A Fighting Chance

It all worked pretty well. Until the 1980s, that is.

At that point, with scant notice and very little public discussion, a momentous event occurred: thanks to a Supreme Court ruling about a century-old banking law and an amendment quietly passed by Congress, the cap on interest rates was effectively eliminated. Suddenly, banking was changed forever. The usury ban for large American banks disappeared, and deregulation became the new watchword. The bigger banks were now unleashed, and they started loading up credit cards with fees and escalating interest rates—tactics that would have been illegal just a few years earlier. Once the banks began to figure out just how lucrative these cards could be, they started juicing their profits by lending money at superhigh interest rates to people who were a lot less likely to repay all those loans. By the 1990s, they were targeting people who were barely hanging on—those with modest or erratic income, those who had lost their jobs and were scrambling. In other words, the banks were targeting people just like the folks who ended up in the bankruptcy courts.

But for all their enticing new opportunities to make big profits, the bankers faced a new problem. As the number of bankruptcy filings continued to skyrocket, the megabanks had to write off more and more bankruptcy losses.

One spring, an executive at Citibank called me. He had read some of my bankruptcy work, and he invited me to come do a day-long seminar to help them think through how to cut their bankruptcy losses.

I took the train from Philadelphia to New York and arrived at the Citibank building in Manhattan just as hundreds of employees were streaming into the building. I was ushered into a brightly lit conference room with about forty men, all outfitted in expensive suits. I pulled out my graphs and charts, the Citibank people pulled out their data, and we got under way.

As we discussed the bank’s bankruptcy numbers, I wasn’t surprised. Most people struggled with debt for a long, long time before they went bankrupt. People didn’t suddenly run up credit card bills on Tuesday and then dash to the bankruptcy courts on Wednesday. People who ended up in bankruptcy court put up lots of red flags ahead of time. My advice to Citibank was pretty simple: If you want to lose less money, stop lending to families who are in financial trouble and can’t afford to take on more high-interest debt.

After finishing my pitch, I heard lots of interested murmurs, and hands went up around the room. But before anyone took the floor, a slightly older man spoke up. He had been quiet, watching the discussion with a faintly bemused smile.

“Professor Warren,” he said firmly.

The room went immediately silent, signaling that the Head Honcho was now speaking.

“We appreciate your presentation. We really do. But we have no interest in cutting back on our lending to these people. They are the ones who provide most of our profits.”

He got up, and the meeting was over. I never heard from Citibank again.

So there it was. The banks were losing money when people filed for bankruptcy, and even though they knew they could cut their losses with a quick credit check on their customers, they didn’t want to stop. In fact, they did the opposite. Even as a family got more and more behind on their bills, the banks made more offers: Consolidate your bills with our new credit card! (At a mere 29 percent interest…) Take a home equity line of credit! (And the bank takes your home if you get too far behind…) Get a second mortgage—and a third!

Why would the big banks do this? Here was the trick: Even with the bankruptcy losses, the banks could make more money if they kept giving credit to people who were in trouble. Yes, the banks had to absorb bigger losses when people went bankrupt. But in the meantime, they could make a lot more money from all those people on the edge who didn’t file for bankruptcy protection, or at least didn’t file for another year or so. Interest rates and fees were so high that, in the end, the banks came out ahead—way ahead.