CRS Report for Congress
Bankruptcy and Credit Card Debt:
Is There A Causal Relationship?
March 19, 1998
Mark Jickling
Economic Analyst
Economics Division

Congressional Research Service ˜ The Library of Congress

This report explores the relationship between credit card debt and the fast-
growing rate of personal bankruptcy. Is the bankruptcy code so biased towards
debtors that it encourages irresponsible and/or fraudulent credit card borrowing, or
have lenders themselves been reckless in issuing credit cards to households with
limited financial resources and sophistication? Legislation before the Congress
(H.R. 2500, H.R. 2650, and S. 1301) proposes reforms in bankruptcy law that would
benefit credit card lenders by requiring certain debtors to repay their debts out of
future income. (For an analysis of these proposals, see CRS Report 98-69A.) This
report, which will be updated only if significant new research is published or if new
data become available, consists primarily of economic analysis and does not
presuppose an extensive knowledge of bankruptcy law.

Is There A Causal Relationship?
Personal bankruptcy filings now exceed one million per year. Why should
bankruptcies have risen to record levels during a period when the economy has
enjoyed two of the longest peacetime expansions in history, with unemployment,
inflation, and interest rates all falling? Something must have changed in household
finance; credit cards are among the “usual suspects.”
Credit cards figure prominently in the debate over bankruptcy reform. Credit
card lenders argue that bankruptcy makes it is too easy for debtors to avoid paying
their debts, creating an incentive for reckless or fraudulent borrowing and
exacerbating recent losses to credit card loan portfolios. They support legislation
(H.R. 2500 and S. 1301) that would require some debtors to repay a portion of what
they owe. Opponents of such proposals, including some consumer groups, argue that
the high-power marketing campaigns of credit card issuers amount to an
irresponsible extension of credit to households with low incomes and little financial
sophistication, many of whom are then thrust into bankruptcy by any unforseen
economic trouble.
Does bankruptcy cause excessive losses to lenders, or do lending practices
cause bankruptcies? Credit card debt has grown rapidly since the early 1980s, but
it is still a small share (less than 11%) of all household debt, which is dominated by
mortgage and home equity debt. However, the interest charged on credit cards is
high, and, moreover, it is “sticky,” that is, credit card lenders have not cut their rates
when the general level of interest rates falls. Reasons for this stickiness may lie in
structural and permanent features of the market, or in unique historical circumstances
in the credit card industry’s development; in any case, a dollar of credit card debt is
more expensive than a dollar of other debt.
Since 1989, the aggregate debt burden (debt payments as a percentage of
income) of American families has been flat. However, the debt burden has fallen for
upper income families and risen for low-income families. Financial distress (when
more than 40% of income goes to debt service) has also increased among lower-
income families. Have credit cards played a role in these trends? The debt burden
arising specifically from credit cards appears to be minor: 0.5% of income in 1995,
but somewhat higher and rising for low-income households. Could credit card
borrowing by low-income families, though small in the aggregate, be a straw that
broke the camel’s back and a source of increased bankruptcy filings?
The percentage of families using credit cards to borrow has increased since
1983, with lower-income families leading the rise. However, the median amount
borrowed by low-income families has not risen significantly: the expansion of credit
card loan volume is primarily attributable to upper-income borrowers increasing their
balances. And for these borrowers, the overall debt burden has been falling.
The available aggregate data do not show that credit card debt has caused a
major shift in U.S. household financial conditions. Many bankruptcy filers no doubt
have unusually high amounts of credit card debt, but statistical information about
their overall financial circumstances does not exist.

Credit Cards and Household Finances..................................4
The Distribution of Household Debt...............................4
Why Are Credit Card Interest Rates So High?.......................5
Historical Accidents........................................8
Consumer Indifference to Interest Rate Levels...................9
Switching Costs..........................................10
Household Debt and Access to Credit Cards............................11
Trends in the Aggregate Household Debt Burden
Competition and Access to Credit Cards...........................13
Summary of Data and Conclusion....................................16
List of Figures
Figure 1. Credit Card Loan Charge-offs (Percent)
and Personal Bankruptcy Rate
(Filings per 1,000 population), 1984-1997*........................2
Figure 2. Revolving Credit Outstanding by Holder, 1980-1997...........5
Figure 3. Selected Interest Rates, 1980-1997..........................6
List of Tables
Table 1. Major Categories of Household Debt, 1980-1997.................4
Table 2. Net Pre-Tax Earnings as Percent of Outstanding Balances for Selected
Types of Bank Credit...........................................7
Table 3. Measures of the Family Debt Burden: .........................12
Table 4. Debt Burden from Credit Card Debt
(Percent of Income Consumed by Debt Service Payments)
Table 5. Family Credit Card Debt, 1989-1995..........................15

