This Horse Ain't Dead Yet

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By albaby1
November 6, 2001

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Society regulates a million different types of human behavior, why shouldn't society regulate who can get credit and who can't?

Sorry to jump back in after a few days' delay, but I got a little busy. Had a little hurricane scare in there, too, which makes life in South Florida lively at times.

Jeff, I agree with the above statement. Ironically, I would guess that more people have credit card applications denied than driver's license applications. I also believe, though, that it would be difficult to fashion such a regulation that accomplishes the twin goals of denying credit to those who can't handle it, but provides credit to those that can, as efficiently as the market.

Perhaps the difference in our opinions stems from our perceptions of the sub prime borrower pool. Certainly that pool contains the over-extended 18-year old living in his mom's basement, whose only fleeting thought is a vague hope that he can finish Resident Evil II on his charged big screen TV before the repo men come.

However, that pool also contained many of my classmates and colleagues - and myself. I graduated (foolishly) from the most expensive law school in the country, after having attended (equally foolishly) one of the most expensive undergraduate schools in the country. I, like many of my classmates, graduated with tens of thousands of dollars in student loan debt. Our "net worth" was negative for many years after graduation; and even those among us that chose to work for the high-salary large law firms would have had difficulty qualifying for prime credit. Those who chose to work in other areas of the law would have been completely locked out for years. These were not slack-jawed teenagers running up a balance on Playstations, Limp Bizkit CD's and MP3 players - these were working couples (with kids in some instances). There are countless folks who enter the labor force straight from college with significant debt, and many other working grown-ups who have neither the payment history nor the asset reserves to qualify for prime credit. We are part of the sub prime borrower pool.

Credit is a boon even for those who never run a balance or pay a dime in interest. With a credit card, you can accept virtually any pay schedule - weekly, biweekly, bimonthly, or even monthly - broadening your employment options. You always need reserves for unexpected expenses, but with credit you need not keep those reserves in non-interest bearing checking accounts. Credit cards are a more convenient method of payment (independent of financing), as we have discussed at length.

The empiric question is - which of these types predominate the sub prime borrower pool? I think the answer to that question shapes our policy decisions. My own feeling is that lenders try desperately to exclude the electronics-buying teens, and try to hit the more responsible borrowers, because defaults don't pay. Moreover, the three most common proximate causes for personal bankruptcy are involuntary unemployment, divorce, and unexpected medical expenses - events that are far less likely to be experienced by our basement teenager. The truth is undoubtedly that the sub prime pool is a broad spectrum of debt-laden graduates, median-salary workers with minimal assets or a spotty payment history, temporarily unemployed professionals, credit-abusing teens, and ordinary folks who have no idea how to properly manage credit.

Because of this, I think it would be difficult to fashion a regulation that actually works. Scratch that - it is easy to fashion a working regulation, but only under the assumption that sub prime lending has minimal social utility (like underage drinking or 30 year olds dating underage girls). Perhaps driving is a good analogy to sub prime borrowing. If you've ever been in an accident, you probably pay higher insurance rates, but the state neither prohibits you from obtaining insurance nor from driving. One reason for that is because the ability to drive has such high personal and social utility. If we made the assumption that those who had been in accidents were joyriding teenagers who had no notion of personal responsibility, then perhaps we might reach a different regulatory conclusion. Instead, we are content to allow private market insurers to simply assemble actuarial tables and adjust the price of driving, much as we allow lenders to assemble actuarial data on repayment behavior and adjust the interest rates accordingly.



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