Pay Now or Pay More Later: What Can We Really Do about Toxic Assets?

For those of you who still think a “tarp” is something to cover up ugly debris, the government's TARP (Troubled Asset Relief Program) program actually does reflect the literal sense of the word quite well. Although the TARP has been an ever evolving work-in-process since it was first conceived by Hank Paulson in the last days of the Bush Administration, one aspect of it has not changed. TARP still represents the government's best efforts to help the financial industry contain a mountain of largely uncollectible debt. Yet months after the first attempts to bail out the banks, we still don't know just how toxic their "troubled assets" really are.

If you are wondering why the Feds and the Treasury and SuperObama can't just clean up the mess, it's worth taking the better part of an hour to listen to this week's public radio program, This American Life. NPR's Adam Davidson and TAL's Alex Blumberg have produced some of the best reporting to date on the banking crisis (See “Giant Pool of Money” and “Another Frightening Show about the Economy”.)

The most recent segment, “Bad Bank,” explains why we American taxpayers may have no choice but to pay “as much as we can” to redeem debts that bankers made to people with lousy credit and no credible means to pay back their loans. As a researcher from Deutsche Bank, Joe Lavorgna, wrote bluntly in a recent report: “Ultimately, the taxpayer will be on the hook one way or another, either through greatly diminished job prospects and/or significantly higher taxes down the line.” Mr. Lavorgna goes on to suggest that the government should "estimate the highest price it can pay for the various toxic assets on financial institution balance sheets," and then then cough up the funds even at taxpayer expense.("Taxpayer Beware: Bank Bailout Will Hurt").

If this sounds like a holdup note, both the reporters on this story and the economists and bankers they interview agree, it is. The banking industry after all its greed and excesses is basically telling us, “Pay up now, or just pay more later.”

But as one expert in banking crises from the Columbia University School of Business points out, this aspect of the financial crisis is not really new. According to Professor David Beim, history shows that governments have always bailed out the banks because societies can't function without them. He cites the example of a banking crisis in 37 AD that had the Roman emperor galloping back to the capital posthaste with bags of money to give to the bankers who had created the problem by making bad loans. Sound familiar?

Professor Beim notes that this has happened over and over and over again, only not on such a global scale. We'd be in great shape, relatively speaking, if the U.S. were merely Indonesia or Argentina. The IMF could intervene, take over the bad banks, clean things up, and the global economy would keep chugging along nicely. But take a behemoth like the United States with its Bank of America and Citigroup, which together hold over a quarter of all the money in the U.S. banking system, and we face a dilemma of a different order of magnitude.

The problem is compounded by the continuing belief that such dire outcomes “can't happen here” and by the anger of the American public who are still telling politicians to let the bankers take it on the chin even though it could propel the United States into a economic crisis that would make make the Great Depression pale by comparison.

Yet by far the scariest part of this reporting on the state of “bad banks” does not come from tales of people losing jobs or homes or life savings, but rather from a simple graph. According to David Beim, this is the hard data that shows we are not simply facing a housing crisis or a credit crisis but something much deeper and more systemic.

The graph shows that for much of postwar history, the collective debt of the American consumer has always been a mere fraction of our gross domestic product (GDP), usually hovering around 30%, sometimes rising to 50%, but in the last ten years, rising faster and until it reaches a point where the indebtedness of the American people equals GDP. That means 100% of what we owe is equal to 100% of all the goods and services we produce.

That has only happened twice in the last hundred years: in 1929 and now. As a nation we are literally out of room to borrow because we don't have the assets to borrow against. From this perspective, the problem of banks' toxic assets, intractable as it seems to be, is just the tip of the iceberg. We have all been victims of our own collective greed and our collective indifference to consumer borrowing run amuck.

So what can we do? Well, according to the experts we don't have many choices. Thanks to the fiscal irresponsibility of the past decade, we have a war we've borrowed to pay for, and a financial system that deregulation has helped send into a tailspin. And we, as consumers, have gone along for the “free” ride that is proving to be a costly fantasy trip.

We can pay now, or pay more later. And no amount of outrage or denial will change that.

Consumer Debt - The Next Credit Crisis?

Consumer Debt: The Next Credit Crisis?