Bankruptcy and Credit Card Debt:
Is There A Causal Relationship?
A number of bills before the 105th Congress (H.R. 2500, H.R. 3150, and S.
1301) would subject individuals filing bankruptcy petitions to a means test. If their
income were sufficient to repay a certain percentage of their debts, they would be
required to file a Chapter 13 “wage earner” bankruptcy, under which they would turn
over their income (after deductions for living expenses) to a court-appointed trustee
for distribution to their creditors. Chapter 13 is available under current law, but only
about 30% of bankruptcy petitioners choose it. The rest prefer Chapter 7, where one
may give up certain assets (to be sold for the creditors’ benefit) and remaining
unpaid debts (with certain exceptions) are immediately discharged, or canceled,
leaving one free to make a “fresh start” with future income unencumbered.
If this “needs-based” bankruptcy proposal is enacted and works as intended1,
and significant numbers of bankruptcy filers repay portions of their outstanding debt
in Chapter 13, among the principal beneficiaries will be credit card lenders. Unlike
loans that are secured by liens on the borrower’s assets, such as home mortgages and
car loans, credit card lending is unsecured. In Chapter 7 bankruptcy proceedings,
unsecured creditors are the last to share in the liquidation of a debtor’s assets, and
unsecured debt is the first to be discharged. (Some forms of unsecured debt, such as
student loans, are given priority by the bankruptcy code, and are not discharged.
Secured creditors, on the other hand, retain their right to foreclose on property
pledged as collateral even after bankruptcy.) In a typical Chapter 7 consumer
bankruptcy case, the banks and other firms to whom credit card debt is owed see2
their claims extinguished, and get nothing in return. And their claims may often be
a substantial part of the debt that is discharged by the bankruptcy court, since credit
cards function as a lender of last resort for many of those in financial distress.3
Given the nature of credit card debt and its treatment in bankruptcy, one would
expect some correlation between the incidence of personal bankruptcy and the losses
experienced by credit card lenders. Figure 1 below compares the percentage of
credit card loans that commercial bank have charged off (given up for lost) each year
since 1984, with the annual number of personal bankruptcy filings per 1,000

1For an analysis of the bills, see CRS Report 98-69 A: Needs Based Consumer
Bankruptcy: Proposals Before the 105th Congress, by Robin Jeweler.
2About 95% of nonbusiness Chapter 7 cases are “zero-asset” bankruptcies, where none
of the debtor’s property is sold for creditors’ benefit. See: McHugh, Christopher. 1996
Bankruptcy Yearbook and Almanac. Boston, New Generation Research, 1997. P. 39.
3Current and comprehensive data on the origin and size of debts in personal bankruptcy
cases are not available. The bills above would direct the courts to compile such statistics
from bankruptcy petitions.

Figure 1. Credit Card Loan Charge-offs
(Percent)and Personal Bankruptcy Rate
(Filings per 1,000 population), 1984-1997*
Source: FDIC and U.S. Courts. * Jan.-Sept., annualized.
The two figures track each other roughly until 1994, when they become
virtually identical. This correlation helps explain why credit cards have been at the
center of the debate over the ongoing “epidemic” of personal bankruptcy. The
increase in personal bankruptcy since the early 1980s — during a period when the
United States has enjoyed two of the longest economic expansions ever recorded in
peacetime — is puzzling. No single factor can be identified with confidence as the
principal cause, but something must have changed in household finance.4 Credit
cards are among the usual suspects. Even though credit card debt represents a fairly5
small fraction of total household debt, its rate of growth since 1980 has been the
fastest of any component of that total. In addition to growth in the volume of
lending, the credit card industry has been characterized by rapid change in other
!the number of major credit and debit cards in circulation has grown from just
over 100 million in 1980 to about 500 million. Ten million more American
families had credit card debt in 1995 than in 1983,6

4For a review of the suggested causes of increased bankruptcy filings, see CRS Report
97-637 E, One Million Personal Bankruptcies in 1996: Economic Implications and Policy
Options, by Mark Jickling.
5Credit card debt outstanding in September 1997 was less than 11% of total household
debt. (See table 1 on page 4 below.
6According to the Federal Reserve’s Survey of Consumer Finances.

!the proportion of households with access to this form of credit has increased,
following direct mail and telephone solicitations by card issuers that have
numbered in the billions, and
!technology has created new uses for the cards — at the gas pump, in foreign
cities, in supermarkets, on the Internet, etc. — and has made their use more
convenient — for instance, clerks no longer look though a ledger of bad or
stolen card numbers before each sale — so that they have become nearly
indispensable to many households, even those that do not use the cards to
The relationship of credit cards to bankruptcy is controversial. Credit card
lenders argue that the current bankruptcy code is too lenient toward debtors and
encourages abuse. Since a quick, easy, and relatively painless way to avoid
repayment of unsecured debt is available, many consumers are said to choose to file
bankruptcy rather than live within their means. The existence of the bankruptcy
option, following this line of reasoning, causes irresponsible and/or fraudulent
behavior by borrowers, which inevitably drives up loan losses. Credit card issuers
have been strong supporters of “needs-based” bankruptcy and other reforms designed
to shift the costs of personal bankruptcy from creditors to debtors.7
Opponents of such proposals, however, see the causal relationship flowing in
the opposite direction. They argue that the marketing tactics of credit card lenders
— the ubiquitous mass mailings, offers of “pre-approved” lines of credit, low initial
interest rates, etc. — amount to force-feeding a very expensive form of credit to
households with little financial sophistication. Many such households take on debt
burdens that they cannot repay, or which at least put them closer to the edge, so that
any setback to their financial situation drops them into bankruptcy court. If lenders
experience high loss rates, in this view, they are only reaping what they have sown,
and in any case, they are compensated for risk by the high interest rates they charge.
Does bankruptcy cause excessive losses to lenders, or do lending practices
cause bankruptcies? This report considers the evidence that may shed light on these
questions. The following sections examine (1) the significance of credit card debt
in terms of the total picture of consumer finance, (2) the growth of, and competitive
conditions in the credit card industry — in particular, the issues of why credit card
interest rates are so high and whether the credit card market has expanded principally
through marketing to low-income, high-risk households — and (3) changes in the
debt burdens of American households. (Debt burden, or debt service payments as
a share of total income, is an indicator of the ability to pay.)

