04 Mar 2009  Op-Ed

Credit is Not the Bogey

"As we attempt to jump-start the economy of 2009, we should recognize both the risks and the advantages inherent in a robust credit industry," write HBS lecturer Nicolas P. Retsinas and Eric S. Belsky. The director and executive director, respectively, of Harvard University's Joint Center for Housing Studies, they offer a prescription for making credit neither too easy nor too hard to get. Key concepts include:

  • It is time to recalibrate the country's access to credit.
  • Tight credit threatens to shut the safety valve of the low-wage sector of the economy.
  • At the same time, open lines of credit should no longer be available to students with no income, just as mortgages should not be extended to buyers who cannot afford the payments.

 

In this recession, we seek the bogey. If we can identify a villain, the recourse is simple: slay (or neutralize, or bail out) it. The search harks back to a management primer: identify the problem; find the solution.

The search has centered on the credit industry: the vast network of lenders eager to loan Americans money. In the housing sector, an explosion of subprime lenders gave borrowers deals that were truly too good to be true, trapping them in impossible loans. In the retail sector, credit card agencies flooded mailboxes, offering easy entrée to the good life broadcast on nightly commercials. From one vantage, the credit industry is to blame for our economic woes.

The solutions have centered on tightening credit—loaning only to homebuyers who can make a 20 percent down payment, returning to the standards of 20 years ago where buyers were supposed to pay no more than 28 percent of their income for housing, and rejecting "credit-impaired" borrowers with less-than-stellar records. Credit card companies have raised fees and increased penalties.

Consumers have emerged as both victims and perpetrators. They are victims to the extent that ruthless lenders (home and credit card) gulled them into ever-ascending loans. They are perpetrators in that they rang up expenses (mortgages, gizmos, travel, and frivolities) with abandon-fueling the overall indebtedness.

Already this paradigm is influencing behavior. Today home buying is down; rentals are up. Retail spending is down; savings are up. Yet a simplistic credit-as-bogey outlook masks a more nuanced picture.

From a different vantage, credit was an economic white knight. Easy credit fueled the prosperity of the past decade. American statesman Daniel Webster called credit "the vital air of modern commerce." A panoply of mortgage products (not all predatory, not all egregious) fueled the homebuilding industry, which kept the economy afloat during the last decade. While other sectors plummeted, housing stayed strong. Related industries such as wood, gypsum, and cement flourished as did companies that made appliances and furniture. Now that only stellar borrowers with large down payments and hefty incomes get mortgages, we have seen the homebuilding and home-buying industry, and with it the economy, retrench.

As for retail, now that consumers are cutting back on purchases, retail giants are shrinking or dying. T.J. Maxx, Bed Bath & Beyond, Circuit City—the brand-name mainstays of Retail America—are laying off thousands of workers.

Just as crucially, tight credit threatens to shut the safety valve of the low-wage sector of the economy. Many Americans have been borrowing, quite simply, to live. Try paying for an apartment, food, transportation, clothes, and medicines on the $20,000 annual salary of a low-wage worker. We have an anodyne myth that everybody who works full-time in this country can somehow make do: The "secret" to their making do is generally a Visa card, with a balance that they never pay off. For low-wage workers, credit has been the lifesaving crutch.

So as we attempt to jump-start the economy of 2009, we should recognize both the risks and the advantages inherent in a robust credit industry. Credit undergirded our economic expansion. If we close the spigots too tightly, we must be prepared to accept an economy that stagnates.

Absent access to credit, we must also be prepared to watch low-wage workers slide into desperate straits. On an individual level, we will see more misery. On a macro level, we will see more evictions, more repossessions, more bankruptcies. Whatever the virtue of savings, some people cannot save: They live paycheck to paycheck, with each month's bills lapping at the monthly income. Low-wage workers need credit. They need it to stay in their homes, feed their families, and drive to their jobs. With the right products and the right terms, these workers can still have access to that crucial crutch.

The challenge is to recalibrate the country's access to credit. No more open lines of credit to students who have no income—indeed, to students who have never paid a utility bill. No more mortgages to buyers who cannot afford the payments—indeed, to buyers who have no "rainy day" savings. Underwriting must once again deserve the name. Micro-print contracts must be transparent and protect the consumer. Lenders must take responsibility not just for originating loans, but also for loans' performance.

Government must help oversee this recalibration. If we vanquish credit as the villain behind our downturn, the victory may be Pyrrhic.

About the authors

Nicolas P. Retsinas and Eric S. Belsky are director and executive director, respectively, of Harvard University's Joint Center for Housing Studies. They are coeditors of Borrowing to Live: Consumer and Mortgage Credit Revisited (Brookings Institution Press, December 2008).