Beggar Thy Neighbor: A History of Usury and Debt

Chapter 8: The Consumer Debt Revolution

Chapter 8 The Consumer Debt Revolution Solvency should be a simple financial concept: if your assets are worth more than your liabilities, you are solvent; if not you are in danger of bankruptcy. —Financial Crisis Inquiry Commission, 2011 The erosion of state usury laws in the United States reflected the new attitude that had been developing toward debt since the 1970s. Debt was no longer feared. The term had been replaced in consumer culture by the term credit; how much credit lenders extended to borrowers was a reflection of the borrowers’ status in life, not a potentially damaging tool that could alter the borrowers’ lifestyles and future prospects. Debt was being accumulated at a fast rate, suggesting that consumers either were borrowing with a high degree of certainty about their future earnings prospects or were being sold a financial product with which they were not familiar. Decades of finance theory and political ideology combined to relegate worries about the absolute levels of interest rates to the back burners. Real rates of interest were more important than absolute levels. Portfolio theory assumed that poorly rated debt could enhance the yield on a fixed income portfolio, justifying its issuance in the first place. Securitization had made credit generation easy, especially for institutions outside traditional banking known collectively as the shadow banking system. And bankruptcy had become somewhat predictable. Models could predict a corporate bankruptcy with a fairly high degree of confidence. Debt was no longer the bête noire in the financial jungle; now it was just another financial tool. During the latter twentieth century and the early twenty-first, rates of interest charged for loans became less of an issue than in the past. Credit was so widely available in the United States that there was a credit line for everyone, at a price. Those charged high rates through readily accessible 300 Chapter 8 credit lines such as subprime credit cards, payday loans, and pawnbroker loans were assumed to realize why they were being charged usurious rates. Unlike the microlending trend in the developing world, high rates were not considered damaging but simply the cost of business for those whose credit ratings were sub-standard. Like the other assumptions about debt in general , this was valid for corporate finance but less so for personal finance where uncertainty was much more common and potentially volatile. The old beggar-thy-neighbor idea was well understood in the developing world but mainly ignored in the United States. Marketing notions such as the American Dream and “unlocking the equity” in a home led to an unprecedented explosion in borrowing on the consumer, governmental, and corporate levels. Borrowing in anticipation of future income became the norm and was approached with great abandon. Since first used in the 1920s, discounting anticipated future revenues and had been the norm in the corporate world; it was becoming increasingly popular with consumers as well. The problem was obvious, however. Anticipating a high future growth rate in earnings may have been feasible for many companies but unrealistically high rates used by individuals could be much too optimistic. Most companies were required to keep their debt to equity and interest cover ratios in sensible proportion to maintain decent credit ratings. The same would not be said for consumers who viewed easy credit as a rite of passage. That assumption was aided immeasurably by politics. The debt bubble beginning in the 1990s affected Britain as well as the United States. Traditionally, Britons and Americans had differing views on indebtedness, based in no small measure on the differences in per capita income and property values. Britain also came to the credit game later than the United States, only embracing credit card use and higher levels of mortgage leverage during the 1980s. Data showed that the average Briton was borrowing 3.5 times his or her salary to mortgage a home; not far from the average American level of mortgage indebtedness after 2001. This liberal attitude has common roots extending back almost thirty years. But the problem was that it replaced the older multiple of 2.5 times, meaning that Britons and Americans added another year’s income to their mortgage indebtedness . During the post–World War II years, the average British family had a higher household savings ratio and a lower household debt ratio than the average American family. Until the mid-1980s, prosperity there in the American sense was a bit more elusive. Consumer credit was not as easy to obtain, mortgages were...