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10a Hurlston Credit And Debt


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10a Hurlston Credit And Debt

  1. 1. Consumers International World Congress November 2007 I saw a movie in 1962. It was called - Live now, pay later.1 A warning about the dangers of credit. Forty years on the warning voices say the same thing, but the credit world has moved on. Borrowing per household has increased astronomically and consumer goods bestride the globe. A new cry – almost as strident as the warnings – is the call for everybody to be able to get into debt. The respectable name is financial inclusion. What do consumers want? More debt or less debt? Of course our slogan at the time of Live now Pay later was “What do we want – Everything; When do we want it – Now”. We now live in more moderate times, but wanting it now is a healthy consumer characteristic which will be with us for a long time. In order to be able to get it now we need not just money but access to money. And we need not just access to money we have now, but immediate access to money we shall have in the future. The world of lending has made that available to consumers with unimaginable efficiency – imagine the UN or the OECD creating an interoperable network worldwide of holes in walls through which we can get hold of money in any currency from our savings or our borrowing indiscriminately. 1
  2. 2. This consumer paradise has helped the economy as well as it has helped us: the consumer’s access to lifetime income spins the wheels of commerce, creating work and jobs in factories worldwide. Research by Burke et al2 has shown that the velocity of spending through credit cards gives the economy an additional boost. At high level, quot;The totality of lending leads to the totality of debt”. More than 90 percent of consumers borrow, spend and repay wisely. Research for the European Union by Dourmashkin et al3 shows that in a liberal economy with light regulation, repayment is easier rather than harder for consumers. But if 90 or more percent of us lead charmed lives, perhaps seven percent of borrows hit the buffers. A small percentage but a large number of people. The question is: how do we help them while avoiding polarisation between state funded, rights-based and often adversarial services on the one hand and the for-profit companies on the other, who may not act in the best interest of the borrower? Here, I would argue, consumer credit counselling, which acts for consumers and engages lenders, offers the magic bullet. Its efficiency however depends on asymmetry of information, which returns us to the role of the credit card. Here, as of now, the world divides into the anglosphere – where the credit card accounts for a high proportion of borrowing - and the rest. To illustrate the gulf for you; in the European Union, UK and Ireland account for three-quarters of all credit card debt - that is the dividing line between the anglosphere and the rest. 2
  3. 3. The trend worldwide is towards the wider use of the credit card and we are likely to see elsewhere a pattern of individual multiple debt, with credit cards and personal loans accounting for over 90 percent of borrowing between them, more or less evenly shared. But there is a major difference between the credit card on the one hand and the personal loan on the other. The personal loan is in the sensate band of credit - like the mortgage. The consumer is fully conscious of borrowing. The credit card on the other hand is insensate – because for many transactions, at the moment of payment, neither the consumer, nor the bank, nor the merchant knows whether borrowing is taking place. As a result the credit card has dangerously blurred the distinction between borrowing and payment and that is why it calls for special treatment. What is to be done to protect the small proportion of consumers at risk without inconveniencing the vast majority of confident consumers? Education certainly. Micawber put it simply quot;Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result miseryquot; 4 That simple truth can be extended into lessons, courses and no doubt degrees as credit replaces annual income with access to lifetime income. 3
  4. 4. But there are doubts about the efficacy and value for money of education in this context. First, there is little evidence that education works. I refer you to a paper presented last year to G8 by the Federal Reserve Bank5, which evidenced only two examples of proven success, in both cases involving the raising savings ratios in individual US states. The OECD produced last month a non-proven verdict on national education spending6. In our sector there is a clear need for evidence-based education; it is no panacea. Education at time of need is obviously more useful - that is the moment when the consumer is most likely to want it and be receptive. But you cannot educate away the unexpected – which is the cause of many debt problems – other than perhaps warning borrowers that the unexpected might happen to them. But borrowing is as much about behaviour and psychological need as about finance. We have started behavioural work in the Foundation for Credit Counselling but more needs to be done7. The stigma attached to borrowing has virtually disappeared. Through student loans in most countries governments are saying - we think borrowing is part of life. At the same time the main cause of financial distress is distress of some other kind - neither overborrowing nor overlending. 4
