The Magazine

Credit Is Given

Indebtedness (and its discontents) is as old as human nature.

Mar 5, 2012, Vol. 17, No. 24 • By JAY WEISER
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Stripping away the moralizing, Hyman shows that the 20th-century expansion of consumer debt was driven by the drop in the price of consumer capital goods as a result of mass production, and by steadily rising incomes that made them affordable if consumers could pay over time. Twenty-five years before Keynes’s General Theory, Henry Ford introduced a business proto-Keynesianism, priming the pump to expand his production by offering consumer financing for his Model Ts. Other consumer durables manufacturers followed: By the 2008 meltdown, General Motors Acceptance Corporation and General Electric Capital Corporation were so huge that they posed systemic risk.

After World War II, a government fearful of a return to the Depression applied Keynesianism to housing. Engorged New Deal loan guarantee programs, subsidized interstate highways, and the mortgage deduction generated a suburban housing boom and debt-fueled lifestyle that required the middle and working classes to finance cars, furniture, and appliances. Even now, many economists wistfully hope for housing to return as the driver of the American economy.

Hyman fails to understand the proto-Keynesian implications of his argument. The credit card debt expansion of the 1980s, he claims, created no new investment, unlike loans made directly from banks to businesses. In reality, as increased consumer debt boosted spending, manufacturers would naturally expand their production capacity. The consumer debt boom’s other key driver was the massive drop in information costs starting with 19th-century railroads, telegraph, and printing technology. Using new technologies such as card catalogs, Charga-Plates, and Addressographs, local agencies provided credit reports for individual borrowers within a city. As databases became automated, today’s nationwide credit agencies developed. By the 1990s, computerization advanced, and bank-issued consumer credit cards became universal.

Not only did computerization allow better assessment of individual borrowers’ credit risks; it sliced consumer credit card and mortgage debt into AAA securitized bonds and riskier segments. This let lenders sell the bonds into the public markets, freeing up their capital for new loans—and in a harbinger of moral hazard, minimized their due diligence, since the bondholders now bore the primary risk of consumer default.

These innovations massively increased consumer debt, starting in the 1970s, just as the underpinning of the postwar debt expansion—lifetime jobs with rising incomes for white males—eroded. European and Asian competitors ate away manufacturing jobs, while white women and African Americans gained access to higher-quality jobs previously reserved for white males. High-income upper-middle-class feminists demanded equal access to credit, but the egalitarian spirit of the time (plus a desire to undo the legacy of segregation on the cheap) led equal access to credit to be framed as a civil rights issue, regardless of ability to pay. While African Americans and new Latino immigrants might have been better off saving in order to build their wealth, they were encouraged to borrow, despite tendencies to carry more debt at higher rates than other groups. As the decades went on, the pressure increased to extend credit to unqualified minority borrowers: on banks through the Community Reinvestment Act, and on Fannie and Freddie through congressional squeezing. (To be sure, the financial services industry was perfectly happy to make reckless subprime loans on its own.)

Perversely, the 1986 Tax Reform Act’s effort to lower the top income tax rate fueled both the late 1980s housing bubble and the 2000s mega-bubble. The act eliminated the deductibility of credit card interest but kept it for mortgages, even including second mortgages (now revolving credit lines styled as “home equity lines”). This encouraged consumers to use their homes as ATMs through increased leverage, removing most lending discipline.  Given the Fannie/Freddie-implied federal guarantee, and bipartisan fealty to the “ownership society,” lenders made increasingly massive bets on housing.