Where the Money Is

"Why do you rob banks?" The question was put to Willie Sutton, famed bank robber of the 1940s. He replied, "Because that's where the money is." That's how most businesses work: They make profits by dealing with customers who have money. And that is how the lending business used to work: Companies made loans to people who had the money (or soon would have the money) to repay them.

Much has been made about the changing nature of America's debtors. Americans don't have the same work ethic that they once did, people don't work hard to pay their bills as they once did, and on and on. Even my [Elizabeth's] elderly father agreed, telling me quiet stories of destitute families that labored for years to pay bills they had run up during the Great Depression. My father used to talk about Herring Hardware, a farm supply store that my grandfather had run in rural Oklahoma beginning back in 1904. When the Dust Bowl hit in the 1930s and families could no longer scratch a living out of their modest farms, many packed up and headed west, an exodus etched in the national memory by John Steinbeck's Grapes of Wrath.

Some of those families never forgot the debts they left behind. Twenty years later, my grandfather would still get an occasional envelope with a few twenty-dollar bills and a handwritten note: "Grant, we finally got ahead a little. Put this on my account, and let me know if I owe you more. Aileen sends her best to Ethel." My father would lean back at the end of one of these stories and remark that these were "good people, good people who followed through on what they owed." Then he would pause and draw his mouth into a hard line. "Folks just aren't like that anymore."

But my father -- and everyone else who talks about changing values -- overlooks one very important fact: Borrowers aren't the only ones who changed. Lenders changed too, arguably far more than the people to whom they were lending. Most Americans guard their credit ratings jealously, living with a slightly prickly sensation that they could be cut off if they fell behind or forgot to pay a bill. What they don't realize is that when a borrower makes a partial payment, when he misses a bill, and when his credit rating drops, he actually gets more offers for credit. He is not just down on his luck, behind on his bills, and short on cash; he has now joined the ranks of an elite group -- The Lending Industry's Most Profitable Customers.

Consider the example set by Citibank, America's largest credit card issuer. In 1990, I [Elizabeth] was hired as a one-day consultant by Citibank to address a gathering of some forty senior lending executives. The task: use my research to suggest policies that would help Citibank cut its losses from cardholders in financial trouble. I arrived at Citibank's New York headquarters with dozens of graphs and charts tucked in my file folders. I was ushered into a large, brightly lit conference room where each chair was filled by someone outfitted in a starched shirt, silk tie, and dark suit. The executives stayed with me all day, eating lunch at the conference tables as we continued our discussions about the effects of unemployment on loan defaults and the rising number of bankruptcies among two-earner families.

As the afternoon came to a close, I summarized my recommendations. The short version could be boiled down to a single, not very startling, idea: Stop lending money to families that are already in obvious financial trouble. This would have been quite easy to implement. Citibank had reams of data on most of its borrowers, particularly those who had black marks on their credit reports. I suggested that the policy could be put in place within a few short months, potentially cutting Citibank's bankruptcy-related losses by as much as 50 percent.

There were interested murmurs around the room, and several hands eagerly shot up. But before I could call on anyone, one slightly older man spoke up. He had been silent throughout the long day, leaning back in his chair and giving me a faintly bemused smile. "Professor Warren," he began. The room hushed immediately, and I suddenly realized that I had been oblivious to the corporate pecking order; this was the guy who outranked everyone else in the room. "We appreciate your presentation. We really do. But we have no interest in cutting back on our lending to these people. They are the ones who provide most of our profits." With that, he got up, and the meeting was over. I was ushered out, and I never heard from Citibank again -- except to get my monthly credit card bills.

Citibank understood the new economics of consumer credit. Credit card issuers make their profits from lending lots of money and charging hefty fees to families that are financially strapped. More than 75 percent of credit card profits come from people who make those low, minimum monthly payments. And who makes minimum monthly payments at 26 percent interest? Who pays late fees, overbalance charges, and cash advance premiums? Families that can barely make ends meet, households precariously balanced between financial survival and complete collapse. These are the families that are singled out by the lending industry, barraged with special offers, personalized advertisements, and home phone calls, all with one objective in mind: get them to borrow more money.

After he suffered a heart attack, missed several months' work, and fell behind on his mortgage, Jamal Dupree (from chapter 4) got the hard sell from his mortgage lender. When Jamal missed a payment, the mortgage company sent him dozens of personalized letters with a single goal -- to persuade him to take out yet another mortgage. "They'd send out a notice, saying 'you need a vacation, take out this thousand dollars and pay it back in ninety days.' If you didn't pay it back in ninety days, they charged you 22 percent interest." When he didn't respond to the mailers, the mortgage company started calling Jamal at home, as often as four times a week. Again, the company wasn't calling to collect the payments he had already missed; it was calling to sign him up for even more debt. Jamal resisted, but his mortgage lender didn't let up. "When I turned them down, they called my wife [at work], trying to get her to talk me into it."

The strategy used by today's lenders exactly reverses the approach bankers used a generation ago when their main goal was to be repaid on time, not to string along the payments for as long as possible. Herring Hardware may have collected most of its debts -- even during the Great Depression -- but its lending policies were radically different from those embraced by today's major lenders. Unlike today's megabanks, Herring Hardware stopped making loans when a family got in trouble. Grandfather Herring would never have dreamed of sending a flyer in the mail cheerfully suggesting, "Fred, you're behind on your payments for the fertilizer. Can we lend you the money for a new cookstove?" Nor would the local bank have suggested a second mortgage to the family that had just missed a payment on its first mortgage.

There is another important difference. When families arranged credit in my grandfather's store, he charged them a simple 1 percent per month. Neither he nor the bank had any penalty fees or shifting rates of interest. When someone missed a payment, the rate was still 1 percent a month. Today, that practice has disappeared. Like Jamal's mortgage lender, many banks routinely double or even triple the interest rate the moment someone is a few days late with a payment. Then there are the fees. This year credit card companies will charge more than $7 billion in late fees (quadruple what they charged less than ten years ago) -- a penalty unheard of in my grandfather's day. Moreover, when my grandfather got a check in the mail, he applied it to the principal balance on the loan; he wouldn't have dreamed of telling those families that with compounded interest at the new rates and special overbalance fees and late-payment penalties, they now owed $4,000 for their original $800 purchase.