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Consumer Credit and the Politics of Market Access Gunnar Trumbull November 2009 Introduction From 1980, consumer debt levels rose across most of the advanced industrialized countries. In the United States, non-mortgage household debt increased by half, from 17% to 26% of annual disposable income. In France, which had started from a much lower base, household non-mortgage debt increased six-fold. Still, French household borrowing remained 50% below the level in the United States. Consumer credit default rates were correspondingly lower in France. In 2005, 2% of consumer credit accounts in France were in default (over 90 days late), compared to 6% in the United States. 1 This extraordinary growth in household debt testifies to a revolution in consumer lending. From a market in which capital had been rationed, in both France and the United States, credit had become abundant. Even relatively poor 1 Cédric Houdré, L’endettement des ménages début 2004,” Insee Première 1131, April 2007. households were able to gain access to credit. For middle class households, there seemed to be virtually no limit on the credit they could access. At the same time, the French were persistently more frugal in their use of credit than their American counterparts. To understand why American households borrowed so heavily in this period, I compare the postwar trajectory of consumer credit markets in the US and in France. Figure 1. Household debt as a share of disposable income, 1980-2005. 2 non-mortgage debt total debt 1980 1991 2005 1980 1991 2005 US 17% 22% 26% 70% 98% 135% France 3% 8% 18% 30% 40% 64% Explanations of differences in household credit use, both over time and across countries, have tended to emphasize the distinctive nature of, and changes in, supply and demand for credit. The most common set of explanations attributes differences in credit supply to the perceived riskiness of consumer borrowers. The bulk of economic accounts of consumer borrowing therefore focus on institutions intended to manage borrower risk, including credit rating agencies, secure collateral, and bankruptcy. 3 They emphasize the need to manage non-payments, and the role that institutional context—including property rights and information sharing—can play in helping lenders to detect consumers’ ability and willingness to pay. A second common explanation has focused on cultural determinants of demand. French families were portrayed as 2 Federal Reserve Board, Bureau of Economic Analysis. 3 Japelli and Pagano, etc. culturally thrifty. American families were seen to have sacrificed fiscal responsibility in the interest of materialism. 4 Culture has also been invoked to explain changes over time. In such accounts, cultural norms about credit are perceived to have changed, with recent generations more accepting of credit. I argue that national patterns of consumer credit use are best understood as reflections of policy accommodations over social policy goals in the two countries. In both cases, access to credit was closely tied to concerns about public welfare. How they understood that connection was nearly opposite. In France, credit was a threat to working class welfare. From the 1950s to the early 1980s, administrative restrictions on credit price and volume reflected a concern that consumer credit would crowd out critical industry investment. By the late 1980s, rising concerns about overindebtedness of French households led policymakers to see credit as a potential social trap that threatened permanent social and economic exclusion. In the United States, “third-way” policies of the Bill Clinton administration embraced liberal access to credit as a channel for social mobility. As housing markets boomed in the late 1990s, their bet seemed to be justified. First-time home buyers, who tended to hold less equity in their houses, experienced dramatic profits due to high levels of leverage. With newfound wealth in their homes, they were able to roll over credit card debt into loans secured on home equity. The Financial crisis of 2008 was, in significant degree, the decisive defeat of third-way economic policy. Theories of Consumer Credit The economic theory of consumer credit has its roots in arguments made by two influential postwar economists. The first, Franco Modigliani, proposed that individual decisions 4 Juliet Schor, The Overspent American (New York: Harper, 1999). about consumption, saving, and borrowing were dictated by changes in income over the course of an individual’s lifespan. 5 The core insight of his ‘lifecycle’ savings hypothesis was grounded in the distinction between consumption and utility. Whereas consumption measured the money you spent, utility represented the benefit you gained from it. Modigliani’s core assumption, borrowed from the utilitarian philosophers of the 19th century, was that ‘marginal’ utility decreased as an individual’s consumption increased. This amounted to the seemingly reasonable claim that a dollar spent by a rich man generated less utility for him personally than a dollar spent by a poor man. Jeremy Bentham had famously used the assumption of declining marginal utility to justify a redistributive welfare state, on the grounds that it would maximize social utility. Modigliani’s proposal was that individuals would opt to redistribute their purchasing power across different periods of their lives, through savings and borrowing, in order to maximize their lifetime utility. The Modigliani model seemed to provide a rationale for consumer debt that was unrelated to economic investment, since individuals might borrow in expectation of higher future income. The second piece in the puzzle was introduced by Joseph Stiglitz in a 1981 article with Andrew Weiss on credit rationing. 6 In the absence of additional information about the intention of borrowers, Stiglitz and Weiss proposed, lenders could not distinguish between borrowers that 5 Franco Modigliani and Robert Brumberg, “Utility analysis and the consumption function: An interpretation of cross-section data,” in Kurihara, ed., Post-Keynesian Economics (New Brunswick, NJ: Rutgers University Press, 1954). 6 Joseph E. Stiglitz and Andrew Weiss, “Credit Rationing in Markets with Imperfect Information,” American Economic Review 71/3 (1981): 393-410. accepted to pay a higher interest rate because the loan was genuinely risky and those who accepted to pay a higher interest rate because they did not intend to repay the loan at all. The credit rationing thesis was an extension of George Akerloff’s 1976 account of the ‘market for lemons’ in used car markets. Akerloff had argued that when customers could not detect hidden flaws in used cars, they would pay less, and those lower prices would induce sellers to offer only cars with flaws. Without better information, the fear of lemons became a self-fulfilling prophecy. Extended to credit, the market failure thesis suggested that without additional information about borrower motivations, price alone would not be sufficient to create an efficient market, and many deserving but risky borrowers would not be able to secure loans. Taken together, the Modigliani life-cycle theory and the Stiglitz-Weiss theory of credit rationing provided a theoretical account of patterns of credit use. As lenders adopted new and sophisticated credit scoring technologies in the 1980s and 1990s, they were able to overcome the adverse selection problems that Stiglitz and Weiss suggested would lead to credit rationing. 7 The life-cycle smoothing theory gave policymakers a reason to allow household debt to expand. Rising household debt levels could be justified on the grounds that increased access to credit would improve consumption smoothing and thereby raise private household utility. 8 Even more important for policymakers, higher household debt seemed to promise increased economic growth. If credit constraints had previously made consumption excessively sensitive to current income, then consumers were not borrowing as much as would be optimal given their total 7 Darryl E. Getter, “Consumer Credit Risk and Pricing,” Journal of Consumer Affairs 40/1 (2006), pp 41-63. 8 Japelli and Pagano, 2009. resources, including assets and future income. This implied that greater access to credit would raise consumption, and thereby output. 9 More household debt would boost GDP growth, and this would benefit both individuals and the whole economy. It is a measure of the influence of their theories that both Modigliani and Stiglitz would be awarded the Nobel Prize for their work on consumer credit. So compelling was this argument that by 2005, the IMF was urging the core European countries to pursue financial liberalization in order to increase household debt. They estimated that financial liberalization could increase the EU’s GDP by 0.5% to 1% per year. Stiglitz himself became a key framer of ‘third way’ economic policies during his tenure as Clinton’s chairman of the Council of Economic Advisors. At the same time, consumer credit was proving to be highly profitable for the financial sector. Politically, pro-credit policies of the 1990s were grounded in a cross-class coalition driven by financial sector profitability on the right and ‘third-way’ consumer credit advocates on the left. The Stiglitz-Weiss/Modigliani framework provided the theoretical cement that held the two sides together. The second common explanation for growing levels of debt attributes the trend to changing cultural norms about credit. In these accounts, consumer debt rose because in the 1990s because consumers became more comfortable with credit. Typical of this sentiment is a writer for the Wall Street Journal in 2000: “In a nation that once saved all it could, and resisted taking on debt, Americans no longer just borrow money to buy houses. They load up on debt to 9 Tullio Jappelli and Marco Pagano, “Capital Market Imperfections,” American Economic Review 79/5 (1989): 1088-1105. purchase stock. To go on vacation. To pay the electricity bill. To buy groceries.” 10 This idea of a generational change in perceptions of consumer credit has been a theme of consumer credit studies since at least the beginning of the century. In 1958, the vice-president of Security-First National Bank of Los Angeles warned: “The doctrine of thrift – the idea that individuals should save first in order to buy luxury goods, had deep roots in this country…. This concept died hard, but it did fall.”11 Thirty years before that, one could hear the same analysis being voiced. In 1929, Samuel Grafton wrote of the then emerging credit selling plans: “Once there was shame in not buying for cash…And once there was great shame in borrowing. Now all of that is dead gone.” 12 Data on household use of credit show that most people’s parents bought on credit for most of the past century. Surveys conducted in the 1950s show that about half of Americans at any time reported using installment credit. In 2005, about 60% of Americans reported having non-mortgage debt. (See below.) The key difference is that credit users in the 1990s and 2000s repaid their debt more slowly. Given the constant of household debt, why have observers 10 Gregory Zuckerman, “Borrowing binge in U.S. sparks concern Debt is at a record level and those who might least afford it have been accumulating most,” Wall Street Journal, July 5, 2000. 