The middle-aged woman in Janesville, Wis., who recently posted a request for $5,000 on Prosper.com, an online marketplace for personal loans, chose a screen name that elegantly distills her station in life. BusyLady52 is indeed a busy lady. By day, she works for the county in an office job; at night, she’s a dispatcher for the city bus line. In addition, she cares for her aging and ailing parents and a younger sister who suffered a debilitating brain injury in 1987. Yet all this work has brought neither security nor much satisfaction, and BusyLady52 now strives to crawl out from under a lifetime of debt.
In a photograph that BusyLady52 posted alongside her request, she looks positively regal, with a fur-trimmed V-neck shawl, a pretty necklace and a bright smile. The effect is endearing, and the picture, together with a short note explaining her situation, signals authentic desperation. Like many of the listings on Prosper, this one seems to whisper, Will you take a chance on me?
Prosper is a marketplace brimming with woe. In this respect it is not so different from a dating site, except that on Prosper people are looking for money, which is immeasurably more useful, and often harder to come by, than love. Love will sometimes find you in the dark when you least expect it, and change your life. This almost never happens with money. If you aren’t born with it, there are really only two legitimate ways to get it: You work for it, trading your time and effort, or you borrow it, putting on the line your reputation, assets and future income. For vast numbers of Americans today, the first option simply isn’t working out, and the second choice — borrowing — has become a way of life. The problem isn’t just record debt, but also the terms. Credit cards offer rates that are fluid and unpredictable, with high fees and little sympathy for hardship. Worse still are payday loan centers, which lend out money at obscene rates — 400 percent or more on an annual basis — yet have become a necessary crutch for many.
Prosper bills itself as an Internet-age alternative to such creditors. The system, which has been in operation since February, is at once ingenious and faintly surreal; its premise is that strangers — lenders and borrowers — will come together to execute meaningful, serious and risky transactions in a self-consciously anonymous environment, not unlike the way buyers and sellers do business with each other on eBay. If they succeed, “person-to-person” lending sites like Prosper — competitors are coming online soon — could upend the credit industry, bringing transparency and fairness to a market not known for either. Borrowers who’ve been shut out of the loan market find money at reasonable interest rates, and people with money to lend get a return that can surpass that of other investments. Prosper, which manages the loan, takes a small cut of the deal. (Borrowers pay 1 percent of each loan and lenders pay .5 percent on the money owed to them.)
There is much to question about this setup. Critics and skeptics wonder about the risks involved for both borrowers and lenders, the site’s adherence to equal-opportunity regulations, and, most important, the very logic behind its operations, the idea that people with money will actually lend to people in need, especially to borrowers who have poor financial records. Yet the idea sounds intuitively attractive to many who follow the credit industry and are familiar with its pitfalls. “Looking at it from 10,000 feet, this is a great idea,” says Elizabeth Warren, a professor at Harvard Law School who’s an expert on bankruptcy law. “It could have the wonderful effect of making markets work the way they should, driving down the amounts charged for loans to the true marginal cost.”
Warren suggests that Prosper is much more than a novel Web site — it’s an example, she says, of one of the ways the Internet might transform the credit industry into a fairer, more equitable business. “There are things going on in the lending industry that if it were transparent would never occur,” she says. At least in theory, sites like Prosper hold the potential to free many in the middle class from the stranglehold of credit card debt and to give low-income Americans a way out of the debt traps laid by unseemly payday loan centers.
Another intriguing possibility is that Prosper can help instill financial discipline in people who’ve had trouble with money all their lives. Warren points out that one of the questions that people who study debt and bankruptcy in America wrestle with is “whether anyone should be lending money to people who are already in financial trouble.” The answer would seem to depend on the borrower. For some people in debt, a little bit of money offered at a reasonable rate can set the world right again, while for others, as a wise man once said, mo’ money, mo’ problems. But determining which borrowers can be saved from those who are simply undisciplined is a labor-intensive task, and mainstream creditors — credit card firms and payday loan centers — hardly make the effort. They charge everyone a high rate with the expectation that some will default, and others will live forever in lucrative, revolving debt.
The virtual world of Prosper offers a far more personal experience. Trading money on the site is an intensely social activity, in which lenders sit in constant judgment of the most intimate aspects of borrowers’ lives, scrutinizing their financial histories and making public guesses about their responsibility. Successful borrowers, meanwhile, must convince lenders to part with their money, not only by disclosing their finances, but by pleading their cases directly, promising to work harder at managing their money.
And the process seems to be working. Many of the lenders on Prosper, for instance, know almost nothing about BusyLady52, not even her name (which she asked me not to publish). What they do know about her (a middling credit score, a couple of current delinquencies) is the sort of thing that would render her ineligible for a traditional loan. Yet lenders saw in her story some spark of genuine responsibility, a possibility that she’d do well if given a chance. More than 50 people got together to give her a total of $5,000 at a 16 percent rate. She now says she’s determined to set her money straight again, if only to prove herself to those who invested in her. “Grateful?” she says. “When I got up this morning and saw the money in my account — oh, you have no idea.”
Late in 2003, Richard Duvall, a technology entrepreneur in the U.K., left Egg, the world’s largest online bank, which he had founded in 1998. At the time, he says, he had more money in the bank than he’d ever had in his life. To the credit bureau, however, Duvall apparently looked like a risk. “Two days after I left Egg, I went into a cell shop, and after spending two hours choosing a phone, I went up to the counter and said, ‘I’d like this one,’” Duvall recalls. The sales clerk asked Duvall a series of questions to assess his credit-worthiness: Was he employed? How long had he lived in his home? (As it happened, he’d recently moved.) The answers were not satisfactory. “They said, ‘We can’t give you that phone. You don’t meet our requirements for a loan.’”
Duvall’s story expresses the idea that animates person-to-person lending: Good people are being overlooked. Traditional creditors use a trove of data to assess us all, thoroughly scrutinizing our financial records and giving each of us a score. But because these scores are determined by algorithm rather than human beings, they invariably miss important aspects of our financial lives. In Duvall’s case, the mobile phone shop’s credit program overlooked the money he had in the bank.
For Duvall, the cellphone incident was a spark of inspiration, one of the reasons he hit upon the idea for Zopa, a person-to-person lending site that opened in the U.K. in March 2005. Duvall, who’s now the CEO of Zopa, says the firm now has 70,000 members, and has made millions of dollars in loans. A U.S. version of the site will open this summer, serving, at first, only California.