7For examples of these arguments, and rebuttals, see: U.S. Congress. Senate.
Committee on the Judiciary. Subcommittee on Administrative Oversight of the Courts. Theth
Increase in Personal Bankruptcy and the Crisis in Consumer Credit. Hearing, 105st
Congress, 1 session, April 11, 1997. (S. Hrg. 105-89) 154 p. and: U.S. Congress.
Committee on Banking and Financial Services. Consumer Debt. Hearing, 104 Congress,nd

2 session, September 12, 1996. (Serial No. 104-74) 458 p.

Credit Cards and Household Finances
The Distribution of Household Debt
Bankruptcy, almost by definition, is a condition of excess debt. Table 1 below
presents aggregate debt figures (dollar amounts outstanding) for the major categories
of household debt: home mortgages (including home equity loans) and consumer
credit, the latter of which is broken down into (1) auto loans, (2) credit card, or8
revolving credit, and (3) “other,” which includes loans for mobile homes, boats,
trailers, education, vacations, etc.
Table 1. Major Categories of Household Debt, 1980-1997
HomeConsumer Credit
Mortgages Auto LoansCredit CardsOther
$ Bill.% of$% of$% of$ Bill.% of$ Bill.
Total Bill. Total Bill. Total Total
1980 904.971.8112.08.958.54.6184.914.71260.3
1985 1378.8 69.5 211.7 10.7 131.6 6.6 260.5 13.1 1982.6
1990 2455.0 75.3 283.9 8.7 250.9 7.7 269.2 8.3 3259.0
1995 3358.5 74.9 367.1 8.2 464.1 10.4 291.6 6.5 4481.3
1997* 3767.5 75.4 409.3 8.2 524.3 10.5 293.1 5.9 4994.2
* Third quarter; other figures end-of-year.
Source: Federal Reserve. Balance Sheets for the U.S. Economy and Release G.19.
These figures — which are not adjusted for inflation — show that revolving
credit has been the fastest growing type of household debt since 1980. Revolving
credit, in turn, is dominated by bank credit card lending, as is shown in figure 2
below, which sets out revolving credit by holder. Commercial banks and pools of
securitized assets (loans which have been packaged as bonds and sold to investors,
and which are no longer carried on the originating banks’ books) account for about

80% of the total loan volume.

However, revolving credit remains a relatively small fraction of total household
borrowing, which continues to be dominated by home mortgage debt. Since 1980,
households have taken on about $465 billion in additional revolving card debt, but

8Revolving credit includes not only bankcards, such as Visa and Mastercard, but also
cards issued by oil companies and retailers.

Figure 2. Revolving Credit Outstanding by
Holder, 1980-1997
over the same period mortgage (and home equity) loans outstanding have grown by
nearly $3 trillion.
Source: Federal Reserve. Release G.19.
Why then does the bankruptcy debate focus on credit card borrowing rather than
on mortgage debt? One answer is that mortgages are little affected by the
bankruptcy process: the lender’s right to foreclose if the loan is not repaid survives
bankruptcy. Another answer, more germane to this report, is that credit card interest
rates are among the highest, if not the highest, charged by mainstream lenders. A
dollar of credit card debt will require a greater share of the borrower’s income than
a dollar of other debt. (Credit card debt became even more expensive relative to
mortgage debt when the Tax Reform Act of 1986 took away the deductibility of
credit card interest payments.) It may be, therefore, that credit card debt raises debt
burdens disproportionately to its share in total household borrowing.
Why Are Credit Card Interest Rates So High?
There are two parts to the question of credit card interest rates. The first is: why
have rates been so high? The second is: what impact do these rates have on
household finances? That is, are they so high that they cause financial distress and
lead to bankruptcies? The first question has been the subject of much research
independent of the bankruptcy issue. That research is summarized here.
The price of a loan — the interest rate charged to borrowers — is determined
by several factors. The interest rate must yield enough revenue to cover the lender’s
costs (cost of funds, administrative costs, etc.) and it must include a risk premium to
cover the possibility of borrower defaults. The size of the premium varies according
to the lender’s perception of the credit risk involved in a particular loan or class of
loans. Credit card loans are at the riskier end of the scale. They are unsecured, as

