About 1.5 million households filed bankruptcy in the last year, making bankruptcy as common as college graduation and divorce. The recession has pushed more and more families into financial collapsewith unemployment, declines in retirement wealth, and falling house values destabilizing the American middle class. Broke explores the consequences of this unprecedented growth in consumer debt and shows how excessive borrowing undermines the prosperity of middle class America.
While the recession that began in mid-2007 has widened the scope of the financial pain caused by overindebtedness, the problem predated that large-scale economic meltdown. And by all indicators, consumer debt will be a defining feature of middle-class families for years to come. The staples of middle-class lifegoing to college, buying a house, starting a small businesscarry with them more financial risk than ever before, requiring more borrowing and new riskier forms of borrowing. This book reveals the people behind the statistics, looking closely at how people get to the point of serious financial distress, the hardships of dealing with overwhelming debt, and the difficulty of righting one's financial life. In telling the stories of financial failures, this book exposes an all-too-real part of middle-class life that is often lost in the success stories that dominate the American economic narrative.
Authored by experts in several disciplines, including economics, law, political science, psychology, and sociology, Broke presents analyses from an original, proprietary data set of unprecedented scope and detail, the 2007 Consumer Bankruptcy Project. Topics include class status, home ownership, educational attainment, impacts of self-employment, gender differences, economic security, and the emotional costs of bankruptcy. The book makes judicious use of illustrations to present key findings and concludes with a discussion of the implications of the data for contemporary policy debates.
About the Author
Katherine Porter is Professor of Law at the University of California Irvine School of Law. In 2010-2011, she was the Robert Braucher Visiting Professor at Harvard Law School. She is an expert in consumer credit law and has testified several times before Congress. Her published research addresses mortgage servicing, financial education, and consumer bankruptcy.
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BROKEHow Debt Bankrupts the Middle Class
STANFORD UNIVERSITY PRESSCopyright © 2012 Board of Trustees of the Leland Stanford Junior University
All right reserved.
Chapter OneDriven by Debt Bankruptcy and Financial Failure in American Families Katherine Porter
The waiting room is ordinary enough—lined with rows of simple metal chairs and barren of decoration other than a government poster of rules and regulations. The people in the room are ordinary too. They wear jeans and work boots, simple sun dresses and sandals, khaki pants and button-down shirts, or uniforms from retail stores. A few navigate into the room with a walker, and others try to find a space to accommodate a baby stroller. The room could be a local Social Security office or a parking permit bureau, just another pedestrian pause in daily life, but its atmosphere is the giveaway. Rather than the heavy stickiness of boredom, the room is filled with quiet anxiety. Conversations are hushed and brief. Many people twist their hands or study their shoes. The scene is like the waiting area in an emergency room, and for good reason.
This is the room where people wait to be diagnosed with a financial emergency—bankruptcy. The bankruptcy trustee calls people inside a small examination room and quickly reviews their debts, assets, income, and expenses. The trustee asks few questions; it's an easy diagnosis of flat broke in most cases. The need for these families to have legal help with their debts is obvious from their bankruptcy court records. Credit card debts, medical debts, and other unsecured debts typically total more than an entire year of the family's current income, and more than half of them are behind on their mortgage or car payments, facing foreclosure or repossession. Satisfied in most instances that the family qualifies for bankruptcy relief, the bankruptcy trustee sends husbands and wives, mothers and fathers, widows and young singles back to work or home.
As they leave the trustee's office, most people ask their attorney, "What's next?" They have typically struggled seriously with their debts for the previous one to two years. In fact, many households spent months simply scraping together the money and paperwork needed to file a bankruptcy petition. Most are skeptical that their problems just ended. What comes next in bankruptcy varies with people's circumstances. Some will receive a discharge of their debts in a few weeks, while others will struggle to repay creditors for years. Some will save their houses and see bankruptcy as a miraculous cure. Others will suffer continued hardships, skid farther down the economic ladder, and view bankruptcy as a plea for help that went unanswered.
