I strongly recommend reading this: ‘How unlimited interest rates destroyed the economy“, Thomas Geoghegan, Harper’s Magazine, April 2009.
It is subscription only. Here is a brief excerpt. The article is worth the price of picking up a copy at your local store.
Amidst all the writings about the financial crisis — both nonsense and expert insights — this describes an important and overlooked aspect of the problem. Perhaps the most important aspect. While the conservative media frets about the increase in government liabilities from $65 trillion to $70 trillion, tens of millions of American households groan under loads of debt from which they can never escape. Other than through bankruptcy. Here lies the potential for serious social unrest. Radicalism, perhaps even violence.
Opening
The number of collection and foreclosure cases in this one county {of Chicago} — 174,000 — is equal to the total number of people in three entire Chicago wards: every man, woman, and child. I stress “child” in particular, since the banks give out credit cards like candy. Yes, 174,000 cases — and that was before the economy tanked. These are not old-fashioned collection cases either. Typically, the banks are enforcing arbitration awards handed down by “private arbitrators” who more or less work full time for the banks. So the banks can sue anyone anywhere in any court in America without having to provide a witness or prove a case.
The pain of all this may get much worse. If deflation comes (even in a mild form), it means each dollar of debt will be harder to repay. That’s why populists in the 1890s took up their pitchforks: deflation made it increasingly difficult to pay off the principal on their loans. But at least in the time of William Jennings Bryan, they were only paying back at 5 percent. While we deflate, credit card holders will be paying off at rates of 20% to 35% , and 1890s-type deflation would make the rate feel more like 35% to 50%.
What’s the worst of all the legal changes that fill up collection courts? There are so many, but I’d pick the legalization of usury. It’s the form of deregulation that not only drove us into debt but also sped up the loss of the manufacturing jobs that created our middle class — that, in short, brought about our current Time of Troubles.
Conclusion
Finally, we should think about ways to “inject equity” directly into the accounts of working people rather than into banks. The best way to do this is to announce a plan to raise the gross replacement rate of Social Security from 44 percent to something closer to 65 percent, which is still short of the rate in many European social democracies. We can afford this as much as or more than they can.
We could aim to reach that goal gradually, over the next twenty years, but even announcing the goal encourages future-oriented thinking. It would encourage people to believe that they could invest in real things again, instead of pinning their hopes on the false and predatory promise of a big, Vegas style payout. The promise of a real public pension that people can live on would lead fewer of us to chase bubbles in good times, even as it gave all of us the confidence to keep spending when times were bad.
Schumpeter feared that this kind of countercyclical thinking by people on the left would lead to a stagnating form of socialism, or even the end of capitalism, But socialism, in the state run form he anticipated, is not inevitable, or even desirable. Social democracy, European style, which Schumpeter did not expect, is desirable. Sure, I’d like the European governments to run up a bit of public debt to pump up demand over there—I don’t think that’s so immoral. What’s immoral is to pump up demand, as we have, by handing out easy money at high interest and driving people into debt.
Even in Babylon they spared people that kind of captivity. We now have to ensure our own country does the same.
Afterword
Please share your comments by posting below. Per the FM site’s Comment Policy, please make them brief (250 words max), civil, and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
For information about this site see the About page, at the top of the right-side menu bar.
For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar. Of esp interest are:
Posts about America’s debt:
- Death of the post-WWII geopolitical regime – death by debt, 8 January 2008 – Origins of the 1982 – 2006 economic expansion; why the down cycle will be so severe.
- A picture of the post-WWII debt supercycle, 26 September 2008
- Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
My apologies for not being strictly on-topic but I’m curious about FM’s opinion about the $1.1 trillion purchase of US bonds and Fannie and Freddie debt.
It seems to me that they are trying to walk a fine line, easing the credit crunch a bit while not starting anything like inflation. I know that you’re pretty confident that inflation is dead for a while, Fabius, but I also note that the last couple of days has seen the US dollar skid and commodity prices perk up a bit. Are these, in your opinion, temporary or permanent trends?
Also, although $1.1 trillion seems like a lot of money to appear out of thin air, but at the same time seems like very little money compared to the amount of losses in the housing market over the last couple of years. The fact that this amount is small compared to recent losses indicates that this is going to be the first of several Fed purchases. What side effects do you foresee from this?
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Fabius Maximus replies: My analysis is too long and complex to be given on this site except in fragments, but in brief I expect that defaults will the primary method by which we shed the too-heavy debt load accumulated during the post-WWII era. Socialization, moving debt from private to public, will not work over the long-term because the public sector cannot meet its existing liabilities. Inflation will not “work” because it requires marks, a people unprepared for inflation — not likely since the Great Inflation was the formative economic experience for the Boomers.
