The Marketing of Consumer Debt to America
Charles R. Geisst
Bloomberg Press, 2009, 274 pp. ISBN 978-1-57660-325-3
Geisst has written several books on finance and economics. In this book he explains how the American public got into so much consumer debt. It’s very well written. I read about half of it before I became bogged down in financial concepts I didn’t understand.
Loans to individuals did not begin until the early twentieth century. In the post-World War II period a debt explosion began that popularized debt and encouraged indebtedness. It was caused by increasing wealth and a political environment that encouraged borrowing as a way of fueling consumption. Once the horse was out of the barn, there was no turning back. (3)
Approximately $2.5 trillion in consumer debt (excluding mortgages) amounts to $8000 per person in addition to the $10 trillion government debt (another $40,000 per person). Mortgages add another $15 trillion for another $88,000 per person. An individual pays about $5,200 per year in interest and taxes to service this debt. (4) And this does not include the 2008 bailouts!
High debt levels cause impoverishment. The odious nature of debt has been forgotten (replaced by the complimentary sounding word “credit”) and this will prove to be the most egregious error of modern culture. (5)
“The ability to bundle residential mortgage loans and other forms of indebtedness and use them as collateral for bond borrowing allowed banks to keep their balance sheets clear of many previously created loans and to continue generating credit.” The value of collateral was overlooked in favor of creating even more debt-backed securities, leading to the credit market crisis beginning in 2007. (9)
“Using long-term debt (such as a mortgage) to finance consumption was finally the death knell for the buy-now-pay-later society. Consumers were not only eating out more frequently than in hard times, they were also eating the family residence in the process.” (10)
“The time to save is now. When a dog gets a bone, he doesn’t go out and make a down payment on a bigger bone. He buries the one he’s got.” Will Rogers (11)
“Optimism about the future fuels present purchases. This is the implicit assumption behind modern consumption.” (12) “Today it has become cannibal consumption. …The use of one form of credit to pay another has increased exponentially to the point where it has become a cycle of debt with no exit.” “Consumer credit is easy to obtain and expensive to repay.” (13)
If credit cards were called debt cards, the point would be more striking. Paying off one credit card with another is a way of life and an explosive social time bomb. (16)
Structured finance became the intellectual side of Wall Street. The esoteric side of structured finance lacked transparency. Even their creators were not sure what looming problems might result. The minimum payment is an example. As long as cash continues to flow, the lenders’ objectives have been met. But it causes customers to be in debt far longer and pay much more than they intended. All those monthly payments provide an ongoing income stream that the credit card companies love. (24)
“The Great American Debt machine encourages consumption because perpetual indebtedness benefits the investors who purchase it through securitized assets, relying on the cash flows it produces.” These lenders “are not behaving like creditors, and consumers are not behaving like borrowers. They are on opposite sides of a marketable investment. The holders of the debt depend on it for cash flow and smile when the portfolio extends itself. The debtors, on the other hand, smile when they can extend their payments…because they can avoid a nasty bill they cannot afford.” (33)
The Maxwell Motor Car Company was the first manufacturer to offer its cars on time payments in 1916. It required 50 percent down and the balance paid in 8 equal installments. In the 1920s a standard mortgage had to be repaid in 3 years.
“When the war ended, consumer credit began to expand again. Once the horse was out of the barn, money became readily available; businesspeople realized that the best way to prompt consumers to buy was by making easy credit available… The consumer revolution and the accompanying debt revolution, starting before the crash, quickly became the prescription for the economy, two-thirds driven by consumer spending.” (59) “A victorious America would celebrate the end of the war by spending its way to prosperity….” (60)
John Biggins introduce the first credit card, a plan called Charg-It in 1946. Bank of America introduced its own card in 1958, allowing customers to pay their balances over time while being charged interest on the unpaid balance. (62)
The debt-to-equity ratios of manufacturing companies began to rise after the war. Modigliani and Miller developed the theory that a firm’s value is determined by its investment decisions rather than by its financing decisions. The idea began to circulate that profits could be enhanced by additional debt. (66-67) By the 1960s, it was accepted that credit should be extended to as many companies as possible to foster economic growth. The idea would spread to consumer finance shortly thereafter. Leverage is the way to go. However, leverage is a source of instability. (71)
Credit cards became very popular with banks because they employed adjustable rates before the era of adjustable rates. Within a few years, adjustable rate mortgages (ARMS) became extremely popular because they offered relief from the high fixed-rates, some up to nearly 15% in 1983. ARMs brought about a shift in risk from banks to homeowners. (76)
“Of all the causes of bankruptcy, the most common is having too much debt. For the consumer, this clearly meant too much consumer debt. In 1986 alone, over 400,000 cases of personal bankruptcy were filed…” The same time period witnessed a continuing explosion in consumer debt fueled by new innovations in securitizing consumer debt. (78)
The Tax Reform Act of 1986 abolished tax exemptions for consumer interest. This gave rise to a 20-year period in which home loans would be used to finance credit card expenditures, all based on the assumption that home prices would continually rise. Equity as the mirror image of debt was now becoming accepted. (79)
Credit cards provided the first experiment with adjustable rates. When the bank recognized this flexibility, they wisely marketed it as a convenience to the consumer (who didn’t have to pay the whole balance when it was inconvenient). (87)
The big difference from other kinds of borrowing is that the credit card debt was unsecured. And the idea of collateral for consumer purchases disappeared. Commercial paper became the popular method of funding the purchase of credit card receivables. (88-89)
“The logic used by the card companies seemed foolproof. Because credit cards were not collateralized, higher interest had to be charged to most customers. If write-offs could be contained at small percentages of the total, the business could grow. Then a new element was introduced. To enhance yields, cards were offered to those in riskier categories such as students or those in low-income groups.” “Simple risk/reward ratios suggested that riskier cardholders could legitimately be charged higher inters.” (98)
“Student default rates on government-guaranteed loans ran as high as 30 percent in the late 1980s and early 1990s, the highest default rate suffered by lenders. Yet banks still were willing to solicit students by mail, offering them credit. It seemed almost natural that those debts should be sold to a third party as well.” “Credit was no longer simply easy to obtain. It had been commoditized.” (104)
“Competition among the credit card companies led to too many cards being offered and mounting debt by consumers who could not afford to pay it back. The minimum payment was the only way that multiple card debt could be maintained. Similar stories abounded among all strata of society.” “A similar situation was found in the 1990s when subprime lending developed, offering mortgages to low-income people who were the least able to afford the high rates attached.” (105)
Credit cards have proved to be the most successful financial innovation in American history. More than 2.38 billion cards exist. More than a billion cards are in use in the U.S., 3 credit cards for every person. (110-111)
I didn’t get to the Mortgage explosion, the politics of credit, and the prescription and outlook.
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