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[Debtor Nation:
The History of America in Red Ink • By Louis Hyman • Princeton
University Press, 2011 • 392 pages]
"The
author doesn't make the distinction between accumulated real capital and
cheap credit created through a banking system cartelized by the Federal Reserve."
The debate in Washington over the
nation's debt and debt ceiling has President Obama announcing to the White House press corps,
"What we need to do is to do our jobs, and we have to do it the same way
a family would do it. A family, if they get overextended and their credit
card is too high, they don't just stop paying their bills."
Extending the president's analogy, FoxNews.com's Jake Gibson cobbles together government
data to determine that the typical American has debt totaling 89 percent of
yearly income. Meanwhile the US government's debt is 162 percent of annual
revenue, making the average American appear positively
debt shy.
What would it actually take to pay
the bill? The current GDP is $14.12 trillion. The government could loot the
whole country immediately — everything nailed down or not — and pay the whole tab. It would be a debt-free stone age!
No, the bill can't be paid and
won't be paid. That much should be obvious. But denying the obvious is a
mental trait built into the structure of the system. The economic crisis of
2008, which continues to produce shock waves, was really just the realization
that the consumer-debt load at the time was unsustainable.
Washington was the head cheerleader
for, and architect of, the entire racket. The culprits weren't Wall Street,
Bear Stearns, and Lehman Brothers; the real driving force was decades of
government policies that "expanded the numbers of Americans in debt and
legitimated borrowing as an alternative to saving," writes Louis Hyman
in his extraordinary book Debtor
Nation: The History of America in Red Ink.
The author takes us back to a time
when retailers provided credit. We've all seen western movies where the farm
wife charges her provisions at the general store, with the tab presumably to
be paid when the crops are harvested and sold.
Credit and income information was
hard to obtain just after the turn of the century, thus credit was granted to
those known and trusted. John Mackey built what would become Household
Finance Company, lending small amounts of money at monthly interest
rates of 10 percent. The cost of collection was high, and there was no
Federal Reserve spewing forth liquidity. Mackey had plenty of customers
because banks didn't lend to consumers.
Usury laws began to pop up, setting
maximum rates at a fraction of what Mackey was charging, but as Hyman points
out, the laws only served to send working class people to loan sharks
charging between 60 and 480 percent per year.
Most credit was secured by
household goods, because few people owned homes. And when Detroit began to
crank out cars, auto finance was born. Companies like GE finance and GMAC
were created to provide retail and wholesale finance, allowing consumers to
borrow as never before. These installment credits were not subject to usury
laws because judges ruled that installment purchases were luxuries and not
necessities. And the threat of a visit from the repo man kept people diligent
with their payments.
The availability of credit began to
blur class distinctions as people's consumption converged. Women were the
target of installment credit because it was believed they couldn't resist
buying dresses on installment to look their best. Credit managers were
thought to provide control over borrowers, keeping them from overextending
themselves. "The vicious chain of being in debt … was forged when
I married and set up a home," an anonymous housewife wrote in Collier's.
Government swung into full gear in
support of housing finance during FDR's New Deal. While Hyman innocently
calls New Deal policies a "practical harnessing of private capital for
social ends," the Federal Housing Association (FHA) standardized housing
and its finance, leading to standardized, suburbanized, government-loving, overindebted Americans.
Short-term balloon notes were
replaced with a government policy encouraging long-term debt, "partially
because the government language reframed mortgages not as a heavy debt, but
as responsible long-term investments for the borrower," writes Hyman.
"Americans were encouraged to become comfortable with long-term debt in
a way they never had before."
Homes in America weren't a ball and
chain anymore, but a wise investment, to be funded with ever more
"residential finance filtered from distant investors through federally
made markets." Government had extinguished the stigma of debt; and one
now had to convince, not George Bailey down the street, but
"large, impersonal corporations" as to one's creditworthiness.
However, as the author points out,
"The real owners [of these homes] were the banks and insurance
companies, who found a safe source of income in the midst of the Depression."
On the heels of state-sanctioned
mortgage finance, banks barreled into consumer lending with the help of the FHA's
Title I program. "The guarantee of profits through federal
insurance mitigated bankers' suspicions about consumer lending, and bankers
opened FHA Title I loan departments."
For the first time, bankers looked
beyond business for avenues to make loans. With a lack of creditworthy
commercial borrowers to lend to, bankers eagerly embraced the Title I
program.
After unleashing this torrent of
credit, FDR's administration looked to tamp down the resulting price
inflation with "Regulation W," birthed from "a contorted
reading of the Trading With the Enemy Act." Reg. W sought to regulate
how much, and under what terms, consumers could borrow. The unintended result
was the creation of revolving credit, allowing consumers to borrow as never
before.
Hyman's most enlightening chapter
is entitled "Securing Debt." After decades of urging the American
public to borrow and banks to lend, in the 1960s the government planted the
securitization seed that would grow to tip the financial system over in 2008.
LBJ's Great Society looked to push capital into decaying cities, but the
buying and selling of individual mortgages was cumbersome. Mortgage paper
needed to be bondlike, and the Housing Act of 1968
implemented this vision, remaking "the American mortgage system in a way
that had not been done since the New Deal."
