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Saturday, December 10, 2005

Hair of the Dog

Think credit card companies would be reluctant to offer credit to people who recently filed for bankruptcy?:

Credit Card Offers Stacking Up at Homes of the Newly Bankrupt, by Timothy Egan, NY Times: ...If it seems odd ... that banks would want to lend money to the newly bankrupt, it is no mystery to the financial community, which charges some of the highest interest rates to these newly available customers. Under the new [bankruptcy] law, ... they may be even more attractive because it makes it harder for them to escape new credit card debt and extends to eight years from six the time before which they could liquidate their debts through bankruptcy again. "The theory is that people who have just declared bankruptcy are a good credit risk because their old debts are clean and now they won't be able to get a new discharge for eight years," said John D. Penn, president of the American Bankruptcy Institute... Credit card companies have long solicited bankrupt people, on a calculated risk that income from the higher interest rates and late fees paid by those who are trying to get their credit back will outweigh the losses from those who fail to make payments altogether. ... But the new law makes for an even better gamble for lenders... Bankers defend the practice of soliciting the newly bankrupt, saying it gives them a chance to build a new credit history. ... The credit card offers ... higher interest rates - 23 percent or more, which is typical for offers to the newly bankrupt... The study found that a third of low- and middle-income American households reported using credit cards for basic living expenses - rent, groceries and utilities - in any 4 of the last 12 months. ... "The people I'm seeing right now, they're mostly middle or lower middle class," said Jack Burtch, a bankruptcy lawyer in Washington State. "In a good many of the cases, credit cards are what got them into trouble. And I don't see how credit cards will get them out of it."

The incentives on both sides seem to encourage risky behavior, and I don't like seeing people on the edge given the opportunity to alleviate difficulties in the short-run by turning to easy, but high interest rate credit. But it's a free country, they're adults, and if people want to sign up for credit cards after bankruptcy, and if banks are willing, should the government stop them? So long as losses from failure to pay are confined to the borrower and lender and do not spill over as an externality to third parties, I see no reason to step in. But I would hope the risks and terms of such contracts, including the legal remedies that encourage firms to offer this risky credit, are absolutely clear to borrowers.

    Posted by on Saturday, December 10, 2005 at 12:26 PM in Economics, Regulation | Permalink  TrackBack (0)  Comments (10)

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