Update 340: Middle Class Cash & Credit Crunch
Case Studies, Problems and Policy Solutions
The long-awaited, much discussed, often feared inversion of the yield curve — where long-term yields fall below short-term ones — occurred at about 1 pm ET this afternoon. As we have discussed, this is a widely recognized harbinger of recession, news that does not bode well for an American middle class that still feels the pain of the last one.
Today we examine a specific aspect of the economic condition of the middle class, short-term cash and credit problems, and promising cash-in-hand policy solutions — especially relevant now and likely even more so down the road.
Good weekends all,
Four-in-ten Americans say they would not be able to cover an emergency expense of $400 or would be forced to sell property or borrow money to pay for such an expense. Sen. Sherrod Brown cited this statistic during last week’s Senate Banking Committee hearing with Consumer Financial Protection Bureau Director Kathy Kraninger.
Although there’s been debate about making the tax code more progressive and ameliorating income inequality, cash-in-hand policy solutions are needed to help the 40 percent of lower and middle class Americans facing an unexpected expense today.
Who is the Middle Class?
The federal government has no official definition of the middle class; economists and social scientists focus on income and wealth, categorizing households into income quintiles. Richard Reeves of Brookings defines the middle class as Americans in the middle three income quintiles — Americans earning between $37,000 and $147,000 a year.
The middle class is shrinking as a percentage of the overall population. A December 2015 Pew analysis found that middle-income Americans are now in the minority, with middle-income households totaling less than 50 percent of the adult population compared to about 61 percent in 1971. Notably, the share of aggregate income held by middle-income households has also declined from 62 percent in 1970 to 43 percent in 2014 — a decrease of almost 20 percent.
Source: Pew Research Center
Per the Federal Reserve’s latest Economic Well-Being of U.S. Households report, 40 percent of Americans do not have enough savings to cover a $400 emergency expense. The report does not break this percentage down by income bracket, but we can assume that lower- and middle-income households are most represented in this group.
Three common unexpected expense scenarios:
- Health care expenses: In 2017, one-in-five adults had an unexpected medical expense, with a median cost of $1,200. Unsurprisingly, over a quarter of Americans did not seek care for a medical condition due to inability to pay.
- Home and auto repairs: According to national estimates, two-thirds of American households are underinsured, and the two most common car insurance deductibles are $500 and $1,000.
- Job loss or redundancy: The Bureau of Labor Statistics figures for February 2019 show 1.4 million people permanently laid off, nearly 1.1 million people on temporary layoff, and over 800,000 people unemployed as a result of completing temporary jobs. Unexpected periods of unemployment can be a strain on household finances and can easily surpass $400 in unexpected expenses.
An expansion of the Earned Income Tax Credit (EITC) would provide middle class Americans with an income boost to help cover a $400 unexpected expense. Last month, Sen. Sherrod Brown and Rep. Ro Khanna introduced the Cost-of-Living Refund Act of 2019 (S.527, H.R. 1431), which would nearly double EITC benefits for families with children, increase the maximum amount childless workers can claim from $519 to $3000, and decelerate the phase-out. It is similar to Brown/Khanna legislation introduced last Congress, the GAIN Act.
Source: Tax Policy Center
The bill also allows claimants to receive EITC benefits as a one-time advance. This advance would be capped at $400 a year and could be used as an alternative to putting an unexpected expense on a credit card, borrowing from a friend or family member, or being forced into the predatory loan market.
Regulating Short-Term Lending
For Americans in a financial squeeze, many inevitably turn to payday lenders who charge interest rates for loans that can rise above 391 percent. Borrowers often get trapped in an endless cycle of debt beginning with a small, one-time payday loan. According to a Consumer Financial Protection Bureau (CFPB) study, two-thirds of payday borrowers had seven or more loans in a year.
Under President Obama, the CFPB proposed a Rule that required payday lenders to evaluate a consumer’s ability to repay, offer alternative options, and prohibit lenders from making collection attempts without giving notice to the borrower. Former Director Cordray argued that most customers who take out payday loans cannot afford them and the payday lending industry was taking advantage of an especially vulnerable population. In November 2017, while serving out his term, Cordray finalized the “Payday, Vehicle Title, and Certain High-Cost Installment Loans” Rule.
Cordray’s successor at the Bureau, current White House Chief of Staff Mick Mulvaney, has previously called the Bureau a “sick, sad joke,” and as a congressman proposed a bill to abolish it. When President Trump appointed him CFPB Director, Mulvaney loosened its oversight of the payday industry and dropped several of the agency’s lawsuits against payday lenders.
Current CFPB Director Kraninger has continued this degulatory push, and has proposed changes to weaken the Rule. Last month, Sens. Durbin, Merkley, Brown, and Feinstein sent a letter to CFPB Director Kathy Kraninger opposing the ongoing attempts to gut the Rule; all 47 Senate Democrats signed onto the letter expressing support for the Rule.
A Crisis Away
An unexpected expense can push a middle class family into crisis, forcing them into a situation where they may have to choose between seeking medical help or paying their bills. In some cases, they are forced to find the money elsewhere, whether that be by increasing their credit card debt or taking out a high-interest payday loan.
Sen. Brown and Rep. Khanna’s bill would help protect middle class Americans from unexpected expenses and reduce the use of harmful payday loans. The financial insecurity of 40 percent of Americans illustrates that the recovery is not complete for everybody and setbacks and crunches punish those hurt most by it.