noted above, and they are relatively unsupervised once the initial decision to issue
a card is made. A borrower can — indeed, is likely to — increase the size of his debt
as his creditworthiness declines.
Figure 3. Selected Interest Rates, 1980-1997
Source: Federal Reserve.
A high risk premium means that credit card interest rates will be high relative
to other rates.9 However, one would still expect the absolute level of credit card rates
to fluctuate as lenders’ costs go up and down. This has not happened. As figure 3
above shows, credit card rates have been not merely high, but “sticky.” They have
not followed the general trends in interest rates, which raise and lower lenders’ cost
of funds.
If lenders’ interest costs go down and their interest revenues do not, their profits
will increase, other things being equal. The table below presents data on the10
profitability of credit card operations of depository institutions. Over the period
1974 through 1996, credit card lending was the least profitable of the four types of
loans. However, the standard deviation of credit card profits was much greater than
for other types of lending: profits tend to be quite high or very low, even running into
negative returns. This is what one would expect from any high risk/high reward
business operation: a volatile rate of return.

9Administrative costs are also higher for credit card lending than for other types of
loans, because of the large numbers of accounts and transactions. See: Canner, Glenn B. and
Charles A. Luckett. Developments in the Pricing of Credit Card Services. Federal Reserve
Bulletin, v. 78, September 1992. P. 658.
10See also U.S. General Accounting Office. U.S. Credit Card Industry: Competitive
Developments Need to be Closely Monitored. (GAO/GGD-94-23) April 1994. P. 19.

Table 2. Net Pre-Tax Earnings as Percent of Outstanding Balances for
Selected Types of Bank Credit
PeriodCredit card MortgageCommercialInstallment
Average (%)1.772.482.252.15
Standard Deviation2.050.711.210.59
Average (%)2.992.601.422.35
Standard Deviation0.950.490.520.43
Source: Federal Reserve. The Profitability of Credit Card Operations of
Depository Institutions. (Annual Report to Congress.) August 1997. Table 2.
In a competitive market, the long-term returns for different types of lending
ought to be about equal. The fact that credit card returns are the lowest over 1974-
1996 may simply indicate that the time period selected includes two downturns in the
credit card lending cycle: 1980-81, when returns were low, and 1995-96, when they
were actually negative (-2.93% in 1995 and -3.75% in 1996).
The 1973-1996 performance of credit card profits contrasts strikingly to the
period beginning in 1983 (at the end of the recession of the early 1980s) and ending
in 1993 (before the onset of the record charge-off rates of the last few years). Over
that 11-year period, credit cards’ average profitability was the highest of the four
lending operations, while the variability of returns was half that of the longer period.
During the shorter period, the average interest rate paid by credit card borrowers was
stable, despite a downward trend in the general level of interest rates.
The combination of above-average profits and rigid prices is unusual. If above-
average returns are available, new competitors should enter the market and, by
competing for market share, drive prices down until profit levels fall into the normal
range. New competitors did enter the market, but they did not compete on price.
There was considerable suspicion of price-fixing in the credit card industry; in 199111
the Senate passed a measure that would have set a ceiling on credit card rates.
To most economists, it seemed unlikely that anti-competitive collusion, or price
fixing, could explain the stickiness in interest rates. The credit card industry
consists of thousands of lenders — 6,800 in 1997 — each of whom decides12
individually what rate to charge consumers. There are no significant barriers to

11Senate Amendments 1333 and 1334 to S. 543 (102nd Congress).
12In fact, there is considerable variation in the rates charged by individual lenders; it is

entry: it is relatively simple and inexpensive for any bank to become a member of
the Visa or Mastercard associations. Nonbank corporations like General Motors and
AT&T also issue bankcards. Competition is also present from other cards, like Sears’
Discover and American Express’s Ultima, from bank ATM cards, and from cards
issued by merchants. Several explanations for why credit card rates did not fall have
been put forward. These focus on (1) particular historical circumstances in the
development of credit card markets and, with more direct relevance to the credit
card/bankruptcy question, (2) consumer behavior and (3) non-price competition.
Historical Accidents. A number of unique historical circumstances have been
suggested as reasons why credit card rates remained high and inflexible between13

1983 and 1993.