Nearly all of these families will remember their few minutes with the bankruptcy trustee as one of the most painful moments of their lives. Bankruptcy is a head-on encounter with promises to pay that cannot be honored and privations suffered trying fruitlessly to make ends meet. These families' aspirations of middle-class security evaporated under pressure from debt collectors. At least for now, their version of the American Dream has been replaced by a desperate hope that things do not get even worse. Driven by debt, these families are at rock bottom.
* * *
Anthropologist Katherine Newman asserts that there are no ceremonies to mark downward mobility. This is a stark contrast to the graduation ceremonies and housewarming parties that mark upward mobility. But meeting the bankruptcy trustee is exactly such a ceremony. It is a visible group experience characterized by a routine series of events that tangibly marks a decline in class status. Bankruptcy is a public declaration that a family has "fallen from grace," to borrow Newman's characterization of Americans who skid down the economic spectrum.
In the waiting rooms of bankruptcy trustees across the United States, in 2010 approximately 1.5 million families endured the bankruptcy ritual. Their experiences are evidence that some people lose the borrowing game that has become the American economy. Increased consumption was largely financed by debt, rather than by increases in wages or appreciation of assets. The consumer spending that drove the economy at the end of the twentieth century was not costless. It was bought and paid for with interest charges, late fees, increased stress about making ends meet, and sometimes, the humiliation of bankruptcy.
The debt loads that are commonplace among today's families would have been unthinkable a mere generation ago. The Great Recession that began in mid-2007 has widened the scope of the financial pain caused by overindebtedness, but the problem predated the large-scale economic meltdown that captured headlines. And all indicators are that consumer debt will be a defining feature of middle-class families in years to come. The "deleveraging" process of paying down debt and increasing savings has just begun. Along the way, more families will lose their homes or cars, trade off family time for second jobs, endure dunning from debt collectors, and slip farther down the economic ladder.
This book exposes the underbelly of consumer debt. It tells the stories of families who filed for bankruptcy in early 2007. Even at that time when the economy was still strong, some households could not make ends meet. The plight of the bankrupt families in this book illustrates the financial pain that the Great Recession inflicted on tens of millions of middle-class families as the economy crashed in late 2007. A survey by RAND researchers found that between November 2008 and April 2010, 39 percent of families had experienced one or more indicators of financial distress: being unemployed, having negative equity in their homes, or being two months behind on their mortgage or in foreclosure. This "new normal"—a world of layoffs and job losses, cuts in social programs, and continued housing depreciation—only means that more people will find themselves collapsing under the weight of debts incurred in brighter economic times.
Bankruptcy is a public window into how consumer debt has reshaped the middle class and its economic and social life. The staples of middleclass life—going to college, buying a house, starting a small business—carry with them more financial risk than ever before because they require more borrowing and new, riskier forms of borrowing. This book is about the endgame for those who borrowed in the hope of prosperity but could not sustain the heavy debt burdens of middle-class life. In telling these stories, we use empirical data. The figures and tables in this book reveal who suffers serious financial distress, how they get to that point, the hardships they face as they deal with overwhelming debt, and the difficulty they have righting their financial lives. Real people stand behind these statistics. This book tells the stories of their financial failures, exposing a part of middleclass life that is often lost in the success stories that dominate the American economic narrative.
DEBT: THE NEW MIDDLE-CLASS STATUS SYMBOL
The middle class is a powerful concept. Historically, the size and prosperity of the American middle class has been heralded as a great social and economic achievement. Membership in the middle class is associated with homeownership, educational opportunity, comfortable retirement, access to health care, and last but certainly not least, an appetite for consumer goods. The middle class also has political appeal, as demonstrated by President Barack Obama's decision during his very first week in office to establish a Middle Class Task Force. As chair of the task force, Vice President Joe Biden explained that middle-class life is the "old-fashioned notion of the American Dream" and that he and the president had "long believed that you can't have a strong America without a growing middle class. It's that simple. It's that basic." The task force has focused its energy on job creation, retirement security, work-family issues, and higher education.