On Prosper, it’s common to find borrowers who claim that traditional credit agencies have overlooked some meaningful measure of their finances. To put up a loan listing on the site, borrowers determine the amount they’re looking for and the maximum interest rate they’re willing to pay. (You can borrow up to $25,000 on Prosper; depending on what state you live in, you might face a minimum loan amount as well.) Borrowers give Prosper a few bits of personal information — annual income, bank account number and Social Security number — and authorize the site to collect financial data from credit agencies. Prosper shows potential lenders the data it collects, including a credit grade, the number of credit lines the borrower has opened in the last decade, the number of delinquencies he’s had, and his ratio of debt to income.
Often, though, borrowers will argue that these numbers don’t tell the whole story. Sometimes, they have a point. If I told you about Person X, who had a credit rating of H.R. — “high risk,” the lowest rating — a string of recent delinquencies, and a 20 percent debt-to-income ratio, you’d probably conclude that she was heading straight to bankruptcy. Lending this person money would be about as profitable as throwing it into a fountain and waiting for your wish to come true. But what if I also told you that this person, Suzy, had accumulated her debt while she was studying at Harvard Law School? And what if I mentioned that she had just graduated with honors, and had accepted a job at a Manhattan firm with a starting salary of $140,000 a year? She only needs a loan to tide her over until she starts work. Now I tell you that she’s willing to pay a 20 percent interest rate on your money. Would you take a risk on her now?
To be sure, things on Prosper, as in real life, are not always so clear-cut. You won’t usually find the Harvard Law student with a guaranteed future salary looking to pay a high rate for a loan. But there are many whose future incomes look assured, and who appear to be much better credit risks than the numbers would suggest. William Bulck is a 26-year-old student in Milwaukee, Wis. Prosper gives Bulck a credit grade of C, which is about average; according to Experian, a credit reporting agency, there is a small but not insignificant chance that someone with this credit score will default on a loan. Bulck has a debt-to-income ratio of 10 percent, which is not terrible, but not great either. When Bulck went in search of a traditional bank loan to help him pay his way through school, he met with one rejection after another. “I have a friend who is a bank manager, and when I talked to him, the first place he said to try was Prosper.”
Early in May, Bulck put up a request for a loan of $2,800, offering an interest rate to lenders of 13.9 percent. “This loan is probably the hardest thing I have had to ask for in a very long time, and I appreciate your help,” his listing began. Bulck went on to describe his situation. He receives financial aid, he said, but his next disbursement doesn’t come until August, and he’d have a hard time until then. But he assured possible lenders that his future looked bright. He’s in his last year of school, and he expects to find a job soon. “I don’t anticipate any problems paying this loan back,” he wrote.
Despite his assurances, a risk-averse investor would have found much to be wary of in Bulck’s listing. His chosen field of study is creative writing, not a major known for the swiftness with which it places graduates in steady employment. There’s a more basic problem, which is whether you can trust him. Bulck posted a photograph — he’s seated at a desk, writing, a cat perched nearby — and though he looks decent enough, it would have been impossible for any lenders to know for sure that Bulck was really a student due to get a financial aid check in August, and was not, instead, just practicing his creative writing to get some quick cash.
As it happened, people believed Bulck’s story, and he got his loan. But that’s not the case with everyone. Lending money on Prosper is no different from lending money in real life — it’s possible, and some might say likely, that some people aren’t who they say they are, and that they won’t pay you back. Prosper is explicit with lenders about this risk, and it advises people to get around it by diversifying. If you have $5,000 to invest in Prosper, the site encourages you to spread your money among many people. Every loan on Prosper lasts for three years (borrowers face no penalty for paying the loan early). If you give $50 to 100 people who have a credit grade of C, chances are that over the course of three years, some people — about three, according to Experian — will default on their loans. But if you get a 14 percent return on your money from those who do pay you back, you’ll make more than $1,000 on your $5,000 investment, enough to cover your losses.
To understand why Prosper has the potential to become a blessed alternative for many borrowers, it helps to understand the enormous changes that have occurred in the American financial service industry during the past three decades. The story begins in 1978, when the Supreme Court handed down a unanimous decision that revolutionized the credit industry, and consequently laid the foundation for the dismal state of American households’ finances. In Marquette National Bank v. First Omaha Service Corp., the court essentially invalidated state usury laws — the laws that set a legal limit on the interest rates banks could charge for credit. The court decision allowed companies like Citibank to provide Americans with credit cards at sky-high rates, a deal that proved attractive both to customers, who were willing to pay for what looked like easy money, and to the bank corporations, which cashed in on the appetite for credit. (The PBS program “Frontline” has put together an excellent history of the industry.)
Some economists argue that the surge in easy credit was good for the economy, as Americans began to spend at an increased pace. But the rise of credit cards also caused a consequent rise in credit debt. American consumer debt now totals more than $2.1 trillion, and it is growing rapidly. Moreover, says Michael Stegman, a management professor who directs the University of North Carolina’s Center for Community Capitalism, the credit card industry usurped the market for traditional, lower interest-rate bank loans. The unsecured loan business — that is, loans made to people who don’t put down an asset, such as a house, as collateral — dried up. “Today you can’t walk into a bank, even with good credit, and get an unsecured loan for, say, $15,000,” Stegman says. “And if you’ve got any kind of impaired credit, forget it.” Many people, that is, have no alternative but to borrow money using credit cards.
For Americans with the lowest incomes, another dangerous force emerged in the 1990s: the payday loan industry. These retail centers offer money at high cost on a short-term basis — they’ll give you cash on Tuesday in return for a promise of payback on Friday. As Jeanne Ann Fox, who studies the payday loan industry at the Consumer Federation of America, points out, loan centers don’t make the true costs of such loans clear to customers. A typical two-week loan will cost you in the neighborhood of $15 or $20 in interest per $100 in principal. For people who need money immediately — and studies show that many payday loan customers are using the cash for food and other necessities — such a fee might sound reasonable. What the loan centers don’t say is how much these loans work out to on a long-term basis. A $20 fee for a two-week, $100 loan represents an enormous annual interest rate — a 521 percent APR.