!Until the early 1980s, interest rates were capped by state usury ceilings.
Because of inflation, credit card rates during the 1970s were generally set at
the legal maximum; thus, there was no experience of price competition based
on interest rates when the limits were removed.
!Capital expenditures related to computerization in the industry may have been
high in the 1980s, resulting in above normal administrative costs.
!The heavy demand for credit as the recession of 1980-82 ended may have
allowed lenders to increase their loan volume as much as they wished without
having to compete for market share.
!Banks may have overestimated the risk premium by failing to anticipate that
the expansion of the 1980s would last as long as it did.
!The risk premium for credit card loans may have increased in tandem with the
rise in bankruptcy rates (shown in figure 1 above), with the result that rates
held steady as the cost of funds declined.
Taken together, these factors suggest that, in normal times, credit card interest
rates will rise and fall as other rates do, and that recent rate rigidity does not signal
a failure of competition. In other words, the behavior of rates and profits during the
1983-1993 period was an anomaly that will not be repeated. The evidence to date
on this claim, however, is mixed: the average rate declined from the 17%-18% range
to 15%-16% between 1992 and 1994, but has fluctuated very little since. However,
other interest rates have been relatively stable since then as well. Other analyses of
rate rigidity focus on permanent features of the credit card market.

the average rate that has been inflexible. Some lenders adjust their rates as the general level
of interest rates changes, while others offer lower rates to selected customers. The mystery
is why such lenders do not dominate the market, and why competition does not force others
to emulate them.
13This analysis draws heavily on Canner and Luckett, op. cit., and Ladermann,
Elizabeth. What’s Special About Recent Credit Card Problems? Journal of Lending and
Credit Risk Management, v. 80, September 1997. P. 21-24.

Consumer Indifference to Interest Rate Levels. Lawrence Ausubel, in a

1991 article that has become a touchstone for much subsequent research on the topic,14

sees in the persistence of high rates and high profits a failure of competition. Credit
card issuers, he concludes, have exercised market power, behaving like monopolists
despite a market structure (easy entry, many sellers) in which competitive conditions
ought to prevail. His explanation is based upon consumer behavior: users of credit
cards have not acted in accordance with the assumptions that underlie economic
models of competition.
In other words, consumers have not responded to lower interest rates, removing
the incentive for lenders to compete on price. This seems paradoxical. Why would
borrowers not flock to the lender with the lowest interest rates? In his answer,
Ausubel divides credit card applicants into two groups: one group expects to borrow
and pay interest, the second expects to use the card only for convenience and to pay
the bill in full each month. The first group is sensitive to the interest rate charged;
the second is not, because its members do not expect to pay any interest at all.
Why do banks not compete by lowering interest rates to attract as many of the
first group as possible? There are two reasons. First, people who don’t mind
borrowing at high interest rates are likely to be poor credit risks. They may be in
financial distress, they may be consumers who are unwilling to pace their level of
consumption to their incomes, or they may be financing some risky entrepreneurial
project for which they cannot secure credit elsewhere. Lenders face an adverse
selection problem: if they lower interest rates, they will find themselves with a riskier
pool of loans.
Second, and most important to Ausubel’s analysis, many of the second group
do end up borrowing, contrary to their expectations. In consumer surveys, about half
of households claim that they always or nearly always pay their credit card bills in
full each month. Banks, however, report that about 75% of credit card accounts15
incur interest charges. This disparity suggests that a large number of credit card
borrowers do not act in their self-interest (by demanding low interest rates) because
(1) they do not expect (ex ante) to borrow, and (2) they are unwilling to admit to
themselves (ex post) that they are borrowing, or perhaps expect their indebtedness
to be short-lived.
These “unexpecting” borrowers are the credit card companies’ preferred
customers, but, since they do not think of themselves as borrowers, lenders cannot
attract them by lowering interest rates. These consumers will focus instead on such
features as the annual fee charged, the length of the grace period before interest is
assessed, the credit limit, and various “enhancements” — rebates, frequent flier
miles, and the like. In sum, from the lender’s perspective, cutting rates is16

counterproductive for two reasons:
14Ausubel, Lawrence. The Failure of Competition in the Credit Card Market.
American Economic Review, v. 81, March 1991. P. 50-81.
15Ibid, p. 71-72.
16Actually, three reasons: no firm likes to cut prices, and for credit card lenders it is
particularly painful because lowering rates across the board reduces income from all

!low rates attract less reliable borrowers, with the undesirable result of
increasing the lending institution’s credit risk exposure; and
!the best credit risks ignore offers of lower rates.
This analysis runs counter to a fundamental assumption about how markets
work: that consumers can make rational decisions in their own economic self-
interest. It requires not only that many credit card users make an initial mistake (“I
won’t use the card to borrow”), but that they keep making essentially the same error
(“I will pay off the whole debt this month and won’t have to pay interest next
month”). The notion of persistent economic irrationality on the part of large numbers
of consumers, which ought not to exist in conventional microeconomics, may have
implications for the high rate of personal bankruptcy. Consumer groups who
attribute bankruptcies to over aggressive marketing of credit cards often portray
consumers as victims of forces and urges they cannot control. Credit counseling,
which both lenders and consumer groups favor, does not involve just the techniques
of balancing a household budget, but at times mimics Alcoholics Anonymous and
other self-help groups that operate through catharsis and spiritual transformation.
For example:
Overspending with credit cards, says the Consumer Federation of
America, is an obsession that can get out of control....”If you want to see
a grown person cry, sit in on one of my counseling sessions and watch me
cut up the credit cards,” says Betty Matthews, a consumer credit17
counselor. “Yes, we do. We cut them in half.”
Ausubel’s analysis does account for the stickiness of credit card interest rates,
but there is another explanation for the failure of consumers to demand lower rates,
an explanation that is consistent with the assumption of consumer rationality.
Switching Costs. Consumers paying interest on an unpaid credit card balance
have an incentive to seek out lower rates. The bigger the balance, the stronger is the
incentive. However, consumers who owe a large amount on their current card (and
who would benefit most from a lower interest rate) may face switching costs, as
follows. If they try to open an account with a credit card issuer offering a lower rate,
that issuer will not know whether their intention is to refinance their existing debt or
to take on additional debt. As a result, their applications are more likely to be turned
down. In addition, switching cards may involve giving up favorable treatment from
the present lender, such as higher credit limits granted to those with good long-term
repayment records. From the lender’s point of view, the adverse selection problem
again emerges: the applicants responding to offers of lower rates are likely to be
those whose debt levels are already high.18