The analogy to the Austrian and German (Weimer) hyperinflation is unrealistic. As described in the many accouts of the era (e.g., “The World of Yesterday” by Stepha Zweig), non-wartime inflation was not even in the mental universe of those people.
Central Bankers are a strange breed. Gradualist and reactionary (i.e., reactive rather than proactive), they are almost useless in coping with a crisis of this magnitude. Which is why we have the great paradox: Bernanke is one of the foremost students of Andrew Mellon’s mistakes (more precisely, those of the decision-makers of the Hoover Administration), yet he is repeating most of their mistakes. Perhaps decisive if done 6 – 12 months ago, now it is just another of the too-late, too-small responses. But it is a milestone, just the same; a Rubicon thoughless crossed.
Also, this is not a housing crisis. A relaible time-saver: when see that used as as a benchmark or significant metric of the crisis by an expert, one need read no further. The author is clueless about the nature of this global crisis. To use a bad analogy: when watching a house burn down, it is not a bed-fire. That might have been the initial cause, but the flames have moved beyond that. When fighting the fire, the fact that it started in a bed is irrelevant. It’s like discussing which tree was the starting point of a forest fire.
“Finally, we should think about ways to “inject equity” directly into the accounts of working people rather than into banks”
That statement would not have made one bit of sense a short time ago but it does now – with a multitude of caveats. Seriously, if the whole financial problem boils down to homeowners not being able to make their mortgage payments, as we are told, and if we assume it is the obligation of the government to do something about this problem, then how is it a better solution to make the banks solvent by covering their mistakes than to make the homeowner’s solvent by covering their mistakes?
I opt for the idea that is not the business of government either way but since we crossed that line a long time ago, probably never to return what are the rules of morality we are now playing by?
Beats the hell out of me.
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Fabius Maximus replies: There is a technical term for this kind of government action. It’s called “policy errors.” The sort of ad hoc and thoughtless actions which turned a normal depression into the Great Depression.
“deregulation that not only drove us into debt” “handing out easy money at high interest and driving people into debt”
Yes, poor helpless old us, being driven at gunpoint into massive personal debt by mean dirty nasty old deregulation!
Sorry, but quite frankly, if you are carrying any credit car debt at all beyond your monthly due date, you are simply a financial retard. You deserve everything you get from the banks and courts. One could only wish that all the nonsense the money was wasted on was repossesible, like a car or house is, so that the goods could be sold to people who are more responsible in restitution for the non-payment.
If you are looking for social unrest, keep leaning on us in the financially responsible half of the country harder and harder, and keep making them bail out the financially incompetent half.
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Fabius Maximus replies: How wonderful, how brave and bold. Providing easy access to debt is like selling addictive drugs: abuse is certain, with highly unpleasant social consequences. Your moral indigation is useless. To the people affected, to the US economy which suffers from the resulting recession, to you when your family suffers from a high rate of vacant homes nearby that turn your neighborhood into a slum — or to your family when robbed or raped by criminals that infest such areas.
Your indigation is as useful as that of a doctor with a patient in cardiac arrest, who instead of treatment comments on the bad lifestyle that caused the crisis.
The serious issue of bankruptcies and unrepayable consumer debt stands on its own, and doesn’t require the additional red flag of deflation. At present, with the dollar and treasury yields sinking, and the prospect of even greater deficit spending, inflation seems the more likely result.
But what does this mean: “the gross replacement rate of Social Security from 44 percent to something closer to 65 percent”? What is “gross replacement rate”?
I like the drift of the article; a useful bookend to it might be Paul Craig Roberts’ article in today’s Counterpunch, which sums up the way social security benefits have been cut since Clinton’s time. Bi-partisan, business instigated agenda on Social Security has been cut it back, get rid of it.
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Fabius Maximus replies: This refers to the fraction of pre-tax working income “replaced” by social security payments. In many public pension systems it is 80% – 100%, esp for police and firemen.
The problem is that the government cannot pay the promised Social Security and Medicare payments. Cutting the promises was one, albeit painful to the Middle Class, method to deal with the bomb before it exploded. All too little, too late.
What Counterpunch article do you refer to?
We know that they are retards. The problem is why a financial institution would allow said retards to borrow so much money! Speaking of which, I too fell into that trap. I borrowed about two year’s worth of income (over a period of time) on one of those 0% for 12 month deals. I wised up and I eventually paid it back, but it wasn’t easy. I imagine it would be much more difficult for a couple with kids.
