10.7 Consumer credit
10 min read•august 21, 2024
revolutionized American spending habits and economic growth. From for sewing machines to 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 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
- 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
- (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
- introduced the first charge card in 1950
- Initially for restaurant expenses
- Bank of America launched the (later Visa) in 1958
- entered the market in 1958 with its charge card
- (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
- (1912) and (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
- 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
- (1974) addressed billing disputes
- (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
- 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 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
- 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
- "" 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
- 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 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
- provided mortgage forbearance and suspended student loan payments
- 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
Key Terms to Review (34)
American Express: American Express is a multinational financial services corporation known primarily for its credit card, charge card, and traveler's cheque businesses. It plays a significant role in consumer credit by providing individuals with the ability to make purchases on credit, which can be paid off in full or over time, thus influencing spending behaviors and financial management.
Bankamericard: BankAmericard was a credit card program introduced by Bank of America in 1958, which later evolved into what we know today as Visa. This card revolutionized consumer credit by allowing users to make purchases on credit at various merchants, changing the way people approached spending and payments.
Buy now, pay later: Buy now, pay later is a payment option that allows consumers to make a purchase immediately and defer the payment to a later date, often through installment plans. This method is becoming increasingly popular as it provides consumers with the flexibility to buy products without the immediate financial burden, facilitating easier access to credit and promoting consumer spending.
CARES Act: The CARES Act, or Coronavirus Aid, Relief, and Economic Security Act, is a significant piece of legislation enacted in March 2020 to provide economic relief in response to the COVID-19 pandemic. This act aimed to support individuals, businesses, and healthcare providers by offering financial assistance through various measures such as direct payments to citizens, expanded unemployment benefits, and loans for small businesses. By addressing consumer credit concerns, it sought to stabilize the economy during an unprecedented crisis.
Charles E. Merriam: Charles E. Merriam was an influential American political scientist and public administration expert, known for his work on the role of government in the economy and his advocacy for consumer credit reform. His ideas contributed significantly to shaping modern public policy, particularly in understanding the relationship between consumer behavior and economic systems. Merriam's emphasis on the importance of data and empirical research laid the groundwork for future studies in consumer credit and its impact on society.
Consumer Credit: Consumer credit refers to the ability of individuals to borrow money or access goods and services with the promise to repay later, typically through installment payments or revolving credit. It plays a crucial role in enabling consumers to make significant purchases, such as homes, cars, and appliances, by spreading the cost over time. This financial tool has transformed consumer behavior, encouraging spending and facilitating economic growth.
Consumer Leasing Act: The Consumer Leasing Act is a federal law enacted in 1976 that regulates consumer leases, requiring lessors to provide clear and detailed disclosures about the terms of a lease agreement. This act aims to ensure that consumers have all necessary information to make informed decisions when leasing goods such as cars or appliances. By enhancing transparency, it helps protect consumers from deceptive practices and promotes fair competition among lessors.
Consumerism: Consumerism refers to the cultural and economic ideology that encourages the acquisition of goods and services in ever-increasing amounts. It emphasizes the importance of personal choice, material wealth, and the role of consumers in driving economic growth. This concept is crucial for understanding various aspects of retail innovation, the development of large department stores, and the expansion of consumer credit in modern economies.
Credit availability: Credit availability refers to the ease with which individuals and businesses can obtain loans or credit from financial institutions. This concept is closely linked to interest rates, lending standards, and economic conditions, influencing spending and investment decisions across various sectors. Understanding credit availability helps illustrate the dynamics between banks, borrowers, and the overall economy, as it directly impacts consumer behavior and business growth.
Credit card companies: Credit card companies are financial institutions that issue credit cards to consumers, allowing them to borrow money to make purchases with the promise to pay it back later, usually with interest. These companies play a significant role in consumer finance, facilitating immediate access to funds and enabling a culture of consumer credit that impacts spending behavior. By providing a platform for electronic transactions, credit card companies have also been essential in the rise of online shopping.
Credit cards: Credit cards are financial tools that allow consumers to borrow money up to a certain limit to make purchases or pay for services, with the expectation that the borrowed amount will be repaid, typically with interest. They have revolutionized consumer spending by offering convenience and immediate access to funds while also influencing consumer credit behavior and financial responsibility.
