Wednesday, April 04, 2007

Opinion: Debunking the Myths of Credit
Congress is now holding statistic-thick hearings on predatory lending. But in order to make sense of the modern credit industry, you must first understand its biggest myths.
By James Scurlock
Special to Newsweek
Updated: 2:53 p.m. PT April 3, 2007

April 3, 2007 - Two years ago, I set out to tackle one of the most perplexing riddles of our time: After two decades of unprecedented prosperity, why can’t America get out of debt? My quest took me to every corner of the nation, from the Heartland to the Deep South. I talked to hundreds of people and spun their stories into a book and a film, both of which I titled “Maxed Out”—for obvious reasons. For all of their differences, each person's story shed light on a credit industry that is vast, hugely profitable, sometimes predatory and not at all what most of us assume. So before we try to make sense of the subprime mortgage meltdown or contemplate another step into this dangerous new world, we've got to understand five of the biggest myths of the modern credit industry:

MYTH ONE: What counts is good credit. No doubt you’ve been told by now that your credit, or FICO, score (a secret mathematical formula devised by Fair Isaac & Co., the Minneapolis firm for whom it's named) is the key to your financial future. The idea is to distill the information on your credit report into a single number that lenders can use to make credit decisions instantly without human intervention—the higher the score, the more financially fit you are. That means it simply reflects how well you’ve floated credit in the past—not your ability to manage debt in the future. And it has nothing to do with your income. Rather, the more available credit you have—no matter your ability to pay it back—the better your score.

MYTH TWO: Banks only lend what you can afford to pay back. It may be hard to believe that banks make most of their profits on the least responsible customers, but it’s the two thirds of us who can’t pay off our credit-card balances who contribute all of the interest and most of the penalties—money that goes directly to the banks’ bottom lines. I remember one indignant woman who’d never used credit cards and paid for everything in cash—nothing like the deadbeats in my film, she told me. So why, she demanded, did she have a terrible credit rating? Because despite the fact that she'd never owed a dime and had the means to pay back credit, she had no history of borrowing. Still not convinced? Think Enron. The same banks that stuffed our mailboxes with 6 billion credit card offers last year gave Enron billions of dollars—until the Houston-based energy company went bust, of course.

MYTH THREE: Bankruptcy provides an easy out. We hear a lot about gamers buying flat-screen televisions and BMWs only to run to bankruptcy court for protection. But according to Harvard professor Elizabeth Warren, who interviewed thousands of bankrupt Americans, most waited until the industry had already “picked their bones clean” with sky-high interest rates, penalties and fees. Warren discovered that while most Americans would give everything they owned to avoid admitting defeat, their banks were demanding upward of three times what they'd originally borrowed.

MYTH FOUR: The government is looking out for me. Wrong again, I’m sorry to say. Time after time, Congress and the courts have sided with the industry over the consumer. In 1978, The Supreme Court decided that banks could “export” high interest rates from one state to another regardless of local usury laws (meaning companies can post shop in the few states like Delaware and South Dakota that don't regulate interest rates and charge customers across the country based on those state laws). Two decades later, the justices extended that same principle to credit-card fees—adding insult to injury by allowing penalties for paying as little as one day late to more than double. But what about Alan Greenspan? you ask. Wasn’t he looking out for us? Not so much. The Fed is a private corporation owned by the big banks; its mandate is to protect them, not you.

LAST MYTH: If we just taught people how to balance their checkbooks and read their credit-card agreement or their exotic mortgage, the problems would go away. Wrong, wrong, wrong. These contracts are so complicated and convoluted that not even Harvard Law School professors or MIT math whizzes understand them. Worse, the terms and conditions can be changed at any time. Outsmarting your credit-card company is like beating the house at blackjack. As the dealers like to say, good luck.

James Scurlock is a writer and documentary filmmaker whose latest release, “Maxed Out: Hard Times, Easy Credit and the Era of Predatory Lenders” has won critical acclaim. It is also available in print from Simon & Schuster. For more information, go to