The long-term rate is important because studies show that people who take out short-term loans are often repeat customers, borrowing a steady flow of money from several payday centers over the course of a year. Twelve states currently have laws on the books that effectively ban payday loan centers; of the rest, the state that has kept the closest watch on the industry is Colorado. Last November, Paul Chessin, one of the state’s assistant attorneys general, published a comprehensive study of how payday loan centers operate in the state. Chessin found that the average payday loan customer in Colorado obtains about nine payday loans per year. In a given year, this average customer, Chessin wrote, “pays a total of $477.16 in finance charges and is indebted for a total period of just over five out of twelve months.”
People who study the payday loan industry have a name for the hole in which these repeat customers find themselves — the “payday loan trap,” or “debt treadmill,” which describes the cycle of taking on payday loans just to keep financing previous loans. Chessin found that repeat customers are quite lucrative to loan centers. In Colorado, people who borrow 12 or more times per year account for two-thirds of the payday loan business in the state. (You can read Chessin’s study in PDF format here.)
One curious feature of the payday loan business is its almost complete lack of price competition. The industry has seen explosive growth in recent years, with loan centers dotting urban and suburban storefronts across the land. In Colorado, there were fewer than 200 loan centers in 1997; by 2005, the number had grown to more than 600. Economists predict that intense competition leads to lower prices — in this case lower interest rates for loans. But Chessin found that the average APR on loans has remained virtually steady (at slightly under 400 percent). “We have not seen price competition in this industry,” says the Consumer Federation of America’s Jeanne Ann Fox. “Even when there’s a lender on every corner, you don’t find that.”
A representative for the Community Financial Services Association of America, the payday loan industry association, did not respond to my inquiries. The industry has maintained, however, that it needs to charge three-digit interest rates because it is offering extremely risky loans. This would seem to make intuitive sense — after all, these companies are lending money to people who have low incomes, and they do not take any collateral in return for the money. If a substantial number of their customers are likely to default, you’d expect payday loan firms to charge rates high enough to keep their business profitable.
But Chessin’s study undercuts that argument. He points out that between 1996 and 2004, payday lenders in Colorado reported an average “charge-off rate” — the rate of loans that weren’t paid back — of 3.34 percent. Chessin notes that this is comparable to the loss rate for most bank loans. “For the same period, the charge-off rate for all consumer loans made at commercial banks was 2.69 percent; for credit cards, it was 5.15 percent,” Chessin writes. What this means is simple: Payday loan customers aren’t deadbeats — indeed, they may be good credit risks.
All this data builds to a compelling conclusion about the credit industry today. Financial institutions appear to be making exorbitant profits from loan products — payday loans and credit cards — that are by all measures overpriced. The high interest rates are tenable only through a lack of transparency. Customers don’t really know the true price they’re paying, and don’t have any real alternative to these products. Such a market, though tremendously profitable, is ironically also vulnerable to competition from a more nimble, inventive upstart. That is exactly the role that sites like Prosper aim to play.
I met Chris Larsen, Prosper’s co-founder and CEO, at the company’s austere headquarters in a small office space on the first floor of an old building in San Francisco’s financial district. Larsen, who in 1996 co-founded E-Loan, one of the first Internet loan brokers, is an understated fellow, and when he talks about the credit industry, he doesn’t sound especially impassioned about the possibility that his company might transform it. Still, there’s no mistaking that Larsen, who has long been feted for his consumer-rights advocacy — in 2003, he spent $1 million of his own money to push California to adopt a tough financial privacy bill — is on a mission.
“My opinion of the consumer credit industry is that it works well in the formation of credit, but it’s really a problem by the time it gets to the consumer,” he says. “You have consumers being misled, it’s too expensive, not very transparent, and not very open.” He adds, “Access to credit is right up there with healthcare and education in terms of being fundamental to a society. You have so many bad things going on in the current system, so many bad things.”
Shane Garza, a 29-year-old information technology manager in Grand Rapids, Mich., might be the sort of customer that Larsen has in mind when he describes the difficulties some Americans have with credit and debt. At the same time, Garza, a serial borrower, illustrates how Prosper may not work for everyone, and how tough it can be to determine whether someone who’s made bad decisions with money deserves any more.
“My problems started with these payday loans while trying to get caught up on my rent,” Garza wrote on a Prosper loan request he posted in mid-April. Garza has an extremely poor financial record. According to the credit information on Prosper, his credit grade is H.R., he has a debt-to-income ratio of 8 percent, and he has opened 29 credit lines in the last seven years, with two current delinquencies. He posted a list of the various sums he owed to payday loan firms: Magnum Cash Advance, $700. Sonic Cash, $400. Payday 2day, $400. Mr. Cash, $300. NE Cash, $200. 10 Dollar Payday, $300. My Cash Now, $400. CPD, $300. Cash Advance Net, $500. “I have been paying the minimum amount for over 4 months and I can not take it any longer,” he wrote on Prosper. “I get paid biweekly and they take over 500 each pay period. If I can just get these consolidated, I will be in the clear.”
But this loan was not the only request that Garza had posted. From the middle of March to early May, he put up about a dozen requests, withdrawing many of them within a couple days. His story was not exactly consistent in each of these postings — he varied the amount he was requesting, varied his tone (sometimes he was terse, sometimes verbose, sometimes he was solicitous), and even changed the photos he used. In some listings he included a photograph of himself, while in others he put up a picture of a woman dressed in a tight shirt, and in one he used an image of a cute puppy. On the Prosper message boards, one user asked, “What is up with the different pictures? Some are a guy and some are a girl … what is up with that? Are you trying to go for sex appeal or something?”
For lenders, deciding whether to give money to people with bad credit isn’t easy; a poor financial record arouses all kinds of suspicions — Is this person lazy or just unlucky? — and the suspicions are hard to overcome. In many respects, Garza looks like someone who needs to be saved. Were you a lender with a deep sense of social mission, you might give him money just out of charity. But he also looks like someone who needs some serious financial discipline. Giving him more money might only make his situation worse.
“The truth is I am addicted to debt, and I don’t know why,” Garza tells me on the phone. He says he learned this fact about himself on Prosper, as a consequence of his loan requests. Each time he posted a listing, people would ask him some very basic questions about his financial life — “If you’re in debt, why do you want to borrow more money?” — that he says awakened him to the destructiveness of his behavior. The Prosper message boards are peopled with some extremely savvy financial experts, “and they make it a point to call you out on certain things you mention in your loan request,” Garza says. He spent three years in credit counseling, but it was only on the Prosper message boards that he’d learned some of the very basic facts about money — “Don’t spend money on things I can’t afford,” Garza says. He explains that he’s been paying off his various debts diligently since he came on to the site. “The fact that there’s this site changed the way I think about money. Everything I learned about money is due to Prosper.”