11 D.Z. Albright, Vice-President, Security-First national Bank of Los Angeles, “The Role of Consumer Credit,” 1957 Consumer Credit Symposium, New York: Consolidated Reporting Company, 1958, p 53. 12 Samuel Grafton, “Need, Gold, and Blood,” The North American Review 227/3 (March 1929), p 342. consistently claimed that their parents shunned credit? We may tend to perceive our parents as fiscally prudent because of the demographics of credit. People have always borrowed more heavily when they were young, starting their careers, and having children. By the time children have grown and are starting their own families, their parents are typically relying less, or not at all, on credit. A second reason is almost certainly psychological. The idea that consumer credit has become accepted in society has probably never been fully true. Surveys of consumer credit consistently show that consumer’s words and deeds are at odds. In his survey of poor consumers in Harlem, for example, David Caplovitz finds that attitudes about credit and credit practice diverged dramatically. Although 59% of respondents said buying on credit was a bad idea (and only 15% said it was a good idea), only 21% of families reported only ever paying cash for consumer durables they purchased. 13 It may be that people attribute to their parents their norms about credit use that they themselves hold, but that they are not able to live up to in practice. Against these economic and cultural arguments, I propose that consumer credit markets are best understood as the outcome of an evolving cross-class coalition focused on welfare goals, rather than as an evolving effort to reach efficient market outcomes through regulations that manage market failures. The same sort of analysis is likely to be pertinent to other kinds of markets. Some of these, like health care, public lotteries, and insurance, are self-evidently tied to broader welfare outcomes. Even seemingly ‘natural’ markets like agricultural products and manufactured consumer goods can be constituted by cross-class coalitions that have as their goal specific welfare outcomes rather than the pursuit of efficiently functioning markets. For markets of this kind, we may understand more about both regulatory variation, and likely future 13 David Caplovitz, The Poor Pay More (New York: Free Press, 1967), pp 95-97. regulatory directions, if we approach them as variants on welfare policy rather than regulatory patches to fix specific market failures. Why did American politicians encourage credit extension when their French counterparts did not? National patterns of credit use have been dictated by the way in which the political left and right have linked household credit to questions of welfare and redistribution. In the United States, the supply of consumer credit has been supported by an evolving cross-class welfare coalition that, for idiosyncratic reasons, did not exist in other countries. The groundwork for abundant consumer credit was laid in the 1910s and 1920s, when credit access was supported by the left as a benefit to the emerging working class and by the right as an alternative to expansive welfare of the kind that was spreading in Europe. In the 1950s and 1960s, consumer credit was supported as an element of the postwar productivity coalition, in which the left supported credit to the working class and the right encouraged credit as a bulwark against communism. By the 1970s, credit market access became a consensus issue of equal rights campaigns by women and blacks. In the 1990s, consumer credit had again been re-imagined, this time as a middle-ground ‘third way’ policy that would both empower the poor and drive returns high returns on financial investments. The evolving political coalitions that sustained support for consumer credit over time also legitimated shifting public discourses about the rationale for consumer credit. Consumers in the 1910s and 20s were relying on credit as a form of insurance in case of injury, unemployment, birth, or any other shock to income or expenses. During the 1950s and 1960s, consumers, stereotyped as returning soldiers, were borrowing to furnish their newly acquired houses. This sort of borrowing was perceived to create a virtuous circle, in which greater demand drove manufacturing productivity and higher wages. During the 1970s, credit became a symbol of economic equality for women and blacks. It also helped middle-class Americans to hedge against the rising costs of everyday goods that was driven by the OPEC oil embargo. By the 1990s, consumers were borrowing to maintain a growing standard of living in the context of stagnant real wages. In France, politicians on the left and right shared a reluctance to accept liberal access to consumer credit even once consumer lending became profitable. As in the United States, their approach to consumer credit markets was grounded in a welfare-like cross-class coalition. But, unlike in the United States, French politicians emphasized the risks: that excessive consumer credit would crowd out industrial investment, that interest charges would reduce purchasing power, and that over-indebted consumers could become permanently excluded from the benefits of social and economic citizenship. More pragmatically, banks that had failed to enter the consumer lending market in the 1980s raised little objection to restrictive policies on credit rating and usury, since they wese would apply to consumer finance companies without a significant impact on the banking system. Credit Use in France and America For most of the postwar period, Americans have been heavy users of consumer credit. In 2007, three quarters of families held consumer debt in the form of mortgages, installment loans, and credit card balances. Outstanding credit card debt averaged $10,637 per person, spread across 5.5 bank and retail cards; outstanding installment debt averaged $21,000, primarily in the form of automobile and educational loans. 14 Taken together, all non-mortgage consumer credit 14 Nielson Report, April 2009; Experian marketing insight snapshot, March 2009; Federal Reserve Board, Survey of Consumer Finance. was equal to 25% of household disposable income. If we include equity extracted from homes that was used for consumption (and to pay off consumer debt), outstanding consumer debt as a share of disposable income rose to 33%. Servicing all of this debt was imposing an ever higher burden on the family budget. For 15% of families, monthly debt service payments accounted for over 40% of their disposable income. The burden of debt service was especially high for the poor. Among families in the bottom 20% of income, over a quarter faced monthly credit payments that exceeded 40% of their disposable income. 15 How did American households get so far into debt? If American households were spendthrifts, French households were frugal. Between 1955 and 1985, American households consistently carried consumer (non-mortgage) debt equal to 15%-20% of their disposable income. During the same period, French household debt rose gradually from 1% to 3% of disposable income. From the mid-1980s, household debt levels rose dramatically across the advanced industrialized countries. Yet French debt levels remained persistently low, even relative to other European countries. By 2005, French household debt had not yet caught up with the level of debt carried by American households in 1955. 15 Brian K. Bucks, Arthur B. Kennickell, Traci L. Mach, and Kevin B. Moor3e, “Changes in U.S. Family Finances from 2004 to 2007: Evidence from the Survey of Consumer Finances,” Federal Reserve Bulletin, February 2009, pp A37-A50. Figure 2. Household non-mortgage debt in France and United States, 1945-2005 (share of disposable household income) 35.00% 30.00% US (with extracted equity) 25.00% 20.00% US 15.00% 10.00% France 5.00% 0.00% 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Notes: Home equity extraction contribution to consumer spending and debt reduction estimated at 80% of total home equity extraction, assuming that 20% of extracted equity was shifted to other assets. Based on Kennedy and Greenspan, 2008. France experienced no significant home equity extraction. This broad pattern of credit use in France and the US is reflected in the share of consumer durable sold on credit. A survey by the Federal Reserve Board in 1949 found that half of new cars, refrigerators, and TVs purchased in the United States were sold on credit. 16 As wartime restrictions on credit were eased in the early 1950s, consumer credit grew as a share of all purchases. In the 1950s, 85% of new cars and 80% of new TVs were sold on credit. 1718 Credit 16 CHA, UFB, “Notes sur le financement des ventes à credit aux Etats-Unis,” December 1952, pp 1-2. 17 Michel Drancourt, Une force inconnue: le credit (Paris: Hachette, 1961), p 26. sales represented 60% or all durable goods sales, and a third of all retail sales. 19 In France, credit sales as a share of total retail sales were significantly lower. In 1954, 19% of new car sales were on credit, and 70% of TVs. 20 By 1960, the credit share of car sales rose, to 26%, and for televisions fell, to 50%. 21 By 1965, 40% of new cars were being sold on credit. 22 Compared to the US, where two thirds of all cars were being sold on credit in the 1950s, in France the share seems to have been about one third. André Malterre, in his study of credit sales in the US and France, found credit accounted for roughly 60% of all durable goods sales in the United States in the mid-1950s, including cars, refrigerators, TVs and radios. In France, only about 30% of such items were sold on credit. 23 By the 1990s, revolving credit accounts had made it difficult to distinguish which particular products were being sold on credit. Nevertheless, the broad cross- 18 Union federale de la consommation, Bulletin Mensuel d’Information 29 (1955), p 48. 19 François des Aulnoyes,” Le credit à la consummation,” Combat January 30, 1954 ; Michel Drancourt, Une force inconnue: le credit (Paris: Hachette, 1961), p 26. 20 Marius Allègre, “Étude du credit a la consummation,” Conseil Économique, March 4, 1954, p 269. 21 “Le Credit a la consummation en France,” Agence Economique et financière, June 9, 1959. 22 Gerard Constant, "La Vente à crédit," Les Cahiers Français, April 1965, p 18. 23 André Malterre, “Problème du credit à la consommation,” Journal Officiel 20, 11 August 1961, pp 770. national pattern of credit sales seems to have been the same. In 1995, 22% of all household goods were being sold on credit in the United States, compared to 9% in the France. 