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TRENDS IN CONSUMER CREDIT ^ AFFORDABILITY Y 4, B 22/1:103-145 Trends in Consuner Credit fiffordabi... HEARING BEFORE THE SUBCOMMITTEE ON CONSUMER CREDIT AND INSURANCE OF THE COMMITTEE ON FINANCE AND BANKING, URBAN AFFAIRS HOUSE OF REPRESENTATIVES ONE HUNDRED THIRD CONGRESS SECOND SESSION JUNE 9, 1994 Printed for the use of the Committee on Banking, Finance and Urban Affairs Serial No. 103-145 S5 U.S. GOVERNMENT PRINTING OFFICE^'V'f^-,. ^«0'=^4;?,,^ 80-082CC WASHINGTON : 1994 ForsalebytheU.S.GovernmentPrintingOffice SuperintendentofDocuments,CongressionalSalesOffice,Washington,DC 20402 ISBN 0-16-046316-5 00 TRENDS IN CONSUMER CREDIT AFFORDABILITY Y 4.B 22/1; 103-145 Trends in Consuner Credit ftffordabi. . . HEARING BEFORE THE SUBCOMMITTEE ON CONSUMER CREDIT AND INSURANCE I OF THE COMMITTEE ON FINANCE AND BANKING, URBAN AFFAIRS HOUSE OF REPRESENTATIVES ONE HUNDRED THIRD CONGRESS SECOND SESSION JUNE 9, 1994 Printed for the use of the Committee on Banking, Finance and Urban Affairs Serial No. 103-145 ^»u* m ^f»^/;o U.S. GOVERNMENT PRINTING OFFICE'^ '^jrr<t^^«Of<i:,= 80-082CC WASHINGTON : 1994 *-t>-^r--. ForsalebytheU.S.GovemmeniPrintingOffice SuperintendentofDocuments.CongressionalSalesOffice.Washington.DC 20402 ISBN 0-16-046316-5 HOUSE COMMITTEE ON BANKING, Fff^ANCE AND URBAN AFFAIRS HENRY B. GONZALEZ, Texas, Chairman STEPHEN L. NEAL, North Carolina JAMES A. LEACH, Iowa JOHN J. LaFALCE, New York BILL MCCOLLUM, Florida BRUCE F. VENTO, Minnesota MARGE ROUKEMA, New Jereey CHARLES E. SCHUMER, New York DOUG BEREUTER, Nebraska BARNEY FRANK, Massachusetts THOMAS J. RIDGE, Pennsylvania PAUL E. KANJORSKI, Pennsylvania TOBY ROTH, Wisconsin JOSEPH P. KENNEDY II, Massachusetts ALFRED A. (AL) McCANDLESS, California FLOYD H. FLAKE, New York RICHARD H. BAKER, Louisiana KWEISI MFUME, Maryland JIM NUSSLE, Iowa MAXINE WATERS, California CRAIG THOMAS, Wyoming LARRY LaROCCO, Idaho SAM JOHNSON, Texas BILL ORTON, Utah DEBORAH PRYCE, Ohio JIM BACCHUS, Florida JOHN LINDER, Georgia HERBERT C. KLEIN, New Jersey JOE KNOLLENBERG, Michigan CAROLYN B. MALONEY, New York RICK LAZIO, New York PETER DEUTSCH, Florida ROD GRAMS, Minnesota LUIS V. GUTIERREZ, Illinois SPENCER BACHUS, Alabama BOBBY L. RUSH, Illinois MIKE HUFFINGTON, California LUCILLE ROYBAL-ALLARD, California MICHAEL CASTLE, Delaware THOMAS M. BARRETT, Wisconsin PETER KING, New York ELIZABETH FURSE, Or^on ISTYDIA M. VELAZQUEZ, New York BERNARD SANDERS, Vermont ALBERT R. WYNN, Maryland CLEO FIELDS, Louisiana MELVIN WATT, North Carolina MAURICE HINCHEY, New York CALVIN M. DOOLEY, California RON KLINK, Pennsylvania ERIC FINGERHUT, Ohio Subcommittee on Consumer Credit and Insurance JOSEPH P. KENNEDY II, Massachusetts, Chairman HENRY B. GONZALEZ, Texas ALFRED A. (AL) McCANDLESS, California LARRY LaROCCO, Idaho MICHAEL CASTLE, Delaware LUIS V. GUTIERREZ, Illinois PETER KING, New York BOBBY L. RUSH, Illinois DEBORAH PRYCE, Ohio LUCILLE ROYBAL-ALLARD, California JOHN LINDER, Georgia THOMAS M. BARRETT, Wisconsin JOE KNOLLENBERG, Michigan ELIZABETH FURSE, Oregon DOUG BEREUTER, Nebraska NYDIA M. VELAZQUEZ, New York CRAIG THOMAS, Wyoming ALBERT R. WYNN, Maryland RICK LAZIO, New York CLEO FIELDS, Louisiana ROD GRAMS, Minnesota MELVIN WATT, North Carolina SPENCER BACHUS, Alabama MAURICE HINCHEY, New York RICHARD H. BAKER, Louisiana PAUL E. KANJORSKI, Pennsylvania FLOYD H. FLAKE, New York BERNARD SANDERS, Vermont MAXINE WATERS, Cahfomia CAROLYN B. MALONEY, New York PETER DEUTSCH, Florida (II) CONTENTS Page Hearingheldon: June 9, 1994 1 Appendix: June 9, 1994 43 WITNESSES Thursday, June 9, 1994 Galbraith, James, ProfessorofEconomics, UniversityofTexas 25 Lereah, DavidA., ChiefEconomist, Mortgage BankersAssociation 27 Lewis, Chris, Banking and Housing Director, Consumer Federation of America 29 Lindsey, Hon. Lawrence, Governor, Federal Reserve Board 5 Parente,Frank, Economist, EconomicResearch Division,AFL-CIO 31 APPENDDC Prepared statements: Kennedy, Hon. JosephP 44 Roybal-Allard, Hon. Lucille 46 