Business Week: The Poverty Business

While William Watson and Margaret Wente are shrugging their shoulders at growing inequality in Canada, and endorsing policies that would make our income distribution more like that of our southern neighbour, concerns in the US about rising inequality are actually getting a better hearing. An example is the following article in Business Week (The Poverty Business: Inside U.S. companies’ audacious drive to extract more profits from the nation’s working poor).

Nouriel Roubini gets in on the game in a follow-up to the story:

As an online addition to this excellent cover story Business Week asked me and another blogger, Tyler Cowen from George Mason University to debate online the following question:

Stop Fleecing Poor Americans. The U.S. government should place greater restrictions on car sellers, pay-day lenders, and tax preparers who offer the working poor cash or credit with high fees and interest rates. Pro or con?

I presented the Pro view while Tyler presented the Con view.

Pro: Exploitation, Plain and Simple

by Nouriel Roubini, Stern School of Business

Most poor households lack financial literacy and are at risk of falling prey to exploitative lending. In the case of subprime mortgages, for example, economically disadvantaged borrowers have accepted teaser rates without realizing they can ill afford the much higher rates they’ll see down the line. Other forms of lending to low-income borrowers present similar dangers.

These vulnerable Americans often end up in debt traps, with unclear and exorbitant interest rates or fees on car, payday, or tax-preparation loans. Borrowers with inadequate financial education and meager finances often fail to realize the imprudence of such loans until it’s much too late.

The government must intervene to prevent such arrangements from occurring in the first place.

Yes, lawmakers’ restrictions may make it harder for those in need of quick cash to obtain it. But on a larger scale, these limits will produce a better outcome than leaving millions of households crushed under the weight of monies owed—and forced into bankruptcy.

The carnage and ruin caused by the subprime meltdown serves as a lesson in what can happen when credit markets balloon without the benefit of appropriate supervision and regulation. The subprime fiasco threatens to cause a generalized crunch in consumer credit that will lead to a hard landing, and possibly a recession, for the entire U.S. economy.

Let’s learn from our mistakes and ask government to do its job by protecting economically disadvantaged Americans.

And, somehow surprisingly, some bloggers who are not sympathetic to my pessimistic views on housing, subprime mortgages and the economy sided with my views on this particular debate.

My conclusion is simple: private markets do usually work but they work best when they are subject to appropriate supervision and regulation; not heavy-handed regulation but the minimum necessary to avoid predatory lending practices and to ensure that greed and irrational exuberance do not lead to disasters of the sort of the subprime meltdown. History teaches that markets and capitalism work best when there are institutions that allow them to function properly without undue distortions, externalities, manipulation and other well known market failures.

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