24 The French clearly relied less on consumer credit than their American counterparts, but this seems not to have reflected a specific objection to buying on credit. When the founders of the Carte d’Or credit card surveyed the French in 1965 to assess openness to a genuine credit card, 60% said that they would appreciate access to credit. 25 A survey conducted in 1969 found that three of four workers at Renault viewed consumer credit favorably. 26 By the early 1990s, attitudes had hardly changed. A survey in 1992 finds that 74% of French were favorable to credit; 24% are opposed credit use. Similar surveys were conducted in the US in the 1950s, and they revealed greater apprehension. A survey in 1954 found that 50% of American households thought installment buying was a good idea, versus 37% who opposed it. 27 A similar survey of farm-operator families in 1959 found that 54% thought it was acceptable to buy household equipment on credit. 28 While it would be a mistake to place too much weight on such surveys, it 24 Hubert Balaguy, Le crédit a la consommation en France (Paris: Presses Universitaires de Paris, 1996), p 22. 25 Maurice Roy, "La guerre des cartes est déclarée," L’Express, March 4, 1968. 26 Seidman 2004, p 264. 27 Jan Logeman, “Different Paths to Mass Consumption: Consumer Credit in the United States and West Germany during the 1950s and 1960s,” Journal of Social History 41/3 (2008), p 544. 28 RLDM, Box 152, folder 32, Robert L. D. Morse, “Credit and its Use: Attitudes and Practices of Kansas Farm-Operator Families, 1955,” Draft article, May 14, 1959. does at least seem clear that the French were not strongly culturally averse to using consumer credit. The French lag also seems not to reflect any particular technical or innovative deficiency. In reality, the cross-border diffusion of consumer credit innovation has been surprisingly quick. If many of the early consumer credit leaders in the US were students of the European small loan institutions, by the end of World War II, the flow of small credit innovation and diffusion had reversed. Bankers around the world were visiting the US in the 1950s to track developments in the small loans and credit card sector. French bankers made repeated study trips of this kind in the 1950s and 1960s. Credit cards were especially subject to the smooth international transfer of technology and ideas. Many of the early payment cards were specifically targeted at businessmen who traveled. In 1947, the International Air Transport Association launched the Universal Air Travel Plan (UATP), an international credit card accepted by 72 airlines. 29 The early travel and leisure cards, Diners’ Club and American Express, were also specifically international in their orientation. Diners’ Club was launched in 1950 in the United States; its French-owned affiliate opened for business just four years later, in 1954. The American Express card launched in 1958 in the United States and in 1961 in France. American banks began experimenting with revolving credit in 1958 and 1959; France saw the first experiments with revolving credit in 1962, directly inspired by the American model. When computer systems emerged that could automate account tracking and billing, the French moved quickly to adopt them. In the United States, JC Penney 29 BdF CNC, 1427200301, box 318, Grande Bretagne, Reglementation des ventes à crédit, février 1955 – décembre 1968, Correspondence, Sharman Wright, Bank of England, December 31, 1954. purchased four IBM 1400 machines in 1962 to process their credit accounts; in France, Cetelem installed two of the same computers the following year. As one prominent French lender would later acknowledge, nearly every credit innovation in France had been directly borrowed from lender innovations in the United States. If the French were willing to use credit and their consumer finance companies had the capabilities to offer it, why did borrowing rates remain so low? The answer hinges on a combination of business context and regulatory response. Until the mid-1980s, the sector was barely profitable. At the same time, national industrial policy focused available funds on investment rather than consumption. Whereas American lenders were willing to make largely unprofitable loans to consumers, France’s lenders were not. Even France’s dedicated finance houses required cross-subsidies from retailers and manufacturers to survive. One side effect of this low profitability was that they delayed launching revolving credit facilities until the mid- 1980s, when a confluence of financial liberalization the discovery of profitability in consumer lending made such plans financially feasible. The late move into revolving loans helps to explain some, but not all, of the continued low credit extension under liberalization in the late 1980s and 1990s. French households were borrowing more, but not too much more. The reason had to do with a series of regulatory responses that focused on consumer over-indebtedness as a threat to social and economic inclusion. Supported by a cross-class coalition that included the Catholic right and labor left, credit markets were hemmed in by new restrictions on usury, the collection of positive credit data, the provision of ‘free’ credit, and a provision for discharge under bankruptcy. Unlike in the United States, where credit access was seen as a tool for social mobility, excessive consumer debt was seen in France as having the potentially marginalize an entire segment of the population. A Supply-Side Revolution Observers who trace the emergence of the ‘hyperliquid’ consumer credit market typically point to five revolutions: securitization, risk scoring, credit reference bureaus, risk-based pricing, and low monthly payments. The first three changes are either not distinctive to the United States, or have strong analogs in France. The last two are predominantly American practices that do help to explain differences in lending outcomes that we observe between the two countries. First, much emphasis has been placed on the role of securitization of consumer credit as a tool for reducing the cost and increasing the volume of capital available for lending. In the United States, the first credit card accounts receivables were securitized in 1986. This practice has mainly been limited to the United States and, later, Britain. But European lenders also found ways to directly tap the markets for inexpensive capital. In 1984, Cetelem made its first convertible bond offering. By including an option to purchase stock, it helped Cetelem to tap Europe’s deep corporate bond markets at favorable interest rates. Second, observers have pointed to the role of advanced risk analysis and credit scoring in reducing loan losses and increasing the range of potential borrowers. But these technologies were not unique to the US market. Credit scoring technology that emerged with the computer revolution of the 1970s spread rapidly to the largest consumer lenders around the world. In the US, Fair Isaac developed the first consumer credit scoring system in 1970. Cetelem in France adopted a similar statistical scoring technique borrowed from the United States in 1974. Third, much has been written about the role of credit reference bureaus in reducing the risks of consumer borrowing. 30 One might imagine that some of the difference in credit extension we see between France and the United States is attributable to the availability of accurate credit data. But this problem is not as great as it would theoretically seem, for three reasons. In the absence of positive credit data, French lenders found other means of assessing creditworthiness. They relied initially on a strategy of indirect risk assessment by marketing credit products to customers who had already successfully repaid sales loans agreed to by retailers. Credit reference bureaus had long played an important were important role in the US credit market, but that was primarily because the US market was so highly fragmented. In the 1950s and 1960s, the US had tens of thousands of consumer lenders. France by contrast had only a small number of lenders, including less than a hundred registered consumer finance companies, and the largest of these had since 1974 shared black list data with each other. In general, repayment risk seems to have been relatively easy to manage among the many challenges of making cost-effective consumer loans. The final two changes in lender practice are genuinely distinctive to the United States, and likely played important roles in the high level of consumer debt in that country. The first of these is risk-based pricing. Traditionally, consumer lenders pooled the risk of their borrowers, so that the impact of good and bad credit risks would offset each other. The beauty of risk pooling was in the power of large numbers: even if a lender did not know the risk of any individual, he knew a lot about the likelihood of repayment in a properly-defined population. In this way, credit 30 See Tullio Jappelli and Marco Pagano, “Information Sharing in Credit Markets,” Journal of Finance 48/5 (1993), 1693-1718. served as insurance. As with other forms of insurance at the time, risk pooling provided a transfer from lower risk to higher risk individuals. A pair of innovations caused this system to break down. The first was a set of new information technologies that allowed individual risk assessment. If one assumed that individuals were different in systematic ways, instead of homogenous members of a group, then each individual represented a different level of risk and should therefore pay a different risk premium. Suddenly, risky borrowers would be given access to credit, but that access would come at a higher price. Critics of this approach noted that charging higher prices could accentuate risk, making risk scoring a self-fulfilling prophecy. The last revolution in lending practice that remained distinctive to the United States was the negative amortization account. 31 For American lenders, the business logic of reducing required monthly payments had long been understood. First, lenders knew that lower monthly repayments reduced loan defaults. Second, in a world in which creditors where competing for customers, it made little sense to lose a good customer simply because they had paid off their loan. In 2000, for example, the cost of acquiring a new credit card customer in the United States was roughly $50. That placed a premium on customers you already had, especially if they were proven re-payers. Moving to a negative amortization minimum repayment rate was an easy way of retaining reliable customers. Financial data from Cetelem’s Historical Archives allow us to trace how the costs of lending changed over time. Figure 3 below breaks down the total interest charged on a loan into its cost components. Note first the dominant role of administration and interest payments, and the relatively low cost of provisions for nonpayment. The significant increase in the cost of capital 31 Citibank’s Andrew Kahr claims to have invented the idea of the 2% minimum credit card payment. from 1960 to 1986 were almost entirely offset by lower administration costs and a reduction in government taxes. Figure 3. Cost components of Cetelem loans, 1960-1992. 