Is The Credit System Broken?

Corey Calabrese in Wall Street Pit, July 26, 2009

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Cash strapped American consumers are increasingly walking away from their obligations. It started with houses that they couldn’t afford and now it’s spreading to other types of debt.

Those on the front lines of the debt industry say there is a small but increasingly noticeable group of strapped consumers who, like Ms. Birks, are deciding they will simply stop paying. After loading up on debt eagerly provided by the card companies during the boom times, these people now find themselves trapped in an endless cycle where they are charged interest on interest and fees upon fees while the lenders get government bailouts.

They are upset — at the unyielding banks and often at their free-spending selves — and are pre-emptively defaulting. They could continue to pay for a while longer but instead are walking away. “You reach a point where you embrace the darkness of default,” said Adam Levin, chairman of the financial products Web site Credit.com.
The lending industry term for these people is “ruthless defaulters.” In a miserable economy where paychecks, savings and expectations are all diminished, their numbers will surely grow.

“They’ve done the math on their account and they’re very angry,” said Corey Calabrese, a Fordham Law student who is an administrator of the school’s walk-in clinic for debtors at Manhattan Civil Court. Public sentiment is on their side, she added: “For the first time, Americans are no longer blaming the borrower but are looking at the credit card companies.”

I shouldn’t think that this come as a surprise to anyone. Americans have shown a willingness to walk away from their homes and the associated debt that most never believed existed. It was only a matter of time until that attitude spread to other forms of debt. The concept that one had a moral obligation to repay borrowed money vanished somewhere along the way and it’s taken a severe recession to bring that fact to light.

As they watch the banks they believe induced them to take on unreasonable debt receive serial bailouts and then argue about how many millions of dollars they should be allowed to pay their employees the cynicism grows. If them why not me becomes the rationale for default. Those pesky unintended consequences once again rear their ugly heads.

It’s difficult to say how far this has spread in the culture but that may not be important. Two years ago, walking away from your home would have been considered extreme. Now it’s often viewed as the intelligent solution. Consider it likely that defaulting on other forms of debt becomes as socially acceptable.

If that happens, then we will have witnessed the death in some form of the great American credit system. Lenders will ruthlessly tighten standards and a large piece of the consumer society is going to lose its easy access to credit, in fact many might well lose access to any credit. Figure out what happens to consumer spending in that scenario.