outstanding loans (unlike, say, home mortgages, where a lower rate applies only to credit
extended after the rate cut).
17Koch, Kathleen. Credit Card Debt ‘Crushing Millions,’ Group Says. CNN
Interactive, December 16, 1997.
18For a full development of the switching costs argument, see: Calem, Paul S., and

The switching costs argument posits that consumers are not irrationally
indifferent to high interest rates, but that they face obstacles when they try to obtain
lower rates. The “pre-approved” credit may not be approved after all. However, the
explanatory power of this argument is challenged by anecdotal evidence of
widespread “card surfing,” the practice of switching accounts rapidly from one card19
to another to take advantage of low rates offered for some introductory period.
To summarize, each of the explanations for rate stickiness has problems, but all
imply that high rates need not signify illegal collusion among lenders. However,
even though lenders have sound and plausible reasons for maintaining high rates, the
question remains what impact those rates have on consumer finances. The next
section considers the part credit card debt plays in the aggregate household debt
Household Debt and Access to Credit Cards
Trends in the Aggregate Household Debt Burden
To a family in financial trouble, the amount of debt is generally more important
than its composition, and the amount of debt service payments required month by
month is more important than the amount outstanding. What has happened to the
total debt burden during the ongoing surge in personal bankruptcy filings? The
Federal Reserve’s latest Survey of Consumer Finances includes information on debt
ratios, that is, the relationship of debt service payments to total income. Table 3
presents these data for 1989, 1992, and 1995, broken down by family income level.
The table also includes, as a measure of families in financial distress, the percentage
of families whose debt payments exceed 40% of their incomes.
The aggregate debt burden for all families, as measured by the ratio of debt
payments to total income, has been essentially constant since 1989. Within the
income distribution, however, there has been a shift: families with incomes below
$50,000 devoted more of their incomes to debt payments in 1995 than in 1989, while
those with incomes above $50,000 devoted less. This need not mean that upper-
income households are reducing their aggregate debt levels — in the case of credit
card debt, as will be seen below, they clearly are not. It may mean instead that their
incomes are growing faster than their debts. Conversely, those in the lower part of
the income distribution may have experienced either falling incomes or rising debts
(or both). There is a question, in other words, whether these trends in the burden of
debt follow from changes in the pattern of borrowing or from increasing income
Table 3. Measures of the Family Debt Burden:

Loretta J. Mester. Consumer Behavior and the Stickiness of Credit Card Interest Rates.
American Economic Review, v. 85, December 1995. P. 1327-1336.
19Bailey, Jeff, and Scott Kilman. Here’s What’s Driving Some Lenders Crazy:
Borrowers Who Think. Wall Street Journal, February 20, 1998. P. A1.

Ratio of Debt Payments to Income and Families in Financial Distress,
Aggregate Debt RatiosFamilies with Debt Payments
Income(Debt Payments / Income)Greater Than 40 % of Income
1989 1992 1995 1989 1992 1995
All Families15.615.815.410.911.611.1
< $10,00016.
$10-24,999 12.7 16.5 16.1 13.9 16.0 16.9
$25-49,999 16.7 17.0 17.2 10.6 9.7 8.5
$50-99,999 17.4 16.0 16.7 5.7 4.7 4.3
> $100,00014.
Source: Federal Reserve. Survey of Consumer Finances, 1995.
Turning to the proportion of families in financial distress, a corroborating
pattern is observed. The percentage of families who spend more than 40% of their
incomes on debt service has risen in the lower income brackets and fallen in the
upper. The dividing line however, is now at the $25,000 income level, rather than
$50,000. The figure for all families is again roughly constant.
The observation that debt burdens and financial distress have both been rising
for lower-income families suggests a source of the rising numbers of bankruptcy
To what extent has credit card debt contributed to these trends? Table 4 below
shows the debt burden arising specifically from credit card debt. Again, the measure
is debt service payments divided by total family income.
The data in table 4, like those in table 1 above (showing the dollar value of
different forms of household debt), suggest that credit card debt is a minor factor in
the overall household finance picture. For all households, debt service on credit
cards consumes only one-half of 1% of family income in the latest survey. That
figure has grown since 1989, and it is inversely related to family income (just as the
overall debt burden is), but even for the poorest families it is a small fraction of