1960 32 1973 33 1986 34 1992 35 Consumer lending rate 18.7% 19.2% 18.8% 17.6% Breakdown of costs: Administration 7.0% 7.0% 5.1% 3.8% Interest 6.0% 9.4% 10.3% 8.8% Risk 0.7% 0.8% 1% 1.9% Tax 4.5% 1.0% 1.2% 1.0% Profit 0.8% 1.0% 1.2% 2.1% Source: Cetelem Historical Archive, data compiled by author. These data on credit costs at Cetelem show that the single most important factor in rising profitability was the reduction in administrative costs. From 1973 to 1992, the costs of administering a lone were cut in half. Computerization was a core part of the reason. As Cetelem’s president, Pierre Boucher, acknowledged: “Computers…constitute the hard core of our strategy. 36 In December 1962, Cetelem installed 2 cutting-edge IBM 1401 machines. In 1973 it is replaced with an IBM 370/145, which was 40 times more powerful than the two 1401 32 "Des Tarifs pratiqués dans la vente a crédit des biens de consommation durables," Revue du Centre d’Information et d’Etude du Crédit, no. 3 (October 1962); Michel Renault, “La Vente a Crédit s’acclimate en France,” Le Monde, November 29, 1962. 33 BNPP CHA, “La finance et la trésorerie,” à Découvert, no. 9, June 1973, p 6. 34 CHA, Pascal Bonnet, “Tenir nos taux,” Nous, no. 2, June-July 1987, pp 10-11. 35 CHA, Nous Avons 40 Ans, April 1993, p 25. 36 CHA, Correspondence from Pierre Boucher, director general, October 4, 1982. (D01) machines combined. In 1984, they upgraded to an IBM 3081, again the lastest computer technology. The computers allowed them to take advantage of telecommunications. In 1974, Cetelem installed an internal data network called Transpac that connected all of the roughly 200 Cetelem offices and agencies. In 1980, they begin making real-time approvals over the network, and by 1981 all approvals were made over Transpac. In 1983, loan approval times were brought below one minute. By 1984, 3,000 affiliated retailers were connected directly to the Cetelem network via France’s early public teletex network, Minitel. US lenders were equally aggressive in embracing technology. From the early 1970s, JC Penney’s management made substantial investments to improve operations and lower costs. In 1974 they leased 7,000 sales credit communications terminals and eleven System 4000 computers from TRW. In 1975 they completed a nationwide Interconnect System that enabled instant credit authorization from any of the stores. In 1977 they deployed new statistical risk- evaluation systems at each of their 22 regional credit offices. These systems were expected to increase credit application approval rates by 18%. 37 Automated IBM remittance processing equipment was installed in 1978. With the help of greater automation, JC Penney’s credit operations made a profit for the first time ever in 1975. 38 After a downturn corresponding to the high inflation of the second oil shock, profits returned. See Figure 4 below. 37 “Report to Credit Management,” JC Penney Management Report 4/8 (September 1977). 38 JCPCR, Credit: Credit Growth Campaign, 1975, Steve Kernkraut, “Update: Net cost of Credit,” Internal document, Credit department, September 28, 1975, pp 1, 8. Figure 4. JC Penney Charge Card Operations, Net Earnings (1969-1982). $ millions 80 60 40 20 0 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 -20 -40 Ironically, it was this profitability that would spell the end for retail credit. Retailers too small to have their own brand card simply accepted the main bank cards. Retailers that valued their own-brand credit cards contracted out the service to consumer finance companies like HBSC and GE Capital. Retailers with profitable in-house credit programs were made offers that they couldn’t refuse. In 1985, JC Penney acquired a bank, the First National Bank of Harrington, Delaware, and renamed it the JC Penney National Bank. 39 In 1999, GE Capital purchased JC Penney’s credit business. In 1986, Sears launched the general purpose Discover Card, with no fees and a 1% refund. With the addition of insurance and real estate services, financial services 39 JCPCR, JCPenney Credit: 40th Anniversyary Booklet, 1998. accounted for the lion’s share of Sear’s earnings between 1986 and 1991. 40 The Discover network was ultimately acquired by Morgan Stanley in 1997. Retailers’ share of the US consumer credit market fell from 12% in 1971 to 8.9% in 1981. 41 By the 1980s, France’s lenders were also thinking differently about their industry. The high inflation period of the late 1970s-early 1980s in particular had proved formative. Through the steep fluctuations in interest rate that the inflationary shock demanded, lenders learned that consumer demand for credit was highly insensitive to price. Not only did consumers not seem to care about nominal interest rates, they also were seemingly indifferent to real interest rates. The first lesson came from the run-up in inflation in the late 1970s. After bouts of significant inflation during the 1970s, inflation in France briefly touched 20% in mid-1981. In order to maintain reasonable real interest rates, consumer finance companies pushed their consumer loan rates to almost 30%. At first they didn’t know how borrowers would respond. It had long been assumed that 25% represented a psychological ceiling for borrowers. Yet as this barrier was passed, the head of the Association of French Finance Establishments (APEF) recalled concluding that ”30% per year could be adopted without significant consequences…” 42 As the crisis deepened, loan applications actually increased. 40 Ronald D. Michman and Alan J. Greco, Retailing Triumphs and Blunders: Victims of Competition in the New Age of Marketing Mangement (Westport, Conn.: Greenwood Publishing, 1995), p 39. 41 JCPCR, JCP Credit – 10 year strategic Plan, 1983-1993, Part 1, JCPenney Credit Division, Stategic Plan, April 1983, p A-1. 42 Le Matin, June 29, 1981. Figure 5. Nominal and real consumer lending rates in France, 1979-1986 43 30% 25% 20% 15% 10% 5% 0% 1979 1980 1981 1982 1983 1984 1985 1986 Consumer borrowing rate Inflation Real interest rate The second lesson came with the decline in inflation in the early 1980s. It was during this period that lenders found that consumers were also insensitive to real interest rates (i.e., nominal interest minus inflation). As inflation fell, lenders lowered their interest rates more slowly— recurring bouts of inflation in the 1970s had taught them to be cautious. The result was a growing wedge between consumer interest charges and inflation. Between 1983 and 1986, average real interest rates for consumer credit in France rose from 10% to 15%. Yet demand for credit continued to rise dramatically. By 1986, lenders who had observed this phenomenon drew the obvious conclusion. The head of one consumer finance company explained: “Consumers pay almost no attention to the absolute level of the rate. They are interested mainly in the monthly payment…No study has ever shown the least correlation between a rise in the cost of credit and a 43 Philipppe Manière, "Les constructeurs auto "bradent" leurs prêts," Quotidien de Paris, April 30, 1986. reduction in consumption.” 44 For Cetelem, the insight was decisive for the company’s strategy. In 1986, CEO Pierre Boucher sent a note to the entire company declaring: “The interest rate is not a decisive element in households' decisions to take a short-term loan.” 45 Cetelem would no longer be the lowest cost lender, as it had in the past. They would instead focus on product features that consumers did seem to value. Liberalization in the United States These changes in the logic of lending were accompanied by government policies that, in the US case, liberalized credit access. These reforms were driven primarily by a vision of competitive discipline on consumer lenders. The first blow to usury caps came from a court case, the 1978 Marquette National Bank vs. First of Omaha Supreme Court decision that applied state- of-origin usury rules to out-of-state credit card lenders. In the case, Marquette National Bank of Minnesota had filed claim against First of Omaha for charging 18%, which was permitted under Nebraska state law, to its credit card customers in Minnesota, where usury caps limited interest rates to 12%. Marquette at the time was charging its customers 12% interest, plus a $10 fee to cover expenses. Apart from the differences in interest rate and fees, the services were the same: revolving credit cards that were both affiliated with the BankAmericard (Visa) network. The defendants argued that the National Bank Act (National Bank Act, Rev.Stat. § 5197, as amended, 12 U.S.C. § 85) preempted state usury laws (Minn.Stat. § 48.185 (1978)) for states in which they were not located. The relevant passage of the law, Section 85, read: “Any association may take, receive, reserve, and charge on any loan or discount made, or upon any notes, bills of exchange, 44 Le Matin, June 29, 1981. 45 CHA, Pierre Boucher, internal memo, 1996. or other evidences of debt, interest at the rate allowed by the laws of the State, Territory, or District where the bank is located.” Since the Nebraska bank operated no branch banks in Minnesota, the court found they were not located in Minnesota. Justice William Brennan noted: “Minnesota residents were always free to visit Nebraska and receive loans in that State.” He argues that the intent of the original 1864 National Bank Act was to create a “national banking system”; any change in section 85 should therefore be made by Congress, not judicial interpretation. 46 Suddenly, national banks enjoyed an unprecedented advantage in competition against retailers and state banks. Both federal and state regulators responded quickly to eliminate the advantage. A provision added to the 1980 Depository Institutions Deregulation and Monetary control Act (PL 96-221) extended the Marquette state-of-origin policy to state banks insured by the Federal Deposit Insurance Corporation (Section 501). In order to untie the hands of retail lenders and local finance companies that competed with banks, most states changed their usury policies. By the end of 1981, 45 states had either raised their usury rate ceilings for consumer loans or eliminated them all together. For states that retained usury laws, smaller local lenders found that they could partner with out-of-state banks to provide loans that exceeded local interest rate caps. Tax preparers began working with banks to make tax refund anticipation loans (RALs). These RALs had APRs of 150% to 300%, and were used especially by low-income recipients of the Earned Income Tax Credit. Pay-day lenders and auto title lenders, whose loans 46 U.S. Supreme Court, Marquette Nat. Bank v. First of Omaha Svc. Corp., 439 U.S. 299 (1978), No. 77-1265, 439 U.S. 299. ranged up to 390%, also partnered with out-of-state federally chartered and FDIC banks to exempt themselves from state usury laws. 47 The Consumer Federation of America lamented: “The result is a set of usury laws that should make a finance company proud.” 