Along with "privatizing"
Fannie Mae, the bill created the mortgage-backed security, directed mortgage
funds toward low-income borrowers, and authorized the Treasury to be the
buyer of last resort to the market. The federal government's intrusion in the
housing market continued to grow. The idea that Fannie Mae was suddenly cast
adrift to market forces is fallacious. Fannie was required to buy low-income
mortgages and its "larger market actions would remain partially under
government control."
With the passage of the Emergency Home Finance Act of 1970, Congress
then created a secondary market for conventional mortgages, which "drew
on the mortgage-backed security financing techniques developed in the Housing
Act of 1968."
Although the government's
backstopping of the market didn't cover the entirety of Fannie and Freddie's
portfolios, it was close enough to suit investors. "Dangling promises,
diversified portfolios, and foreclosable houses convinced many
investors." As Hyman explains, actuaries calculated that default rates
were three times higher for a 95 percent mortgage versus a 90 percent
mortgage, "but investors trusted the U.S. government to make good on the
payments, even when the American borrowers could not."
Freddie Mac teamed up with Lewis
Ranieri's
Salomon Brothers and First Bank of Boston to create collateralized mortgage
obligations (CMOs) in 1983. CMOs could be split into slices (tranches)
allowing buyers to satisfy whatever risk appetite they had. "With the
right math, a mortgage could be turned into anything."
The same model was used to bundle
credit-card receivables. In 1994, the Financial Accounting Standards Board
(FASB) fielded a proposal that would have required that banks hold reserves
against securitized revolving debt receivables. The proposal was voted down
decisively.
While the Basel
Accord regulations required banks to increase their capital ratios,
securitized debt obligations and mortgage-backed securities required no
capital to be maintained against these investments, unlike individual loans.
Securitizing the debt allowed banks
to make as many credit-card loans, or mortgage loans, as they possibly
wanted, as if they were treasury bonds. The capital requirements meant to
hedge risk simply pushed banks toward securitization rather than reducing
their lending.
From there, lenders packaged
mortgages and credit card loans that were underwritten using automated
risk-modeling programs based on very thin data, enabling "more
inexperienced lenders to be overconfident, taking the model for
reality." Quoting a senior project manager for Fair
Isaac's Horizon system, Hyman writes, "'the borrowers who
tend to go bankrupt look just like a lender's most profitable
customers.'"
Mr. Hyman lectures at Harvard in
the field of history, and his rich and detailed chronicling of the
government's fostering of consumer debt makes Debtor Nation an
outstanding book. However, in his epilogue, the author reveals himself to be
somewhat of a frustrated Marxist, who has resigned himself to the notion that
America runs on capitalism and the present financial crisis, "occurred
not because capitalism failed, but because it succeeded in doing what it does
best: profits and inequality."
He writes that government is needed
to channel capital to social good, which "is the best way to solve the
distressing failures of the market economy." Hyman then goes on to spend
time at book's end fretting about the overaccumulation
of capital.
Of course there has been anything
but an overaccumulation of capital. And all of
these profits he speaks of have evaporated as lenders charge off the bad
debts made during the boom. Capital is savings. And there is little of that.
Capital can't be printed. Consumption must be delayed.
The creation of money via the Fed
has weakened the savings rate by diverting funds from productive uses. As
Frank Shostak explained recently,
If however the flow of real savings
is falling, then, regardless of any increase in government outlays and
monetary pumping overall, real economic activity cannot be revived. In this
case, the more the government spends and the more the central bank pumps, the
more will be taken from wealth generators — thereby weakening any
prospects for a recovery.
However Hyman does stumble onto
this insight while muddling around during his overaccumulation
worries: "Without possible productive investments, investors, who still
need to put their money somewhere, are drawn into asset-bubbles and
speculation."
The author doesn't make the
distinction between accumulated real capital and cheap credit created through
a banking system cartelized by the Federal Reserve.
Americans today go to great lengths
to protect their credit scores. We've been convinced that a high credit score
speaks for our integrity and goodness as a person. To have no borrowing
history makes you suspect. Avoiding debt and saving money doesn't make you
prudent; borrowing and paying back does.
Professor Guido Hülsmann
explains where decades of credit stimulation
have led us:
"Capital can't be printed. Consumption
must be delayed."
The net effect of the recent surge
in household debt is therefore to throw entire populations into financial
dependency. The moral implications are clear. Towering debts are incompatible
with financial self-reliance and thus they tend to weaken self-reliance also
in all other spheres. The debt-ridden individual eventually adopts the habit
of turning to others for help, rather than maturing into an economic and
moral anchor of his family, and of his wider community. Wishful thinking and
submissiveness replace soberness and independent judgment. And what about the
many cases in which families can no longer shoulder the debt load? Then the
result is either despair or, alternatively, scorn for all standards of
financial sanity.
Hyman sees the current credit
system as inherent to capitalism itself. However, fiat money, central
banking, and fractional reserves are antithetical to capitalism. It is savers
who initiate a "process of civilization," as Hans Hermann Hoppe
points out in Democracy: The God That Failed.
It is the government's promotion of
debt that has made Americans dependent, dispirited, and uncivilized.
Douglas French
Mises.org
Douglas French is president
of the Mises Institute and author of Early Speculative Bubbles &
Increases in the Money Supply. See his tribute to Murray Rothbard.
Article originally published
on www.Mises.org. By authorization of the
author
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