10.7 Consumer credit

Consumer credit revolutionized American spending habits and economic growth. From installment plans for sewing machines to credit cards and online lending, it reshaped how people buy goods and manage finances.

The evolution of consumer credit reflects broader economic shifts. It fueled industrial expansion, democratized access to goods, and created new financial institutions. However, it also raised concerns about debt levels, inequality, and economic stability.

Origins of consumer credit

• Consumer credit emerged as a pivotal force in American economic development, reshaping consumer behavior and business practices
• The evolution of consumer credit reflects broader shifts in American society, from agrarian to industrial to consumer-oriented economy

Early forms of installment plans

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• Originated in the 19th century with furniture and sewing machine purchases
• Allowed consumers to acquire expensive goods through regular payments over time
• Singer Sewing Machine Company pioneered installment selling in the 1850s
  • Offered machines for $5 down and$3 monthly payments
• Installment plans expanded to other durable goods (pianos, farm equipment)
• Helped fuel the growth of manufacturing and retail sectors

Rise of department store credit

• Department stores introduced charge accounts in the late 19th century
• Enabled customers to make purchases and pay bills at the end of the month
• Macy's and Marshall Field's were early adopters of store credit
• Credit departments assessed customer creditworthiness
• Store credit cards emerged in the 1920s
  • Allowed customers to carry balances and make minimum payments
• Department store credit fostered customer loyalty and increased sales

Expansion in the 20th century

• Consumer credit experienced rapid growth throughout the 20th century, paralleling the rise of mass consumption
• Expansion of credit facilities played a crucial role in democratizing access to consumer goods

Impact of automobile financing

• General Motors Acceptance Corporation (GMAC) established in 1919
  • Provided loans directly to car buyers
• Installment financing made automobiles accessible to middle-class consumers
• By 1926, 75% of cars were purchased on credit
• Auto financing stimulated the growth of the automobile industry
  • Increased production, employment, and related industries (roads, gas stations)
• Created a model for financing other durable goods

Growth of credit cards

• Diners Club introduced the first charge card in 1950
  • Initially for restaurant expenses
• Bank of America launched the BankAmericard (later Visa) in 1958
• American Express entered the market in 1958 with its charge card
• Interbank Card Association (later MasterCard) formed in 1966
• Credit cards revolutionized retail transactions and consumer spending habits
  • Offered convenience, security, and short-term credit
• Rapid adoption led to a cashless payment system and expanded consumer purchasing power

Major consumer credit institutions

• Various financial institutions emerged to meet the growing demand for consumer credit
• Competition between different types of lenders shaped the consumer credit landscape

Banks vs finance companies

• Commercial banks initially hesitated to enter consumer lending
  • Viewed as risky and beneath their traditional business model
• Finance companies filled the gap in consumer credit market
  • Personal Finance Company (1912) and Household Finance Corporation (1878) were pioneers
• Banks gradually entered consumer lending in the 1920s and 1930s
  • Offered personal loans and later credit cards
• Finance companies specialized in higher-risk, higher-interest loans
  • Focused on subprime borrowers and specific industries (auto loans)
• Banks dominated credit card issuance and prime consumer lending
• Regulatory differences impacted competition between banks and finance companies

Role of credit unions

• Credit unions emerged in the early 20th century as member-owned financial cooperatives
• Focused on providing affordable credit to working-class and middle-class consumers
• First U.S. credit union founded in 1909 in New Hampshire
• Federal Credit Union Act of 1934 established federal regulation and chartering
• Credit unions offered lower interest rates and more personalized service
  • Competed with banks and finance companies in consumer lending
• Expanded services over time to include credit cards and mortgages
• Non-profit status and member-ownership structure influenced lending practices
  • Often more lenient credit standards and focus on financial education

Government regulation

• Government intervention in consumer credit markets increased throughout the 20th century
• Regulations aimed to protect consumers and ensure fair lending practices

Truth in Lending Act

• Passed in 1968 as part of the Consumer Credit Protection Act
• Required lenders to disclose credit terms in a clear and uniform manner
  • Annual Percentage Rate (APR) and finance charges
• Standardized the calculation of credit costs across different lenders
• Gave consumers the right to cancel certain credit transactions within three days
• Amendments expanded protections
  • Fair Credit Billing Act (1974) addressed billing disputes
  • Consumer Leasing Act (1976) required disclosure of lease terms
• Improved transparency in credit markets and consumer decision-making