Economists and public policy researchers have been saying the same thing for years. Americans cannot go on spending the U.S. economy into continued prosperity and themselves into hock. And yet recent history seems continually to thumb its nose at these gloom and doom prophesies.

First, it was the combination of a bull stock market and low interest rates that made it seem as if one could borrow forever, invest in the latest hot stocks, and make money.

Then home equity lines and rising housing prices turned the family homestead into a convenient piggy-bank, not just for actual home improvements, but for new cars, vacations, and paying off credit card balances that had gotten a little out of hand.

Now the market has been down for four straight months, the values of homes are falling, and people are finding that their net equity may be zero or worse, they may actually owe more on their mortgage than their home is worth.

So far most pundits have focused on the crisis in the housing market as the most significant aspect of this economic downturn, but there are worse scenarios ahead to keep you up at night.

Consumer spending accounts for a substantial amount of the U.S. gross domestic product; it counted for as much as 72 percent of GDP as recently as April 2007. Yet in February of 2008 consumers turned in their weakest spending performance in 17 months, suggesting that this key component of the U.S. economic engine is also slowing down significantly. If you think of the average American consumer as the “little engine that could,” imagine what the economic impact will be if that consumer turns into the “little engine that can't any longer.” Few public officials want to acknowledge that we may be in a recession now, but a fall-off in consumer spending may make recession inevitable and not necessarily the mild contraction everyone keeps hoping for.

At the same time, many U.S. credit card holders are finding themselves deeper and deeper in debt, amounting to nearly $1 trillion as of 2007. And what are credit card companies doing to help the American consumer? They're shortening the time to pay, increasing fees for late payments, piling on the fine print of their contractual agreements and laughing themselves all the way to the bank.

It used to be that credit card companies made most of their money on the interest owed by consumers who didn't pay off their balances in full each month; those who do pay the full amount monthly are referred to “deadbeats” by these companies. But increasingly, credit card companies are making far more money off the fees they charge. According to RK Hammer, a bank-card advisory firm, card issuers took in $13 billion in fees [in 2006], not counting $12 billion in late fees (Kiplinger, February 22, 2007).

You may feel like you're the only one who ignores the the fine print on your credit card or those supplemental “changes to your account” that you get with your monthly bill, but don't feel stupid or lazy because you just can't take the time to figure out what your contract with your credit card issuer really means. Professor Elizabeth Warren of Harvard's law school gave her third-year law students the exercise of figuring out what the fine print on an average credit card really meant, and they found it far more challenging than they expected. If Harvard law students cannot figure this out, how can the average consumer be expected to understand the fine print, especially if it includes language like “we reserve the right to change the terms of this Agreement at any time”?

Although Congress has periodically investigated these abuses and even wrung their hands over the way credit card companies take advantage of the most vulnerable consumers, it has done little to prevent them. That may finally be about to change with the introduction of legislation by Senator Carl Levin and Representative Carolyn Maloney who have put forward a cardholder's bill of rights. This bill would require such consumer protections as a ban on collecting interest for amounts already paid, timely notice of changes in interest rates, and the ability to cancel a card if rates suddenly rise. Professor Warren has also advocated for a Financial Product Safety Commission to regulate the industry, which so far has largely operated on its own terms.

These are useful first steps. But in the meantime, consumers should follow the old Latin adage: caveat emptor, or let the buyer beware, whenever they are tempted to open a new credit card account to get an extra 10% off the next purchase, or get money back on their gas purchases, or any other seeming “freebie.” In most cases, you're better off using your debit card and not paying the annual fee or any other “hidden” fee in your credit card contract. If you do want a credit card, try getting one through your local credit union or savings and loan, where you can talk to a real human being if you run into any kind of trouble.

Credit card users should also realize that in a troubled economy they hold far more power than they might think. If the U.S. economy depends so heavily on consumer spending to stay healthy, now is the time for U.S. consumers to exercise their voting and lobbying power by letting Congress know they want a level playing field for credit card holders, and at least enough regulation to ensure that someone who borrows a little money to buy a dishwasher or a stereo system is not paying many times the value of that purchase by falling into the credit card trap.

If the U.S. wants to avoid the next credit crisis, it needs to take a pro-active approach to consumer credit card debt and not wait for the housing bubble to be followed by a wave of credit defaults and bankruptcies as consumers fall back on the plastic as their last resort for making ends meet.