Credit score: A credit score is a numerical representation of a person's creditworthiness, based on their credit history and other financial behaviors. It helps lenders assess the risk of lending money or extending credit to an individual. Higher scores typically indicate better creditworthiness, which can lead to lower interest rates and better loan terms.
Credit Unions: Credit unions are member-owned financial cooperatives that provide a wide range of banking services, including savings accounts, loans, and credit. They operate on the principle of serving their members rather than maximizing profits, often offering lower fees and better interest rates than traditional banks. By pooling resources, credit unions empower their members to access affordable financial products, promoting financial stability and community development.
Creditworthiness: Creditworthiness is the assessment of an individual's or entity's ability to repay borrowed money, often evaluated through their credit history, financial stability, and overall financial behavior. It plays a crucial role in determining whether a lender will extend credit and on what terms, including interest rates and repayment schedules. The evaluation of creditworthiness helps lenders make informed decisions and manage risk in lending practices.
Debt accumulation: Debt accumulation refers to the process of incurring debt over time, often due to the continuous borrowing of money to finance expenses. This can occur through various means such as credit cards, loans, and mortgages, leading to a growing total amount owed. As consumers increasingly rely on credit for purchases, debt accumulation becomes a significant concern, particularly when it surpasses their ability to repay, potentially resulting in financial distress or bankruptcy.
Diners Club: Diners Club is a charge card company founded in 1950 that pioneered the concept of a credit card by allowing customers to make purchases at various establishments and pay for them later. This innovation greatly impacted consumer behavior, enabling individuals to dine and shop without immediate cash, which was a significant shift in how transactions were conducted in the mid-20th century. As a result, Diners Club played a crucial role in the expansion of consumer credit in America.
Equal Credit Opportunity Act: The Equal Credit Opportunity Act (ECOA) is a federal law enacted in 1974 that prohibits discrimination in lending based on race, color, religion, national origin, sex, marital status, or age. This act ensures that all consumers have an equal chance to receive credit and access financial services, contributing to fair lending practices within the consumer credit market.
Fair Credit Billing Act: The Fair Credit Billing Act (FCBA) is a federal law that protects consumers from unfair billing practices and provides a mechanism for disputing charges on credit card accounts. It ensures that consumers can challenge incorrect or unauthorized charges and sets specific procedures for resolving these disputes, making it a crucial element in the realm of consumer credit. The act enhances consumer rights in managing their credit accounts and promotes transparency in billing practices.
Fair Credit Reporting Act: The Fair Credit Reporting Act (FCRA) is a federal law enacted in 1970 to promote accuracy and privacy of information in the files of consumer reporting agencies. It regulates how credit information is collected, accessed, and shared, ensuring consumers can understand and control their credit reports. This act is essential for protecting consumers in the realm of consumer credit, giving them rights regarding their credit information and holding credit reporting agencies accountable for the accuracy of the data they report.
Financial literacy: Financial literacy is the ability to understand and effectively use various financial skills, including personal financial management, budgeting, and investing. It empowers individuals to make informed decisions regarding credit, savings, and expenditures, which are essential for achieving financial stability and success. This skill set is especially crucial in navigating consumer credit, enabling individuals to manage debt responsibly and avoid financial pitfalls.
General Motors Acceptance Corporation: General Motors Acceptance Corporation (GMAC) was established in 1919 as a financial services arm of General Motors, primarily to provide vehicle financing and insurance services. It played a crucial role in promoting consumer credit by making it easier for individuals to purchase automobiles through installment loans and leases, thereby boosting car sales and expanding automobile ownership in America.
Great Depression: The Great Depression was a severe worldwide economic downturn that began in 1929 and lasted through the late 1930s, marked by widespread unemployment, significant declines in industrial production, and deflation. This period dramatically reshaped American society and led to major changes in government policies and labor movements.
Household Finance Corporation: The Household Finance Corporation (HFC) was a financial institution that specialized in providing consumer loans and credit services primarily to individuals and families. It played a significant role in the development of consumer credit in the mid-20th century, offering various financial products such as personal loans, home improvement loans, and debt consolidation loans. By targeting consumers with limited access to traditional banking services, HFC helped shape the landscape of household finance and credit availability.
