Saturday, October 8, 2016

Credit and Debt

One of the factors contributing to the severity of the Great Depression was the development of easy credit. Automobile loans made the first inroads against Americans' traditional resistance to consumer debt, since cars held their value over time and lenders could have confidence that a repossessed car would sell for enough to cover the defaulted loan.

From there, businesses began extending credit for other durable goods such as furniture and radios. However, unlike automobile loans, these loans were typically not paid off. Instead, as the family got within a few payments of the end, they'd decide to buy another item or two to make their home a little nicer. Because they'd have to requalify if they made a new note, they'd just add the new items to the existing note. Over time the debt would get spread onto a large number of possessions, many of which should in theory have been paid off.

At least some of the stock market bubble was driven by casual lending policies. It was possible to buy stocks with only ten percent of your own money and get the rest on credit, a practice known as buying on margin. This was allowed only because the market was going up steadily, but no one noticed that the practice of extensive leverage was disconnecting stock prices from their fundamentals. Eventually that bubble burst, resulting in "margin calls" as the value of people's stocks fell below the point at which they had the requisite amount of money invested. When they sold the stocks they could no longer afford to own, it resulted in a devolutionary spiral that brought down other forms of ersatz wealth based upon credit. As the economy contracted, people who could no longer keep up with their consumer loan payments often lost all their household furnishings, since all the items were on the same note and thus collateral against it.

Similarly, our nation's current financial woes have their roots in the unwise expansion of credit. In the 1990's, laws were passed to encourage renters to become buyers on the theory that neighborhoods of homeowners were more stable. However, the promoters of these laws confused cause and effect, not understanding that homeowners were more stable because their middle-class values encouraged both home ownership and social stability. Simply giving people the money to buy a house did not give them the value-sets and habits of mind that make for stable middle-class neighborhoods. Furthermore, many of the loans were of the riskiest sort, and the people taking them out often were stretching far beyond their means to cover the monthly payments.

Fast forward to 2008. The Global War on Terror and speculation in the petroleum markets had driven gas prices at the pump to record heights. Many people were paying four dollars or more per gallon for gas. Suddenly people were deciding whether to buy gas or pay their mortgages, and decided that they needed to get to work now, and could hope to catch back up on their mortgages later. It produced a rash of foreclosures in the areas where speculation and refinancing had created a bubble which drove prices far beyond the fundamentals. From there the tightly interconnected mortgage securities markets began to unravel, leading to a rapid crash in the housing market and massive consequences throughout the economy.

However, being overextended and even underwater on mortgages is not the only debt problem facing America. Easy personal credit, especially credit cards and other unsecured revolving accounts, have led many American families into a nightmare of chronic debt that is unsustainable. The percentage of Americans carrying balances on their credit cards and paying only the minimums are at record highs. Even people who consider themselves frugal are playing musical chairs with their credit card debt, using one card to pay off another or paying their utilities and other routine bills with credit cards.

In the 1930's people discovered just how deep the rabbit hole of debt went. It looks like we're about to see yet another round of it, as the bills come due for the faux prosperity we tried to keep up while fighting a two-front war -- right in time to deal with another fanatic tyrant.

Crossposted at The Starship Cat.