  5. 5. These stresses hit our relationships, our health, our ability to work. Under their pressures our normal common sense crumbles as does any education we might have been given. WHO papers in progress suggest that half the people in debt are clinically depressed and vice versa. When helping the overindebted we are not dealing with fully rational people. That is why we at FCC are working on an online form of free treatment with cognitive behaviour therapy, specially adapted for people with current debt problems. In these circumstances what is to be done by governments and lenders to help the victims without harming the happy users of modern services? Regulation or legislation is rarely the answer beyond a framework. Too often the laws of unintended consequences override the laws of good intention. We need efficient and understanding regulation, ready to out bad practices - such as stealth charges by banks or turning payment insurance into a bonanza for the lender. And that is where in recent years lenders, and credit card companies in particular, have ceased to keep their part of the contract in the anglosphere where good behaviour axiomatically earns light regulation in the interests of all. Today the main onus to improve lies with lenders. They need to reflect whether their own recent practices have damaged their own long-term interest as well as inviting regulatory intervention. The search for short term gain by individual lenders may well have imposed a collective loss on the industry. 5
  6. 6. Lenders have relied too much on sophisticated risk modelling at the expense of considering the consumer because they were sure that it would allow them to lend beyond the rate of economic growth without incurring higher losses. Lenders - American lenders in particular - have introduced business models which rely for their probability on borrowers quot;teetering on the brinkquot;, which regulation cannot ignore. In the United Kingdom, lenders have developed products which depend on penalties for their profitability and collectively…as charged in the Journal of Business Ethics8…they have undermined responsible lending. In the United States they have provoked the light touch regulators...the Federal Reserve Bank and the Office of the Comptroller of the Currency to unprecedented action. In a speech last month9 John Dugan the Comptroller of the Currency reminded us that “Congress has not been inclined to regulate much beyond disclosure”. The theory is one to applaud…”if consumers are provided with adequate information, they will choose the ones they want and like best and banks will innovate and compete without government interference to meet the consumers’ demand” But John Dugan now sees a state of disequilibrium in consumer protection such that – if credit card companies don’t clean up their act, the state will have to step in. This is a mighty change in approach. Already the Federal Reserve has proposed this year improvements in disclosure including 45 days notice to consumers about rate changes. The Comptroller is still not calling for a ban on penalty pricing but he is now 6
  7. 7. suggesting one further step…that consumers should be given the general right to opt out of a rate increase. So as we speak the old order in the anglosphere may be yielding place to new10: the credit card companies are clearly in a last chance saloon. That would not be good news for most consumers either…regulation imposes costs and inconveniences as well as slowing innovation. So what are consumers to do, other than watch the battle from the sidelines? Consumers need to be rational. We all like something for free. But in recent years the costs of financial services through cards and lending in particular have been unfairly loaded on the unhappy and the improvident. All consumers should pay fairly for the service they use. Consumer organisations need to be ready to say - Charge most of us a little more. Consumer organisations must engage both with regulators and lenders, but engage with caution. The road from engagement to co-option is a short one. In addition to formal engagements there are techniques old and new for calling lenders to account. The Office of the Comptroller of the Currency was influenced by the number of complaints from members of the public as well as vox pop on Capitol Hill. Credit cards are accounting for forty percent of all the complaints about banks which come to the Office. 7
  8. 8. New media too have given new force to consumer power. The battle against bad practice can be led by individuals and by websites in the new world as well as by formal consumers with 20th century structures. All of us here need to be not only prominent in organisations but ready for the hand-to-hand battles too, if we are to be efficient and relevant in these new times. Ideally we shall persuade lenders to amend their practices in time so light regulation can survive in the anglosphere and be attractive in other countries where the wider use of cards can bring benefits to consumers. Otherwise we shall come to agree unwillingly with the French poet, Theophile Gautier, who warned us that the looser shoe also hurts the foot. 8
  9. 9. ENDNOTES 1British film directed by Jay Lewis, starring Ian Hendry, June Ritchie and John Gregson 1962 2Burke T, Allison K, Whittaker M Spending Power: the link between credit cards and retail sales, Credit Card Research Group, UK April 2003 3Dourmashkin N, Betti G, Rossi M C, Verma V, Yin Y Study of the problem of Consumer Indebtedness: Statistical Aspects, OCR Macro for Directorate-General for Health & Consumer Protection Commission of the European Communities October 2001 4 David Copperfield by Charles Dickens 5Hogarth J M, Financial Education and Economic Development paper prepared for Improving Financial Literacy International Conference hosted by the Russian G8 Presidency in Cooperation with the OECD November 2006 6 OECD, Education at a Glance, September 2007 7Ata N, Bicakova A, Self-Control and Debt: Evidence from Data on Credit Counselling European University Institute Finance and Consumption Programme, June 2007 8Richards M, Palmer P, Bogdanova M, Irresponsible lending? A case study of a UK credit industry reform initiative, Journal of Business Ethics October 2007 9Remarks by John Dugan, Comptroller of the Currency, to Financial Services Roundtable, September 2007 10La Morte d'Arthur by Alfred, Lord Tennyson. quot;The old order changeth yielding place to new.quot; 9