Lehman Brothers, the 4^th largest investment bank in the country, is declaring bankruptcy. While the average person may not be affected by this particular financial crisis, the storm is just beginning for many people. 

LB is not a commercial bank insured by the federal government but as it is a giant in the investment industry, the news should be equated with a hurricane watch for all Americans.

The general disaster in the mortgage industry, including the collapse of Freddie Mac and Fannie Mae, and now the crisis in the investment banking industry have been brewing for a decade.

How did all of these financial crises take root? Here is the perspective of a fairly typical American woman with a bunch of kids who will be saddled with the consequences of our behavior:

As the economy of the 1990s grew, some advocacy groups began pushing for a relaxation in lending standards to ensure that all potential buyers had a better shot at securing a mortgage. An interesting article about the extension of mortgages to lower income and minority homebuyers can be found at http://findarticles.com/p/articles/mi_m4126/is_11_85/ai_57894563/pg_1?tag=artBody;col1

When researchers in the 1990s found a discrepancy in the mortgage approval rates between whites and people of color, a presumption was made that racism was at the core of the denials. 

http://www.consumersunion.org/finance/accessw400.htm is just an example of one article discussing the need for lenders and the government to find a way to expand mortgage opportunities for people of color. 

Perhaps if one compared the financial circumstances of those denied mortgages, the general truth would have been clear- the denials were based on a lack of credit-worthiness.  While there most-assuredly were individuals behaving in a discriminatory manner, the fact that more people of color were denied credit does not automatically lead to an accurate conclusion that the disparity was rooted in race.

Too often, allegations of discrimination were inserted into the discussions to prevent people from questioning the lowered standards that would come into widespread use in the sub-prime mortgage industry.

Efforts to increase homeownership in minority communities also increased home ownership amongst lower income Whites.  While expanding homeownership seems to be a great goal, on a strictly emotional level, the potential problems of extending credit to those people without the necessary income (regardless of race) at the time of the qualification was shortsighted. The availability of sub-prime mortgages drove our economy in a disastrous direction.

It can and must be argued that the increase in mortgage availability to people who should not have been approved drove up the value of homes in a clearly predictable supply and demand analysis: more buyers = more demand = increase in housing value.

The increasing value of homes did two things- encouraged homeowners to refinance their homes to draw out the “equity” that emerged as a result of the increased demand and also allowed people who were not credit-worthy to get mortgages that they did not have the resources to pay. 

The equity drawn against home values was not necessarily used to pay down other debt, but instead used for items or activities that had no lasting value on a financial spreadsheet.  Because many people actually took out loans that were greater than the value of their homes, they are now deeper in debt than they had imagined possible.  These increased loans have left many homeowners upside down on their houses- they owe more than their home is worth so they can not sell, even if they need to move.

The use of both balloon payment mortgages and adjustable-rate mortgages emerged as a way for consumers to put off paying today what they probably wouldn’t be able to pay tomorrow.  Many of the people who took out balloon mortgages cannot qualify for a refinance because they are in either a no better or diminished financial position today and their home value has dropped.

A USA Today article dated 3/30/2005 clearly recognized the potential risk of ARMs but buyers continued buying from lenders who wanted to lend.

No one cared…

In 1998 the journal, Economic Inquiry, published an article by Theodore E. Day and S. J. Liebowitz that predicted the outcome we are in fact seeing today in the mortgage industry. The article, titled “MORTGAGE LENDING TO MINORITIES: WHERE'S THE BIAS?” noted: “The currently fashionable "flexible" underwriting standards of mortgage lenders may have the unintended consequences of increasing defaults for the "beneficiaries " of these policies. ( JELJ7, G28)”

When we use race or socioeconomic wedges to drive policy based on emotion, we are driving on the wrong side of the road.

Now, we see the failure of the investment banks as a result at least in large part because of the over extension of these questionable mortgages.

There can be no question that the failure of these investment banks that relied heavily on investments in mortgages will send many people running to their computers to figure out whether they are personally affected by this mess.

What people may not be seeing is the bigger storm that is yet to hit. The credit card industry will be next in the line of failing businesses as consumers struggle to pay their debt.

As banks used ratios of payment:income to issue credit, those lower mortgage payments fed into the distribution of credit cards to those with questionable ability to pay the resulting revolving credit balances. 

