personifies the typical financial conundrum faced by our
membership:
I'm writing you today to inform you of the difference your
company has made in my life. My previous car payment was $348
and with my rent being $699 a month including my other
household bills I could barely make ends meet. Some weeks I
could not feed myself due to the strain of having this enormous
car payment. Just two weeks ago your credit union approved me
for a car payment of $192. You guys saved me $156 dollars each
month. My interest rate went from 23.9 percent down to 8.9
percent. You guys helped me keep food on the table.
This email is one of many I regularly receive, and affirms to me
that we are doing what you want us to do--we are taking care of
consumers, helping them improve their financial situation, and putting
money back in their pockets to use in supporting their families. I
believe we need to strengthen America's cooperative credit unions as an
essential resource for the current fiscal crisis plaguing this country.
To conclude, I frequently tell my staff that we are not doing our
job if our members are not in better financial health today than when
they first sought our services. I hope this testimony gives you a
glimpse into the benefit we bring to our Nation's financial table.
Thank you for the opportunity to present to you today. I will be
glad to answer any questions.
______
PREPARED STATEMENT OF IDA RADEMACHER
Vice President for Policy and Research, Corporation for Enterprise
Development
October 4, 2011
Good afternoon, and a special thank you to the Subcommittee on
Consumer Protection and Financial Institutions--especially Chairman
Brown and Ranking Member Corker--for convening a hearing focused
explicitly on exploring ways to help everyday Americans build (or
rebuild) their wealth at a time when our collective and individual
balance sheets are very much in the red. For over 30 years my
organization has been deeply engaged in researching and advancing
promising strategies that help low, moderate and middle income (LMI)
families and communities build wealth and financial resiliency. At no
time has our work and the work of our many partners been more needed--
or more difficult--than right now. And at no time has the leadership of
Congress on issues of consumer financial protection and helping
families save and build assets been more important than right now.
It is my goal with this testimony to achieve three objectives:
First, I will provide you with a concise (but bleak)
picture of the current state of financial security among
middle- and low-income households in America, and describe how
the set of policies we currently have on the books to protect
LMI consumers and help them build wealth have missed their
mark.
Second, I will present a framework that illustrates--from a
household's perspective--what it really takes to build
financial security and economic mobility over time.
Third, I will describe a range of actions that members of
Congress--and of this Subcommittee in particular--could take in
the near future that would help millions of Americans
successfully navigate the financial marketplace and begin to
save, invest and build assets that will help us to rebuild our
middle class and our economy.
Financial Security and Stability Among LMI Households
The middle-class squeeze in America is more pronounced and more
consequential than at any time in modern history. New research in the
last few years has really helped us get a better handle on some
additional the dimensions of financial security that go beyond income
poverty and unemployment statistics. For example:
Over half of the population in the U.S. with a credit score
has what can be considered subprime credit. In some areas, that
number closes in on 70 percent.
One in four Americans either have no bank account, or are
considered ``underbanked'' meaning they use alternative and
largely unregulated financial products and services that are
often very high cost and abusive. In the African American
community, the number of un- and underbanked households rises
to one in two, or 50 percent.
Over half the population doesn't have enough liquid savings
and assets to help them survive at the poverty level for 3
months if they lost their source of income (that's only about
$4,000 for a family of three).
Another recent survey found that over half the population
isn't confident they could find a way to scrape together $2000K
if they had an emergency.
Last week the company CardHub.com published its Q2 2011
Credit Card Debt Study, showing that consumers accumulated
$18.4 billion in new debt in the second quarter of 2011--a 66
percent increase over the same quarter in 2010, and a 368
percent increase over the same period in 2009.
Middle-income household debt-to-income ratios have risen
from 67 percent in 1983 to 100 percent in 2001 and 157 percent
in 2007. And the evidence indicates that the debt pile-on was
directed at maintaining normal consumption not enhanced
consumption.
None of this bodes well for the future of America's middle class.
Make no mistake, ``middle income'' and ``middle class,'' are not
synonymous. To illustrate this point, consider the 2009 research study
from the Pew Economic Mobility Project that found that almost half (45
percent) of black children whose parents were solidly middle income
ended up falling into the bottom of the income distribution as adults,
compared to only 16 percent of whites.