I don’t know whether to believe Garza’s tale of conversion-by-Prosper. It will be some time, perhaps, before it’s possible to tell whether the site made any difference to his financial life. But early in May, Garza posted his final loan request on Prosper, asking for just $1,000 at a rate of 23.75 percent. “I would like to take out this loan to help my credit. I have a very bad rating and I am not going to blame anyone other than myself for it,” he wrote. Twelve people got together and funded his loan.
At the moment, this is a rarity on Prosper — people with credit ratings of H.R. seldom find funding. Some observers think this might be a permanent feature of the marketplace. “There are some consumers who have no credit or extremely bad credit who will be hard-pressed to find anyone on Prosper who’ll take a risk on them,” says Jennifer Tescher, director of the Center for Financial Services Innovation.
Some lenders I spoke to said they were opposed to Prosper becoming a haven for people with low credit scores. They were afraid other lenders might flee if borrowers with low credit ratings continue to obtain loans and then default on their commitments. (When borrowers default, Prosper contracts with a collection agency to try to get back the money.) There is some logic to this. At the moment, the idea of trading money with strangers might sound, to many people, fairly scary, and maybe the best way to encourage lenders to put their money in Prosper would be to keep people like Garza away from the site.
Prosper has taken many measures to combat fraud and mischief. The company complies with state lending laws that set maximum interest rates lenders can get for their loans — the rate runs from a low of 6 percent in Pennsylvania to a high of 24 percent in several states; you can’t charge someone a payday-loan-comparable 400 percent rate on Prosper. Prosper is also subject to regulation by the Federal Reserve and the Federal Trade Commission, and must also comply with the federal Truth in Lending Act and the Equal Credit Opportunity Act, which prohibits racial and gender discrimination.
Larsen has faith in what he thinks of as Prosper’s main asset — the sense of community it fosters between lenders and borrowers. In fact, the site attempts to cultivate community by encouraging both lenders and borrowers to join affinity groups. On Prosper, you can declare an affiliation to any number of organizations — there are Prosper groups for Harvard alumni, for people from Guam, for Christians, for people who love Apple computers, and many more. Larsen points out that you can get better rates on your lending and borrowing if you belong to a group, but if you default on your obligations, your actions will adversely impact others in the group. This is meant to keep borrowers in line. The idea is that people who belong to a group will feel an enhanced obligation to pay back a loan to remain in the good graces of their fellow Apple users or Harvard alumni.
This sort of peer pressure has long been used as a tool to goad borrowers into paying back micro-loans in the developing world. It reflects, says Elizabeth Warren of Harvard, an axiom of money lending. “Making decisions about whom to repay when you’re in financial trouble is less about law and more about social relationships,” she points out. Every one of the Prosper borrowers I spoke to agreed on this point. They were all so grateful to the people who’d taken a chance on them that they put their Prosper loans ahead of any other debt they had to repay.
And that goes for Garza. “I swear to God, it’s been a revelation to me,” he says of his experience on Prosper. “I swear, it’s the best thing that’s happened to me on the Internet.”
When Anya Kamenetz, 25, graduated from college in the spring of 2002, the United States was still reeling from Sept. 11, the tech industry was going bust and the employment market was stagnant. Though Kamenetz — having been raised in a middle-class family that helped her pay for school without acquiring debt — knew she was better off than most, she found the transient lifestyle of freelance work and infrequent paychecks frightening. And all around her peers were facing the same woes: few promising job prospects, hemorrhaging credit card bills and five-figure student loans. She began to wonder if the American dream — of upward mobility, family security and employer-subsidized healthcare — was for the first time ever falling out of reach.
It is the same question she asks in a new book, “Generation Debt: Why Now Is a Terrible Time to Be Young.” An investigative look at the financial pressures facing America’s youth, the stories in “Generation Debt” sound a refrain that may be familiar to many of today’s twenty-somethings. “[It is] layoffs. Underemployment. Flat incomes,” Kamenetz writes. “No health insurance, no retirement plan, no paid vacation. Unaffordable housing. Moving back in with Mom. Turning 30 with negative savings and no assets. Putting off marriage or kids because they can’t afford them.”
In the book, we meet Sean, a 23-year-old from New York with a B.A. in psychology who temped and delivered pizzas for a year in Vermont before moving back to his parents’ home and taking a position at a marketing firm that paid $10 an hour with no benefits. And Nita, who at 24 has been in and out of college for six years, unable to balance out her tuition payments and $10,000 credit card debt with a stream of low-paying, uninsured jobs at Pier One, Borders and Home Depot. Then there’s Dan, a 33-year-old Ph.D. dropout who after a few years of dead-end, entry-level jobs moved back into his parents’ Michigan home to care for his blind father and ailing mother; he fears he may never have the private pensions, home equity or Social Security payments they do.
Kamenetz also takes on cultural pundits who would pigeonhole her peers as “twixters” — apathetic, materialistic video-game addicts who are unwilling to commit to careers. She expresses hope that her book might be a call to action that helps her generation become involved in the education, healthcare and Social Security reform decisions that are being made right now and that will certainly shape their future.
I spoke with Kamenetz at Salon’s New York office about some of the psychological motivations behind consumer spending, the changing American workplace, the future of student loans and whether now is really such a terrible time to be young.
What made you decide to write this book?
When I started working after college, my editor at the Village Voice was working on some of these ideas — about the politics of being young and the economics of being young. “Generation Debt” was actually her coinage. And you know, [the work] really connected the dots for me. I saw that it was the real youth politics. Young people do feel left out of the consensus and left out of the political conversation, and feel like their needs are not being addressed. I started talking to people who were saying there are bread-and-butter concerns that affect young people as a class — putting food on the table, paying the rent, paying the bills, being able to get somewhere, being safe, being able to raise a family. It’s all of those things.
I know that to a degree, there is a certain amount of hyperbole involved in selling a book, but —
Oh, do you mean the book’s subtitle?
Yes. Your subtitle is: “Why Today Is a Terrible Time to Be Young.” I mean, is it really that bad?