Maybe we need a law that says that an individual can’t get an unsecured credit limit more than 3x his monthly income.
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Fabius Maximus replies: You have re-discovered why civilizations for 4 thousand years have limited or forbid usury. Congratulations!
Seneca: I did a google search and, very roughly, the gross replacement rate looks like the percentage of your pre-retirement income that you receive from your pension – in this case Social Security.
Comment #3: “Sorry, but quite frankly, if you are carrying any credit car debt at all beyond your monthly due date, you are simply a financial retard.”
Andrew B obviously is not responsible for his own medical insurance premiums and never contemplates losing his medical insurance.
Consider Italy, where, when it comes to loan sharks, they are now dealing with the pros.
In 1996, a credit card issuer sent me notice they would double my interest rate. Pursuant to Pennsylvania law, they offered me the option to reject the new terms, cease using the card and pay off my debt under the old terms. As I’d never missed a payment with them, I was surprised, and I called customer service.
They assured me they had “mistakenly sent that notice to everyone” and my rate would not change. Of course, they weren’t responsible for what was said on the phone; by the time I realized they were indeed doubling the rate, the time allotted for refusing the new terms had expired.
I made minimum payments for another year and a half, but when something had to give… they were the logical choice. In effect, they turned a good customer into a deadbeat. At the new rate, I’d literally never pay off the debt.
Today they don’t have to give you the option to refuse; contracts in which one party can modify significant terms unilaterally are perfectly enforceable… so long as that party is a large corporation.
Would it be within Federal authority to limit consumer interest rates to, say, 12% plus the annualized rate of increase of the consumer price index, and to freeze existing loans at current rates, excepting rates that were offered with a specific time limit, unless the borrower defaults on two successive payments, or three payments within twelve months?
Would it help at all if they did?
Why oh why would anyone sign such a contract in the first place? If a contract allows the other party to change the terms at any time, just don’t sign the damn thing.
Obviously, many people disagree and are happy to sign to those terms. This is a cultural problem, which I’m not sure you can fix easily with legislation. If people want to sign themselves into slavery you’ll have a hard time stopping them.
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Fabius Maximus replies: We do not allow people to “sign themselves into slavery”, which is exactly the point. Debt contracts are not slavery, but can be as easily regulated as slavery. Part of our problem is the attitude that these things cannot be fixed, despite the long history of successfully doding so both in America and elsewhere. Our amnesia about these things is a large part of our fetters.
The Founders didn’t think of everything, but they thought of quite a few things. You can’t sign away your constitutional rights even under contract law. A constitutional prohibition against usury looks good in hindsight.
The juxtaposition of these comments by FM is interesting:
“Inflation will not “work” because it requires marks, a people unprepared for inflation — not likely since the Great Inflation was the formative economic experience for the Boomers.”
“Bernanke is one of the foremost students of Andrew Mellon’s mistakes (more precisely, those of the decision-makers of the Hoover Administration), yet he is repeating most of their mistakes.”
Isn’t then Bernanke a Boomer repeating a well learned mistake? Lesson from a Boomer: Don’t underestimate Boomer’s ability to make mistakes, not care, adapt to the conditions created by their own mistakes, and even thrive in them. Its called “opportunism”
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Fabius Maximus replies: These are very different things.
Bernanke wrote about Mellon’s mistakes in his study at Princeton. It all looked so simple, with 60 years’ highsight. He’s discovered that on the “battlefield” these things are more difficult to manage.
With regards to inflation, it is a far simplier thing. Unanticipated inflation is the magic sauce of monetary policy, able to work miracles. However it requires marks, people unaware of the possibility of inflation and its consequences. That was true of Germany and Austria in the early 1920’s, as it was of Americans in the late 1960’s and 1970’s. However, inflation was the formative economic experience of the boomers. Like “survivors” of the Great Depression, they spend their entire lives expecting a repeat of this formative experience.
This accounts in part for their eagerness to go into debt. They “count on” inflation to make it go away.
I’ll add to my last comment. Sometimes opportunists intentionally make “mistakes”. They then often get paid well to unravel their mistakes. Sound familiar?
“However, inflation was the formative economic experience of the boomers. Like “survivors” of the Great Depression, they spend their entire lives expecting a repeat of this formative experience.”
You miss the fact that they were the children of the G.D. survivors and so learned the lessons of the their parents reactionary experiences to the G.D.
“This accounts in part for their eagerness to go into debt. They “count on” inflation to make it go away.