Clearly there is something besides income that has historically
helped to make middle-class status more ``sticky'' and
multigenerational. One of the key ``somethings'' has been asset
development--home ownership, higher education, savings, inheritance--
these are all part of the explanation. Historically white families have
more of these. A lot more. Professor Thomas Shapiro of Brandeis
University and renowned expert on racial wealth disparities finds that
white families are four times more likely than blacks to inherit, and
when they do the median inheritance is 10 times greater. Another recent
Pew report found that between 2005 and 2009 median household wealth
plunged 66 percent among Hispanics and 53 percent for blacks, while
dropping just 16 percent for white households. The result is that the
net worth of white families is now 20 times greater than that of black
families and 18 times more than Hispanic households--the largest gap in
25 years. The middle class is shrinking across the board. But for
communities of color, the middle is being decimated.
The Role of Tax Policy in Asset Building
The shrinking ranks of the middle class and the growing wealth gap
are phenomena that are as predictable as they were preventable. The
recession has clearly exacerbated the problem, but at its core the
widening wealth gap reflects years of Government policy decisions that
disproportionately help high-income households build assets while
virtually ignoring the needs of the middle class and explicitly
penalizing efforts by low-income households to save and invest.
Last year CFED and the Annie E. Casey Foundation published the
report ``Upside Down'', which showed that the Federal Government spends
upwards of $400 billion a year to encourage Americans to save for
retirement, go to college, start businesses, and purchase homes. But
here's the catch: These ``asset-building'' policies are primarily
administered through the tax code as special deductions and deferrals.
As a result these subsidies are overwhelmingly accessible primarily to
Americans in the very highest income brackets, with little evidence
that the incentives generate much in the way of net new savings.
Meanwhile, the majority of the population in middle- and lower-income
brackets who do not have enough of a tax liability to warrant
itemizing--those most in need of building a financial cushion to deal
with short term income shocks and long term economic uncertainty--
receive miniscule levels support.
In 2009 more than half of the $400 billion in asset-building
benefits went to the top 5 percent of tax-payers. The bottom 60 percent
of households received less than 4 percent of those subsidies. Another
cut of the data shows that households making a million dollars or more
received a $95,000 subsidy to help them build assets--enough to finance
a pretty good college education for their kids. Households making less
than $20,000 got about five dollars--enough to finance 2 days of school
lunch.
This ineffective and skewed allocation of expensive tax subsidies
has added to both the Federal deficit and the growing wealth gap
between Americans with means and those working to make ends meet.
A Framework for Household Financial Security
The thing is we do know what it really takes for a household in
America to build financial security over time. But at present we don't
do a lot to help average families succeed in this endeavor. CFED has
created the Household Financial Security Framework to describe the
basic elements of building household financial security, which, on the
face of it, looks relatively straightforward. Individuals must first
learn the knowledge and skills that enable them to earn an income and
manage their financial lives. They then use their income to take care
of basic living expenses and service debt payments, and then--if income
has exceeded expenses--they can save some for future purposes. When
they have accumulated enough liquid savings, they can leverage those
savings and invest in assets that will appreciate over time and
generate increasing levels of income, equity and net worth. Throughout
the cycle, access to safe, affordable financial products, insurance and
consumer protections help households protect the gains they make.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
In reality, there is nothing particularly straightforward about
getting a household balance sheet to balance, much less tip toward
asset accumulation. As the data I reviewed earlier makes abundantly
clear, financial security is the exception rather than the rule for the
majority of Americans. Every day, as people try to navigate the
increasingly complex financial marketplace, they need to make choices
without full information, clear guidance or adequate protection. It's
not that people don't understand the downsides, inconveniences and
long-term implications of being unbanked, using costly credit, skipping
their mortgage payment or failing to save for college or retirement.
But without adequate income, savings or products options, their choices
are limited. A big part of the problem has very little to do with
individual knowledge and skills and instead has to do with the systems,
structures and protections that exist--or don't--in the financial
marketplace.
The primary goal of policy change aimed at strengthening the
financial security of households should be to ensure that the market
provides a range of safe, affordable, and accessible financial products
that meet the transactional, savings and credit needs of low- and
moderate-income households and to establish consumer protections that
enable all households to participate fully in the consumer financial
markets with confidence and trust.
Which brings me to my final objective: Outlining a range of
specific policies and actions I would urge Members of the Subcommittee
to take with your colleagues to improve the asset building
opportunities of all Americans.