Table 4. Debt Burden from Credit Card Debt
(Percent of Income Consumed by Debt Service Payments)
Income 1989 1992 1995
All Families0.20.40.5
< $10,0000.20.81.3
$10-24,999 0.3 0.6 1.0
$25-49,999 0.4 0.6 0.7
$50-99,999 0.3 0.4 0.6
> $100,0000.10.10.2
Source: Edelberg, Wendy, and Jonas D.M. Fisher. Household Debt.
Chicago Fed Letter, November 1997. Table 5.
However, it could be argued that even a small increase in the debt burden might
have a significant impact on households with low incomes, which lack savings and
other financial resources to weather economic adversity. Is there a straw that has
broken the camel’s back? While the median debt burden has grown for low-income
families, have they gained greater access to credit cards? The next section takes up
this question, by returning to the issues of growth and competition in the credit card
Competition and Access to Credit Cards
To the casual observer, that is, to anyone with a mailbox or a television set, it
appears that credit card issuers compete rather vigorously. If competition is not
based on price, what form does it take?
In 1995 and 1996, returns on the credit card operations of banks were negative.
In 1997, the bad news continued; there is now talk of a general retrenchment in the20
industry. This development is not out of accord with economic theory, which
predicts that in a free market, excess profits will be competed away. (Lending
markets in the United States have in any case been prone to boom-and-bust cycles.)
How did this happen during a period when the rates charged to borrowers held steady
and when an important component of lenders’ costs (the cost of funds to banks,
reflected by the general level of interest rates) had fallen and remained low? A
possible explanation is that competition among credit card lenders took the path of
lowering credit standards.

20Anderson, Tom, et al. Who Will Survive the Bank Card Shakeout? ABA Banking
Journal, v. 89, November/December 1997. P. 55-64.

The question of credit standards is directly related to the bankruptcy reform
issue. If banks, in search of profits, have voluntarily assumed higher credit risk by
lending to those whom they would previously have deemed unacceptable risks, their
contention that lenient bankruptcy laws are to blame for rising loan losses invites
That credit card borrowing is now more widely available would seem self-
evident to the casual observer introduced above, deluged everyday by unsolicited
offers of credit. In addition, the shift of commercial banks’ lending business fromth
big corporations to small households has been one of the clearest trends in 20
century finance.21 But an expansion of credit card lending — which has certainly
occurred22 — does not necessarily indicate a decline in credit standards. Available
data, however, do shed some light on the recent evolution of the credit card market.
Data from the Federal Reserve’s Survey of Consumer Finances on the
percentage of families reporting credit card debt and the median dollar value of such
debt are presented in table 5. Ausubel’s research discussed above suggests that
credit card debt may be significantly underreported by survey respondents, but there
is no reason to think that the degree of such “wishful thinking” by consumers should
have changed markedly between 1989 and 1995. In other words, the figures ought
to give a roughly accurate picture of the change in the incidence of credit card debt
even if they understate the true percentage of households that carry such debt.
The first set of figures in table 5 shows a steady increase in the percentage of
families with credit card debt (not the same as families with credit cards). Looking
at the breakdown by family income, the rate of increase is inversely related to the
level of income. The proportion of low-income families with credit card debt has
increased substantially; that of high-income families has grown less or, in the case
of families at the top of the income scale, has shown no consistent pattern of growth.
This may be attributed to several factors. High-income families were probably more
likely to have had credit card debt before 1989, so there was less room for growth.
In addition, some families in the upper income brackets may have substituted home
equity loans (where rates are lower and interest is tax deductible) for credit card
Nonetheless, the more rapid growth in the incidence of credit card debt among
lower-income families does suggest a policy of extending credit to households who
previously were denied access. It is interesting that for families with incomes below
$10,000, the incidence of debt grew rapidly between 1989 and 1992, but much more
slowly between 1992 and 1995. This pattern suggests a typical lending cycle, in
which the volume of loans expands until credit quality deteriorates, whereupon credit

21See, e.g., Ogden Nash on pre-war consumer lending, where the guiding precept was
that money must never be lent to anyone who actually needs it: “Yes, if they request fifty
dollars to pay for a baby you must look at them like Tarzan looking at an uppity ape in the
jungle,/ And tell them what do they think a bank is, anyhow, they better go get the money
from their wife’s aunt or ungle.” (From Bankers Are Just Like Anybody Else, Except Richer)
22Outstanding credit card loans by commercial banks grew from $52.5 billion in 1984
to $217.3 billion in 1996, an increase of 314%, while total loans grew by 86%. (Source:

Table 5. Family Credit Card Debt, 1989-1995
Percentage of Families Reporting Credit Card Debt
Income 1989 1992 1995
All Families39.943.847.8
< $10,00013.423.325.4
$10-24,999 29.1 39.7 41.9
$25-49,999 53.1 55.8 56.7
$50-99,999 59.0 51.3 62.8
> $100,00040.134.037.0
Median Value of Family Credit Card Debt
(Thousands of 1995 Dollars)
Income 1989 1992 1995
All Families1.21.11.5
< $10,0000.40.50.6
$10-24,999 0.8 0.9 1.2
$25-49,999 1.1 1.2 1.4
$50-99,999 1.8 1.6 2.2
> $100,0002.42.73.0
Source: Federal Reserve. Survey of Consumer Finances. Various Years.
standards are tightened. Banks’ recent losses from credit card operations suggest23
that such a loan cycle may have peaked in the credit card market in the early 1990s.
The second set of figures in table 5 shows the median value of family credit
card debt. These figures tell a different story: median credit card debt has increased
among all families, but the increase has not been dramatic, which is what would be
expected from the figures on the debt burden arising from credit cards (see table 4
on page 13). This pattern of moderate growth in aggregate credit card balances,
without striking variation by family income, suggests that the growth in total credit
card debt outstanding is not primarily a result of expanded access to credit among

23On credit tightening, see: Zandi, Mark. The Lender of First and Last Resort.
Journal of Lending and Credit Risk Management, v. 80, September 1997. P. 14-20.

lower-income families. This is also the conclusion reached by a 1997 study by Peter
Yoo of the Federal Reserve Bank of St. Louis:
Increases in credit card debt are largely attributable to increased
average credit card debt per household, not from more households with
access to credit cards. Moreover, households in the top half of the income
distribution account for most of the growth of credit card debt, even
though lower-income households increased their access to credit cards and
their average debt at a faster rate than the total population. So most of the
increase in credit card debt between 1983 and 1992 is attributable to
households with previous credit card experience and with above-average
incomes, not to inexperienced, low-income households.24
Returning to the issue of bankruptcy reform, the data in table 5 do not show that
lowering credit standards to accommodate low-income (and, other things being
equal, high-risk) borrowers is mainly responsible for the growth in credit card loan
volume. There may have been a general loosening of credit standards, consistent
with the cyclical nature of most lending operations, but there is no obvious evidence
that low-income, financially unsophisticated households were the special
beneficiaries (or victims). These observations provide little support for the
contention of anti-reform groups that irresponsible, greedy, and reckless lending
policies have led to record bankruptcies.
Summary of Data and Conclusion
The data considered thus far — the available data — do not provide any direct
way to assess the impact of credit card lending on the rise in personal bankruptcy
that began in the early 1980s. We have seen that the incidence of credit card debt
has increased significantly among lower-income families, and that the aggregate debt
burden of such families has risen simultaneously. However, credit card debt does not
appear to have played a leading role in the growing debt burden of these families.
The data do not show that the median family credit card debt, either as a dollar figure
or as the percentage of family income that debt service requires, has reached a level
that justifies alarm. Credit card debt, despite an impressive rate of growth over the
past decade, remains a small percentage of household debt, and the families with the
greatest amount of debt outstanding are those with the highest incomes and,
consequently, the greatest ability to repay.
Still, personal bankruptcies continue to soar. The conclusion must be that
analyses based on aggregate, average, or median statistics are of limited value in
identifying the causes of personal bankruptcy. As a group, bankruptcy petitioners
must be unrepresentative in their levels of debt or in their debt/income ratios. This
is no surprise, despite claims that the stigma of filing bankruptcy has declined. Only
scattered and fragmentary information about the financial condition of bankruptcy
petitioners is available. For example, a 1996 VISA study reported that bankcard

24Yoo, Peter S. Charging up a Mountain of Debt: Accounting for the Growth of Credit
Card Debt. Federal Reserve Bank of St. Louis Review, v. 79, March/April 1997. P. 13.
(This study was done before the 1995 Survey of Consumer Finances was released.)

losses due to bankruptcy in 1995 amounted to $4.7 billion, or an average of $5,400
per nonbusiness bankruptcy.25 This figure is considerably higher than the median
figures reported in the Survey of Consumer Finances, but it is not so large as to
suggest that it dominates the petitioners’ balance sheets. Without information on
petitioners’ other liabilities, together with their assets and incomes, the credit card
figure lacks context and meaning. (The bulk of the VISA study is a survey asking
the reasons why people filed for bankruptcy. The most common response was
“overextended,” which only begs the question that most interests policy-makers and
economists: why are so many consumers overextended when the economy appears
to be doing so well?)
Is credit card borrowing a trap for the unwary, bringing disorder into the
financial houses of an unspecifiable number of atypical families and individuals?
Perhaps, but so are medical expenses, divorce, job loss, casino gambling, narcotics,
investment scams, and so on. Anecdotal evidence abounds, statistical evidence is
scarce. The difficulty in considering bankruptcy reform proposals lies in the need
to make decisions about general trends without knowing the particulars.

25Consumer Bankruptcy: Consumer Debtor Survey. In: U.S. Congress. House.
Committee on Banking and Financial Services. Consumer Debt. Hearing, 104th Congress,nd

2 session, September 12, 1996. (Serial No. 104-74) p. 437.