But the task force has ignored entirely a revolutionary change in the lives of middle-class Americans: the increase in household debt. In the mid-1980s, the ratio of debt to personal disposable income for American households was 65 percent. During the next two decades, U.S. household leverage more than doubled, reaching an all-time high of 133 percent in 2007. Measured in the aggregate, the ratio of household debt to gross national product reached its highest level since the onset of the Great Depression. This record debt burden, which crested just as the financial crisis began, set up families to suffer deeply as foreclosures, unemployment, and wage stagnation set in for the years to follow.
The consumer debt overhang, however, began long before the financial crisis and recession. Exhortations about subprime mortgages reflect only a relatively minor piece of a much broader recalibration in the balance sheets of middle-class families. Debt began to climb steeply beginning in about 1985, with its growth accelerating in nearly every subsequent year. The run-up in consumer debt coincided with a period of deregulation of financial institutions and the preemption of state usury laws that capped interest rates. Unfortunately for American families, the debt binge was not accompanied by meaningful increases in disposable income. While income crept up, debt shot up, as Figure 1.1 illustrates. As debt grows relative to income, families must stretch their dollars farther to pay for current consumption, while keeping up with debt payments. At some point, income simply becomes insufficient, and families must either curtail spending or default on debt.
The growth in debt outstripped the appreciation of assets during this same period. In other words, increases in liabilities—mortgage debt, home equity lines of credit, student loans, and credit cards—collectively grew faster than increases in assets—houses, cars, stocks, or cash savings. Edward Wolff of the Levy Economics Institute has calculated that as far back as 1995, the amount of mortgage debt began to increase faster than house values. The result of the increased borrowing was to constrain or retard growth in household wealth. Indeed, between 2001 and 2004, the typical (median) American household's wealth actually declined. This was an unprecedented event because the wealth decline occurred during a period of economic expansion. Household debt outstripped household asset accumulation for the middle class. For households with wealth between the 20th and 80th percentiles of the entire distribution, the debt-to-equity ratio climbed from 37.4 in 1983 to 51.3 in 1998, and then topped off at 61 percent in 2004 and 2007. Whether assessed against income or assets, debt grew in proportion to other changes in families' balance sheets.
The boom in borrowing spans social classes, racial and ethnic groups, sexes, and generations. Every age group, except those seventy-five years or older, had increased leverage ratios between 1998 and 2007.15 Similarly, African Americans, Hispanics, and non-Hispanic whites all saw their leverage ratios grow from 2001 to 2007. This is not to suggest that the debt explosion was equally distributed. For example, between 2004 and 2007, typical people who lacked a high school diploma and typical households headed by a person between ages sixty-five and seventy-four experienced particularly sharp increases in their debt burdens. In particular periods, some groups saw modest declines in consumer debt, but the overwhelming trend was increased amounts of debt among nearly every type of family. By 2007, when debt burdens peaked, 77 percent of American households had some type of outstanding debt. Consumer debt has become one of the most common shared qualities of middle-class Americans, usurping the fraction of the population that owns a home, is married, has graduated from college, or attends church regularly.
TOO BIG TO FAIL AND TOO SMALL TO SAVE: MIDDLE-CLASS FAMILIES IN CRISIS
As debt increases, so too does the risk of financial failure. This is as true for American families as it is for large corporations, where the catchy phrase "highly leveraged" captures a profound tilt into the red on a company balance sheet. Over the long haul, increases in consumer debt seem to explain a significant portion of the increased numbers of consumer bankruptcies.
The escalation in debt has turned the smart financial decisions of the prior generation, such as purchasing a home or taking on student loans, into high-stakes economic gambles for middle-class families. Today, millions of Americans are losing those bets, struggling to avoid financial collapse. This statement was as true before the Great Recession as it is today. As President Obama explained in January 2010, "Too many Americans have known their own painful recessions long before any economist declared a recession." The per capita bankruptcy rate, shown in Figure 1.2, provides one example of this phenomenon. Bankruptcy has become more frequent in the American population over the past three decades, although the filing trend of the past few years reflects the major reform of the bankruptcy laws in 2005.