Also, in 2005 Congress passed bankruptcy reform legislation that limited a consumer’s ability to walk away from credit card debt.  This encouraged credit card issuers to give credit to people who would not have previously qualified.

I don’t buy most of the charges of predatory lending in the mortgage industry but I do think that predatory lending in the credit card industry is rampant and must be dealt with immediately. The credit card industry must take steps to prevent its collapse immediately.

Some examples of problems created by credit card companies: 

People get a card with a low “introductory” interest rate and make purchases.  They make payments based on the low rate and then, with 15 days notice, the credit card company unilaterally changes the interest rate. Now a person who budgeted payments at a 5.9% interest rate gets socked with payments at 19.9% or 23.95 or possibly 29.9% or, worse yet, 33%.

These rising interest rates do not have to be linked to the consumer’s behavior in regards to that particular card.  Citibank can raise a cardholder’s rate based on an issue with Capitol One. Rising interest rates can also be attributed to random and unpredictable changes in the bank's standard to determine an interest rate.  My mother just had a credit card raise her interest rate raised because her credit score is now 1 point below a threshold the card company just established.  She has never been late, never been over her limit.  Yet her monthly payment has now increased with no warning.

Credit card companies send out bills with payments due before the end of the billing cycle and then charge ridiculous late fees designed to prevent consumers from paying down debt. 

Rather than deny a charge, banks allow charges that take a consumer over the limit and then charge fees because the consumer is over the limit. 

A quick example of how changing credit card rates is impacting overall financial stability in the United States consider the following:

A person with $10,000 debt at a 5.9% interest rate could reasonably expect to have a payment of approximately  $150.00 per month.

At 9% interest the payment jumps to just over $180.00.

At 23% the payment becomes about $290.00.

At 33% the payment moves to over $370.00.

This scenario spells disaster for people living on the edge financially.  Double the consumers' trouble with rising gas prices further eating into the pocketbooks of the average American family and now, guess what- people can’t afford to pay their mortgages. Which takes us full circle to the mortgage collapse.

The perfect storm has been building. The bankruptcy reform of 2005 fueled the foreclosure crisis as it encouraged financial policies that undermined more and more Americans who just wouldn’t be able to pay it all.  We are now about to see the eye of this storm tighten.

The credit card industry is bailing water but it cannot bail fast enough. Soon, those companies will be knocking on Congress’ door seeking the same bailout those who came before them received.

This has got to stop.  Perhaps before we bail anyone out, Congress must tell lenders to reform their policies immediately.  One quick strategy: the lenders should try dropping the interest rates to Prime plus 1 or 2 or 3 or even 5.

For the average American, this would drop credit card payments.  Then tell consumers that the rate is locked in as long as they make their payments on time.  If a consumer is late, meaning 30 days late, then that particular credit card company should freeze their credit line at where it stands.  That is fair.

It is not fair for credit card B to punish the cardholder preemptively.  This piling on by the credit card companies is leading an increasing number of borrowers to question why they should pay at all.

I believe that most people want to pay their debt.  If credit card companies don’t try to meet consumers half way, an increasing number of people will no longer feel obliged to pay their debt.

In conclusion, we need to be prepared for the fact that the worst is yet to come.  The truth is that people of color will be affected in greater numbers, as people of color are more likely to be economically disadvantaged. This is not the result of racism. The coming financial crisis is not fueled by racism. It is fueled by an over extension of credit to consumers who have not demonstrated an ability to pay.

The coming crisis is fueled by irresponsible personal behavior by borrowers, predatory credit card lending and a convergence of the problems caused by poorly thought out mortgage industry policy and practice.

Congress will be tempted to step in and take over with more regulation and more oversight.  That will be the easy solution, but it will be the wrong solution.  Congress should not bailout the investment industry and it should not bail out credit card companies. 

Bailouts will lead us closer to a centralized banking system.   Bailouts lead to a more powerful and more intrusive federal government. Bailouts encourage irresponsible behavior by all parties because they create a safety net that removes individual risks.

Our country is in a financial mess and almost everyone is to blame. Now is the time for creditors to look at their policies and begin to act, voluntarily, in ways that will slow down the storm. Consumers must also step up to the plate and commit to paying what they can and forgoing what they can’t afford. 

The people must work to solve this problem before it is solved for us. I guarantee the solutions that come out of Washington during a crisis will not be in the long term best interests of we, the people.