Fair Credit Reporting Act

• Enacted in 1970 to regulate the collection and use of consumer credit information
• Established consumers' rights regarding their credit reports
  • Right to access credit reports
  • Right to dispute inaccurate information
• Imposed obligations on credit reporting agencies
  • Ensure accuracy of information
  • Investigate consumer disputes
• Limited the use of credit reports to permissible purposes
• Set time limits for reporting negative information
  • Most negative information limited to 7 years
• Amendments strengthened protections
  • Fair and Accurate Credit Transactions Act (2003) added identity theft provisions
• Improved accuracy and fairness in credit reporting, impacting lending decisions

Economic impact

• Consumer credit has had profound effects on the American economy, influencing both micro and macroeconomic trends
• The availability of credit has shaped consumer behavior and overall economic growth

Consumer spending patterns

• Credit availability increased consumer purchasing power
  • Enabled acquisition of durable goods (cars, appliances) and services
• Shifted consumption patterns from cash-based to credit-based purchases
• Smoothed consumption over time
  • Allowed consumers to buy now and pay later
• Increased demand for luxury and non-essential goods
• Credit cards facilitated impulse purchases and online shopping
• Led to changes in retail strategies and marketing approaches
  • Emphasis on financing options and credit-based promotions
• Contributed to the growth of the service economy
  • Travel, entertainment, and hospitality sectors benefited from credit card use

Debt levels and household finances

• Consumer debt as a percentage of disposable income rose significantly
  • From about 40% in 1960 to over 100% in the early 2000s
• Increased financial leverage in household balance sheets
  • Higher debt-to-income and debt-to-asset ratios
• Changed savings behavior
  • Decline in personal savings rates since the 1980s
• Debt service payments became a significant portion of household expenses
  • Debt service ratio peaked at over 13% in 2007
• Increased vulnerability to economic shocks and interest rate changes
• Generational differences in debt accumulation and management
  • Millennials faced higher student loan debt burdens
• Debt levels influenced wealth accumulation and retirement planning
  • Both positive (asset acquisition) and negative (interest costs) effects

Technological innovations

• Technological advancements have revolutionized the consumer credit industry
• Innovations have improved efficiency, accuracy, and accessibility of credit

Credit scoring systems

• Fair, Isaac and Company (now FICO) introduced the first credit scoring system in 1956
• FICO scores became industry standard, ranging from 300 to 850
  • Based on payment history, credit utilization, length of credit history, types of credit, and recent inquiries
• Automated underwriting processes, reducing human bias in lending decisions
• Enabled risk-based pricing of loans and credit products
• VantageScore introduced in 2006 as an alternative to FICO
  • Developed by the three major credit bureaus
• Machine learning and AI enhanced credit scoring models
  • Incorporated alternative data sources (utility payments, rental history)
• Credit scoring improved access to credit for some consumers
  • Also raised concerns about algorithmic bias and financial privacy

Online lending platforms

• Peer-to-peer (P2P) lending platforms emerged in mid-2000s
  • Prosper (2005) and Lending Club (2006) were early pioneers
• Connected individual borrowers with individual or institutional lenders
• Utilized online applications and automated underwriting
• Expanded to include marketplace lending and digital banks
  • SoFi, Avant, and Kabbage entered the market
• Offered faster approval times and potentially lower interest rates
• Introduced new credit assessment methods
  • Analyzing social media data and online behavior
• Challenged traditional banking models and expanded credit access
• Raised regulatory concerns about consumer protection and systemic risk
• Accelerated the trend towards digital and mobile-first financial services

Social and cultural effects

• Consumer credit has had far-reaching impacts on American society and culture
• Changed perceptions of debt and financial management across generations

Changing attitudes toward debt

• Shift from 19th century view of debt as moral failing to acceptance as financial tool
• Post-World War II era saw normalization of consumer debt
  • "Buy now, pay later" mentality became prevalent
• Credit cards transformed everyday transactions and spending habits
  • Blurred lines between needs and wants
• Generational differences in debt perception emerged
  • Baby Boomers more debt-averse than Millennials and Gen Z
• Financial literacy movements arose in response to growing consumer debt
  • Emphasized responsible credit use and personal finance education
• Debt became intertwined with notions of the American Dream
  • Homeownership and higher education increasingly debt-financed
• Cultural narratives around debt evolved in media and popular culture
  • From cautionary tales to aspirational lifestyle portrayals