Federal Policies To Encourage Asset Building and Consumer Protection
Some would argue that in the current economic climate, with so many
people struggling just to make ends meet, it isn't realistic to focus
on saving and wealth building. But this view is unnecessarily limited;
earning and saving is not an either/or scenario, and it is incumbent on
us to help households find a way to do both. Saving is critical for
low-, moderate- and middle-income households precisely because these
families are the most vulnerable to income shocks from job loss,
medical emergencies, and even car repairs. Such emergencies can knock
them totally off course financially. Research from the Urban Institute
shows that owning a small amount of assets--even just the $4,000 or so
that it takes to move out of asset poverty--provides as much protection
against material hardship in the face of an economic shock as being in
the next highest tier of the income distribution. As a starting point,
we must at the very least commit to getting people on the path toward
financial stability by giving them the tools and assistance required to
reduce debt, repair credit, get banked and build savings, and by
protecting them from scams and from abusive and deceptive products.
Households need access to safe, affordable consumer financial products
and services. Individuals and families need to have information in
order to effectively compare the costs and benefits of different
financial products and make the best choices for themselves.
CFPB Recommendations
A significant portion of this work now falls under the purview of
the Consumer Financial Protection Bureau. This institution can provide
vital support to consumers in the financial markets, and do so without
massive new Government spending or onerous mandates. Rather, CFPB can
do a great deal to facilitate savings and asset building by LMI
households through ensuring that consumers' interests are considered
and valued in the context of Federal financial regulation processes
that already exist. Congress, of course, has a critical role to fulfill
with regard to CFPB; you can ensure that the Bureau is fully capable of
meeting its mission and establish accountability for achieving its
goals.
The first step that the Senate should take is to confirm a
director to lead CFPB. One of the overarching goals of the
Dodd-Frank Act was to unify the oversight and regulation of the
entire financial services marketplace under one set of clear,
transparent rules with consumer well-being in mind. Without a
director, the Consumer Financial Protection Bureau doesn't have
the authority to regulate many types of nonbank financial
businesses, leading to an uneven playing field in which some
firms are required to play by the rules while others are not.
The Bureau is significantly restricted in its ability to
regulate in many areas, including nonbank financial
institutions, payday lenders, private education lenders,
consumer credit rating agencies, and mortgage servicers.
CFPB must have a confirmed director not just for administrative
reasons or to expand its authority, but also to actually
achieve its primary objective: to protect consumers from
financial products that exacerbate financial distress. Rather
than banning ``bad'' products, the Bureau's leadership has
indicated that it plans to pursue this mission through
incenting the delivery of products and services that provide
measurable benefits to consumers and by ensuring the consumers
have the information they need to make informed choices about
what products and services are best for them. The alternative
credit industry thrives for three reasons all too familiar to
consumer protection experts: first, the intense demand for
emergency credit; second, a captive, vulnerable, and often
unsophisticated population; and third, the lack of a single,
clear, trustworthy, and enforceable regulations for the product
landscape. CFED commends the Bureau for its intention to focus
on improving consumers' ability to access and understand
information about these credit products through disclosures,
financial education, and supervision of lenders.
Congress should encourage the CFPB to focus on improving
disclosures for all consumer financial products. Both
transaction products and credit products can and often do build
hidden fees and penalties into their products that create
conditions of financial uncertainty for LMI consumers that they
can ill-afford. With transaction products, issues include
overdraft charges, insufficient funds fees or point of sale
charges. For example, research by former Assistant Secretary of
the Treasury Michael Barr shows that the most important
features of transaction products for LMI consumers are
transparent monthly costs and Federal consumer protection.
The CFPB should examine the impact that expanding the
amount of information reported to consumer credit rating
agencies would have in helping thin- and no-file consumers
build their credit records. The CFPB should study and supervise
the credit information markets with an eye toward increasing
their transparency and fairness.
Consumer credit reports are now sought not just by prospective
lenders evaluating specific consumers' loan applications, but
also by landlords, employers, banks and others. Credit reports
have never been more critical to a person's ability to
participate in the financial mainstream, but they are opaque,
lightly regulated, and difficult for consumers to work with.
Moreover, as many as 70 million Americans have no credit files
or no payment histories in their credit files, and consequently
have no credit score. Tens of millions more have too few
payment histories in their credit files to be scored with
precision. A straightforward solution is to simply add more
information to credit files. Utility and telecommunications
bills are nearly universal; including all payment information
for these transactions would enhance credit access for millions
of households. This market-driven policy response will help
lenders better assess credit applicants and decrease the
Nation's persistent--and widening--wealth gap.
