Wednesday, October 19, 2011

The Origins of American Debt-Serfdom

The commodification and expansion of credit and the transformation of housing from shelter to speculation doomed the nation to debt-serfdom.

How did America become a land of debt-serfs? We can trace our debt-serfdom to three core dynamics which now dominate the American economy. To understand the transition from a state of minimal financial wealth/maximum freedom to one of debt servitude (illusory wealth and sacrifice of freedom for all that lifetime debt can buy), we first need to understand the gradual nature of this transmogrification.

It has become a cultural given that major political changes are often wrought by conspiracies, official or informal. Conspiracies--otherwise known as crony or cartel capitalism and insider manipulation of process and perception--do exist. However, major cultural shifts are long, drawn-out affairs that result not from conspiracy but from the steady application of self-serving agendas by wealthy, politically powerful special interests.

It may be difficult for many to imagine, but it was once difficult to obtain credit.Two generations ago, "if you want a loan, you have to prove you don't need it." Applications for credit cards, auto loans and mortgages were examined by bank officers in your local branch, people who had actual working knowledge of your payment history, account balances, etc. (Student loans did not exist.)

A modest home improvement loan required lengthy applications and a face-to-face meeting with a senior bank officer, who asked probing questions about your personal finances. (I know this because I went through the process in 1980.)

Credit card limits were low--$500 was common--and it required an application to raise the limit on your one credit card (multiple cards were frowned upon as risky). An increase in your credit card limit was a reason to celebrate--you'd won the trust of your bank through prudent management of your money.

I know this sounds like 1880, but it was actually 1980, a mere 30 years ago. People had a home mortgage, but prior to 1970 the balances were modest in terms of annual income, and the primary reason people got a mortgage was not to speculate on housing but because it was cheaper to own than rent, as millions of veterans qualified for low-down payment VA loans. (The Armed Forces were much larger in those days, in terms of active-duty personnel as a percentage of the population.)

In this environment of what we might call "artisan credit" issued by local bank branches, debt was frowned upon as risky and buying things required saving money. The auto industry had long depended on auto loans to sell millions of vehicles, but a hefty down payment was generally required.

A household with minimal savings was deemed a credit risk; the only way to get credit was to slowly build up savings and perfect history of paying one's bills and debts. The only way for many to qualify for a credit card was to pledge cash savings to the bank: if you failed to pay, the bank would take your savings for payment of your debt.

You see the problem with this low-credit, low-risk environment: profits were slim, not just for banks but for retailers and the real estate industry. If people had to save up to buy a new item of clothing or an appliance, then the retailers were limited in how many gew-gaws they could sell. If people stayed put and didn't buy and sell their houses frequently, then developers, lenders and realtors had a very limited field of profit-making opportunities. If only people who qualified via stringent credit standards had access to credit, then the transactionf ees and interest earned from credit were also limited.

The "solution" to that low-risk, low-churn, low-credit environment was the commodification and mechanization of credit. An analogy can be found in industrial consumer goods such as autos. When autos were hand-made by artisanal craftsmen, they were extraordinarily expensive. When Henry Ford mechanized the production, effectively turning them into mass-produced commodities, they became affordable to tens of millions of households.

The same thing happened with credit when computers took over the task of qualifying borrowers. A computer program assessed credit on a simple point system, and voila, the costly task of assessing credit risk fell to pennies per borrower. Not entirely by happenstance, banks found that millions of households that had been viewed as risks now qualified for credit, as the issuing and servicing of credit--credit card annual fees, transaction fees, late fees, etc.--became a fast-growing, monstrously profitable gusher for banks.

Retail sales could now be driven by desire rather than arduous, purposeful savings and a prudent credit record. The consumerist vision of the American Dream can be summarized thusly: to become a better, grander, different person, all you need to do is consume differently. With access to commoditized credit, virtually anyone with a job could buy, buy, buy on whim, impulse and advert-created desire. Easy, almost-universally accessible credit in vast amounts created the perfect world for both retailers and banks.

Powerful real estate interests funneled the rapid expansion of credit into vast profits by incentivizing "moving up," a code-phrase for transforming the housing market from one focused on security and shelter to speculation: the more times people sold and bought homes, the more transaction fees could be generated and the more developments sold.

A great number of seemingly subtle policy changes drove this transformation of housing from shelter to a speculative market accessible to Everyman and Everywoman: jumbo loans, expansion of Federally guaranteed mortgages, the easing of credit standards, the erasure of capital gains on owner-occupied residences, and so on. All these worked to expand access to credit, the incentives to churn and the size of loans available to consumers and homeowners.

What was not visible at the start of this commodification of credit was the inevitable end-game: anyone with a pulse and a willingness to lie/prevaricate/mislead via omission was issued jumbo mortgages to speculate in a real estate bubble of truly epic proportions; consumers were issued not one or two credit cards, but dozens, many with astronomical credit limits given the modest income of the borrower; students became indentured debt-serfs to lenders via massive student loans, and the need for saved cash essentially vanished as "no down payment" mortgages, auto loans and credit-based purchases became the norm.

Credit is a form of leverage. If a household earns the median household income of $49,000 a year, then trade-offs and disciplined sacrifices have to made to save up enough cash to buy consumer goods, education, a bigger, more luxurious house, etc. With access to abundant credit, then the need for adult-level discipline, sacrifice and trade-offs all go away; the household can indulge every desire and goal with child-like abandon.

So a household income of $49,000 can leverage purchases made with borrowed money up to $250,000 or even higher; with no down payments and super-low "teaser" interest rates, such a household could leverage their modest income into $500,000 in debt for everything from a university education to a McMansion to a boat to lavish overseas vacations--there was almost no limit to the debt "qualified" once down payments/cash vanished as a requirement and interest rates were manipulated below market rates to foster the illusion of solvency.

The initial conditions of any system set up the end-state. The commodification of credit to serve the interests of powerful industries made a credit bubble and collapse inevitable. It also made debt-serfdom inevitable. A culture and economy that once rewarded adult values and behaviors--discipline, sacrifice, trade-offs and the understanding that there is a price to every decision--was transformed into one that richly rewarded adolescent abandon, impulse and the temptations to lie to get what you want right now, or even more telling, "what I deserve." In that phrase, the propaganda of the marketer reached perfection.

So how do we fix an economy and culture gutted by debt, its people reduced to debt-serfdom? We write off all bad, uncollectable debt, and we severely restrict credit to everyone and every financial entity. Now that the economy has become dependent on debt the way a junkie is dependent on heroin, going "cold turkey" will be painful. But just as for the junkie, the only alternative to rehabilitation/moving beyond addiction is extinction. There is a price to every decision.

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