Monday, August 24, 2015

Consumer Finance Research: Global Approaches and Methods - Taking On Debt (Part 1) Perspectives from across the Social Sciences

By Erin Taylor and Gawain Lynch

Photo by Erin Taylor
In the wake of the subprime mortgage crisis in the United States, regulatory bodies and researchers are paying increasing attention to the causes and consequences of personal debt. Mortgage debt has gained the lion’s share of attention, yet non-mortgage household debts (incurred through credit cards, store cards, lease-to-own arrangements, payday loans, and so on) represent a significant portion of household debt. They are critical to household well-being, not only due to the sheer amount of debt that households hold, but also to the fact that debt is used to keep households running on a daily basis.

Understanding why households become over-indebted is a crucial step to planning interventions at the level of the consumer or through policy. However, understanding the causes and consequences of debt is not straightforward. While it is tempting to focus on “over-indebtedness,” there are vastly different schools of thought as to how to define what that means, why people take on unsustainable debt, and what can be done about it.

Moreover, the problem of unsustainable household debt is not limited to the world's wealthiest countries. Globally, consumer debt inhibits the ability of households to meet their basic needs, and interest charges make it increasingly difficult to meet repayments. It can seem to permeate every aspect of one’s life and prevent households from recovering economically.

Debt also has a macroeconomic impact: when a society’s level of household debt is high, consumer spending is lower, and therefore so is economic growth.

What is really needed are different ways of thinking about debt. In this post we take on debt, metaphorically speaking, with a view to moving the conversation forward. Reviewing cross-cultural evidence collected using a variety of qualitative and quantitative methods can assist us to view the problem of debt from different perspectives and help us to design better policy and practices for fair lending, financial education, and the problem of over-indebtedness.

Good and bad debt

The first step to understanding why people become over-indebted is to be clear about what debt itself means. While debt carries a social stigma, it is in fact a fundamental part of economic transactions. As the anthropologist David Graeber points out in his book “Debt: The First 5,000 Years”, the common belief that economic transactions began with bartering, progressed to money exchange, and ended with credit is completely false.

Instead, Graeber tells us, trade began with systems of credit, with people remembering what they owed to one another, writing debts down on paper, or notching it into tally sticks. Graeber's argument builds upon a long line of work by anthropologists who have collected empirical and ethnographic evidence from many parts of the developing world.

Mainstream economics also highlights the positive aspects of debt. At the micro level, taking on debt is viewed as a rational behavior because it allows for investment and consumption smoothing over the course of one’s life. Taking on debt allows us to offset our current wants against our future income, thereby maximizing utility. At the macro level, credit is a foundation of market mechanisms, with complex systems of monies and payment clearance systems smoothing transactions between buyers, sellers, and mediators, most of whom will never meet each other face-to-face.

Economic and anthropological perspectives therefore suggest that credit is foremost a tool, not a moral failing. However, indebtedness is often judged in moral terms. As we explain below, debtors are often represented as people with few financial skills, or who cannot control their impulses. Yet, this condemnation of debtors is relatively new. During the past few thousand years, some of the world's major religions have prohibited usury, the charging of interest. In this case, it is the creditor, not the debtor, who is viewed as engaging in immoral activity.

Photo courtesy Joe Deville, Lived Economies of Default
What counts as “good” and “bad” debt will differ according to both context (country, type of economy, culture, infrastructure) and case (an individual's or household's portfolio, needs, psychological profile, preferences). From a practical standpoint, however, we can say that good debt turns bad when a debtor’s negative balance exceeds their ability to pay. When payments cannot be met, fees and interest charges reduce the amount of spending power available and access to credit for both the present and future selves.

Psychologists and sociologists have described in depth how unmanageable debt negatively impacts individuals’ mental health and damages social relations. The experience of over-indebtedness can be devastating in ways that go well beyond, and are more severe than, economic shock.