48 Marquette v. First of Omaha left open a range of questions about the scope of state regulatory authority over national banks that would be settled only during the 1990s. In 1996, the Supreme Court heard the appeal of Smiley v. Citibank, in which a New Jersey man had argued that the late fees charged by Citibank violated the state law restricting late fees. Banks, which in the debates leading up to the 1968 truth in lending legislation had argued that fees should be treated separately from interest charges, now argued that they were equivalent to interest and thus covered by the Marquette v. First of Omaha precedent. When the Supreme Court found in favor of Citibank, credit card use of late fees expanded, from an average late fee of $12 in 1996 to $29 in 2002. 49 Similar cases explored the ability of state regulators to dictate minimum repayment rates. In 2000, the California legislature passed legislation requiring credit card issuers to include a warning on their statement that paying only the minimum balance would increase their principal. In ABA v. Lockyer (2002) the American Bankers Association sued the Attorney General of California, alleging that the law infringed on a different provision of the 47 Michael S. Barr, “Banking the Poor,” Yale Journal of Regulation 21 (2004), pp 161- 173. 48 RLDM, Box 212, folder 24, Letter from the Consumer Federation of America to the Senate Banking Committee, June 17, 1982. 49 Furletti, “Credit Card Pricing Developments and Their Disclosure,” Fed Discussion Paper, January 2003. National Bank Act that provides for “all such incidental powers as should be necessary to carry out the business of banking.” 50 The ABA argued that cost of printing such a warning made the law “overly burdensome” on banks, and was therefore preempted by the NBA itself. In 2004 the Office of the Comptroller of the Currency issued new rules that preempted states regulation of a wide range of nationally chartered bank activities, including use of non- interest charges, credit account management, mandatory disclosures, and interest rates and fees. 51 By the time of the 2004 rules, it had become clear that federal preemption of state bank regulations was being treated expansively. Mark Furletti writes: “The agency [OCC] essentially declared that states have little or no authority to impose any consumer-protection-oriented regulation on nationally chartered banks and that any such regulation is the province of federal law.” 52 Liberalization in France Between 1984 and 1987, the French financial sector was dramatically liberalized. This included the elimination of ‘encadrement de crédit’, the privatization of previously nationalized banks, and a shift in authority over banks from the finance ministry to the competition ministry. For both banks and finance companies, liberalization would change their approach to consumer lending. For banks, liberalization would initiate a period of rapid expansion into the personal loan business, followed by failure and retrenchment. For consumer finance companies, 50 National Bank Act, Section 24 (seven). 51 Mark Furletti, “The Debate Over the National Bank Act and the Preemption of State Efforts to Regulate Credit Cards,” Temple Law Review 77 (2004). 52 Furletti, “Credit Card Pricing,” p 16. liberalization opened up the market for revolving credit accounts of the kind that American consumers had long enjoyed. France’s banks had traditionally avoided consumer credit. The few times when they had moved into the area, as in the early 1970s, they had failed. Close administrative guidance from the Banque de France had also made it difficult for banks to compete in the sector. As recently as 1982, the governor of the Banque de France had written to all of the banks asking that they extend no more personal loans. 53 This sort of stop-go administrative oversight made it difficult to justify the significant investment large-scale consumer lending would require. More importantly, France’s postwar indicative planning had relied on banks to finance its projects, and banks became dependent on these investments for their profits. Financial liberalization changed this. Firms in France began to seek non-bank sources of capital. They increasingly began to look to the stock market, to factoring, and to self-financing through retained earnings. 54 Bank corporate lending fell from 159 billion francs in 1982 to 109 billion in 1983, corresponding to a steep rise in interest rates. Yet, even as interest rates began to fall off, corporate borrowing continued to decline. By 1986, outstanding corporate loans were down to 75 billion francs. 53 François Gomez, «La vente à crédit aux particuliers, » Gestion et Technique Bancaires 451 (June 1985), p 597. 54 Richard Deeg and Mary O’Sullivan, “The Financialization of Europe,” paper presented at the Annual Meeting of the American Political Science Association, Philadelphia, 2006. Liberalization and the decline in corporate lending pushed banks to look for other sources of revenue, and consumer lending became a focus of intensive interest. 55 As one observer noted : "Banks live from lending. Once they realized that companies had less and less need for them, they turned to households with increasing ease as credit was liberalized." 56 France’s large banks allocated large blocks of funds to a new push to extend their consumer lending business. Credit Agricole alone allocated an additional 20bn francs to consumer credit in 1986 and 1987. 57 Through this push, they were able to increase dramatically their share of the consumer lending market. From financial liberalization in 1984 to 1987, their share of the total consumer lending grew from 18% to 25% 58 They accomplished this in three ways. First, they offered lower rates than the consumer finance companies. Whereas the latter were charging in the range from 15% to 18.25% at this time, banks began offering rates from 12% to 16%. 59 They justified these lower rates based on 55 Jean-Pierre Robin, "Credit a la consommation, les français s'americanisent," La Vie Française, June 21, 1987. 56 Françoise Fressoz and Philippe Boulet-Gercourt, «Les Français flambent à crédit, » Libération, August 13, 1987. 57 Florence Paricard, "Consommation: le taux de crédit doit baisser," La vie française, March 30, 1986. 58 Françoise Fressoz and Philippe Boulet-Gercourt, «Les Français flambent a crédit, » Libération, August 13, 1987. 59 Françoise Fressoz and Philippe Boulet-Gercourt, «Les Français flambent a crédit, » Libération, August 13, 1987; Journale des Finances, May 30, 1987. their lower cost of capital, but also on their detailed knowledge of their clients, many of whom were long-term depositors. They also began aggressively expanding their credit agreements with retailers. For the first time for a French bank, BNP in 1986 allied with the retailer Euromarché to provide a Carte bleue credit card co-branded to the Euromarché. 60 Third, France’s big banks started providing their best customers with access to revolving credit accounts. Traditionally, banks lent in the form of personal loans with fixed repayment schedules. In the fall of 1987, BNP launched Crédisponible, with revolving credit at 15.8%. Credit Lyonnais followed in September 1987 with Crédilion. Societé Génerale offered Crédiconfiance. 61 Credit Agricole formed a consumer finance affiliate called Unibanque to offer revolving credit. As banks entered the consumer lending market, credit growth boomed. Non-mortgage household debt in France rose from110 billion francs in 1984 to 370 billion francs in 1989, the peak of the credit boom. Over the same period, the share of indebted households rose from 39% to 53%. 62 Average household debt as a share of disposable income increased from 3.5% to 7%. 63 By 1990, the credit boom had dramatically slowed, from annual growth of 30% in 1987 to 20% 60 Florance Pricard, « La Carte bleue fait credit, » La Vie Française, October 12-18, 1987. 61 Florance Pricard, « La Carte bleue fait credit, » La Vie Française, October 12-18, 1987. 62 « Les Français et le crédit," Figaro-Magazine, April 8, 1989, p 94. 63 Roger Leron, Rapport surt l’application de la loi No 89-1010 du 31 Décembre 1989 rélative a la prévention et au réglement des difficultés liées au sûrendettement des particuliers et des familles, 1990, p 7. in 1988, 16% in 1989, to 2% in 1990. 64 Some attributed the reduced growth to the effect of the first Gulf War; others thought that it was simply an artifact of France having “caught up” after years of credit restraint. 65 The most important cause, however, was the failure of France’s large banks in consumer lending. The banks failed for two main reasons. First, banks were not specialists at consumer lending. They had not made the investments in skills or equipment that was required for success in consumer lending. As Jean-Christophe Goarin, head of the consumer finance company S2P (Groupe Paiement Pass), explained: "The handicap for banks is that they have too many products. We have only a few, but we present them well and they are well adapted to the needs of our clients." 66 Second, while consumer finance companies had embraced the idea of tracking past repayment as a predictor of future repayment, banks were still relying on their relationships with their depositors. They assumed that, because they had had known clients for years, that they would be have low repayment risks. What they found was that they faced higher default rates than did consumer finance companies. The high rate of defaults was aggravated by their effort to expand their customer base rapidly, which led some banks to offer loans indiscriminately. Pierre Marleix, head of the trade union-affiliated consumer group AFOC, explained that banks "were 64 Le Figaro, May 30, 1991. 65 La Tribune de l’Expansion, April 8, 1991. 66 Catherine Rigollet, "Le Bazar des produits financiers," L'Express, March 6, 1987. increasingly unconcerned about finding reliable borrowers; they simply wanted to increase their loan volume in order to be big. " 67 By the early 1990s, most banks had already moved to close smaller and delinquent accounts, and it was clear that they would not be leading players in consumer lending, at least not directly. Those that continued to lend did so mainly to their affluent customers. 68 Banks like Credit Agricole that had created their own consumer finance affiliates closed those. 