Fabius you miss much. Boomers experienced nearly 15% inflation. We have effectively 0% now(maybe less if the Gov’t and economists had a way of adapting their methods in real time) and have had less then 4% for nearly a decade. Who do you think is more prepared for substantial inflation of any kind? Boomers or x-gen or after? Inflation is egalitarian. Far better than the vote in the House today. Who do you think has the experience to deal with inflation? It’s a market solution to our problems(at reasonable levels) And who now controls the Gov’t. incl. the Fed? People who know what inflation really is.
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Fabius Maximus replies: IMO your first statement is absurd. Americans are astonishingly ignorant of history, esp ancient history (pre-TV) of the 1930’s. Grab 3 Boomers on Main Street, not involved in finance or history, and I doubt you could learn more about the 1930’s from them than you’d get from watching a few episodes of The Waltons.
As for the second point, you have your opinion — I have mine. Mine is based on quite a bit of evidence and experience, so take it as you will.
FM, Point1: We have gotten down to the essence of this debate. The ability of a generation to absorb the numerical details of a prior generation’s experience is not related to the ability to learn the experiences of a prior generation. If the 2 were directly related the human race would not have survived 200 millenia in the wilderness to have dominated the planet. We are in a period of great flux. Human history does not offer great comfort for those who believe the rational analysis of history based on the published facts will offer a solution. Economists and historians are great, but no less important are anthropologists and sociologists. They just get quoted less.
Your point only holds up to a pole of simple facts. An in depth study of the transfer of emotional experience would be much different. IMHO.
Point2: That’s a cop out. You didn’t dispute the near 15% figure or it’s relation to Boomer adaptibility.
Point 3: Great blog.
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Fabius Maximus replies: I don’t really understand what you’re saying, and its the sort of theoretical discussion of little interest to me (that’s a personal taste, not a value judgement).
“You didn’t dispute the near 15% figure or it’s relation to Boomer adaptibility.”
I have zero idea what this means. The 15% peak inflation rate of the 1970’s is a historical fact, as is the Boombers’ insane combination since then of massive borrowing and minimal savings. Perhaps you consider that “adaptabilty”. I don’t. Over the next few years we’ll see who is correct.
FM. re: your comment on my comment #15: ‘”However, inflation was the formative economic experience of the boomers. Like “survivors” of the Great Depression, they spend their entire lives expecting a repeat of this formative experience. This accounts in part for their eagerness to go into debt. They “count on” inflation to make it go away.”
If they are in control of our institutions and they count on it to make debt go away then surely they will do what they can to make it so. Its the condition they like and count on.
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Fabius Maximus replies: I am touched by your faith in the government’s (or “our institutions) ability to work miracles. Unfortunately I suspect you (and the Boomers) will be disappointed.
Time for another Nolan Bushnell story. Suppose you invent the “Walkman” and want to make money from your new project. One logical exit point occurs when you make a model Walkman, from a bar of soap maybe, and pass it around a room of investors. “It’s portable”, you say, “and it will sound great”. Maybe you get a million dollars and you walk away, or you can go to the next exit point. The next exit point is to build a full on functioning Walkman prototype. “This is ready to go to market.” you say to investors. They give you ten million dollars for 10% of your company, and you spent 10 million building the prototype. The key point is if you spend the 10 million and don’t have a working prototype, you still have a bar of soap, and should have sold it before you blew 10 million dollars for nothing. Make sure you make it to the next exit point. This moral applies to Bernanke. He has no choice but to make it to the next exit point, a re-inflated economy. If this is impossible, the stage is set for an irresistible force hitting an immovable object. Should be quite a show.
“Fabius Maximus replies: I don’t really understand what you’re saying, and its the sort of theoretical discussion of little interest to me (that’s a personal taste, not a value judgement).”
That is the essence of our generational divide.
“I have zero idea what this means. The 15% peak inflation rate of the 1970’s is a historical fact, as is the Boombers’ insane combination since then of massive borrowing and minimal savings. Perhaps you consider that “adaptabilty”. I don’t. Over the next few years we’ll see who is correct.”
While debt accumulation is a hallmark of Boomers so is wealth accumulation. Wealth is not “savings”.
“Fabius Maximus replies: I am touched by your faith in the government’s (or “our institutions) ability to work miracles. Unfortunately I suspect you (and the Boomers) will be disappointed.”
No miracle required. The Gov’t just needs to borrow and burn money until inflation starts. Much simpler than “engineering” an economic recovery. Job done. A task aided perfectly by the prior regime, which pushed us even in times of flush finances to a point on the edge of monetary devaluation. Oh it was headed by a Boomer: G.W. Bush. Will it have consequences?. Yes, rough ones. Will it drive us down a hole like debating details (and bonuses) in Congress ?Hell no.
