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Making credit good again

If we only see the industry as the bad guy behind our economic problems, we risk stifling a key component of recovery.

March 17, 2009|Nicolas P. Retsinas and Eric S. Belsky | Nicolas P. Retsinas is director and Eric S. Belsky is executive director of the Joint Center for Housing Studies at Harvard University.

In this recession, we seek the boogeyman. If we can identify a villain, the recourse is simple: Slay it (or neutralize it or bail it out). Identify the problem; find the solution.

The search has centered on the credit industry, the vast network of lenders eager to loan Americans money. In the housing sector, an explosion of subprime lenders gave borrowers deals that were truly too good to be true, trapping them in impossible loans. In the retail sector, credit card vendors flooded mailboxes, offering easy entree to the good life broadcast on nightly commercials. From one vantage, the credit industry is to blame for our economic woes.

Thus, the solutions have centered on tightening credit -- lending only to home buyers who can make a 20% down payment, returning to the standards of 20 years ago under which a buyer was supposed to pay no more than 28% of his or her income for housing, and rejecting "credit impaired" borrowers with less-than-stellar records. Credit card companies have raised fees and increased penalties.

Consumers have emerged as both victims and perpetrators. They are victims to the extent that ruthless lenders (home and credit card) gulled them into ever-ascending loans. They are perpetrators in that they rang up expenses (mortgages, gizmos, travel and frivolities) with abandon -- fueling the overall indebtedness.

Already this paradigm is influencing behavior. Today, home buying is down; renting is up. Retail spending is down; savings are up. Yet this simplistic credit-as-villain outlook masks a more nuanced picture.

From a different vantage, credit was an economic white knight. Easy credit fueled the prosperity of the last decade. Daniel Webster called credit "the vital air of the system of modern commerce." A panoply of mortgage products (not all predatory, not all egregious) fueled the home-building industry, which kept the economy afloat during the last decade. Although other sectors plummeted, housing stayed strong. Related industries (wood, gypsum, cement) flourished, as did companies that made appliances and furniture. Now that only stellar borrowers, with large down payments and hefty incomes, get mortgages, we have seen the home-building/buying industry, and with it the economy, retrench.

As for retail, now that consumers are cutting back on purchases, retail giants are shrinking -- or dying. TJ Maxx; Bed, Bath and Beyond; Circuit City and other brand-name mainstays of Retail America are laying off thousands of workers or disappearing altogether.

Just as crucially, tight credit threatens to shut the safety valve of the low-wage sector of the economy. Many Americans have been borrowing, quite simply, to live. Try paying for an apartment, food, clothes and medicines on the $20,000 annual salary of a low-wage worker. We have an anodyne myth that everybody who works full time in this country can somehow make do. The "secret" to their making do is often a Visa card with a balance that is never paid off. For low-wage workers, credit has been a lifesaving crutch.

So as we attempt to jump-start the economy of 2009, we should recognize both the risks and advantages inherent in a robust credit industry. Credit undergirded our economic expansion; if we close the spigots too tightly, we must be prepared to accept an economy that stagnates.

Absent access to credit, we also must be prepared to watch low-wage workers slide into desperate straits. On an individual level, we will see more misery. On a macro level, we will see more evictions, more repossessions, more bankruptcies. Whatever the virtue of savings, some people cannot save: They live paycheck to paycheck, with each month's bills lapping at the monthly income. Low-wage workers need credit. They need it to stay in their homes, feed their families, drive to their jobs. With the right products and the right terms, these workers can still have access to that crucial crutch.

Rather than merely tightening credit, the challenge is to recalibrate the country's access to credit so that more responsibility for making good loans lies with lenders and so that the burden is not almost entirely on would-be borrowers. Recalibrating would mean returning to the responsible use of underwriting that is transparent and allows for a higher debt-to-income ratio with a higher down payment. It would allow people with past credit problems to qualify for loans that do not expose them to excessive risks and that start off with manageable mortgage payments relative to their incomes.

No more open lines of credit to students who have no income -- indeed, who have never paid a utility bill. No more mortgages to buyers who cannot afford the payments -- or to buyers who have no "rainy day" savings. Micro-print contracts must be transparent and protect the consumer. Lenders must take responsibility not just for originating loans but for loans' performance.

If instead we merely vanquish credit as the villain behind our downturn, the victory may be Pyrrhic.

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Nicolas P. Retsinas is director and Eric S. Belsky is executive director of the Joint Center for Housing Studies at Harvard University.

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