Tài chính doanh nghiệp - Lecture 18: The democratization of finance: consumer finance

Lecture 18: The Democratization of Finance: Consumer FinanceTrends in Democratization of FinanceFinancial and insurance institutions began with intellectuals and wealthy classGradual spread of risk management institutions required marketing, spread of financial enlightenment, government supportRadical Financial InnovationExample I: InsuranceBurial societies ancient Rome, true insurance policies appeared in Italy in 14th centuryRapid development of actuarial theory starting in1600s with notion of probabilityMorris Robinson Mutual Life of NY 1840: highly-paid salesmen (agency theory)Henry Hyde Equitable Life Assurance Society 1880s: large cash value (psychological framing)Viviana Zelizer: challenging God and tempting fate (psycholoogical framing)Inventions copied around the worldRadical Financial InnovationExample II: Social SecurityGermany, 1889 first national pension planFinancial theory: concept of insurance (Versicherung), large risks, Lujo Brentano, Gustav SchmollerPsychological theory: overconfidence, wishful thinking, hyperbolic discounting Schriften des Vereins für SozialpolitikInformation technology making this possible: paper, typewriters, filing cabinets, German bureaucracy, pasting 11 million stamps on cardsInvention copied around the world, same social security principles in U. S. todayGlitches in the Democratization of FinanceLack of consumer financial sophistication invites their manipulationSimple failures of judgment—behavioral financeConsumer inexperience has compounded errorsMedian Level of Assets First Income Decile, US Households with Heads Aged 51-61, 1992Financial Assets: 0Retirement assets: 0IRA: 0401k: 0Pension: 0Vehicles: $300Home Equity: 0Home value: 0Total Wealth: $5000Median Level of Assets, Fifth Income Decile, US Households with Heads Aged 51-61, 1992Financial Assets: $3000Retirement Assets: 0IRA: 0401(k): 0Pension: $4000Vehicles: $6000Home equity: $29000Home value: $45000Total wealth: $101234Median Level of Assets, Tenth Income Decile, US Households with Heads Aged 51-61, 1992Financial assets: $36500Retirement assets: $40000IRA: $21000Pension: 83259401(k): 0Vehicles: $15000Home equity: $77000Home value: $120000Total wealth: $387609Long-Term Trends in Household DebtIn 1952, consumer credit was only 12% of disposable income. Has trended upward, now is 24%.In 1952, mortgage debt was 22% of disposable income. Has trended upward, now is almost 80%Trends in 1990s reflect growth in confidence.Saving Rate and 10-Yr. Treasury 1953-2003Real Ten-Year Treasury Yield(Yield Minus Latest Annual Inflation) 1953-2003Consumer Confidence 1990-2004Bankruptcy as Ultimate Risk Management DeviceEconomic theory says that with diminishing marginal utility, the risk of extreme ruin is the most important consideration.Without bankruptcy law, none of us could be assured of a decent incomeDebtors were commonly jailed in US in early 19th century.Common Pool ProblemTypically there are many creditors.Without bankruptcy, the first creditor to insist on payment gets paid, others may not.Encourages aggressive actions by creditorsStruggle by creditors to be paid first generates wasteful and painful collection efforts.Creditors cannot meet and decide to split up the proceeds since there are so many of them and time is so short.Early US Bankruptcy HistoryReacting to what they regarded as lenient state bankruptcy laws in colonies, US constitution, Article I, Section 10, prohibits states from “impairing the obligation of contracts.”1800, 1841, 1867, 1898 acts followed financial crisis that rescued multitudes of failed debtors. In 1840, there were half a million failed debtors.1841 law had a discharge provision, after surrendering all one’s assets, one could have a “fresh start.”Bankruptcy Reform Act, 1978First major revision of bankruptcy law since 1938Lowered stigma of bankruptcy, relabeled “bankrupts” as “debtors.”Allowed people to keep moreMade repayment schemes more attractiveLaunched a boom in personal bankruptcies.Bankruptcies have increased five-fold since 1985.Personal BankruptciesUS Personal bankruptcies reached 1.4 million in 1998, a record. Declined to 1.3 million in 1999 and 1.2 million in 2000, rose to 1.45 million in 2001, new record.More bankruptcies than divorces. (1.2 million divorces in 1996)With 