Look at the inflation figures before during and after WW2. One can conclude it was inflation that ended the Gr. Dpr. (From InflationData.com):
1949 -0.95% 1948 7.74% 1947 14.65%
1946 8.43% 1945 2.27% 1944 1.64%
1943 6.00% 1942 10.97% 1941 5.11%
1940 0.73% 1939 -1.30% 1938 -2.01%
Between ‘38 and ‘42 the net flationary change was 12.98%. One can conclude it was inflation that ended the great depression. A lesson perhaps that Ben B. did learn. And is comfortable with. Mr. Obama too.
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Fabius Maximus replies: (1) Correlation is not causation. You might as well concluded that lots of people wearning uniforms ended the Great Depression. This is too foolish to discuss. There is a well-accepted economic framework to discuss these things, which provides an adequate explanation for the end of the GD. If you disagree, go to an economics website and debate it there. As for the rest, these things have been explained several times here — and again, for hopefully the last time.
(2) “The Gov’t just needs to borrow and burn money until inflation starts.”
That is the consensus opinion of economists. Perhaps it is correct. Too bad it did not work for Japan. I doubt it will work for us, either.
(3) “Much simpler than “engineering” an economic recovery.”
Inflation cannot occur during a recession due to the high levels of underutilized capacity (both plant and labor); inflation occurs during a recovery. The exception (there is always an exception) is a currency collapse. Might happen in the future; not likely at present).
(4) “While debt accumulation is a hallmark of Boomers so is wealth accumulation.”
Too broad a statement. The second and third wealth quintiles (#1 being the poorest) in this nation are broke. For details see the Fed 2007 Survey of Consumer Finances.
(5) “Wealth is not “savings”
It is to economists, in one sense of the term. Also, the problem with debt-fueled wealth is that it vanishes like pixie gold. US household net worth peaked in the second quarter of 2007 at $64.4 trillion, and is down aprox $14 trillion since then (over 1/5th).
“What’s the worst of all the legal changes that fill up collection courts? There are so many, but I’d pick the legalization of usury. It’s the form of deregulation that not only drove us into debt but also sped up the loss of the manufacturing jobs that created our middle class — that, in short, brought about our current Time of Troubles.”
Many thx; will go find this in the AM.
So much of the excerpt you posted aligns with the simple fact of the unintended consequencesa and general social costs of the current Maelstrom that no one will/can avoid. Fascinatingly cogent to connect Usury, Dereg and the loss of Manu Jobs……all a GREAT Scam foisted on the terribly unsuspecting populace. One does not go to a Lender to be robbed? or a job to be dismissed? or a Doctor to be chastised?
I am shocked at the smugness of the posts by “Al” …a “boomer”(?) I assume. Please go hide your head for ALL Boomers and do not emerge for a little while, anyway.
FM: “I have zero idea what this means. The 15% peak inflation rate of the 1970’s is a historical fact, as is the Boombers’ insane combination since then of massive borrowing and minimal savings. Perhaps you consider that “adaptabilty”. I don’t. Over the next few years we’ll see who is correct.”
The boomers didn’t do too bad because they bought houses in the 80’s or earlier. The most screwed generation were those were born in the 70’s and 80’s and who bought in the 90’s and early 00’s. The jobs here in the SF Bay area are where the housing prices are high and that massive borrowing went to pay those mortgages. The housing bubble doubly screwed anyone trying to raise a family; those looking for a school district without crime had to pay a premium — a small house in the $700K range and a mortgage payment in the $7000 range/month or so. People paid this with two incomes, each in the $100K range or so, and they were taking in maybe $10,000 or so/month after taxes. They worked all day; they never saw their kids; they were house poor with little left for investment. Now, they’re losing an income, moving out, selling out cheap.
FM:”IMO your first statement is absurd. Americans are astonishingly ignorant of history, esp ancient history (pre-TV) of the 1930’s. Grab 3 Boomers on Main Street, not involved in finance or history, and I doubt you could learn more about the 1930’s from them than you’d get from watching a few episodes of The Waltons.”
Now we get this Jim Cramer (of CNBC) attitude — no compassion for the common man. People are screwed, and they deserve it. Oh wait, some do get compassion, AIG, well, they must have their $180B. Let’s make sure we can still pay the best derivative traders on the planet a decent bonus. The rich get the lifeboats, and the common homeowner, well, what a bunch of suckers. Instead of paying a mortgage, instead of having children, better to have remain childless, moved into a rent-controlled studio apartment, and bought gold bars instead — didn’t they know?