Congress, however, has an important role here, that the Bureau
alone cannot accomplish. Despite compelling evidence that alternative
data credit reporting is a win-win scenario for borrowers and lenders,
utility and telecom firms are reluctant to report full payment
histories to the credit bureaus due to regulatory uncertainty;
currently most firms only report late payments. Some States have
introduced legislation to promote alternative data credit reporting
while others have moved to prohibit the practice. At the Federal level,
some companies that previously reported full payment histories to the
credit bureaus have stopped due to uncertainty about privacy
requirements. Congress can resolve the uncertainty through legislation
that provides affirmative permission to utilities and telecom firms to
report all payment history to the consumer credit bureaus.
Beyond the CFPB
Looking beyond the CFPB, Congress can support many equally
important policy reforms and new opportunities to enhance the ability
of LMI families to save money and build assets. Our research shows that
current U.S. policies--or at least the 90 percent that operate as tax
expenditures--are regressive, invisible and unregulated. They are of
little help to the majority of households that are trying and become
more financially secure. Significant improvements could be made with
the following proposals:
Remove Disincentives To Save
One way to do this would be to eliminate asset tests as this would
primarily benefit working poor households. Asset limits, or caps on the
maximum value of assets a household may have to be eligible for certain
benefits programs, deter people from seeking work, opening bank
accounts and saving money. CFED supports reforms that encourage
economic self-reliance. Congress should consider removing the penalties
in our safety net programs for developing savings that can eventually
help families become financially independent. Congress could follow the
lead of Ohio, Virginia, Alabama, Louisiana, and Maryland--all States
that have eliminated asset tests in their TANF program. They realized
that families applying for TANF had no real financial assets. The cost
of staff time to find nonexistent assets was exorbitant--Virginia
reported that it was spending about $330,000 a year to weed out just
one-half-of-one percent of participants. We commend Congress for making
progress: Senator Chambliss led efforts to exempt IRAs, 529 and
Coverdells from asset limit tests in SNAP. But further action is
needed.
Congress should raise asset limits in SSI. The current rates, set
at $2,000 in the 1980s and never raised for inflation, dampen
initiative and discouraged people from banking and saving, working
toward some amount of financial self reliance. The Senate could follow
the lead of the bipartisan SSI Saver's Act (H.R. 2103).
Improve the Existing System for Savings
Expand the Saver's Credit. The Saver's Credit should be
strengthened and reformed to enable millions of Americans to receive an
additional incentive to build their savings and enhance their financial
security. The original Saver's Credit passed in 2001. The IRS recently
released data showing that 6.4 million tax filers claimed the credit in
2009, the largest number of claimants ever. The average credit was only
$167 though, largely because tax filers with income low enough to claim
the credit have limited tax liabilities. This speaks to the need to
improve the credit, so it can serve the purpose it was designed for:
make saving for retirement rewarding and straightforward for low- and
moderate-income workers. CFED proposes expanding the Saver's Credit to
provide a 50 percent match on retirement savings up to $500 ($1,000 for
joint filers), making the credit refundable, and depositing the match
directly into the filer's retirement savings account. With these
changes, the Saver's Credit would reach as many as 50 million tax
filers. This would provide powerful incentive to lower-income people
who desperately need to build wealth and provide an easy, safe way for
them to save and invest.
Enact Automatic IRA. Seventy-eight million people, half of the U.S.
workforce, lack access to employer-sponsored retirement plans.
Automatic IRA is a legislation that will enable workers without a
retirement plan at work to use payroll deductions to open and fund IRAs
with a minimum of effort. Increasing personal retirement savings is a
critical challenge that policy makers should address. Social Security
has been the most effective solution to elderly poverty, but it will be
increasingly important for workers to supplement Social Security with
personal savings. Automatic IRA is an inexpensive, market-friendly way
to ensure that 78 million workers have the opportunity to save.
Reauthorize the Assets for Independence Act. The Senate should
reauthorize and improve the Assets for Independence Act (AFIA, P.L.
105-285). Individual Development Accounts (IDAs) are a proven tool to
help low-income families achieve financial security through savings and
asset building, and AFIA is the primary source of Federal support for
IDAs. The Assets for Independence program is one of the few programs
that reaches low-income households that focuses on wealth-building and
financial education to help these households get ahead. As a result,
AFIA has been critical to the success and widespread adoption of IDAs
from few accounts in the 1990s to more than 120,000 accounts today.
