I just finished a great book that taught me a lot about the history of debt in the United States. It’s called Borrow by Louis Hyman. Debt has always been around ever since money existed, simply because people have always had an immediate need for money even if they didn’t have enough.
Early in America’s history, the ability to borrow was scarce and hard to come by. Only business owners could borrow, and it was predicated upon the assets they could put up as collateral. For example, farmers went into debt in order to buy tools and materials in order to farm their land. Even though they could only harvest once a year and sell their crops, they needed to continually expend resources throughout the year in order to get a good yield. Bankers from New England started to finance farmers’ move out west, and allow them to take out mortgages to purchase land.
At this point in the story of America’s debt I was surprised to learn that it was around this time (early 20th century) that the original mortgage-backed securities were invented. They were called “participation certificates.” They operated under basically the same process as the “CDOs”, or collateralized debt obligations or recent history – people took out mortgages from bankers to fund their land purchases. Then, the bankers bundled up these loans and securitized them so that they could be re-sold. The magic of securitization was that, if you could re-sell something, your liquidity was immediately bolstered and your perceived risk decreased simultaneously. If you, as a banker, could convince a group of people to take out loans from you, and then you could convince a group of investors to buy the debt off of you, well – you had a nice opportunity to make yourself a profit. Because the debt was no longer on your books, if the borrowers couldn’t pay back the money – too bad, so sad. That was now the investor’s problem!
This situation is one of multiple issues that led to the crash and the Great Depression in 1929. People got really excited because assets could be bought for a high price and then immediately sold for higher, and participation certificates were all the rage because the returns were “guaranteed”, by the houses that backed them. Let’s think about the incentives here though, for a second. How do you think the home builders responded to this investor thirst for mortgage-backed securities? Why, they built more houses! In fact, many of the homes built in the 1920’s were shoddily constructed and built en-masse so that the builders could quickly turn a profit, along with the bankers.
This rapid expansion also changed the minds of Americans about what was “good debt” and what was “bad debt”. The notion of the time was that it was ok to get a mortgage on a property, namely because someone at the local bank said it was ok for you to borrow the funds. Instead of evaluating loan risk solely based on the value of a person’s assets, banks started to look at risk based on the income of the borrower. So, as long as you had a decent job with good prospects, you borrow for a home without a lot of money.
The paradigm shift from asset-based borrowing to income-based borrowing continued into the World War II and post-war eras. Department stores really pioneered how America borrowed at this phase. They invented revolving credit accounts so that shoppers could continually shop and shop, and as long as their minimum payment came in every month, all was well. Department store heads shrewdly figured out that they could not simply re-possess a shirt or a blouse in the same way that a home or car could be repossessed, and they understood that because of the intense competition in retail, denial of credit would likely lead to customers simply walking out the door.
As the American economy flourished after the war, and the suburbs became developed full force, the department stores and the credit they offered went with it. BankAmericard and MasterCharge (now known as Visa and Mastercard) were invented to allow for credit to be extended throughout a network of merchants and not just by a single store. It took a little while for the idea to take off, but when it did, it took the country by storm. Gradually, the offering of credit cards, which were initially just to well-off consumers, found their ways into the hands of everyday citizens.
By the 1970s and 1980s, credit cards were being massively marketed to people from all walks of life. Because of the network that the credit card companies had created, a high amount of leverage could be employed to successfully boost profits. To this day, it is a profitable business with high margins. However, the credit crisis of 2008 and the return of the boom and bust of mortgage backed securities made our country think again about the dangers of unrestrained credit.
The book goes into a lot of detail about the 21st century economic system in America. I learned a ton of history reading it, and would definitely recommend it for that reason. Although I knew that debt had existed in America in different forms over the decades, I had not been aware of the nature with which it had evolved and of the nature with which our attitudes of it had evolved. Before, debt was seen as a moral failing, whereas now people tend to see debt, as a concept, as having no moral underpinnings. Also, the advancement of technology has allowed debt to be democratized in an amazing way, so that now the entire global economic system functions on the basis of credit.
This is a lot to think about. I have been rambling a bit throughout this article, just kind of typing out the things that I remember from what I’ve learned. I’ll have to read more about this topic in order to get a more thorough understanding of the things that Hyman goes over.