U.S. PIRG Consumer Blog: Banks bank on the previous bankrupt

A small, but growing, number of law and social science professors are investigating the implications of unfair consumer credit practices on consumer-debtors. Many of them are now blogging. Two good blogs are Credit Slips and the Consumer Law and Policy blog. One Credit Slips blogger, Katherine Porter, an associate professor at the University of Iowa College of Law, has recently posted an important new study to the Social Science Research Network (SSRN). You can download Professor Porter's paper -- Bankrupt Profits: The Credit Industry's Business Model for Postbankruptcy Lending -- at the bottom of this abstract page.

The study, based on a longitudinal study of bankrupt families, finds empirical evidence to challenge the conventional wisdom (fueled by repeated industry claims), as one bank association lobbyist once said with a straight face opposite me in a TV interview, that most bankrupts are bad guys whose purported inability to handle credit is actually calculated, who often go on pre-bankruptcy "mall shopping sprees" (yes, the bank lobbyist said that on TV) and engage in other opportunistic abuses of the credit system. Professor Porter's robust analysis, however, shows that "industry's characterizations of bankrupt families as opportunistic or strategic actors" are false. Instead, Porter finds that the system works the opposite way-- it is the lenders that are opportunists:

College students and postbankruptcy debtors both face difficulty in meeting bills without borrowing. The credit industry's intense marketing to postbankruptcy families parallels their efforts to lure other vulnerable borrowers into lending relationships. Because bankruptcy is a public process, recent bankruptcy debtors offer a useful group to study to understand creditors' strategies for profiting from financially vulnerable consumers. If lenders' intense solicitation of such customers indeed is drive by these families' propensity to pay late, go over the limit, and revolve large balances, society may wish to prohibit or constrain such lending. Lending strategies that profit from financial distress may be suboptimal because they force society to bear the costs of such distress.

The study is rich in data points and analysis based on the series of interviews conducted with the bankrupt consumers it follows over time. It also provides well-documented and footnoted analysis of the industry's methods, such as this critique of the industry's use of sophisticated lending and scoring models:

One bank spokesperson has asserted that any credit card offers that it sends to people who have filed bankruptcy are inadvertent. The data cast doubt on this denial. Major lenders deploy sophisticated analytical tools to identify future customers and their anticipated profitability. This strategy has been fundamental to the price and term differentiation that dominates the current lending environment. During the same period in which the bankruptcy rate escalated, technology improved the credit reporting and scoring systems. Simultaneously, marketing departments launched powerful incentives such as create "teaser" interest rates and affinity programs to attract customers. Given this formidable marketing prowess, accidental offers are probably rare.

As policymakers on Capitol Hill evaluate legislative changes to rein in dubious and unfair credit card industry practices and fix the mortgage mess that threatens the world economy, this study provides important information about lenders' intent. It deserves widespread circulation. News on the study: AP story; Bankruptcy expert and Professor Elizabeth Warren's blog entry; the Iowa Press-Citizen.