You know, I actually fought with people over the subtitle. [The publisher] originally wanted to call it the “worst” time, but it is just not the worst. Of course, it is trying to get people to pay attention. What it is all really about for me is realizing that we are part of the first generation in America that does not expect to and probably won’t do better than our parents. It’s about taking a step down, and that is a feeling that is terrifying. The American dream has always been about progress and about going up and up — but we are not making as much money as our parents, and maybe we are a little bit less educated than our parents. We are not achieving the milestones of adulthood at the same time that they did.
So we have to compare it to our own standards, we can’t compare it to a global standard? Because, of course, we are not being forced to be child soldiers or work in factories –
Right. In America, there are no people living on a dollar a day. Even homeless people on the streets in New York are better off than people in Mali. American life has always represented the dream of freedom to the world. So it seems like a horrible breaking down of expectations for us to make that comparison because that’s not how it is supposed to be. America is supposed to be the leader.
At one point in the book, you seem to criticize baby boomers for being irresponsible about the future. But as the children of boomers, aren’t many “twixters” caught in the same cycle of entitlement?
It is really a tension. But that conversation takes place in the corridor of affluence, and there are a lot of people who don’t have the expectation of affluence. I tried very hard to make sure other kinds of stories were told.
I just read the book “Money: A Memoir,” and in it the author, Liz Perle, says we spend to feel safe but instead we chip away at the ground beneath our feet. And nowadays that is a pathology that characterizes all of American culture, all of consumerism. The kids are just as bad as the parents and the parents are just as bad as the kids, and I think we are all caught up in it. It’s about someone like me realizing that I never learned what it actually means to be able to afford something.
Do you think that young people are more in a hurry to have the material trappings of adulthood? Shouldn’t there be a period when you just eat macaroni and cheese?
These days, when you are 21, you can get a credit card and you can use it to fly to Miami on spring break. People do that because they see their friends doing it and that is the normal thing to do, but it’s a mistake. At the same time, these people are also going home and eating Ramen noodles. It’s schizophrenic. For instance, everyone has cable TV now. Even very poor people have cable TV. And there is this whole shadow credit economy where no matter how badly off you are, you can buy a big-screen TV. It’s messed up.
I think it is important to keep an eye on the bigger picture. Everybody naturally falls into anecdotes. But when people say, “Well I was a student and I worked a minimum-wage job, big deal,” it is exactly what conservatives want to hear: that somehow all minimum-wage workers are students. And then we don’t see the other side of that life — that not all minimum-wage workers are doing it because they need to fill time over a summer vacation, and that there really is a difference.
Some older people might say our generation has the freedom to be indecisive compared with our parents, who were more soundly drilled with the idea that you have to get out of college, start a career and stick with it. Is that our tradeoff?
Again, it depends on who you’re talking about. The average age of a college student is about 26. So for a lot of people that exploring just doesn’t exist. People are working and going to school, and are dropping out of school and going back. And for the people who do graduate from college — you know, speaking for myself — you get out of college and realize there are no good jobs in the field you wanted to pursue. So you think, maybe I’ll go back to grad school; maybe I can try this and maybe I can try that. We are always looking for the sure thing, the way that we can get back to the security that our parents enjoyed.
You talk about the fact that the part-time, low-skill jobs in retail, in restaurants, are not new and in fact have always been a part of young people’s lives. But because conglomerates have taken the place of many independent businesses, the nature of those jobs has changed — making them more impersonal and dead-end. Is this a story not only about the changing face of the young workforce but about the changing face of American business?
Absolutely. Businesses at every level are slaves to quarterly earnings. And as soon as the earnings go down, they have to cut jobs. So they have to make their jobs interchangeable; they have to lower the quality of the jobs until they’re all mass-produced.
On a practical level, when you have 50 to 100 percent turnover every year, personal concern for your workers is going to go by the wayside. I did a story about union organizers at Starbucks. They talked about this all the time, and I was really shocked. Because some of them were single mothers and some had kids on Medicaid, but what they always talked about was the fact that they got no respect at work. They’d complain, saying, “I get written up for this or for that. I can’t wear earrings. I am not treated like a person.”
You criticize some parents for judging a generation to which they don’t belong. But isn’t it also hard to write about this from the inside? Do you worry about not having perspective?
Absolutely. I wrote the book at an emotional moment, and coming upon all this information and hearing people’s stories ignited a lot of passion for me. I did not write it to indict a generation. Everyone in America needs to work together to get out of this. What I hope, and what I say to my parents, is that we are your children, we are your caretakers, we are the workforce that is going to shoulder the burden when you retire, and therefore it is in everyone’s interest that we get the best start that we can. The reality is that parents support their children; they are supporting them more than ever before. And they are shaking their heads and wondering why this is happening.
Many of your interviewees are truly impoverished. But what is complicated is that again and again in your stories there seems to be a moment or period of irresponsibility — a spending binge on a trip, a car. What happens first: young people making occasional bad decisions or the credit card companies targeting them?
I am not in a position to judge. I think everyone in this book made some mistakes somewhere along the way. But what I am trying to do by choosing such a diverse group is to show that it does not matter where you come from, there are similar patterns that affect almost everyone. It’s true that I don’t think that it is a good idea to put a $10,000 credit line in the hands of someone who is already unavoidably in debt. Because that’s the thing — when you have to borrow money to get into college, just as you take your first step toward independence, already you are a debtor. And it changes your psychology. For a lot of people, it is a rationalization that makes it much easier for them to owe on credit cards.
Because it lets them say, “Well, I already owe $25,000, what’s another five grand?
Right, you get that all the time. I have friends in law school, and everything they do, every penny they spend, they are going to pay two pennies on in the future while they are living on their loans. But that is just an impossible mind frame to be in when you are young and you want to have fun.
Some economic bigwigs, like Alan Greenspan for instance, say that financial management should be a required high school class. What do you think?
Absolutely. You can compare it to sex education vs. what you learn in the schoolyard. With sex education, what you learn in the schoolyard might not be healthy and balanced, but you get the basic mechanics right. But with financial education, what we pick up is totally harmful. We hear, “Have fun now, take your credit card and your free frisbee, look at TV, watch ‘MTV Cribs.’” We are told we should have everything immediately, and that is what life is all about. So, yeah, I think we need a countering cultural force.
Why do you think that that sort of education is needed now in a way that it was not in the past. How is this generation different?