Galbraith, James 90 Lereah, DavidA 107 Lewis, Chris 118 Lindsey, Hon. Lawrence 48 Parente, Frank (with attachments) 127 Additional Material Submitted for the Record Galbraith,James: Written responses to questions from ChairmanKennedy 100 TheNew York Times: "GreenspanSeesSteadyEconomy,"May 28, 1994 101 "New Signs OfSlowingIn Growth,"June 1, 1994 102 'T)ataShow EasedPace OfGrowth,"June 3, 1994 103 "Inflation IsViewedAs Stable,"June 6, 1994 104 Lereah, DavidA., charts 113 Lewis, Chris, charts 125 Lindsey, Hon. Lawrence: Written responses to—questions fromthe subcommittee 62 "The Best of Times The Worst of Times," remarks by Hon. Lawrence Lindsey to Baltimore Chapter ofthe Commercial Finance Association, March 7, 1994 69 Parente, Frank, The New York Times, "The Fed Goes Ghostbustmg," May 6, 1994 138 Roybal-Allard, Hon. Lucille, letter to Mr. David Lereah regardinghis sugges- tionthat low- andmoderate-income loans are riskier 47 (III) TRENDS IN CONSUMER CREDIT AFFORDABILITY THURSDAY, JUNE 1994 9, House of Representatives, Subcommittee on Consumer Credit and Insurance, Committee on Banking, Finance and Urban Affairs, Washington, DC. The subcommittee met, pursuant to notice, at 10:05 a.m., in room 2128, Rayburn House Office Building, Hon. Joseph P. Kennedy [chairman ofthe subcommittee] presiding. Present: Chairman Kennedy, Representatives LaRocco, Rush, Roybal-Allard, Velazquez, Watt, Hinchey, Maloney, McCandless, King, Knollenberg, and Lazio. Chairman Kennedy. The subcommittee will please come to order. This morning the subcommittee examines the recent trends in the availability and affordability of consumer credit. Today's consumer, I believe, finds himself or herself walking a strange economic landscape. In Dickens' words, "it is the best oftimes, and the worst oftimes." It is the best of times because in the past IV2 years the economy has created hundreds of thousands of new jobs, inflation is at its lowest level in 30 years, except for 1986 when oil prices fell through the fioor, banks are starting to lend again, and the Federal budget deficit is finally being contained. Finally, we seem to be getting our economic house in order. On the other hand, consumers and businesses are coming out of economic hibernation and being greeted with a wet blanket instead of a welcome mat by our Nation's financial institutions, including its central bank. Since February, Fed actions have had the effect ofraising short-term interest rates by about 1.25 percent and long- term rates by a comparable amount. Not surprisingly, lenders have passed on this increase to consumers, giving themselves a generous markup in the process. As a result, consumers are walking up to the teller window and finding that there is plenty of credit available but that it is not very affordable. Compared to a year ago, the average consumer is now paving an extra $103 per month on a $100,000 mortgage. That is another $1,200 per year, and an added $36,000 over the life of a 30-year note. By one estimate, this year's rate increases have kept 200,000 families from buying a home. This new debt burden is nothing more than a hidden tax on the middle class. It increases the cost of all forms of consumer debt that is being tied to interest rates. The Fed's 1.25 percent interest (1) rate hike will cost consumers an additional $12.5 billion this year alone on credit card debt, home equity lines of credit, and ARMs. That is a lot of money being drained from our economy that could be going toward the purchase ofnew goods and services. To add insult to injury, consumers are losing on the savings side as well. Not only are they paying more for their loans, they are also receiving less on their deposits. A recent Consumer Federation study shows rates on money mar- NOW ket accounts, accounts, and other deposits are near historic lows. For senior citizens, small savers, and pensioners this creates a serious financial squeeze. They are paying more for what they buy on credit and getting less to pay for what they need to live. For