Oct. 25, 2011
UI study: retaining 1970s credit limits would have reduced bankruptcies by 25 percent
A University of Iowa study suggests that one-quarter of households that filed for bankruptcy in 2007 would not have been in that situation if the credit regulations of the 1970s had remained in place.
Sociology Professor Kevin Leicht analyzed data from the 2007 survey of 2,400 bankrupt Americans. He applied credit limits of the 1970s – a mortgage no greater than 30 percent of income, a car payment no more than 10 percent of income, and a single credit card with a $1,000 limit.
With those regulations, Leicht says 25 percent of the families wouldn't have accumulated enough debt to be bankrupt. If the tighter restrictions still existed, the average person in bankruptcy in 2007 would have spent $667 per month less on debt payments. That's substantial, Leicht says, considering the median income of the bankrupt households was just $23,000.
"Families in bankruptcy today struggle with hundreds of dollars more in monthly payments than the prior generation could have ever borrowed," says Leicht, a faculty member in the UI College of Liberal Arts and Sciences who accessed the data for his study during an annual summer research seminar at the UI Obermann Center for Advanced Studies. "They are stressed by debt burdens that would have been unthinkable, not to mention illegal, under regulations that existed just three decades ago."
Bankruptcy filings have grown overall from about 110,000 in 1960, to over 1.6 million in 2003, according to the U.S. Department of Justice. Filings dipped to 480,000 in 2007, then jumped back up to nearly 1.1 million in 2010.
"Bankruptcy is cyclical, but the trend has been decidedly upward," Leicht says.
According to Leicht, the deregulation of the banking industry in 1980s set the stage for a transformation of the consumer credit landscape. A Supreme Court ruling removed limits on maximum interest rates lenders could charge. Constraints on securities dealings were lifted, and interstate branch banking was allowed.
"There was a feeling when the Reagan administration came in that financial markets were too regulated, and that financial market deregulation combined with tax cuts directed at capital gains rather than earned income would stimulate more investment and economic growth," he says.
No raise, higher bills? No problem … just charge it
The influx of credit appeared just as middle-class wages stagnated. In spite of increases in productivity resulting in higher profits, real median family income increased by just 16 percent, or $8,700 between 1971 and 2007. That's an average growth rate of .4 percent per year, and most of the income gain was a result of people working more hours and more women joining the labor force.
Increased expenses for the mainstays of middle-class life strained budgets further. The median sale price of a single-family home rose from $129,000 in 1971 to $247,900 in 2007. Health insurance premiums have risen at twice the rate of family income since 1996. By the time a child went to school, the average 2009 family spent $38,000 on childcare, compared to only $3,700 in 1960.
To cope with it all, workers put in more hours, reduced savings and increased debt. A married couple's average number of paid hours of work rose from 53 per week in 1970 to 63 in 1997. The percentage of families where both spouses work rose from 36 percent to 60 percent. And average credit card debt per household more than doubled, from $3,000 in 1989 to $7,300 in 2007.
"The expansion of credit made possible by deregulation enabled families to maintain the image of middle-class respectability even as they struggled to stay afloat," says Leicht, coauthor of Postindustrial Peasants: The Illusion of Middle-Class Prosperity. "We loan people money for consumption, which means they'll keep buying products even if employers don't pay them well."
A bump in the road sends it all crashing down
But all that debt and the lack of savings leaves no buffer against the whims of misfortune, Leicht says. According to the Panel Study of Income Dynamics, one-fourth of U.S. families could not sustain a poverty-level standard of living for three months if forced to live on accumulated wealth.
"You're led down a path to borrow, and if you hit a financial bump in the road, you just borrow more. That, combined with increased job volatility, puts the middle class at grave risk," he says.
Many of the 2007 bankruptcy filings Leicht examined were the result of emergencies. Often, individuals lost their job and health insurance, suffered a medical issue, and survived by charging hospital bills and mortgage payments. Soon they'd racked up $60,000 or $80,000 in credit card debt.
"Americans in bankruptcy are a cross-section of the middle class, not a deviant group of failures. They own homes, went to college and have careers," Leicht says. "We should turn a deaf ear to policymakers who cite lack of personal responsibility or moral failure for families' credit problems."
Demanding better wages
Leicht says the recession has caused consumers to scale back spending, realizing that the credit world is not limitless, and that accumulating lots of debt can have serious consequences.
His hope is that consumers will now focus on tying consumption to earnings and seek better wages.
"We have to start collectively demanding more, with the understanding that for our standard of living to go up, our earnings have to rise," Leicht says. "For that to happen, voters have to hold politicians accountable, asking 'What have you done to make my earnings go up?' not 'What have you done to enhance my purchasing power through credit?' That's going to be a hard job because we've not thought in those terms for 25 to 30 years."
The study will be published this fall as a chapter in the book Broke: How Debt Bankrupts the Middle Class (Stanford University Press). The book's editor is former UI law professor Katie Porter of the University of California at Irvine.
STORY SOURCE: University of Iowa News Services, 300 Plaza Centre One, Iowa City, Iowa 52242-2500