The Wall Street Journal story, “The ‘Democratization of Credit’ Is Over — Now It’s Payback Time,” is a solid piece of reporting on how credit that was once offered liberally to lower income consumers has now left a very big hangover. It’s worse than with other income strata for an obvious reason, namely, low income consumers are almost by definition budget stressed, so adding debt to the mix has high odds of leading to a bad outcome (save when used prudently as a short-term bridge, or for a long-term investment, and even then only when conservative cash flow projections confirm the debt service is manageable).
I wish the story had more on how this looked from the lenders’ side, as in what their margins and default assumptions were, but even with the focus on borrowers, the article is revealing. It focuses on Karen King, who admits that, at $36,000 in debt, she had too much of a good time and is now paying for it, literally and figuratively.
But the story glosses over two issues. Of her $36,000 owed, $26,000 is student loans:
Her biggest chunk of debt, $26,000, stems from student loans to pay for her two-year associate’s degree from a community college — loans now in the hands of collectors. The remaining $10,000 or so includes old credit-card balances, debt to a store that rents furniture, utility bills and back taxes. Another obligation is $400 a month she contributes to the rent on her grandfather’s two-bedroom apartment, where her mother, uncle and sister also live.
The story dwells on the lifestyle she had (dining out 2-3 times a week, going to movies) that presumably was a big contributor to the $10,000 she now owes, but skips past the $26,000. Ms. King worked in a shoe store and now drives a tour bus for $13 an hour plus tips. Did that associate degree do her any good in the job market? And I have to wonder if the student debt, which she was not doubt told was sensible (“an investment in your future”) desensitized her to taking on more debt. I admittedly came of age in the era before education inflation kicked in, but my mother recently found one of the old bills from college. I made some crude assumptions and compounded forward the Harvard tuition, room and board forward, and it came a bit over $20,000 a year in current dollars. Ms. King no doubt overspent, but a more important contributor to her current mess is that she threw away a lot of money on a useless degree.
The second interesting bit is she has decided not to declare bankruptcy, the reason apparently being that her impaired credit record has led her to be turned down for jobs. Her debt management decisions are driven by the impact on that scorecard:
When a utility to which she owed $300 offered to settle for less, Ms. King says, she declined, because she was told an overdue bill takes longer to come off a person’s credit report when it is settled for a partial payment.
She rejected any idea of a bankruptcy filing for the same reason. “It takes forever to come off” the credit report, she says.
Before the way to punish debtors was to send them to debtors prison. Now it appears to be to restrict their access to work. Perverse, but effective.