Bankruptcy

The Very Big Men Who Sort Out Debt

By Mechele Dickerson

During the last session this morning, Professor Stephen Lea (University of Exeter) provided a psychological perspective on debt in poor households in Britain. He initially listed the people he believes to be the cast of characters involved in debt. First, there are consumers, and their friends and families. On the creditor side, he made a distinction between business creditors (like utilities) and credit businesses (banks, debt collection agencies ? whom he labels "the very big men who are left to sort out the mess"). Because of England?s long tradition of credit counseling, he also included credit counselors in the cast.

Professor Lea was one of many speakers who observed that debtors typically don?t think they are in debt until the debt is out of control. So, if people pay their mortgage and credit card bills on time, they will say they are not "in debt." He argues that it?s best to think of debt in three stages: the period where people have credit (and are repaying it); the period when they aren?t paying their bills (they are either "can?t pays" or "won?t pays"); and the period when it?s clear they will never be able to pay their bills (can?t pays). Professor Lea argues that debt is a case of inter-temporal choice and that these choices deviate so much from what would be expected by rational choice theory that "not even economists will claim that they are acting rationally."

Professor Lea?s current project is based on information he and his co-authors obtained from surveys sent to people with no known debt, with mild debt (late payments), and with severe debt (they?ve been sued). He comically explained the challenges of collecting this data ("your response rates are truly tragic") since most people don?t want to talk about their debt problems, others just can?t be found, or many distort the results by giving less than fully truthful responses. He found (get ready for a real shocker here...) that most people are in severe debt because they are dirt-poor. While the reasons they may initially have fallen into debt differ somewhat (illness, unemployment, marrying debt, having children, substance abuse, divorce), these reasons are the same ones identified on this side of the pond in the research Provost Sullivan has done with Professors Warren and Westbrook.

In discussing the psychology of poverty-induced debt and how to get out of it, he stressed that people focus on repayments (can I manage it within my foreseeable weekly income?) and largely ignore the total amount of the debt (over time, this is going to cost a fortune). He also noted the other psychological factors that affect poor people who are in debt. For example, they often devise wholly unrealistic ways to get out of debt (playing the lottery). Also, parents make costly economic decisions because they want to prevent their children from being stigmatized. Thus, they don?t want to keep up with the Joneses: they want to keep up with the Joneses? children. In discussing this, he gave a hilarious British conjugation of the verb to "need." It is "I need. You want. He has irrational desires." Parents conclude that their children need branded clothes. They need Christmas gifts. And their desire to avoid having their children stigmatized causes them to make economically irrational decisions.

Professor Celia Hayhoe responded by giving a perspective from this side of the pond (Virginia Tech). A professor in the Apparel, Housing & Resource Management, she explained why she was asked to respond to a Psychology professor?s paper. Why? Because personal finance is not taught in finance departments. It?s taught in a course that used to be called "home economics."  In addition, she?s a certified financial planner who also provides counseling to debtors who are about to file for bankruptcy.  So, she could provide anecdotal evidence of why poor people do the things they do.

Professor Hayhoe also agreed that debtors think that, when you take out a loan, you just have credit. You don?t have debt until you can?t repay it. She noted that one reason consumers have a hard time handling money is because as a society we have largely made money invisible. We have our checks directly deposited, we use credit cards, we don?t open a savings account because we have employer-provided retirement plans. And, because parents rarely take the time to teach children what money actually is and few K-12 schools teach financial education, children grow up and become adults without knowing how to use money wisely. She noted that, since students have never seen what it?s like for their parents to make ends meet, they are often shocked when they graduate from college, have massive student loan debt, then find that their salaries aren?t large enough to quickly repay their debts and also maintain their desired standard of living. Rather than deciding to borrow less in the future, though, they are willing to work harder to ensure that they can consume more.

Full post as published by Credit Slips on May 02, 2008 (boomark / email).