The American economy has been moving on the consumption engine for about 50 years and it has slowly been accelerating. The cultural base that we used to have of honesty — the depression mindset, you could call it — is just gently eroding underneath us. Everything in the economy is trying to make us spend more. The growth in consumer spending is entirely financed by the growth in consumer debt.
And it is so frustrating because federal regulation can so easily stop it. We are one law away from ending people’s hell. But I think there are a lot of dominoes resting there because, like I said, you can’t overstate the importance of consumer spending to the economy.
So, we want it.
We need it. We can’t live without it. What is Apple going to do if you can no longer buy a $200 iPod?
You talk a lot about the problem of paying for school and how tuition assistance has shifted to put a bigger burden on students. Do you think universities, especially private universities with big endowments, should be pressured to cut tuition?
Actually, last spring there was this tuition movement at Yale — my alma mater — where they had a sit-in at the president’s office and students got him to change the payment requirements for a family earning under $45,000 a year. I think that’s great. And it’s happened at almost all the Ivy League schools now, though obviously there’s a limit to how many students that will reach.
The problem is that the public universities where most people go to school don’t have the power to do that because they depend on state support. And I would hate for people to point it out and say, See it’s no problem, you can just go to Harvard. But if you don’t go to Harvard, well, off to the vocational school with you.
Researching this book really made me realize that my opinions about college were patronizing and wrong. There are a lot of images in our society about what it means to go to college and what a good college is — and there is an insanity about it in certain affluent pockets. I think what kids really need to learn is how to manage their money, how to live within themselves and find out what type of work they really want to do. Filling out the perfect college application and going to the perfect green campus are not going to solve that for us. There are a lot of people, I think, who aspire to college who should maybe think differently about their choices.
Because what is really getting painful and cruel now is that about half the people who go to college are not finishing, which has never happened before. The number of people who are going to college has doubled, but the percentage of people who have graduated has stayed the same. I couldn’t figure out how that made sense, and finally someone pointed out to me that up to 50 percent of students don’t finish. Well, then maybe they shouldn’t have done it. It’s not that I want to discourage anyone from going, but I do think there needs to be a clearer understanding of the costs and benefits, instead of this monolithic idea that college is the only path to success.
But don’t you think that in most cases higher education, when you finish it, does pay off?
Of course, I am not saying that college is not important. In my perfect society, more people would go to college because I think it is an enriching and wonderful experience. Ideally, I would like to see an educated citizenry that plays piano and speaks French and enjoys all the benefits of a liberal education. But it doesn’t necessarily pay off financially, and you can’t expect it to. That is basically the point. On the average it does, but there’s no guarantee. And the problem is, the people who face the most challenges in going to college are also the ones who are at the most risk for not succeeding. The real point is that we are ending up with a less upwardly mobile society because the barriers to education are so high — when really they should be the pathways to security.
I interviewed a few people who told me they actually regretted going to college. One woman was over $47,000 in debt from tuition she charged on her credit cards while studying as an English major. After all that, she went on to have a successful career as a chef, but she told me that if she could do it over again she wouldn’t have gone to school.
You talk about the generation’s debt as both a spiritual and an economic problem. What do you mean when you call it spiritual?
Coming through your 20s and establishing your place in the world, you look around and say, “What place is there for me?” And I think part of the feeling of debt is feeling that you have a lot of holes to fill, that there are a lot of obligations you have to meet by virtue of your moment in history. So there is basically a sense of having debts that have been taken out on yourself that you have to pay off. There is so much uncertainty, and there is a fear that we may be at a pinnacle and we are going to go down.
And you think that is somehow unique to now?
No, not necessarily —
Because you could argue that that is just characteristic of youth.
Absolutely. And there are times in history when people feel like everything is ending and there are times in history when people think that everything is beginning. And it is cyclical and it is characteristic of youth. I guess I go back to what it means to be an American now — and I feel like so many generations of Americans were born expecting to inherit the world and we are just not.
But is that necessarily so terrible?
No, no, it’s not a tragedy. Look, my life is not a tragedy; I am a very happy person. I think there is a lot of room for people who are going to live very happy lives in the country that is coming up, but there are things that are going to be lost. We used to have a very privileged view of our place in the world and really believe that the values of freedom and social mobility were our birthrights. Now, it may be that we evolve into a more global understanding of our place in the world. But I wonder what will happen to those ideals when they’re not linked to our own success and about building a better world for our children and ourselves.
How can we try to fix things?
First by removing billions of dollars of subsidies to banks and returning to the direct-loan program that was instituted by President Clinton in 1993 — which is much, much cheaper — and then diverting the billions of dollars saved (something like $60 billion over the next 10 years) to grants. And you have to get universities on board, which is very hard because you need to call on the state government and universities and private philanthropies and, increasingly, private corporations too. And all of those forces need to come down and tell universities they can no longer raise their tuitions in a vacuum.
There also needs to be an integration of community colleges into the state college system because their role is incredibly important and they are the ones on the front lines. Forty-two percent of college students are at community colleges. So obviously they need to be a bigger priority when it comes to college funding and the whole discussion about it.
Do you think those kinds of federal, state and local changes might also affect personal consumer behavior?
They might. I mean, if you change the paradigm and you don’t force people to go into debt, then they have the opportunity to realize they have a choice. They have a real decision over whether or not they are going to have a credit card. And hopefully you make it harder for them to get one.
It’s 1999, the stock market is climbing and a San Francisco hip-hop artist wants to get in. The 31-year-old — call him “Justin” since he prefers anonymity — doesn’t have any extra cash, but he does have credit cards. He writes a Visa check, opens a Charles Schwab account and gets to work.
At first, he doesn’t spend much money. He invests $2,000 in an Internet music start-up, cashing out when it returns almost twice its value. But soon, the easy money of the market becomes too attractive to pass up. Justin ratchets up the stakes. He aims for highflying quick hits — mostly dot-coms — and by the middle of 2000, he has used a dozen credit cards to buy $70,000 in stock.
“I’m living proof that even a monkey couldn’t have lost money in the market when it was going up,” he says, recalling what it was like to see his portfolio’s value reach $220,000.
Then the market crashed. Justin, who makes $35,000 a year, held on. He started moving his debt around, switching to credit card issuers with low introductory rates, then bailing to others when the offers ended. He posted sticky notes all over his house to remind him when the deals went from, say, 2.9 percent to 18.5. He kept an elaborate notebook detailing which stocks he bought with which credit cards, and ultimately figured the dip would rise.