Unfortunately, current economic realities such as State budget
crises and reduced availability of philanthropic grants pose challenges
to a program that has successfully helped low-income families lift
themselves out of poverty. Strong interest and limited local funds have
resulted in nearly every IDA program in the country placing potential
savers on waiting lists. The reauthorization of AFIA presents an
important opportunity to make small, but critical modifications to
increase AFIA's utilization and ensure its continued success.
Recommendations include improving and streamlining requirements and
opportunities for grantees, expanding participant eligibility
qualifications and savings goals, and developing new partnerships,
promoting research, and encouraging innovation.
Build a New System of Child Savings Accounts
Children's savings accounts (CSAs), tax-preferred investment
accounts opened for each child at birth, are powerful financial
products that could expand economic and educational opportunities for
children by encouraging long-term planning, building family wealth and
promoting financial literacy. CFED supports the efforts of our
colleagues at the New America Foundation to establish a lifetime
savings account for every newborn child in America. The America Saving
for Personal Investment, Retirement, and Education Act (The ASPIRE Act)
would set up a special account at birth for every child that could
later be used to pursue post-secondary education, buy a first home, or
build up a nest egg for retirement. The ASPIRE Act calls for each
child's LSA to be endowed with a one-time $500 contribution at birth.
Children living in households with incomes below national median income
will be eligible for both a supplemental contribution of up to $500 at
birth as well as the opportunity to earn up to $500 per year in
matching funds for amounts saved in the account. Financial education
would be offered in conjunction with the accounts.'' \1\
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\1\ http://assets.newamerica.net/the_aspire_act
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States and cities are starting to recognize the value and potential
of offering children's savings accounts. In Maine, every child is
eligible for $500 in a college savings 529 account, and 12 other States
now match contributions to 529s. In San Francisco, every public
Kindergarten student is given a savings account upon enrollment that is
seeded with $50 ($100 if they receive free and reduced cost lunch), and
provided with matching incentives and financial education over time.
Singapore, Canada, and even the United Kingdom have used state funds to
open bank accounts for kids realizing that kids with college funds are
more likely to achieve financially.
Taken together, all of these policy proposals would cost a small
fraction of what the Federal Government currently spends to subsidize
asset building for taxpayers in the highest income brackets, and could
easily be funded by capping some of those expensive unfair and
ineffective subsidies currently in place. Most importantly, they would
begin to address some of the long-term inequities that contribute to
the wealth gap, and they would help millions of families build a more
secure economic future.
Mr. Chairman, thank you very much for this opportunity to testify
before the Subcommittee. I would be pleased to answer any questions you
and the other Members of the Subcommittee may have.
______
PREPARED STATEMENT OF SUSAN K. WEINSTOCK
Director, Safe Checking Project, Pew Health Group, The Pew Charitable
Trusts
October 4, 2011
Thank you Chairman Brown, Ranking Member Corker, and Members of the
Subcommittee for the opportunity to submit testimony about the
importance of transparent and fair financial products and services as a
means to sustain and build wealth. The Pew Charitable Trusts is driven
by the power of knowledge to solve today's most challenging problems.
Pew applies a rigorous, analytical approach to improve public policy,
inform the public, and stimulate civic life. Based on research and
critical analysis, the Pew Health Group seeks to improve the health and
well-being of all Americans. One important component of which is
consumer financial product safety, as research by the Federal Reserve
has documented the link between socioeconomic status and health. \1\
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\1\ Daly, Mary, Greg Duncan, Peggy McDonough, and David Williams,
``Optimal Indicators of Socioeconomic Status for Health Research'',
American Journal of Public Health, 2002 Jul; 92(7): 1151-1157. http://
www.ncbi.nlm.nih.gov/pubmed/12084700
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Pew's Safe Checking in the Electronic Age Project aims to restore
transparency, fairness, responsibility and free market principles to
one of the most common consumer financial products--the checking
account. We appreciate this opportunity to provide further details on
our consumer financial products and services research. Our findings
demonstrate the importance of consumer financial protections, which
allow families to manage their money responsibly and build savings and
assets. Based on our research, Pew developed policy recommendations
that would bring needed transparency, fairness, and free market
principles to checking accounts.