Credit access and inequality

• Expansion of credit increased financial inclusion for some groups
  • Women gained independent access to credit with Equal Credit Opportunity Act of 1974
• Persistent disparities in credit access along racial and socioeconomic lines
  • Redlining practices in mortgage lending
  • Higher interest rates and fees for subprime borrowers
• Credit scores became de facto economic passports
  • Impacting employment, housing, and insurance opportunities
• Debate over the role of credit in perpetuating or alleviating poverty
  • Predatory lending practices vs. credit as a tool for economic mobility
• Alternative financial services (payday loans, check cashing) filled gaps
  • Often at high cost to underserved communities
• Financial technology (fintech) promised to democratize credit access
  • Raised questions about algorithmic bias and data privacy
• Policy debates on balancing credit availability with consumer protection
  • Community Reinvestment Act and its ongoing revisions

Consumer credit in recessions

• Economic downturns have significant impacts on consumer credit markets
• Recessions often lead to tightening credit conditions and increased defaults

Subprime lending crisis

• Expansion of subprime mortgage lending in early 2000s
  • Fueled by low interest rates and lax underwriting standards
• Securitization of mortgages spread risk throughout financial system
• Housing bubble burst in 2006-2007
  • Widespread defaults on subprime mortgages
• Triggered global financial crisis in 2008
  • Lehman Brothers collapse and credit market freeze
• Consumer credit contracted sharply
  • Banks tightened lending standards
  • Credit card limits reduced and accounts closed
• Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010
  • Created Consumer Financial Protection Bureau (CFPB)
• Long-term impacts on consumer credit behavior and regulation
  • Increased scrutiny of lending practices
  • Consumer wariness of excessive debt

COVID-19 pandemic impact

• Sudden economic shutdown in 2020 led to widespread job losses
• Government intervention to support consumer credit markets
  • CARES Act provided mortgage forbearance and suspended student loan payments
• Credit card companies offered payment deferrals and fee waivers
• Decline in consumer spending and borrowing during lockdowns
  • Credit card balances decreased initially
• Divergent impacts across income levels
  • Higher-income households increased savings
  • Lower-income households relied more on credit to cover expenses
• Mortgage refinancing boom due to low interest rates
• Surge in demand for online and contactless payment methods
• Accelerated shift towards digital lending platforms
• Long-term effects on credit scoring and underwriting practices
  • Consideration of pandemic-related financial hardships

Future trends

• The consumer credit landscape continues to evolve with technological and societal changes
• New models and innovations are reshaping how credit is accessed and used

Alternative credit models

• Use of non-traditional data in credit decisioning
  • Rent payments, utility bills, and telecom data
• Expansion of "buy now, pay later" (BNPL) services
  • Affirm, Klarna, and Afterpay offering point-of-sale financing
• Subscription-based credit models
  • Combining credit lines with budgeting tools and financial education
• Blockchain and cryptocurrency-based lending platforms
  • Decentralized finance (DeFi) offering new forms of collateralized lending
• Income share agreements (ISAs) for education financing
  • Repayments based on future earnings rather than fixed interest rates
• Artificial intelligence in credit underwriting
  • Machine learning models for more accurate risk assessment
• Open banking initiatives facilitating data sharing
  • Potential for more holistic financial profiles and personalized credit offers

Fintech and consumer credit

• Mobile-first lending platforms continue to gain market share
  • Streamlined application processes and instant decisions
• Integration of financial services into non-financial apps and platforms
  • Embedded finance and Banking-as-a-Service (BaaS) models
• Increased use of chatbots and virtual assistants in credit servicing
  • AI-powered customer support and financial advice
• Biometric authentication for credit applications and transactions
  • Enhancing security and reducing fraud
• Personalized credit products based on real-time data analysis
  • Dynamic interest rates and credit limits
• Expansion of peer-to-peer and crowdfunding platforms
  • Blurring lines between consumer and small business lending
• Regulatory challenges and opportunities in fintech lending
  • Balancing innovation with consumer protection
• Potential for central bank digital currencies (CBDCs) to impact credit markets
  • Changing the role of traditional financial intermediaries