104 million households in US in 1999, more than 1% of households declare bankruptcy each year.Cumulative effect as years go by.Personal Bankruptcies, US 1999-2003Chapter 7 BankruptcyThis is the liquidation form.Debtors turn over all nonexempt property to trustee and are discharged from most debt.Alimony, taxes, educational loans not discharged.Can’t declare bankruptcy again for 6 years.To read Chapter 7 (or others), go to Title 11 (Bankruptcy) of United States Code, 7 — Liquidation § 701. Interim trustee. § 702. Election of trustee. § 703. Successor trustee. § 704. Duties of trustee. § 705. Creditors' committee. § 706. Conversion. § 707. Dismissal. Chapter 11—ReorganizationPrimarily for businessesSome individuals running small businesses may use Chapter 11Chapter 13–Adjustment of Debts of an Individual with Regular IncomeChapter 13 is a vehicle to repay part or all of debts over time, supervised by court-appointed trustee.Keep all of property and receive a discharge of portion of debtChoosing: Chapter 7 or 13?Those with little assets choose Chapter 7Others try to make a deal with lien holder and choose Chapter 7. (protect house or car)Failing that, and wishing to retain property, turn to Chapter 13.2001 Bankruptcy Reform ActClinton vetoed 2000 bill as too harsh.Harsh new bills passed both houses March 2001, Bush indicated he would sign.Reconciliation conference was scheduled for September 12, 2001, cancelled.Would make it more difficult to escape credit card debt, which tended to be cancelled in Chapter 7 filings since it was unsecured.Credit card companies lobbied hard for this.If can pay 25% of debt, must do Chapter 13, not 7Bad timing for bill, with weak labor marketInformal BankruptcyOnly 40% of credit card charge-offs are due to bankruptcies. (Amanda Dawsey, L. Ausubel)Going bankrupt requires some planning, one has to save $1000 before lawyer will represent you. Down-and-outs don’t do it. Creditors may just give up— not worth it.State laws allow creditors to garnish your wages, even if you never declared bankruptcy.Causes of BankruptciesPersonal bankruptcies tend to be spurred by job loss, health problems, divorce. Americans run up debts they can pay only if nothing goes wrong.Many bankruptcies are by people who are “drowning in mortgage debt,” having bought too big a house.Sullivan, Warren & Westbrook The Fragile Middle Class YUP 2000Credit Card DebtSWW conclude that the biggest single factor in increase in personal bankruptcies in US has been growth of credit card debt.Average debtor in bankruptcy in 1997 had nine months’ income in credit card debt.Credit card debt continues to be extended after initial applicationDebt is incurred a little at a timePayment schedules are different, can become ever more indebted while paying the minimum amount each month.Credit Card Interest RatesAverage American had $5000 in credit card debt, paying an average interest rate of 16% in 1998.Why do they pay such high interest rates?Challenges for the Democratization of FinanceVitally important that individuals can make use of modern risk managementDemocratization of finance can help build proper incentivesWe have left the dark ages in consumer finance, but have yet to reach its potentialI. Livelihood InsuranceReplaces life insurance in dealing with largest risksLong-term policies based on occupational indexesRepeated measures occupational indexes: Robert Shiller and Ryan Schneider Rev. Income and Wealth 1998Powerful impact on conservatism in life’s decisions, makes for more risk takingII. Home Equity InsuranceRisks to values of homes greater than risks by fireOak Park Illinois, 1977Chicago Home Equity Assurance Program 1988Index-based insurance, Shiller and Weiss 1994Yale-Syracuse-NRC program, 2002III. Income-Linked LoansMilton Friedman, Capitalism and Freedom 1962: individuals sell shares in their future earnings, but feared “irrational public condemnation” and feared it would be difficult to track people and enforce contractsChanging timesSuch loans should be based partly on income indexes, to reduce moral hazardIncome-Linked Personal LoansYale Tuition Postponement Option 1971-78Yale Law School Career Options Assistance Program 1988-todayDavid Bowie bonds, David Pullman 1997Australian Higher Education Contribution Scheme (HECS) is dominant form of student loans in Australia todayMYRICHUNCLE.COM