Nine out of 10 Americans have a checking account, making it the
most widely utilized financial services product. These accounts provide
a secure way for Americans to collect earnings and make payments, and
for many, they serve as the entry to the financial mainstream, where
savings and credit products are available. As vehicles for millions of
transactions each day, checking accounts are essential to the national
economy.
In October 2010, the Pew Health Group's Safe Checking in the
Electronic Age Project began a study of checking account terms and
conditions to examine both the state of the marketplace and the effect
of current regulations covering checking accounts. \2\ We analyzed more
than 250 types of checking accounts offered online by the 10 largest
banks in the United States, which held nearly 60 percent of deposit
volume nationwide. Through this research, we identified a number of
practices that put consumers at financial risk, potentially exposing
them to high costs for little benefit. I would like to highlight three
of these concerns: (1) the need for a disclosure box laying out account
terms, conditions, and fees; (2) complete disclosure of all overdraft
options; and (3) prohibition of transaction reordering that maximizes
overdraft fees.
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\2\ Pew Health Group, ``Hidden Risks: The Case for Safe and
Transparent Checking Accounts'', April 2011. http://www.pewtrusts.org/
uploadedFiles/wwwpewtrustsorg/Reports/
Safe_Checking_in_the_Electronic_Age/Pew_Report_HiddenRisks.pdf
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Clear Disclosure Makes the Market More Efficient by Allowing Comparison
Shopping
Consumers need a clear, concise, and easy-to-understand disclosure
of their checking account terms and conditions.
Disclosures are critical for consumers to make informed decisions,
but the information needs to be presented in a format that is clear and
understandable. They should convey key terms and conditions with
clarity so that consumers can compare products and make purchasing
decisions that best meet their needs. Clear disclosures will foster a
transparent, fair, and competitive marketplace for all financial
institutions by allowing them to compete for customers on a more level
playing field.
Unfortunately, the checking accounts in our study did not meet this
standard. We found a median of 111 pages of disclosure documents,
consisting of account agreements, addenda to account agreements, fee
schedules, and pages on the bank's Web site. The banks often used
different names for the same fee or service; put the information in
different documents, different media (Web or hard copy), or different
locations in a document; and did not summarize or collect key
information anywhere. Many of these documents are not user-friendly,
with much of the text densely printed, difficult to decipher, and
highly technical and legalistic. In response, we have developed a model
disclosure box that could be used by financial institutions to provide
relevant information to checking account customers (see below).
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
In developing the disclosure box, we tested different versions with
consumers. In Philadelphia, Minneapolis, and Los Angeles, we heard from
two groups of consumers who had opened a checking account within the
past 2 years: one with parents who had assisted a young adult child and
one with adults ages 21 to 35. Across all groups, participants were
quite positive about the disclosure box. They described the information
in the box as ``comprehensive'' and ``clear,'' and felt that a concise,
easy-to-understand disclosure document would be useful and valuable
when opening a checking account. Across groups, the box was seen as
providing information that might help individuals avoid fees,
penalties, and personal financial errors. One participant said, ``It's
knowledge first of what you are doing so you don't mess your account
up.'' Many thought the disclosure box would be useful if they wanted to
investigate a bank and/or compare banks on the basis of fees.
As a follow-up, in July 2011, Pew commissioned a national survey of
U.S. checking account holders. We found that 78 percent of account
holders find that requiring banks to provide a one-page summary of
information about checking accounts' terms, conditions, and fees would
be a positive change, while only 4 percent say this would be a negative
change. Eight-six percent of Democrats, 74 percent of those who
identify as independents, 73 percent of Republicans, and 69 percent of
those who identify with the Tea Party say this would be a positive
change.
The Truth in Savings Act (TISA) requires banks to offer a schedule
of specified terms and conditions for all deposit accounts prior to
account opening. Such disclosures must be available on demand to
consumers so that they can ``understand and compare accounts.''
Similarly, the Electronic Fund Transfer Act (EFTA) requires financial
institutions to disclose the terms and conditions when a consumer
enrolls in electronic fund transfer services, such as an ATM or debit
card.
Under the Dodd-Frank Act, the rulemaking authority of TISA and EFTA
passed over to the Consumer Financial Protection Bureau (CFPB) on July
21, 2011. The CFPB has the authority and should require a one-page form
that would provide account holders with important fees and terms. This
regulatory change would strengthen disclosure requirements so customers
are given all important information about their accounts up front and
would enable them to shop around for the products most suitable to
their needs.
