Just as the president reminded us yesterday we are not a deadbeat nation, merely borrowing money today to pay the bills of yesterday, so, as the NY Times reports in this all-too-real article, many of the citizens of the US are also living not just paycheck-to-paycheck but short-term-loan-to-short-term-loan. As one debt-consolidation service noted “They’ve been borrowing just to meet payments on previous loans; it builds on itself.”Rings an awfully loud bell eh? (and yes, we know the government’s finances are not run like a households – though at some point the check book needs to balance). People in tough ‘economic’ situations fall into the ‘poverty trap’, borrowing money at ever higher interest rates in a shell game to keep previous borrowers at bay. The average debt for households earning $20,000 a year or less more than doubled to $26,000 between 2001 and 2010 – as people dig deeper, precisely because they long to escape. As the focus of the article notes, ”the belt-tightening was the easy part… the larger problem was cash-flow.” Critically, experiments show that ‘economic’ scarcity by itself – independent of personality or any other factors - fuels a drive to borrow recklessly.
Via NY Times:
The belt-tightening was the easy part. Cancel the cable. Skip the air conditioners. Ration the cellphone, unplug the wireless Internet, cook rice and beans — done, and done. The larger problem for LaKeisha Tuggle, 33, who had lost her public relations job, was cash flow: After her unemployment insurance and savings ran dry, there was none.
The usual explanations for reckless borrowing focus on people’s character, or social norms that promote free spending and instant gratification. But recent research has shown that scarcity by itself is enough to cause this kind of financial self-sabotage.
“When we put people in situations of scarcity in experiments, they get into poverty traps,” said Eldar Shafir, a professor of psychology and public affairs at Princeton. “They borrow at high interest rates that hurt them, in ways they knew to avoid when there was less scarcity.”
People dig deeper precisely because they long to escape.
She recently made an appointment at GreenPath, a national debt-consolidation service, to see whether she could begin to pay down what she has borrowed. “By the time people come to see us, they have no more credit to use,” said Kathryn Moore, a counselor at GreenPath. “They’ve been borrowing just to meet payments on previous loans; it builds on itself.”