Americans aren’t borrowing too much — rather they are investing in a better life — and almost everything Sen. Elizabeth Warren has told you about consumer credit is wrong.
Those are some of the takeaways from a new book called Consumer Credit and the American Economy, according to one of its authors, Todd Zywicki, a law professor at George Mason University.
Zywicki is a longtime vocal critic of the Consumer Financial Protection Bureau (CFPB) — the government agency that was the brainchild of Warren prior to her becoming senator and was mandated by the Dodd-Frank Act — which seeks to protect consumers from abusive financial products and practices.
But in an interview with ThinkAdvisor, the law professor and author worried that such products and practices are not clearly defined by statute and that the CFPB's entire approach is uneconomic.
While admitting his area of expertise is consumer credit, he says the debate over whether a fiduciary standard should be imposed on all financial advisors is analogous in that, from an economic perspective, any rule change will have a cost.
In the interview, the bankruptcy law professor eschewed discussion of securities regulation, but sticking to his area of expertise said that “when it comes to consumer credit, Washington’s approach is to wish away unintended consequences.”
He cites as an example new rules issued late last year by the Office of the Comptroller of the Currency that effectively persuaded banks to eliminate direct deposit loans that the OCC deemed as essentially high-cost payday loans.
But in so doing, the OCC essentially left poor consumers at the mercy of payday loan companies and bank overdraft fees by limiting market competition and consumer choice.
“You really have to think about the cost of doing things,” Zywicki says, noting that consumers with impaired credit will have to pay higher interest so well-intended rules that limit their choices will effectively increase their costs.
The free-market oriented law professor says he is not opposed to regulation per se.
“I distinguish between what I think of as market-reinforcing and market-replacing regulation,” a distinction he feels that Warren, a Massachusetts Democrat, and many in Washington with similar mindsets fail to grasp.
“Market-replacing regulation includes setting interest rate ceilings and banning certain products like payday loans. Market-reinforcing regulation includes sophisticated laws…that harness the forces of competition [to promote consumer choice],” he says.
Apart from regulation, Zywicki’s new book seeks to clarify two other key points he thinks that Warren seems not to understand.
One of those issues concerns why people borrow. The professor says there is a prevalent belief that “people borrow to live beyond their means and sustain a level of expenditure that is not viable” — in other words that other people use consumer credit irresponsibly.
But Zywicki says that is not so. “Households and consumers use credit for the same reason businesses do: “to buy capital goods, and smooth income and expenses; that’s overwhelmingly the reason people use credit cards.”
By buying a washing machine, he says, “people don’t need to schlep to the laundromat each evening; [that’s] no different than a construction company buying a back hoe rather than hiring 10 guys to dig a hole with shovels.'
Another key myth, he says, is that people have too much debt because of credit cards — that they are goaded into buying things they don’t want.
Zywicki says the burden of consumer indebtedness has not increased over time, but people’s purchasing power has increased as credit choices have expanded.
Forty years ago, he said, someone wanting to buy a new refrigerator or bedroom set went to the dealer, signed a finance agreement, paid 40% interest plus an application fee and made costly payments for 36 or more months.
“Today we just put it on a credit card; it’s just better” than the installment loans of the past.
High-charging personal finance companies that bought the loans retailers made — “all that stuff is gone,” he says, adding that the effective APRs have come down.
Returning to the core subject of regulation, the professor and author says that “history tell us you cannot reduce the need for credit among consumers” and further that one of the unintended consequences of regulation is that “it invariably ends up hurting those we want to help.”
In other words, the primary victims of well-intentioned but paternalistic bureaucrats, he says, are “low-income people who are bearing the brunt” of regulations concerning financial inclusion and servicing the unbanked.
The Credit Card Act of 2009, for example, “absolutely pummeled low-income consumers” by raising costs and limiting access to more affordable credit.
Similarly, the CFPB’s qualified mortgage rule “undermines the ability of community banks to use their knowledge of customers to design products that work for them.” By pricing these institutions out of the market, the ironic result he says — “in light of the financial crisis” — is that big banks are “gobbling” market share.
Zywicki doesn’t disagree with Warren about everything. He agrees with her that Dodd-Frank has not ended "too big to fail," and says that there was “unquestionably a problem with mortgage debt” leading to the financial crisis.
He adds that “we’ve seen an unbelievable rise in student loan debt, which seems to be a problem, especially when it interacts with one-size-fits-all regulation that creates problems with people getting housing.”
But a key concept he wants readers to understand is that consumer loan debt is unlike the federal government’s debt, which he says entails “borrowing from the future to fund consumption today, such as [future payments to] retirees.”
The difference is that the entitlement state is problematic because it is not a form of investment, whereas consumers generally borrow to buy houses and cars and to increase human capital through student loans.
[The postwar affordable suburban homes] in “Levittown was financed by consumer credit,” he notes. If you think leaving tiny urban apartments with rented furniture for your own home in the suburbs is a problem, “then credit cards are a problem; but if lives are better off, then you have a different perspective on things,” he says.
“As long as there has been consumer credit, there have been people who have misused it…and people who have been worried about how others use it; but overwhelmingly people use consumer credit to make their lives better off,” he says.
In 1968, a congressional study found that loansharking was the mafia’s No. 2 source of revenue. Since people are going to access credit, it is best to promote competition and access rather than leave poor consumers especially few options.
“We need to respect consumers as grown-ups,” Zywicki concludes. “Recognize that consumers make mistakes, but understand that people know better what to do with their lives than well-intentioned bureaucrats.”
Check out Wall Street's Next Political Storm on ThinkAdvisor.