Installment loans: Installment loans are a type of borrowing where the borrower agrees to repay a set amount of money in fixed payments, or installments, over a specified period of time. These loans typically come with a fixed interest rate and are used for various purposes, including purchasing big-ticket items or consolidating debt. The predictable nature of repayment makes installment loans a popular choice for consumers seeking financial stability.
Installment plans: Installment plans are financial arrangements that allow consumers to purchase goods or services by paying for them over a set period through regular, scheduled payments. This method of payment enables individuals to acquire items they may not be able to afford upfront, thus making larger purchases more accessible. These plans often come with interest rates, which can vary based on the lender, and are a significant part of consumer credit systems.
Interbank Card Association: An interbank card association is an organization that facilitates electronic payments between banks and other financial institutions, primarily through credit and debit card transactions. These associations set rules, standards, and fees for transactions, enabling secure and efficient processing of card payments. This concept is critical in the landscape of consumer credit as it supports the use of cards as a means of borrowing and spending, providing consumers with access to credit facilities.
John Maynard Keynes: John Maynard Keynes was a British economist whose ideas fundamentally changed the theory and practice of macroeconomics, particularly through his advocacy for active government intervention in the economy. His work highlighted the importance of fiscal policies to manage economic fluctuations and promote full employment, making him a key figure in discussions about economic recovery strategies during downturns.
Materialism: Materialism is the tendency to prioritize material possessions and physical comfort over spiritual or intellectual values. This mindset often drives consumer behavior, as individuals seek to acquire goods and services that enhance their quality of life, leading to a culture where consumption is equated with happiness and success. As consumer credit becomes more accessible and mass media promotes desires for new products, materialism becomes a defining feature of modern society.
Peer-to-peer lending platforms: Peer-to-peer lending platforms are online services that connect borrowers directly with individual lenders, bypassing traditional financial institutions. This method allows individuals to obtain loans at potentially lower interest rates while providing investors with the opportunity to earn returns on their capital. These platforms have transformed the lending landscape by leveraging technology to facilitate personal loans, often using algorithms to assess creditworthiness and risk.
Personal finance company: A personal finance company is a financial institution that provides a range of credit and loan products specifically aimed at consumers. These companies focus on offering personal loans, installment loans, and other forms of consumer financing to individuals who may not have access to traditional banking services or who need quick access to funds. They play a significant role in the consumer credit landscape by catering to various financial needs, often targeting borrowers with limited credit histories or those seeking to consolidate existing debt.
Post-wwii economic boom: The post-World War II economic boom refers to the rapid economic growth and prosperity experienced in the United States and many other Western countries from the late 1940s through the early 1970s. This period was marked by increased consumer spending, industrial expansion, and significant advancements in technology, which were largely fueled by returning soldiers, government investment, and the expansion of consumer credit.
Revolving credit: Revolving credit is a type of credit arrangement that allows consumers to borrow money up to a specified limit repeatedly, without needing to reapply for a loan each time. This form of credit is most commonly associated with credit cards, where users can carry a balance from month to month and make partial payments while still having access to the available credit. It provides flexibility for consumers, as they can manage their borrowing based on their individual financial needs.
Truth in Lending Act: The Truth in Lending Act (TILA) is a federal law enacted in 1968 that aims to promote informed use of consumer credit by requiring disclosures about its terms and cost. This legislation seeks to ensure that consumers are aware of the costs associated with borrowing, including interest rates, fees, and other charges, thus enhancing transparency in credit transactions. TILA helps to protect consumers from misleading practices and allows them to make better-informed decisions when obtaining credit.
VantageScore: VantageScore is a credit scoring model developed by the three major credit bureaus—Equifax, Experian, and TransUnion—that evaluates a consumer's creditworthiness. This scoring system utilizes a range from 300 to 850, similar to FICO scores, and incorporates various data points from consumer credit reports to generate a score that lenders use to make decisions on extending credit. VantageScore emphasizes the importance of timely payments, credit utilization, and overall credit history in determining an individual's score.