69 What they did instead was begin to acquire existing consumer finance companies. BNP Paribas bought Cetelem. Credit Agricole bought Sofinco. GE Capital bought Sovac. Credit Lyonnais bought ‘Citifinancement’ from Citicorp France. 70 The failure of bank lending was good for the dedicated consumer finance companies. In 1992 alone, Cetelem stock rose 60% in value. 71 The most enduring impact of liberalization was the shift of consumer credit from installment credit and personal loans toward revolving accounts tied to payment cards. Until liberalization, the active management of credit volumes required by ‘encadrement’ meant that open or revolving accounts were difficult to operate. Not only did consumers control the amount 67 Françoise Fressoz and Philippe Boulet-Gercourt, «Les Français flambent a crédit, » Libération, August 13, 1987. 68 Philippe Reclus, « Les grands réseaux s’alignent sur le taux à 9%, » la Tribune desfosses, September 7, 1993. 69 Le Figaro, May 30, 1991. 70 Renaud de la Baume, “Les banques peinent sur le marché du crédit à la consummation,” La Tribune de L’Expansion, 26 march 1992. 71 Roland Laskine, « Au mieux de sa forme, » La Vie Francaise, January 9-15, 1993. of credit they used, they also tended to rely more heavily on their revolving accounts at exactly the times when the Banque de France was reining in lending. All of this changed with the end of encadrement. In 1985, Cetelem launched their new Aurore card. 72 For Cetelem, the Aurore card was a way to counter the aggressive move by banks into personal lending. They offered it as a co-branded card that allowed them to reinforce their ties with retailers. They also already understood the technology, which they had showcased twenty years earlier with their ‘credit en poche.” By end of 1987, the Aurore card already had 600,000 members. 73 Other consumer finance companies quickly launched their own revolving products. They included Accord by Auchan, Plus by Cofinoga, and Pass by S2P. Credit Commercial de France (CCF) created an innovative revolving account with rates tied directly to the interbank lending rate. 74 Amid all of the new entrants, the Aurore card would dominate the field. By 1995, ten years after its launch, Cetelem’s Aurore card was used by 5 million French (and 1 million other Europeans). 75 By 2000, there were 13 million Cartes Aurore in use, with 250,000 points of sale. 76 Interest rates on 72 The name « aurore » meant dawn, but also sounded like « or-or », or « gold-gold ». Catherine Rigollet, "Le Bazar des produits financiers," L'Express, March 6, 1987. 73 Jean-Philippe Vidal, « L’explosion du crédit à la consommation, » Tribune de l’économie, October 27, 1987. 74 Florence Paricard, "Consommation: le taux de crédit doit baisser," La vie française, March 30, 1986. 75 Figaro-Economie, June 19, 1995. 76 Philippe Herail, “Cetelem: une histoire des valeurs, un avenir,” Cetelem Historical Archive, August 2002. these loans ranged from 12.4% to 16.1%. 77 Some banks also began launching Cartes Bleue tied to revolving credit accounts, including Alterna by Societé Generale, and Provisio by BNP. Interestingly, bank revolving accounts that were initially marketed as luxury products did not remain that way for long. By the late 1990s, France’s banks were facing a surge in personal loan non-payments. One solution, they discovered, was to convert the distressed personal loan accounts into revolving accounts. With longer repayment periods and a flexible repayment schedule, write-offs could be avoided. Indeed research at the time found that only 1.1% of revolving accounts ended up in legal recovery, compared to 3.2% for traditional small personal loans. Driven first by luxury and then by necessity, revolving lending grew from 8.5% of consumer borrowing in 1996 to 17% in 1990. 78 By 2000, 26% of all non-mortgage household borrowing would take the form 77 Le Figaro, March 9, 1987. 78 Roger Leron, Rapport surt l’application de la loi No 89-1010 du 31 Décembre 1989 rélative a la prévention et au réglement des difficultés liées au sûrendettement des particuliers et des familles, 1990, Annex II.. of revolving credit. 79 For consumer finance companies, revolving loans accounted for 37% of all loans. 80 The emergence of revolving credit elicited concerns from the French public. Many feared that it offered “easy credit” that would drive households excessively into debt. Bankers were defensive, arguing that borrowers with access to revolving credit were able to be more financial responsible because of the greater control that revolving credit gave them. Lenders tended to use developmental and evolutionary metaphors when talking about their revolving credit clients. LaJaques Lenormand, the director of the personal lending department at Crédit Agricole, was typical in claiming "clients with access to revolving credit are far more adult, more evolved, better informed and, in this sense, are better managers." 81 French consumers were evidently more circumspect. A survey of French consumers in 1992 found that only 30% knew what revolving credit was. Among those who were familiar with it, two-thirds called it “very useful.” Yet half— 79 François Henrot, « Les instruments du financement à crédit de la consommation en France, » in André de Lattre (ed.), La consommation et son financement en France et dans le monde (Paris: Berger-Levrault, 19xx), pp 56-57. 80 François Henrot, « Les instruments du financement à crédit de la consommation en France, » in André de Lattre (ed.), La consommation et son financement en France et dans le monde (Paris: Berger-Levrault, 19xx), pp 56-57. 81 Figaro-Economie, May 14, 1990. and therefore presumably some significant share of those who called it “very useful”—also called it “a trap from which one never escapes.” 82 A second concern was with the impact that the new revolving credit arrangements would have on consumer protection in sales contracts. One of the core pillars of French consumer protection was the 1978 “Scrivener” law. This law had the effect of linking credit and sales contracts. Under the law, installment credit contracts were binding only with the delivery of a product. Conversely, sales contracts were binding only with the approval of a loan. The law also created a 7-day cooling off period for credit sales that required sellers to take back their products if the buyer decided to nullify the credit contract. In practice, sellers commonly waited seven days before making delivery to avoid having to take back used products if a customer opted to reverse a credit purchase. 83 As French consumers moved away from installment borrowing and toward revolving credit plans, the benefits of these consumer protections diminished. Yves le Duc, general secretary of the French consumer group CSCV, writes: "The Scrivener law …established a link between the credit contract and the sale of a product. This link is dissolving….The large retailers and banks that offer their own cards no longer need to know if a 82 Paul Defourny and Josette Bienfait, Données d’image sur le credit, Paris: Cetelem- BVA, 1992, p 7. 83 Law 78-22, 10 January 1978, transcribed as articles 311 and 313 of the French Consumer Code; La Croix, May 29, 1976. good is delivered, or if it is in good condition…whatever the case, payment is required. This is an important regression with respect to the law of 1978." 84 Re-Regulation in France From 1980 to 1986, the share of French households with outstanding consumer debt grew from 33% to 40%. 85 During the same period, the household savings rate fell from 17.5% to 12%. 86 The growth in the use of credit led to a wide-spread public debate about the causes and consequences of over-indebtedness. Some saw it as a ‘demoralization’ of credit that allowed households to behave more like companies. 87 The dominant interpretation, however, was that French families were using consumer credit as means to compensate for stagnating purchasing power. 88 Yves Ullmo, secretary general of the National Council on Credit, described the effect: "Since , disposable income has increased little. To maintain a certain standard of living, use of credit has been a solution.” 89 Policymakers on the left and right worried about the 84 Philippe Lebellec, « Crédit a la conosmmation : prudence, » La Croix, November 11- 12, 1987. 85 Le Monde, June 19, 1987. 86 Le Monde, January 5, 1989. 87 Martine Gilson, « Credit : les français craquent, » Le Nouvel Observateur, January 26- February 1, 1989. 88 Martine Gilson, « Credit : les français craquent, » Le Nouvel Observateur, January 26- February 1, 1989. 89 Roger Leron, Rapport surt l’application de la loi No 89-1010 du 31 Décembre 1989 rélative a la prévention et au réglement des difficultés liées au sûrendettement des particuliers et sustainability of this strategy. The result was a series of decisions that progressively restricted access to credit for French consumers. The first target of reregulation was the so-called ‘free credit’ that emerged with the relaxation of government credit ‘encadrement.’ These were sales loans that were offered without any direct interest charge. Their goal was to increase sales. In the furniture sector, which quickly embraced the practice, 20.5% of all credit offered in 1984 was without interest. As a merchandising strategy, fee credit seems to have been effective. The two furniture retailers that were most aggressive in offering furniture credit for free—Galeries Lafayette and Castorama— were able to consolidate their position as France’s leading furniture retailers. Galeries Lafayette at the time was offering 94% of its credit sales at zero interest. 90 For the government of François Mitterrand, who in 1984 was struggling to reign in inflation, free credit raised the old fear that unbridled consumer credit would stoke the flames of inflation and so hurt competitiveness. Laurent Fabius, Prime Minister under Mitterrand, attacked the practice as “pushing customers to purchase using credit they don’t really need.” 91 The Banking Law of 1984 reined in free credit sales. Retailers could no longer advertise free credit terms outside of the point of sale. More importantly, when free credit terms were offered, retailers were required to display a lower price for goods when they were purchased des familles, 1990, p 7; Jean-Marc Biais, « Le Piège à mauvais payeurs," L’Epress, February 3, 1989, p 62. 90 Direction du Développement, “Credit Gratuit,” September 4, 1984. 91 Laurent Chavane, “L’enterrement discret du ‘crédit gratuity’”, Le Figaro, 23 July 1984. without free credit. This lower price was set by a formula, based on the average interest rate plus 50%, that for average periods of credit gave prices that were roughly 20% below the ‘free credit’ price. 92 Interestingly, most consumer groups supported the new law, as did small retailers, who did not have the financial means to compete with ‘free credit.’ 