Experiences of debt can transcend the individual in more ways than we might expect, such as when people take on loans to fulfill social and family obligations, or when the inability to repay puts individuals and their kin or social group at risk of losing face. Moreover, the relationship between creditor and debtor can have a significant effect on how people experience the burden of debt, including whether one owes money to a debt collections agency or even to a deity. These complexities make it important to view debt from multiple perspectives, a task that our Consumer Finance Research Methods toolkit will facilitate.

Individual behavior

If personal over-indebtedness is so devastating, why do so many people fall into it? Much discussion of the debt trap focuses on the choices made by individuals. Taking out multiple credit and store cards, buying on impulse, failing to compare interest rates, missing payments, and budgeting poorly are just some of the many ways in which people are viewed to mismanage their own money. Alternatively, some blame consumer culture and aggressive marketing for leading unsuspecting individuals into debt.

Around the world, financial literacy programs teach people how to avoid debt or cope with it. These programs are useful and necessary. Clearly, knowing how to make a budget, compare financial products, and locate product information are critical skills for consumers in today’s financialized world. This is true of wealthy and emerging economies alike, although the learning needs of consumers may differ. In a country with a sizable unbanked population, financial literacy might entail learning to choose microfinance products or to operate a mobile money account via a handset, whereas in a country with a largely “banked” population, learning to use online banking services may be more relevant.

However, recent research in the social sciences indicates that a focus on individual capability does not entirely address the problem of how individuals make sound financial choices. A report by social scientists from the Political Economy Research Centre at Goldsmiths, entitled “Financial Melancholia: Mental Health and Indebtedness”, argues that relatively few individuals become over-indebted because they make bad decisions either due to their own personal failings or via the influence of aggressive marketing.

"Hand-Drawn Payments Option Sign" (Long Beach, CA)
Photo credit IMTFI
Rather, most individuals and households become indebted due to a single shock, such as an illness or a sudden loss of income. They are forced to take on extra debt to cover costs, meaning that they now have to find the money to cover repayments of the principal, bank fees, and interest payments, or to accept employment in debt-based contracts. Some consumers may take on new debts to meet the repayment schedules for older debt obligations. This causes a chronic imbalance in their budgets, making it difficult or even impossible to recover economically. Debt spirals, and this can lead to mental illness and social breakdown.

Escaping debt in these circumstances can be assisted by counseling, but may also require debt relief or even the declaration of bankruptcy. Debt can be particularly “sticky” for the world’s poorest people who struggle to meet daily needs and often do not have a sufficient social safety net, whether one provided by the state or one’s kin and community. However, debt hardship is also a growing preoccupation of regulators in the world's wealthiest economies.

In fact, the Financial Melancholia report warns us that counseling programs that aim for “positive thinking” can reinforce people’s sense that they, and only they, are responsible for their debts. Rather than motivate people to take action and sort out their finances, they can actually increase people’s sense of guilt and “aloneness,” worsen their mental health, and inhibit the process of getting debts under control. Moreover, as Joe Deville points out in his book, Lived Economies of Default, on debt in the UK, debt collection officers play upon these feelings of guilt and shame to coerce people into paying their debts back. People will neglect more pressing expenses and debts to other companies in order to reduce the stress of being pressured by an agency.

Measures are needed to address problems at the community level and leverage the advantages that communities provide. Liability is often seen as the individual’s liability, as if it resides within the individual. We need ways to change this. While we often think of debt as being an individual or household problem, debts are by nature social or even have collective aspects.

In our next post, we will explore, using case studies, how both ethnographic and experimental methods provide useful insights into the social underpinnings of debt, and the ways in which collective behavior impacts loan decisions and practices.

Click here for Part 2 of Taking on Debt. Perspectives from across the Social Sciences.

This post is part of the IMTFI project Consumer Finance Research: Global Approaches and Methods, which seeks ways to build cross-sector and multidisciplinary collaborations in consumer finance. To read more about the project and for links to previous posts in this series, click here. 

No comments:

Post a Comment