Encyclopedia of Sociology

BANKRUPTCY AND CREDIT

abusive use of bankruptcy, some of which are
prosecuted by the government as criminal matters.

STRUCTURAL SOURCES OF BANKRUPTCY

Several changes in American financial life have
contributed to the imbalance of debt with income
and may have increased the numbers of people
who file for bankruptcy.

Consumer credit has been available for dec-
ades, principally as a means to help households
finance a large purchase over a period of time.
Individual sellers extended credit, often on the
basis of personal knowledge of the borrower and
the borrower’s ability to repay. Later, banks, credit
unions, and personal finance companies helped
finance the purchase of homes, cars, and small
appliances. These institutional arrangements of-
fered more protection to the seller and made a
personal acquaintanceship less important in the
lending decision.

The development of credit cards, with
preapproved credit limits, allowed consumers to
buy a large variety of goods or services on credit,
not just large or expensive items. It was not just the
invention of the credit card, however, but some
later developments in its use that have changed
consumer financial patterns in a way that may have
influenced higher bankruptcy rates.

First, beginning in the late 1970s, most states
repealed their laws making usury an offense, and
Congress made state usury laws largely ineffective.
Usury, the charging of excessive interest, was for-
merly regulated by the states, most of which set
limits on the maximum amount of interest that
could be charged to borrowers. With the repeal of
these laws, high rates of interest—some as high as
20 percent or more—could legally be charged.
Prior to this time, such high rates of interest were
usually defined as criminal and were associated
with loan-sharking and the lending practices of
organized crime.

Second, credit cards became a major profit
center for many banks, especially because of the
high interest rates that could be charged. Market-
ing of credit cards mushroomed. New markets,
including relatively low-income families, became
the targets of sophisticated mail and telephone
campaigns. Even though many of the families
might not be able to repay everything they charged,

the large interest payments made the lending prof-

itable. Credit cards are now extensively marketed

to young people, especially college students, who

are relatively unfamiliar with financial matters.

Third, credit devices proliferated to include

gold and platinum levels, cash advances, and many

other features that were both profitable to card

issuers and attractive to card holders. Sometimes

card holders did not understand how these fea-

tures worked; for example, many card holders did

not realize that there is no grace period for repay-

ing a cash advance, and the interest rate on a cash

advance is often higher than the rate for purchases.

Fourth, merchants who accepted credit cards

enjoyed increased business because the buyers did

not have to carry a large supply of cash. Advertis-

ing by stores and restaurants increasingly empha-

sized the acceptability of credit cards, so that the

advertising for goods and services reinforced the

advertising of the credit card issuers. Meanwhile,

the credit card issuers provided protection against

nonpayment to the merchant who accepted a cred-

it card, and they also provided some protection for

the card-holder against the fraudulent use of

the cards.

Fifth, a major restructuring of the U.S. econo-

my occurred at the beginning of the 1990s, in

which millions of workers were laid off or could

find only contingent jobs. Many of these workers

found credit cards to be a convenient way to

maintain consumption levels and their family’s

lifestyle even though their expected income stream

was interrupted.

These trends contributed to an increase in the

numbers of people who had high debt-to-income

ratios. Some people incurred high levels of debt,

often at high interest rates, and simultaneously

experienced declining or stagnant income. While

not every person with a high debt-to-income ratio

filed for bankruptcy, those who did file for bank-

ruptcy had very high ratios. Changes in the Ameri-

can economy during the decade of the 1990s

probably influenced the increase in the number of

bankruptcies. In particular, the increasing indebt-

edness of Americans closely tracked the rise in

bankruptcies.

Rising Indebtedness. The economic changes

of the 1990s, in addition to the well-entrenched

borrowing for home mortgages, car purchases,