93 The second move to restrict credit access focused on the practice of credit rating. In 1988, Jacques de la Rosière, governor of the Banque de France, announced their intention to create and manage a mandatory listing of credit data on all consumer borrowers. This would re-establish a system created in 1946 in which banks reported all of their loans to the central bank. While this process had been retained for commercial lending, consumer lending had made exempt as part of the credit liberalization campaign of the 1950s. Consumer groups strongly supported the creation of a positive or ‘white’ credit database, in part because they thought it would force France’s banks to behave more responsibly. Consumer representative Louis Mesuret warned: “[the banks] do not respect their obligation of prudence and offer credit willy nilly (‘atort et a travers’).” The idea was to allow all lenders to know the total debt held by credit applicants so that they could better evaluate the likelihood of repayment. The Association of French Banks came out strongly against the white list idea, which they saw as an attempt by the non-bank finance companies to gain access to their own clients. Banks reasoned that the long-term relationships they had built with depositors would give them an advantage in offering them loans. Consumer finance companies, by contrast, had traditionally offered loans via retailers, and thus had very little direct 92 François Renard, “Le credit gratuity va pratiquement disparaître,” Le Monde, 25 July 1984, p 19. 93 Laurent Chavane, “L’enterrement discret du ‘crédit gratuity’”, Le Figaro, 23 July 1984 contact with their customers. By sharing data on their customers, banks stood to lose valuable information and gain very little. 94 France’s large banks are reported to have used their political influence to get France’s powerful data privacy body, CNIL, to recommend against the creation of a positive credit listing of the sort proposed by de la Rosière. With the failure of a white list, France’s association of finance companies (Association des sociétés financiers, ASF) launched their own debtor black list in October 1988. This list, which was voluntary to its members, included only borrowers who were at least 3 months late on their payments. Members were encouraged to check applicants against this list before making loans. All but the largest lenders participated, accounting for 35 of the 37 member organizations and 70% of all finance company lending. 95 The Banque de France responded the following year by creating their own black list. Unlike the ASF list, all consumer lenders were required to check loan applicants against the official government list. Unlike the proposed white list, it included only non-payment information. The database, called the Fichier national des incidents de remboursement des credits aux particuliers (FICP), was accessible only to credit providers and to individual debtors who wished to view their own record. 96 In practice, the FICP database became a no-credit black list for borrowers. In 1991, it included 800,000 late payers; by 2003, that number had grown to 2.3 million.97 94 Libération, December 7, 1988. 95 Le Monde, December 8 1988. 96 Chatain, Pierre-Laurent and Frédéric Ferrière, Surendettement des particuliers, Paris: Editions dalloz, 2000, p 188. 97 Libération, March 20, 1993. Since its creation, debates periodically surfaced concerning the potential advantages of collecting and distributing more extensive ‘positive’ credit data, including information on outstanding loans, taxes, income, and assets. In one proposal, which came before the National Assembly in 2005, the center-right UDF party argued that a positive registry would give financial institutions a better sense of total lending and help them to better assess a consumer’s ability to repay. France’s financial institutions were divided on the proposal. Some, including the consumer lending institution Cofinoga, argued that positive data on potential borrowers would help them to avoid adverse selection in selecting customers, thereby reducing both defaults and credit rationing. But many other financial institutions, supported by France’s association of financial companies (ASF), argued that a positive rating system would only assist foreign financial firms—like UK-based lender Egg—to identify and exploit new clients in France. 98 France’s consumer groups generally agreed with this view, worrying that a positive list would become a tool for more aggressive commercialization of credit, leading to higher levels of consumer indebtedness. 99 CNIL again blocked the proposal as an illegitimate use of private data. The third major regulatory move was in the area of bankruptcy. In 1989, France adopted new legislation (the Law on Prevention and Regulation of Individual and Household Over- indebtedness) that introduced for the first time a civil personal bankruptcy procedure. The goal 98 Catherine Maussion, “Credit: tout le monde dans le même fichier?” Libération, 5 October 2002. 99 Bertrand Bissuel and Anne Michel, “Les établissements de credit accusés de favoriser le surendettement, Le Monde, 28 April 2005; Sylvie Ramadier, “La bataille du credit à la consummation,” Les Echos, 21-22 January 2005, p 8. of the project was to prevent the over-indebted from becoming permanently marginalized in society. Until 1989, France provided no useful recourse to over-indebted consumers. Creditors with defaulting borrowers brought their cases to the courts, which summoned the defaulting consumers, who often simply did not appear. Courts would then grant creditors the right to repossess property and attach salaries, typically leading to eviction. 100 For creditors, this ad hoc response created coordination problems, as creditors rushed to secure insufficient assets. With liberalization of consumer credit in 1984-1987, a rising incidence of over-indebtedness led France’s consumer and finance associations to negotiate a novel solution. The law of 31 December 1989, called “Neiertz law” after France’s minister of consumption, Véronique Neiertz, created a new administrative instrument that would work beside the legal system to help resolve cases of consumer over-indebtedness. The law would be reformed several times as the French government has moved slowly toward a workable system that provided for the discharge of personal debt. The core of the new system was a set of Departmental Commissions for Over-indebted Individuals’ managed by France’s central bank and to which any consumer could apply for debt restructuring or relief. The commissions had broad authorities. They could suspend payments for up to two years, restructure the payment period for loans, and modify interest rates. The new repayment schedule was based on the Commission’s assessment of the “minimum vital income” to meet the claimant’s most basic needs, and repayment plans could last up to but not longer than ten years. Formally, Commissions could only propose repayment solutions. If both parties to the negotiation did not voluntarily accept it, the case went before a judge, who, from 1995, had the 100 “Un peu d’oxygène pour les familles surndettées,” Nous 103, March-April 1990, p 9. right to enforce the recommendations of the Commission on both parties (or, in rare cases, to design a new repayment scheme). A series of studies conducted in the 1990s showed that most cases went to the full 10 years, that interest rates were reduced on average from 13% to 9%, and that average monthly payments were reduced from 6,000 francs to 3,800 francs. 101 Within certain limits—business-related debt was excluded, and consumers had to show ‘good faith’ in presenting their case to the commission—nearly all cases were accepted. The number of cases filed with the commissions grew dramatically since their founding. From 90,000 cases in their first year, 1990, the number of cases had risen to 190,000 by 2004. 102 Two features of the 1989 law were distinctive. First, the commissions included no formal requirement for credit counseling, although in practice consumer and family associations often helped indebted households to navigate the administrative procedures. Second, private credit intermediaries were banned in France, although credit consolidation loans remained legal. 103 In assessing cases, the commissions distinguish first between ‘active’ cases of over-indebtedness, in which consumers have simply taken on too much debt, and ‘passive’ cases, in which external causes have made it impossible for the borrower to continue paying. In 2001, active cases 101 Balaguy, Hubert, Le crédit a la consummation en France (Paris: Presses Universitaires de Paris, 1996), p 106-7. 102 The commissions were administrative bodies. Each had four members, representing the Banque de France, the treasury of the department, a consumer association, and a representative of a lender association. In 2003, two non-voting members were added: a social worker, and a lawyer. INC, Le Dispositif Juridique (internal documents). 103 Familles de France magazine 664, September 2000. accounted for 36% of all cases. By 2004, active cases accounted for 27% of all cases. Because the total number of cases had grown substantially, the number of active cases has stayed nearly the same – approximately 50,000 cases per year. In 2004, the most important sources of passive cases were unemployment (30.8%), divorce or separation (14.7%), and sickness or accident (10.8%). 104 As the number of cases seen by the commissions each year has risen, the share of ‘active’ cases has consistently fallen. Consumer creditors were initially highly skeptical of the Neiertz procedure. Initially, in 1990, only 45% of solutions proposed by the commissions were accepted by creditors. Paul Defourny, head of Cetelem, estimated in 1992 that 50,000 of the 160,000 cases heard up until that point represented instances of clear cheating by borrowers—borrowers who had gone from lender to lender in order to borrow as much as they could without intention of repaying. He estimated that the loi Neiertz had cost the lending industry 1bn francs in its first two years. As he describes it, “the [Neiertz] law…moralized our profession by creating a sort of deontological code.” 105 Yet as cases of over-indebtedness rose, and as the commissions showed that they were able to produce workable solutions, industry acceptance of commission proposals rose, to 75% by the end of the 1990s. The final major area of consumer credit re-regulation concerned usury. The 1989 Neiertz law had redefined usury to accommodate different risk classes while still limiting lending outside of a legally defined range. (See chapter 7 above.) The effect was to restrain the more costly kinds 104 INC, Le surendettement en chiffres (internal publication) 105 Renaud de la Baume, “Surendettement: un banquier dénonce les ‘tricheurs’,” La Tribune a l’Expansion, 19 March 1992. of loans while still allowing lenders flexibility in adjusting their rates over time. 106 From the mid-1990s, the interest cap for the most expensive class of loan, the revolving credit accounts, ranged between 20% and 25%. In practice, this meant that certain smaller loans to riskier classes of borrowers were not financially viable without cross-subsidy. A cap at 25% meant that some people would not have access to credit. As in the past, however, what mattered for usury caps was the political will to enforce them. The first test for the Neiertz law came in 1996. In that year, the UK-based Thorn group launched its first rent-to-sell store, called “Crazy George’s,” in Bobigny, France. It followed with a second site in Havre. The store format was based on the company’s highly successful Rent-a-Centre chain, launched in 1992 in the United State, and the equally successful ‘Crazy George’ rent-to-own chain in the UK. The idea of the store was to offer goods under a rental contract that would eventually lead to consumer ownership. Their French stores targeted communities with high concentrations of poor and elderly, and where credit was not readily available. The effective interest rate on the rent-to-own purchases ranged up to 56%. Because the rental was not formally a sale, it did not fall under France’s usury restrictions. 