All Overdraft Options and Their Costs Should Be Disclosed
Consumers should receive comprehensive information about all
available overdraft options including fee amount.
Currently, there are two main categories of overdraft products.
Because banks use different terms for these products, Pew defines
``overdraft penalty plans'' as short-term advances made for a fee by
the bank to cover an overdraft, the median cost of which is $35.
``Overdraft transfer plans'' involve a transfer from another account or
plan--a savings account, credit card, or overdraft line of credit--with
a median cost of $10. The vast majority of accounts provided by the
banks in our study offered both types of overdraft plans.
As of August 15, 2010, new Federal Reserve rules require that
financial institutions obtain customers' affirmative consent (known as
opt-in) before enrolling them in an overdraft penalty plan that covers
debit card transactions at points-of-sale and ATMs. If a customer does
not opt-in, any debit card transactions that overdraw the account will
be denied with no fee charged.
Although Pew supports this rule, we would have preferred the
Federal Reserve include a requirement that comprehensive information
about all available overdraft options (including fee amount) be
provided when the account holder seeks overdraft coverage. Now that
these rules have transferred to the CFPB, we believe that it should
amend the Federal Reserve's rules to ensure that overdraft policy
disclosures are clear and comprehensive. Consumers need to understand
that they have three overdraft options and what each costs: not opting
in, which is free; overdraft transfer plans, and overdraft penalty
plans. They should require full disclosure of consumers' overdraft
options prior to opt-in and as part of the disclosure box. We would
like to see the CFPB issue a model form that would achieve more
effective disclosure of overdraft options.
In Pew's focus groups we learned that of those participants who
were familiar with overdraft options, some were generally well-informed
about banking. However, several others had learned about overdraft
options ``the hard way,'' when they or their child had overdrawn an
account and accrued one or more fees. Participants also expressed
concern that banks depict overdraft policies as ``protection'' and as a
benefit. They tended to see overdraft protection instead as a way for
banks to collect a fee, usually multiple fees.
Our July survey showed support for better disclosure of overdraft
options, with 83 percent of account holders saying they wanted banks to
be required to provide a summary of information about the overdraft
options they offer, how the options work and a description of the fees,
while only 2 percent said this would be a negative change. Ninety
percent of Democrats, 78 percent of those who identify as independents,
81 percent of Republicans and 79 percent of those who identify with the
Tea Party said this would be a positive change, while only 1 percent of
Democrats, 2 percent of independents, 2 percent of Republicans and 2
percent of Tea Partiers said this would be a negative change. Eighty-
two percent of those who said they have a very good understanding of
the terms, conditions, and fees associated with their checking account
indicated this would be a positive change, while only 2 percent said
this would be a negative change.
Transaction Reordering Maximizes Overdraft Fees
Policy makers should require depository institutions to post
deposits and withdrawals in a fully disclosed, objective, and neutral
manner that does not maximize overdraft fees, such as chronological
order.
Transactions (debits, deposits, and checks) presented on a given
day for posting are frequently processed in an order different from
that in which the activity occurred. Such reordering can greatly impact
the overdraft fees incurred by consumers. Our research shows that as of
October 2010, only one of the 10 banks studied, representing less than
5 percent of accounts, informed account holders of the order in which
all debits and credits are posted.
Yet at the time of the study, all banks and all accounts reserved
the right to process debits presented in a given day from highest
dollar amount to lowest dollar amount. By reordering transactions to
pay the largest items first, the money in a checking account is more
quickly depleted so that if a customer overdrafts each small
transaction will result in a fee. Since that time, some banks have
begun disclosing changes to their practices. Wells Fargo, Chase, and
Citibank announced that they would no longer reorder certain types of
transactions for at least a portion of their accounts.
Currently, there are no Federal regulations that govern the order
of posting among transactions processed on the same day. There is no
legal requirement that banks post deposits before withdrawals, nor any
law or regulation governing the order in which they post debits or
credits. The Federal Deposit Insurance Corporation's overdraft guidance
issued in November, 2010, states that its member banks should review
their checking procedures to ``ensure they operate in a manner that
avoids maximizing customer overdrafts and related fees through the
clearing order.'' The Office of the Comptroller of the Currency (OCC)
released a draft guidance for comment in June also inquiring about this
practice.