Other markers of debt problems have also increased in recent years. The percentage of consumers who experienced a third-party debt collection activity has grown steadily in the past decade, doubling from 7 percent in 2000 to 14 percent in 2010. Foreclosure filings, for example, climbed in the 1980s and 1990s. The crisis in the mortgage markets sharply escalated the foreclosure rate; in 2009, one in forty-five homeowners received a foreclosure notice. Debt collection was the leading complaint to the Federal Trade Commission in each of the past several years. Credit card charge-offs, while highly sensitive to economic conditions, have generally crept higher (see Figure 1.3). The volatility of debt default has also increased. The Great Recession is causing a spike in credit card charge-offs that is much larger than other recent recessions.
Subjective measures of prosperity tell a story similar to the hard data: Americans' insecurity about their financial lives is on the rise. A New York Times/CBS poll found that in 1995, about one in six people did not think they would reach the "American Dream," as they defined it, within their lifetime. In 2005, more than 25 percent of people said the American Dream would remain out of their reach. In 2008, the Pew Research Center reported data from surveys asking whether people were better off, the same, or worse than they were five years before, noting that the responses reflected "the most downbeat short-term assessment of personal progress in nearly half a century of polling."
Despite the ubiquity of debt problems, most people in financial distress suffer silently. The Great Recession may have shifted this cultural norm somewhat, particularly in locations where job loss or foreclosure is relatively common. But it is hard to dispute the fact that the media, Congress, and pundits have spent more time on the financial collapse of big banks than of everyday families. At a conference I attended, someone quipped that while banks were "too big to fail," families were "too small to save." In part, this comment reflects the powerful importance of the risk frame in public policy: small incidences of harm rarely receive the attention of large ones, even if the accumulation of small harms dwarfs the single large harm. This preference to prioritize single large events over multiple smaller ones shortchanges middle-class families. The U.S. Treasury's bold intervention in the capital markets is a stark contrast to its anemic response to foreclosures at the family level: the Home Affordable Modification Program (HAMP), which has been criticized as inadequate.
The inattention to the financial well-being of American families existed long before the collapse of Bear Stearns or Lehman Brothers demanded the attention of policymakers. Alan Greenspan's surprise at the number of subprime mortgages that originated during his tenure as chairman of the Federal Reserve is an example of the failure of government to monitor consumer finance at the household level. When consumer credit did come to the fore, concerns about the dangers of borrowing were met with dogged claims that credit regulation would only lead to less availability of credit and no appreciable benefits to consumers. In retrospect, retrenchment in borrowing seems like a good idea. The blind eye that policymakers turned to the risks of consumer borrowing has cost the world economy dearly.
Excerpted from BROKE Copyright © 2012 by Board of Trustees of the Leland Stanford Junior University. Excerpted by permission of STANFORD UNIVERSITY PRESS. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Table of Contents
Chapter 1 Driven by Debt: Bankruptcy and Financial Failure in American Families Katherine Porter 1
Part I The Debtor Next Door
Chapter 2 A Vulnerable Middle Class: Bankruptcy and Class Status Elizabeth Warren Deborah Thome 25
Chapter 3 Out of Balance? Financial Distress in U.S. Households Brian K. Bucks 40
Part II Starting Right, Ending Wrong
Chapter 4 Home Burdens: The High Costs of Homeownership Jerry Anthony 65
Chapter 5 College Lessons: The Financial Risks of Dropping Out Katherine Porter 85
Chapter 6 Striking Out on Their Own: The Self-Employed in Bankruptcy Robert M. Lawless 101
Part III Hurting at Home
Chapter 7 No Forwarding Address: Losing Homes in Bankruptcy Marianne B. Culhane 119
Chapter 8 Women's Work, Women's Worry? Debt Management in Financially Distressed Families Deborah Thome 136
Part IV The Hard Road Out
Chapter 9 The Do-It-Yourself Mirage: Complexity in the Bankruptcy System Angela Littwin 157
Chapter 10 Less Forgiven: Race and Chapter 13 Bankruptcy Dov Cohen Robert M. Lawless 175
Part V The Once and Future American Dream
Chapter 11 Borrowing to the Brink: Consumer Debt in America Kevin T. Leicht 195
Chapter 12 The Middle Class at Risk Jacob S. Hacker 218
Appendix Methodology of the 2007 Consumer Bankruptcy Project Katherine Porter 235
Contributor Biographies 297