“Everyone was saying, ‘Stay in, don’t get out,’ so I’m thinking, ‘Let it ride,’” he says. “I did the math and it was like ‘Whatever, I’m having no trouble paying the minimum and they all have pretty good APRs of around 8 percent.’ It seemed like a small price to pay.”
And it was — until the credit cards pulled the plug. About six months ago, the revolving door of credit slammed shut. Every credit card issuer stopped offering Justin cheap annual percentage rates, or even new cards. Justin continued to pay down his debt, but in March he gave in. Distraught, watching the market dive to ever-lower depths and with no one else to borrow from, Justin contacted a bankruptcy lawyer.
“I found myself with the following choice: Maintain good credit while watching everything I earn go to the credit cards, or declare bankruptcy, ruin my credit but get back my life,” he says. After struggling with guilt and “old-fashioned feelings of honor and responsibility,” he says, “I chose the latter. It’s humiliating. My own stupidity, shortsightedness and greed caused my downfall.”
Justin is a member of the (no longer card-carrying) hangover generation — young, college-educated professionals who charged their way through the boom, only to end up busted in the crash. So far, they’ve been largely invisible. Public debate over credit, debt and bankruptcy has tended to focus on only two types of people: rich manipulators who use bankruptcy to protect their multimillion-dollar homes and lavish lifestyles, and the middle-aged and downtrodden who go bankrupt because of an illness, layoff, divorce or other unforeseen tragedy. But the ranks of the young and restlessly broke are beginning to swell.
More than 615,000 people under 35 filed for bankruptcy last year alone. That’s about half of the nation’s total filings, an increase of more than 40 percent since 1991, according to Harvard Law School studies. And with overall bankruptcy rates up 20 percent in the first three months of 2001, their numbers are projected to go higher.
“Generation in debt” or some other negative label might soon supersede labels like “Gen X or Gen Y,” says Robert Manning, an economic sociologist at the University of Houston and the author of “Credit Card Nation.” And if these wrinkle-free failures — who have already gone from slackers to high rollers to slackers again — aren’t feeling so exuberant anymore, who can blame them? Their lives are about to get worse. A new bill moving through Congress — which President Bush has promised to sign — may make it even harder for them to work their way out of the morass of credit card debt.
Seemingly bought with $37.7 million in campaign contributions, the bill would protect credit card companies by holding consumers responsible for the companies’ overgenerous credit lines, essentially providing the companies with an insurance policy for their risky business practices. If it becomes law, everyone who earns more than a state’s median income — about $39,000 in California, far less than the average income of a San Francisco dot-commer — could be forced to pay at least 25 percent of his credit card debt, and maybe all of it — regardless of what kind of financial peril that puts the person in. The bankruptcy court, once a place that gave out second chances, could become nothing more than a glorified collection agency.
Because young people are the first fired and last hired, because they came of age in an era of go-go economics and since they’re already burdened with record-setting levels of college debt, “they’re the bill’s biggest losers,” Manning says. Even those with high salaries “are fundamentally screwed.”
Maybe profligate dot-commers should be forced to do penance for their conspicuous consumption. But doing so, say experts, would burden the overall economy. People paying off massive debts aren’t saving for their children’s college educations, buying homes, keeping consumer confidence high or saving for retirement.
In the long run, “we’ll all end up paying for them,” says Elizabeth Warren, a bankruptcy professor at Harvard Law School who regularly conducts bankruptcy surveys. “We won’t leave them to die; we won’t put them on the streets. We’ll put up the money.”
Falling into debt at a young age used to be more difficult. Credit was something to be earned, and it usually took time. Moreover, debt was incurred chiefly as a result of major purchases.
“Fifty years ago, if you wanted to borrow money you put on your suit and tie and explained to a banker why you needed to go into debt,” says Allen Rosenthal, a San Francisco bankruptcy attorney. “You had to have a good reason. But now, people go into debt one pizza at a time.”
Travis Plunkett, legislative director of the nonprofit Consumer Federation of America, puts it this way: “Debt has gone from something long term to the short term,” he says. “It’s the difference between a washer and dryer and my weekly groceries.”
Credit card companies catalyzed the shift about a decade ago. Two men started the trend: Richard Fairbank and Nigel Morris, former consultants who took over the reins at Capital One, a credit card issuer, decided to personalize plastic. Instead of offering one card at a set rate, they experimented with multiple cards and all kinds of offers. Bonus APRs, balance transfers, “lifestyle cards” imprinted with yachts, sports teams and college logos — Capital One pioneered all of those ideas. And whenever someone with, say, a Jeep responded to a gold Visa card imprinted with white-capped mountains — as opposed to a forest scene — it made a note of it, creating an associative database that formed the basis for more mailings.
The experiment worked. In 1988, Capital One claimed about $1 billion in credit card receivables; as of last year, its receivables figure topped $8.9 billion.
The growth, of course, didn’t go unnoticed. Fearing for their market share, Citibank, Wachovia, MBNA and all the other major issuers started following suit. At the same time, dozens of new issuers entered the market — Discover, for example — and the trend toward extended, personalized credit continued. Today, just about anyone who wants a credit card can get one, including teenagers.
The cultural and economic effects of open access are difficult to untangle. There are some benefits. Credit card issuers, for example, claim to be providing a service, extending credit to deserving consumers who might otherwise be refused loans by banks. And in “Credit Card Nation,” Manning argues that the democratization of debt gives people the freedom to rebel against perceived injustices.
“As a source of ‘bridge loans’ during the contraction of the welfare state and reorganization of the U.S. labor market (part-time, temporary full-time, temps), bank credit cards offer opportunities or political ‘space’ for Americans to challenge the profit-driven forces of structural change that have profoundly traumatized their lives and the future well-being of their children,” he writes. “With the impending conclusion of this ‘up’ business cycle, Americans will increasingly resort to their credit cards for ‘political’ purposes such as resisting undesirable employment or intolerable household living arrangements.”
Michael Banke, who was recently forced to settle his personal and corporate debts in an Oakland, Calif., bankruptcy court, also argues that credit cards can be a valuable asset. “I started my furniture-building business with two credit cards because I wasn’t bankable,” he says. And over the course of 15 years — until the business went belly up this spring — credit cards saved the company at least three times, paying payroll and covering rent until expected checks arrived.
