How the poor get into debt

I recently got an email responding to my earlier posts about consumerism and debt. It came from a friend who's opinion I respect greatly and who is eminently qualified to comment on such matters. I have posted his extensive comments as I believe they provide a very valuable dignosis of the problem.

"Your column on consumerism is one where I am well positioned to give comment. I live in the deep, dark murky waters of credit to the underserved, and as such have observed several trends. There is no doubt that SA is overindebted, and the efforts to regulate this are getting dictated by big business. Here is basically how the poor are generated into a poor and over-indebted bunch with ruined credit records.

1) We have a large working class base, who cannot afford to buy all of the things the retailers want to sell them ( fancy clothes are as much a problem as the furniture and appliance pulls that you mention). Simple solution - give them credit - some of it is secured, but much of it is "on account", not h.p.

H.P. in itself is not particularly bad - I have no problem with it. In a place where a savings culture is non-existent and financial literacy is low, the only way these people will ever be able to afford this kind of stuff is through HP. And the interest rates are not too bad - prime + 5 I think is the max. The only place where HP goes wrong is in making sure that the people can actually afford the repayments on the stuff they buy, but that is common to all retailers(see below)

2)So the reatilers want to give credit - what are the criteria they use? First they check that they getting some sort of salary, and calculate the maximum the customer can afford. Then they check the credit bureau and make sure he is not bad. Then they give him the ability to spend up to the max of his "affordability" in their store. If he does not stop paying, they allow him to take more. On the surface this all looks fine and dandy. However there are several retail groups (Edgars, Foschini, Woolworths, Truworths etc) And they all do this. And many of them offer interest free periods so that you don't feel the pinch until 6 months down the line.

3) The result is that middle to lower class South Africans have on average 3-4 store cards - essentially credit cards. And because the stores do not take into acct lines of credit extended by other retailers when figuring out how much a person can afford to pay back, people end up with credit 3-4 times higher than they can realistically afford. In fact, if the person has credit with a competitor, the incentive is to give them as much, if not more, credit with yourself to encourage them to buy from you.

4) It would seem at this stage that the pack of cards would all fall down, and the retailers would lose a whole bunch of money, and wise up to their faults (most clothing is unsecured, and that is where credit is granted most freely). However, there are two things that push the spiral further out. Firstly the clothing guys are making 50-100% markup on the stuff they sell. This means they can absorb higher than normal losses on money lent, and financially still justify the sale. (give me a whiteboard, and half an hour to explain the nuts and bolts of this). Secondly, they contribute to the Credit Bureaus. If someone goes bad with one of the retailers, this goes to the bureau, and the common misconception is that they are "blacklisted" (which I suppose they sort of are). Their credit record takes a knock and their ability to ever get credit again is lost, and more importantly, they will lose their ability to buy clothes etc. So rather than face that, many of the people go and take microloans to pay the retailers.

5) Microlending is an alledgedly formalised and regulated industry - it is a space where the govt, in its infinite wisdom, decided to make an exception to the Usury Act (where limits of prime plus 5 are in place) and allow interest rates up to ten times prime (some actually charge more). You don't need me to expound on how this can become a problem, and trust me it is. You end up with 15% of the population getting charged "reasonable rates" for credit and then a massive chasm to the microlending sphere (60-120% a year on 24 month loans, cash loans up to 500% a year). At this point affordability of payments is regulated, and without the buffer of having made a packet on selling them clothes, it is actually in the lenders best interest to make sure the person can afford to pay them back.

6)However the damage is done, and trying to climb back up the credit ladder is also tricky - lenders only contribute negative info to the credit bureaus, so trying to rebuild a credit record is tough, and most of these people will have picked up a judgment or adverse with one of their accounts (12% of the adult SA pop has judgments, a process that is also seriously flawed).

Anyway, not sure how much of that you understood - my viewpoint is that the primary cause for the debt problem are the clothing retailers, and if their lending is not properly regulated, this problem is not going to go away. A new credit bill is being put through govt. now that should address this, but if it is going to impact the retailers, they will no doubt squash regulations that will inhibit them. To read up on the whole microlending/microsaving topic ( this also deals a lot with housing type stuff which should interest you) go to the Finmark trust web site."

I'll respond to this as soon as I have the time.