lenders, though, that fat spread between rates on loans and deposits has helped make the record profits that the industry contin- ues to enjoy. This dilemma was not supposed to happen. Consumers and small businesses should not be facing costlier credit just as the economy is moving into higher gear. Last year. Congress and the America—n people bit the bullet. We agreed to cut the deficit by $500 billion based largely on signals from the Fed that rates would fall and stay low and, thus, help generate growth. Since then, consumers have gone out and contributed mightily to this recovery by consuming goods and services. At the same time, they have not forced serious wage increases or pulled any inflation- ary triggers. In fact, no tangible threats to inflation appear at present. Yet, what have consumers gotten in return for their sacrifices? A series of interest rate hikes that have made it tougher to buy a home, tougher to start a business, and tougher to pay the bills. Now we learn in today's New York Times that the Fed may be raising rates based on a study pretending to show that higher rates will drive inflation down, which in turn will spur higher productivity. But the link between low inflation and high productivity has not been established. In fact, many economists doubt that inflation has any negative impact on productivity until it tops 20 percent. More importantly, I doubt that there are any businesses or business people in this country who would say that higher interest rates will help them modernize and hire workers. They sayjust the opposite. But, unfortunately, the Fed never seems to talk to any real people before coming up with its latest rationale. Some say that ultimately these rate hikes are preventive medicine, a preemp- tive strike to forestall inflation and prolong the recovery. But where is the evidence that this medicine is needed? I hope Governor Lindsey and today's other distinguished witnesses will help answer this and other important questions about what consumers can expect in the months ahead. I want to thank Governor Lindsey in particular for coming here today. We know that he has had to rearrange his schedule to do so and we will do our best to ensure that he is out the door to his next appointment by noon. We look forward to hearing whatever explanations you can come up with and also to having a good ex- change about those explanations. Let me now turn to the gentleman from the California desert and the ranking member of the subcommittee, Mr. McCandless, for an opening statement. Mr. McCandless. Thank you, Mr. Chairman. I will not take much time with an opening statement. I do, however, want to indi- cate to our witnesses a couple of issues that I hope they will address in their remarks. First, I am interested in the amount of consumer installment credit outstanding. Has it been increasing or decreasing? Have customers been paying offold, expensive debts with new cheaper debt? Second, I am curious as to whether banks are becoming more willing to extend credit. Have they qualified more people for loans? Have they experienced lower rates of default? These are the types ofquestions I would like answered. I also want to take a moment to encourage our witnesses to keep their remarks focused on the topic ofthis morning's hearing. I look forward to a discussion of the availability and afifordability of consumer credit, but must remind our witnesses that this subcommittee does not have legislative or oversightjurisdiction, for in- stance, over the Fed's monetary policy or its internal procedures. And with that, Mr. Chairman, I want to welcome our witnesses this morning and thank them in advance for their testimony. Chairman KEhfNEDY. Thank you, Mr. McCandless. Mr. LaRocco. Mr. LaRocco. Thank you, Mr. Chairman. I look forward to this distinguished panel that we have today. I don't know if we will get into what the consumers are doing in the arena of savings. That is a big issue of mine, not only what they are doing in terms of spending and