But Banke says that credit cards also led to his downfall — to bankruptcy, unemployment and the repossession of everything but five old guitars worth $3,000. Essentially, he came to rely too heavily on credit cards; they encouraged what turned out to be unfounded optimism. For example, when business started to dwindle in the early ’90s as cheaper furniture from overseas flooded the market, Banke soothed the slide with plastic. And when his landlord refused to let him sublet part of his 36,000-square-foot warehouse in Antioch, Calif., he used his credit cards to keep the lease instead of closing up the shop.
Every time he charged something, there seemed to be more credit applications in his mailbox. Soon, his credit card debts topped $15,000 — not much in comparison to the $150,000 he owed before filing for bankruptcy, but still more than he could afford to pay.
“They’re like an addiction,” Banke says. “The first credit card, like your first nickel bag, is practically free. But then you’re hooked and the costs keep rising. It’s impossible to say no. If you’re drowning and someone offers you a life preserver, you’ll take it, no matter how much it costs.”
“Bill” is a skinny, Gap-clad 34-year-old bankruptcy filer who also asked that his name not be used. He says he charged everything from trips to fancy dinners — not for credit or for a business but rather for emotional satisfaction. Credit cards “made me feel powerful,” he says. “I was given a $20,000 credit line when I turned 22,” he says. “I was living in Los Angeles and working in marketing, making about $35,000 a year. I was using credit cards to keep up with a lifestyle I wanted but couldn’t afford.”
The sense of power didn’t last. The debt quickly became nothing more than a source of stress. By 1996, he owed $30,000 to five credit card companies. He began to wonder if he was addicted to spending. Unsure, he decided to simply change his circumstances. He moved out of L.A., going back to school in San Francisco to complete his bachelor’s degree. He told his credit card companies that he couldn’t pay, and didn’t. But he continued to live above his means, and as soon as he graduated, in 1999, they came calling.
By then, Bill had found work at a San Francisco ad agency, which paid him $35,000 a year. He tried to pay down his debts. But strapped with an additional $20,000 in college loans, and living in a city where the cost of living rivaled Manhattan’s, there was only so much he could do. Seeking help, he started going to the 12-step program Debtors Anonymous. But when his company laid him off in March, Bill did what he’d always hoped to avoid doing: He filed for bankruptcy.
These days, Bill uses only secured credit cards, debit cards essentially. He’s selling his 1995 Ford Ranger to pay the rent, spends at least one night a week at D.A. meetings and works hard to resist credit card temptation.
“I ask God for help, but it’s hard not to want them,” he says. “I get offers twice a week, at least. I see ads on television, on billboards and on the Net. I don’t even answer my phone because I don’t want to talk to telemarketers who might offer me a credit card.”
You might think credit card companies would learn to stop enticing people like Bill. Since they’ve extended credit to all comers, including admitted addicts, shouldn’t these firms be hurting from having to swallow the debt of broke cardholders? In fact, they aren’t. Credit card companies are taking consumers to the bank. Profits are up nearly 50 percent from two years ago, according to analysts’ figures. The industry hasn’t upped the intensity of its marketing — sending out 3.3 billion mailings in 2,000 — for altruistic purposes, argues Plunkett of the Consumer Federation. The customers who continue to pay monthly minimum payments on huge debts more than make up for those who forfeit.
Nothing in the bankruptcy reform bill headed toward President Bush’s desk addresses the industry’s marketing bombardment. It essentially attempts to deal with the problem of overspending by creating harsher forms of punishment solely for the consumer. The idea is to keep people out of debt by letting them know that bankruptcy won’t protect them from their own mistakes. Call it tough love for the credit-addicted.
Will it work?
“Yeah, right,” says Warren, speaking from her office at Harvard Law School. “Changing the bankruptcy laws will not change who goes into debt; it will change where the money goes. This debate is ultimately about an allocation of wealth. If the banks can squeeze 35-year-olds harder, the banks will get richer and the 35-year-olds will get poorer.”
Harsher bankruptcy laws won’t do much to deter filings because most people don’t consider bankruptcy until they have no other choice, Warren adds. Filing for bankruptcy carries both a social stigma and the financial consequence of limited credit for years to come. But the median debtor who files for bankruptcy owes one-and-a-half times his annual salary to credit card companies. Unless the person wins the lottery or inherits a windfall of cash, “the alternative to bankruptcy is not paying their debt slowly over time, the alternative is staying in a hole for the rest of their life,” says Warren.
To actually stem the tide of debt, which is higher than ever before — and which seriously threatens the economy’s ability to grow — government needs to change the habits of both consumers and credit card companies, experts say. Responsibility needs to be shared.
Congress could start by forcing credit card issuers to include information on the terms of what are essentially high-interest loans. “It would take 30 years to pay off $2,500 in credit card debt if you pay the minimum 2 percent,” Warren says. “Credit card statements should contain that information.”
Limits on distribution must also be put in place, she and others insist. Credit card companies are arguing for a contradictory and unreasonable privilege: “They want an unregulated market for distribution, but they also want the government to act as a collection agent when their customers get into trouble. It’s wrong. They can’t have it both ways.” Lois Brady, a trustee in the Oakland, Calif., bankruptcy court who handles about 50 cases per month, couldn’t agree more.
“I see retired people in here, people on welfare — how is that possible?” she asks. “Why can they get $50,000 credit lines when they make less than $20,000 a year? It’s just criminal.”
Is the credit card industry primarily to blame? Justin isn’t so sure. He accepts the blame for ending up so far in debt, and says that the current bankruptcy process seems far too lenient. His case has yet to be heard by a trustee, but chances are good that all of his debts will be wiped away. He simply has to prove that he intended to pay his debts and didn’t make any rash purchases before filing for bankruptcy. When that’s established, Justin will be able to walk away.
His total cost: a few years of damaged credit and about $7,500 — $500 to a lawyer who filed the paperwork and the $7,000 he paid to credit card companies over the past two years. And the bankruptcy trustee appointed to his case might even let him keep his stock portfolio.
“I can see where the credit card companies are coming from,” says Justin, referring to their attempt to enlist Washington in their collection efforts. But he also believes that it’s not fair to focus only on debtors’ culpability.
“Who in their right mind would extend $100,000 in credit to someone who makes a third of that?” he says. “You have to wonder why a company that knows what I earn kept giving me more credit. They have computers; they know what’s going on. If you had all that information, would you give your friend a loan? I wouldn’t. They shouldn’t either.”