Fabius Maximus: “Also, this is not a housing crisis.”
I agree with this. Please go through this paper by Otto Latsis, on the USSR economy, written in December 1989. Latsis notes the collapse of consumer goods and grain imports, overinvestment in excess capital equipment and industrail production, a shortage of housing; all from the root cause imbalance of very high budget deficits. “Progress of Economic Reform in the USSR“, Otto Latsis (First Deputy Editor-in Chief of the journal Kommunist, USSR), World Marxist Review, December 1989.
Despite aggressive plans to cut the budget deficit to 60 billion roubles in 1990, the Soviet Union collapsed shortly thereafter.
In case of the United States, that collapse might have already happened in 2008, with hardly a whimper of official recognition of the $11 trillion public debt burden. The next few years are the years following December 1991 for the Soviet Union; a last opportunity to contain, and possibly avert a Sovereign default.
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Fabius Maximus replies: Absurd. The US public debt is aprox $6.7T (there is also $4T the government owing debt to itself, net zero). See the government’s data here. That is low relative to that of other developed nations, hardly suggesting a near-term collapse.
The Federal government’s total liability (from past spending and promises for the future) is above $65T (see the 2008 Financial Report of the US Government for the ugly details). That’s probably too big, but we have time (a decade or two) to work it down though inflation and selective default on our promises.
Sen. Bernie Sanders of Vermont is preparing national anti-usury legislation that would cap consumer interest rates at 15%, same as has long existed for credit unions. Recent statements by Pres. Obama seem to support moves in that direction. So it’s a start.
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Fabius Maximus replies: Agreed. But reforms during a crisis are often problematic, with destabilizing side-effects. Capping interest rates changes the risk-reward calculation for creditors, probably leading to withdrawing credit to marginal borrowers — accellerating something they are already doing. This will push many of these borrowers into bankruptcy.
Here’s my amateur take on the general subject:
Towards the end of the financial bubble, Moody’s and Standard and Poors ratings were totally unreliable, and products that should have been rated B at best were given AAA.
Out in the boondocks, Countrywide Savings offices sprang up in every shopping center, luring new home-buyers with teaser rates, while local “appraisers” raised the value of existing homes so that owners could refi and buy new cars.
What causal agent links these two scenarios together? Hint: Countrywide swelled its deposits by offering the highest CD rates, but these were only a fraction of the amounts they were lending to new buyers.
Answer to the above query: low interest rates maintained by the Fed. These low interest rates attracted players like Countrywide (“players” because they were first-time opportunists at the real estate game) who in turn had to go find “players” of their own (first-time home owners) to lend their easy money to. The same game was played at a hundred-fold greater volume by investment banks like Goldman Sachs, which soon could find nothing better to invest in than bets on other companies’ bets (CDOs)
Correction and comments on above amateur interpretation welcomed.
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Fabius Maximus replies: You see one tiny part of the picture, and not the important part. Look at the section 3 — Causes of the Crisis — on the FM Reference Page Financial crisis – what’s happening? how will this end?
So the poor consumer didn’t have a choice, couldn’t help himself? Like an illegal drug, credit cards reach out and force the junkie to use? Makes sense. People are zombies. You convinced me.
With how much respect should zombies be treated? Millions of whom are in the country illegally? Let Obama destroy the parts of the economy that still work in order to save the zombies? It makes a nice bumper sticker.
Gerhard: yes, that was my point. FM likes to blame the consumer, the consumer culture, for the bubble. I blame the ones who created the easy credit, Greenspan among them, in order to provide new investment outlets for their bosses on Wall Street. If your home value went from $300K to $800K in a few years, and you had children who wanted to go to college, would you not take out an equity loan and withdraw a little of this miraculous new value in your home? Should I blame you if you did?
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Fabius Maximus replies: What an odd thing to say in the comments of a post that makes the exact opposite point, to which my intro says “I strongly recommend reading this.”
This problem resulted IMO from public policy errors — largely the de-regulation of the financial sector (e.g., see my reply to comment #5). Almost all aspects of this de-regulation were either moronic or criminal. Most were done on the expert advice of Professors from our top universities, which should give us all food for thought. Most social and economic policy comes from our universtiies. Perhaps something is wrong, seriously wrong, in their operation.
“FM likes to blame the consumer,”
Can you provide a quote or two to support this?
Gerhard: Like an illegal drug, credit cards reach out and force the junkie to use?