In addition, posting orders that maximize overdraft fees,
especially those that post withdrawals from largest to smallest,
continue to be the subject of court challenges as an unfair and
deceptive practice under State law. A Federal judge in California ruled
against Wells Fargo on this practice and stated in his summary of the
case, ``[T]he essence of this case is that Wells Fargo has devised a
bookkeeping device to turn what would ordinarily be one overdraft into
as many as 10 overdrafts, thereby dramatically multiplying the number
of fees the bank can extract from a single mistake.'' \3\
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\3\ Gutierrez v. Wells Fargo Bank, N.A., 730 F. Supp. 2d 1080,
1082 (N.D. Cal. 2010).
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Opponents of this practice say it enriches the bank at the expense
of consumers who receive no benefit from the reordering of their daily
debits or credits. In response, banks have contended that customers
prefer the largest withdrawals to be posted first because these are the
most important (such as rent or mortgage payments), and therefore are
the transactions that one wants to have paid first. However, by opting
in to overdraft coverage, the customer has expressed the desire to have
all overdrafts covered, regardless of size.
We maintain that policy makers should require depository
institutions to post deposits and withdrawals in a fully disclosed,
objective, and neutral manner that does not maximize overdraft fees,
such as chronological order. Our July survey shows that the majority of
the checking account holders agree. Seventy percent of respondents said
it would be a positive change to require banks to process transactions
in the order in which they occur, as opposed to processing them from
highest dollar amount to lowest dollar amount, which can lead to more
overdraft fees.
Hidden Bank Fees Can Drive Consumers Out of the Banking System
To encourage the working poor to build savings and credit, banks,
community organizations, local leaders, and policy makers can promote
policies that allow households to use their bank accounts effectively
and beneficially.
This month, Pew will release a longitudinal study of 2,000 low-
income Los Angeles area households, 1,000 with and 1,000 without a bank
account, which explores the connections between financial services, the
populations they serve or are failing to serve, and the financial
stability of those populations. We found, not surprisingly, that
between 2009 and 2010, a time of great economic turmoil throughout the
country, the ranks of the unbanked (those without a bank account)
increased, with more families leaving banking than opening bank
accounts. But what was surprising was that the most common reason these
households cited for leaving banking was unexpected or unexplained
fees. Nearly one in three listed these fees as the reason for leaving
banking. This is particularly relevant given that even in difficult
economic times only 27 percent attributed their departure from banking
to job loss or lack of funds.
Our study also found that banks hold significant service and
location advantages over alternative financial service (AFS) providers:
79 percent of crossover respondents (those with at least one bank
account that regularly use AFS) report that banks have better customer
service than check cashers and 59 percent prefer the location of banks
to that of check cashers. However, these customers continue to
supplement their depository accounts with services from AFS providers,
citing the need to access cash quickly (30 percent) and the ability to
purchase multiple services, such as money orders and remittances, at
one time (38 percent).
Finally, we found that the banked could better sustain their
savings behaviors, including those associated with long-term goals such
as paying for college, even during economic turmoil and when faced with
high rates of job loss and declining household income.
To encourage the working poor to build savings and credit, banks,
community organizations, local leaders, and policy makers can promote
policies that allow households to use their bank accounts effectively
and beneficially. Additionally, the continued use of AFS by banked
households presents an opportunity for banks to utilize their
competitive advantage and capture this market for revenue-generating
financial services. For example, banks can provide a comprehensive
suite of products including money orders, remittances, check-cashing,
bill pay services, and personal loans. Community organizations, local
governments, depository institutions, along with efforts to reach the
unbanked, such as the Bank On programs, can provide financial education
to help new customers manage costs and build up assets. Banks, policy
makers, and community organizations can capitalize on household
aspirations to build family financial security by providing low-cost,
easy-to-understand opportunities for savings and asset building.
Pew's research demonstrates that bank policies and practices have a
central role in allowing consumers to use and manage their money
responsibly. Yet unexpected fees continue to plague consumers. For
vulnerable populations, these fees can mean the difference between
having a checking account and forgoing these services altogether.
Providing information in a clear, concise disclosure box so that
consumers can comparison shop for an account that best meets their
needs will enhance competition and make the market more efficient.
Practices that maximize fees, like transaction reordering, should be
prohibited, since this makes it very difficult for consumers to manage
their money and avoid these charges. Transactions should be processed
in a predictable manner that responsible consumers can follow. Posting
order should be objective and neutral rather than designed to maximize
fees. These changes allow consumers to build and sustain wealth by
removing much of the hidden risks currently found in checking accounts.
Thank you.