107 Initially, Thorn had envisioned offering the rent-to-own service through its existing French consumer electronics rental company, Visea. Beginning in 1994, Visea began posting 106 Gaudin, Michel, Le Crédit au pariculier: Aspects économiques, techniques, juridiques et fiscaux, Paris: SÉFI, 1996. 107 Crazy George’s 40 outlets in the UK operated on far lower effective interest rates, ranging between 20% and 25%. This was likely due to the more highly competitive consumer lending market in the UK, which gave Crazy George customers other borrowing options. billboards with slogans that read: "If we lend only to the rich, why did we invent credit?” and “If we deny credit to those who are unemployed, what good is solidarity?" 108 The reference to solidarity was a direct attack on the French idea of equal citizenship without equal access to credit. Thorn finally opted to introduce the rent-to-own (location avec option d’achat, LOA) format as an American import. To launch its first Crazy George’s store in Bobigny, they paraded around town in convertibles festooned with balloons and American flags. The French media quickly focused on the new format as an ‘Anglo-Saxon” import. Public interest heightened when the first store was shut down by France’s commercial police (the DGCCRF) on the grounds that they were not accurately reporting the final total price on their goods. For Crazy George’s customers, many of them retired, on a pension, and without access to traditional consumer credit, Crazy George’s provided their only possibility to purchase large household goods. Unlike consumer lenders, Crazy George’s accepted social payments as income to qualify for a loan. In fact a third of all customers reported no household salary income. To manage repayments, the stores sold only to customers within a 5 kilometer radius and insisted that customers drop off their payments in person and on a weekly basis. All applicants were required to give the names and telephone numbers of three friends and two relatives, so that application information could be confirmed. 109 These measures kept default rates below 1%. 110 A survey of customers found that 66% were first-time buyers of basic household goods like 108 La Croix, January 18, 1994. 109 Odette Terrade, “Projet de loi de finances pour 1998 - Consommation et concurrence,” 87/9, French Senate, 1997. 110 “Crazy George’s Déclare forfeit,” LSA 1594, August 27, 1998. televisions and computers. 111 Critics argued that it was wrong for the poor to pay over twice as much for products. And a public poll found that 70% of French opposed the rent-to-sell format. 112 Behind the opposition was a coalition of the Christian right and labor left. France’s Catholic newspaper, La Croix, took a hard line: "consumer lending...is to be condemned, and the old Christian tradition of usury, meaning a total prohibition on the charging of interest, not only abusive interest rates, should be retained.” 113 The union-affiliated consumer group CSCV (Confédération syndicale du cadre de vie) brought a law suit against them for exceeding France’s usury cap. 114 In 1998, Thorn was acquired by Nomura Investment, and the French stores were closed. Credit and the Third Way In the United States, consumer credit was also closely associated with concerns about welfare. The difference was that American policymakers saw credit access as promoting solidarity. The basis for this consensus was an evolving cross-class coalition in favor of credit extension. The coalition proceeded in four stages. In the 1920s, newly efficient installment lenders were embraced as a means to save household borrowers from the extremely high interest rates and harsh collection techniques practiced by unlicensed loan sharks. In the 1950s and 1960s, credit boosted demand for household manufactured goods. This was seen to increase industrial production and jobs, stimulate new business investments, and help workers to secure 111 CSA, survey of 157 customers, October 1997. 112 Le Monde, 25 November 1996. 113 Hugues Puel, “Crazy George’s met l’éthique au défi,” La Croix, 11 December 1996. 114 Crazy George’s à contrecourant, Humanité, February 20, 1998. the benefits of the industrial society they were helping to build. During the 1970s, both women and blacks made credit access a successful part of their campaigns for equal rights. This new access came at a low economic cost, as rising inflation caused by the two oil shocks dramatically reduced the real interest rate on fixed interest rates consumer loans. Across all of these first three periods, industrialists tended to embrace credit as a way to de-radicalize the work force; liberals saw it as a means to support the poor without raising new government resources. By the late 1980s, the seeming benign relationship between working class aspirations and consumer credit turned more sinister. A combination of deregulation, new technologies, low inflation, and low interest rates contributed to making consumer loans highly profitable for lenders. Declining tax rates and revenues as a share of GDP and a new embrace of markets as a means to promote social progress led left governments to embrace ‘third-way’ policies that actively promoted credit market access as a social goal. These two trends increased American households’ access to unprecedented liquidity, and they used it to maintain their purchasing power. Under normal circumstances, this sort of debt-led strategy could not have lasted long. But the late 1990s were not normal. An appreciation in house values and a relaxation of mortgage lending terms led American households that were already in debt to tap their homes as a new source of equity. What appeared at the time as a vindication of the “third way”—with rising house prices seemingly buoying the wealth of even modest homeowners—was in reality only a temporary patch to fill growing wedge between stagnating real wages and rising real consumption. It has commonly been asserted that Americans in the early 2000s treated their houses as ATMs, but this is only partly right. What they were doing in part was using their mortgages as debt consolidation loans. Fully a third of all value extracted from the housing stock via cash-out refinancing or home equity loans was used to pay down existing consumer debt. At the time, this transfer of debt from high-interest rate consumer loans to lower interest rate mortgage loans seemed like a responsible financial decision. But it created two problems. First, households did not stop their consumer borrowing, even as they transferred the debt to their mortgages. Second, the depletion of household assets pushed up the leverage in the US housing market, making family balance sheets especially sensitive to fluctuations in house prices. In a real sense, the US housing crisis that would precipitate the 2008 financial crisis started as a consumer debt crisis with its roots in the 1990s. Why was this allowed to happen? The idea that free access to financial markets could play a role in generating social equality dominated the ‘third way’ politics of the Bill Clinton presidency. To some degree, the focus on financial markets as a boon to the working poor simply made a virtue of necessity. As tax rates fell, rising social demands met declining government revenues, and the political left turned to the markets to finance their social goals. They pushed for state lotteries, with winnings going for progressive causes like education. They advocated for legalizing betting in order to sustain social spending in the face of declining revenues. They embraced the housing and financial assets as a means to invest for future retirement—an approach that came to be known as “asset-based welfare.” In the UK, where a new-left synthesis was also emerging under the Labour government of Tony Blaire, asset-based welfare took the form of Individual Development Accounts—investment accounts opened for every newborn child. In the US, the emphasis of asset-based welfare was on tax-deferred private retirement savings and on home ownership. The fall of the US housing market sounded the death knell for the Third way left. Through the early 2000s, the high mortgage leverage of poor families was a virtue. The high degree of leverage made possible by new low- or no-down-payment mortgages meant that as house prices went up, returns to those least able to make down-payments were disproportionately high. 115 Household debt apologists noted that although debt was rising as a share of household income, it was falling as a share of household wealth. The decline in house values of the late 2000s and the high incidence of foreclosures and bankruptcies took away what leverage had given them. For America’s lower middle class, the financial crash of 2008 stripped away the wealth of a generation of new home owners. The greatest welfare setback in a generation had its roots not in the give-and-take of wage bargaining or labor market reform, but in financial markets that allowed middle class Americans to gamble with their homes. For Third Way Democrats who had embraced markets as a route to social inclusion, these reverses represented a startling betrayal. They also pointed to a deeper problem. If extending financial market access was regressive in its consequences, then the left faced a stark dilemma: one could extend market access at the cost of social and economic cohesiveness, or one could increase social and economic cohesiveness at the cost of market access. 115 Anne Kim, Adam Solomon, Bernard L. Schwartz, Jim Kessler, and Stephen Rose, “The New Rules Economiy: A Policy Framework for the 21st Century,” Third Way Report, 2007, p 8.
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