A more apt analogy would be that two-thirds the people in town are sick; the pharmacy promotes a new drug which makes people feel better (at least temporarily); the doctors prescribe it (because the ones who don’t lose most of their patients)… and nobody asks about the chemical waste the new factory is dumping in the river (those who try are labeled crackpots or anti-capitalists — the factory has raised the town’s net income considerably, and the factory owners make large contributions to local charities and political campaigns).
Addictive drugs will be chosen by some people for individual reasons — that isn’t necessarily a problem. When their widespread use for symptomatic relief becomes the palatable social alternative to addressing the causes of ubiquitous illness, there’s a big problem.
Nobody chooses high levels of debt unless the alternatives look worse. (No one wants to be an addict, either. One may smugly believe in obvious answers, but I guarantee that from the addict’s perspective continued dependence appears as the lesser of available evils.) The important questions are what made debt look more manageable than it really was, and what makes low- or no-debt life an impractical alternative for so many households?
Coises, comment #26:
The alternative of not having high debt is not having a large flat screen tv, the latest gadget from Apple, a brand new Escalade, etc. And for many that IS worse than high debt. After all, if you rent an apartment and default on your credit cards, what happens to you? Not much – debtors’ prisons are constitutionally banned.
At the risk of sounding ‘churchy,’ IMO the only long term solution is for people’s attitudes to change. Material progress is nice, but it can’t be everything in life. If people struck a better balance, and were more concerned about their spiritual progress, they wouldn’t care so much about trying to impress their neighbors.
Perhaps because their parents were negligent, Americans would seem to be living in a fantasy world, where their actions never have harmful consequences to themselves. Is it a belief in Santa Claus or grandfather government? Either way, these fools may need to experience genuine pain. Not the faux pain that FM attempts to portray as pain. Genuine pain that causes persons to alter their self-destructive and other-destructive behaviors.
Stop pampering them, sheltering them, making excuses for them. Are you saying they will remain perpetual children because nothing better is possible?
In the Middle Ages, usury was a mortal sin.
Medici Money: Banking, Metaphysics, and Art in Fifteenth-Century Florence (Enterprise) by Tim Parks explores how the Medici and other Florentine bankers sought to overcome this mindset.
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Fabius Maximus replies: And so it should be. Thank you for posting this.
Serious people have got to realize that we are looking down the barrel of double digit unemployment. Bernanke’s quantitative easing has got to bring mortgage rates down even lower. God knows how they are going to reel that back in later at just the right moment. His timing has been so reactive (not God, Bernanke). It seems like any kind of attempt to stick a hand in there to try to re-stabilize all this disequilibrium has got to create some some other imbalance.
“civilizations for 4 thousand years have limited or forbid usury”
Market forces have taken care of that. A prospective borrower with a FICO score of 850 would have a hard time getting a zero-down mortgage now. Lenders are wanting a down payment of at least twenty per cent even from borrowerw with excellent credit histories.
Fabius, You write “You have re-discovered why civilizations for 4 thousand years have limited or forbid usury. Congratulations!” This is a tad simplistic – let’s recall that during the vast majority of that period, interest – any interest – was considered usury. With, largely, the same devastating effects on economic development as such notions have wherever they still hold sway in the world today (Islamic countries). The liberalization of credit was the main enabler of any sort of sophisticated economy providing above the survival minimum. A bit of skepticism about the calls to curtail credit on usurious basis would not be amiss.
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Fabius Maximus replies: In what major civilizations was their little or no lending with interest, with “devastating effects on economic development”. I cannot think of any. In many cases lending was restricted to certain groups (e.g., the Jews), or operated (like prostitution) in a semi-legal state. But your reference to a “vast majority of that period” of 4 thousand years seems innacurate.
Hi Fab, I don’t have access to the article yet but I am sure I will agree as I have written on this before. My comment is that it is not just interest that started all this, but it is the LACK of a true monetary system. Federal reserve notes are DEBT insturments, if the only way to get money into your economic system is to borrow it you can never pay it off! People don’t realize this simple fact. Until the Federal Resrve Act is changed (or nationalized) we will never get out of this.
Re comment #3: FM: “Your indigation is as useful as that of a doctor with a patient in cardiac arrest, who instead of treatment comments on the bad lifestyle that caused the crisis.”
An excellent answer to a very arrogant attitude.
Fabius, thank you for posting this article on a very interesting topic, and letting us know of its existence. I will try to obtain a copy of Harper’s in order to read the whole thing.
This was a truly excellent article — just read it yesterday. Isn’t it astonishing how there has been absolutely no outrage among the general public by the elimination of age-old legal prohibitions against usury?