consuming, but also what we are seeing in any trends in savings. So I hope we can address it either directly or peripherally and I commend you for putting this balanced panel together, and I will cease my remarks so we can get the Honorable out the door, as you say. Chairman KENNEDY. Thank you, Mr. LaRocco. Ifhe is still Hon- orable when he leaves. Mr. King. Mr. King. Thank you, Mr. Chairman. I also look forward to the testimony. My district and my region still are mired in a recession. Credit is difficult to come by and I will also be looking, as Mr. McCandless is, to the witnesses to tell us exactly what the availability is of credit from banks toward small businesses. They have suffered severely from the credit crunch. I am interested in knowing exactly what steps are being taken or what the forecasts are for credit being made available to small businesses. Thank you, Mr. Chairman. Chairman Kennedy. Thank you very much, Mr. King. Ms. Velazquez. Ms. Velazquez. Thank you, Mr. Chairman, and good morning to our witnesses. I hope this hearing this morning can shed some light on recent and disturbing actions by the Federal Reserve on our Nation's banks. First, Congress and the American people need a coherent and understandable explanation for the Fed's decision to raise short- term interest rates. As far as I can tell, the Fed has been chasing a ghost that does not exist. Inflation is not the great threat. The only result ofthe Fed's actions seems to be hardship for consumers and workers. Thousands of Americans whose dream of home ownership has come true because of favorable mortgage rates may be in for a lot of lost sleep. The Fed's interest rate hike can mean several hundred dollars more every month in mortgage payments for many lower and moderate-income families. That is the difference between sinking or swimming. Higher interest rates can also mean slower growth and less exports and fewer jobs. The American work force is already suffering from falling wage levels and underemployment. I am also very concerned about the bank's response to^the Fed's actions. Banks have been swift to raise the rates for money they lend out to customers when interest rates rise; however, the banks have been slow to pay out higher rates to customers when they bor- row money. Consumers are not getting a fair return on money mar- NOW ket and accounts. Bank's customers, home buyers, workers, and we in Congress need some answers. I hope that we will get some Thank today. you. Chairman KENNEDY. Thank you, Ms. Velazquez. Mr. Lazio. Mr. Lazio. Yes, thank you, Mr. Chairman. I just want to echo the remarks ofmy good friend, colleague, and neighbor, Peter King, and also welcome the witnesses. I look forward to a focused discussion, as Mr. McCandless noted, on the degree of consumer credit and the possible initiatives that we might take to enhance consumer credit. And I hope we do not get into a hearing where we are simply focusing on bashing the Fed without potential outlook from the Re- serve side. So I thank you for the opportunity to be here, Mr. Chairman. Chairman Kennedy. Thank you very much, Mr. Lazio. Mr. Watt, do you have an opening statement? Mr. Watt. No, Mr. Chairman. I am just looking forward to the testimony. Chairman KENNEDY. Thank you very much. There being no further opening statements, we will proceed with our first witness. You will have your entire written statement submitted for the record, and I would ask you to limit your oral statement to 5 minutes, but you can go on as long as you like there, Larry. We I want to thank Larry Lindsey for coming here this morning. appreciate him taking the time and adjusting his schedule to be here. Prior to joining the Federal Reserve Board, Governor Lindsey served as Special Assistant to the President for Policy Development between 1990 and 1991 and as Associate Director for Domestic Eco- nomic Policy from 1989 to 1990. Governor Lindsey, again, we want to thank you very much for your willingness to come forward. We look forward to your testi-