Credit cards carry high interest rates because they experience high default rates. You think card rates are too high? Usurous? Start a credit card company and lend at a lower rate. Say, 5%. You’ll undercut all the competition and sweep the field. You’ll get rich, give consumers a break and all will be rainbows and unicorns. Except it won’t because your net interest margin won’t be wide enough to cover your defaults, let alone overhead.
Nobody should carry a balance on a credit card. It’s a foolishly expensive way to borrow. Yet people do it because they want stuff and they don’t want to wait for it. Some people doubtless are pushed into it by the loss of a job or an unexpected expense. But in my experience it’s mostly the result of an unwillingness to delay gratification. That is a cultural problem and the culture needs to change. As for lender culpability, believe me, by the time this credit crisis plays out the lenders who are still standing will be much more prudent.
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Fabius Maximus replies: What is your point, and of what relevance is it to this discussion? The same could be said of selling heroin. You will get no more sympathy from me for one as the other. Lending money to desperate people, with the full power of the government as your collection agent, is a nasty business — IMO not deserving of government assistance.
Fabius Maximus replies: What is your point, and of what relevance is it to this discussion? The same could be said of selling heroin. You will get no more sympathy from me for one as the other. Lending money to desperate people, with the full power of the government as your collection agent, is a nasty business — IMO not deserving of government assistance.
DH: We were discussing usury, were we not? My comment directly addresses the issue, but I guess I need to simplify. ‘Usury’ is a vacant concept. How high a rate of interest is too high for unsecured lending? The only objective answer is: as high as the borrower is willing to pay and as low as the lender is willing to accept. A loan is a legal contract. One of the few legitimate functions of government is to provide a court system for the enforcement of contracts. These same courts are used to address fraud, such as when a lender misrepresents the terms of loan, or a borrower lies about his financial condition. As to usury, as I said anyone who believes credit card rates are too high is welcome to start a credit card business and charge lower rates. Even 0.0% if you like. It’s a free country, after all. Well, sort of. So go to it, folks. I think you’ll lose your shirts, but that’s your business. When a credit card company misprices risk and loses its shirt the tax payers should not be required to bail it out. It should go bankrupt.
What about the poor who did not get beyond their necks in debt ? They see any savings they had scraped together destroyed by inflation, and have no chance whatsoever of getting onto the housing ladder as house prices are kept artificially high. What kind of example does this set for a sensible approach to house buying or debt management ? Here lies the potential for serious social unrest. Radicalism, perhaps even violence.
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Fabius Maximus replies: I don’t understand. The point of being poor is that they don’t have substantial savings. In the US they are often net debtors. Also, what tense is this in: “They see any savings…” We have almost no inflation now, given the large-ish error bars in such measurements. We’re sliding towards deflation in the near future, and none can see beyond that.
Fabius, the case for easy credit is made very well in Cameron’s seminal work “A concise economic history of the world”, where he shows the easy credit to be a required, if not sufficient, condition for economic development. The relentless harping of the monotheist religions about usury has probably done more to retard the economic development of the world than even the darkest of the Dark Age information suppression efforts. Now, despite the name Cameron works with Western material, but his conclusions translate very well into empirical data from India, where we have centuries of fairly lax Hindu lending vs. usury-based Islamic/Mughal bans on lending to compare – and it turns out easy credit did very well by the Raj even before the British came to really introduce a market economy over here. As other commentators have pointed out, there are no usurious rates per se for productive investment – the problem with recent US lending wasn’t that the rates were high, it was that they went to what was essentially non-return yielding consumption. I normally find you interesting and thought-provoking, but in this you’ve rallied to the simplistic barricade in a major way.
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Fabius Maximus replies: The past 30 years has seen boom-bust cycles of immense size fueled by “easy credit”, causing the kind of suffering usually caused only by the Four Horsemen. Lending to households and businesses in the 1920’s, leading to the Great Depression. Lending to 3rd world nations — almost bankrupting our largest banks in the early 1980’s. Lending to commercial real estate, causing the S&L bust. Lending to SE Asian companies, causing the emerging nations bust of 1997-98. Now we have the mother of all busts. Perhaps Mr. Cameron will write a sequel.
Since large-scale imprudent lending has such massive social consequences — for both creditors and debtors — some form of government control is necessary. The theory of usury laws is that a ceiling on lending rates is the easiest way to prevent imprudent lending, by capping returns to focus creditors’ minds on the importance of collecting principal. The alternative is some complex mechanism to control lending.
All this is unmentioned in your comment, so I think you are the one hung on the “simplistic barricades.” Please excuse the rest of us if we choose not to hang there with you, and end these cycles of credit boom and bust — often with us picking up the tab for your fine theories.