Home > Personal Debts and US Capitalism
by Rick Wolff
There is no precedent in US — or any other — history for the level of personal debt now carried by the American people. Consider the raw numbers. In 1974, Federal Reserve data show that US mortgage plus other consumer debt totaled $627 billion. By 1994, the total debt had risen to $4,206 billion, and by 2004, it reached $9,709 billion. For the second quarter of 2005, the Fed announced that the nation’s debt service ratio (debt payments as a percentage of after-tax income) was 13.6%, the highest since the Fed began recording this statistic in 1980. Past borrowing now costs Americans so much in debt service that more borrowing is required to maintain, let alone expand consumption.
These facts raise two questions: what caused this mountain of debt to arise and what are its consequences? Answering these questions is an urgent matter since, as has been known for centuries, the risks of high debt include economic collapse.
Since the real wages of most workers stagnated or fell since 1975, they responded partly by borrowing to maintain or raise their living standards. Over the last twenty five years, ever more enterprises (stock brokers, insurance companies, lending branches of industrial corporations, etc.) are seeking high profits by offering easier loans (credit cards, basic mortgages, home equity lines, mortgage refinancing, tax-refund advances, etc.). After the stock market bubble burst in 2000, the Federal Reserve tried to contain the damage by drastic, sustained cuts in interest rates. Already debt-addicted, US households responded to cheap, available credit by borrowing much more.
Historically low interest rates and intense competition among lenders drew millions of Americans into borrowing to buy a first home. Not only the native-born exchanged rental apartments for "the American dream." Millions of immigrants borrowed to partake of that dream too. Millions of other Americans borrowed for costly home expansions and renovations. The resulting boom in residential construction and its dependent industries partly offset the depressive economic effects of the stock market bubble burst in 2000. A stock market bubble gave way to a housing bubble. As housing prices were bid up, homeowners’ "equity" in houses rose, and that allowed them to borrow still more with their higher "home equity" as collateral.
In all debt-based economic upswings, the crucial issue is: How long will lenders keep feeding rising debt demands? Nowadays, banks lending to US homeowners usually resell that debt to investors in the form of "mortgage-backed securities." Because the US government is believed to guarantee those securities, more or less, investors around the world have been buying them. The two biggest buyers recently have been banks in Japan and the People’s Republic of China. They are therefore — and note the irony — among the biggest ultimate recipients of the monthly mortgage payments made by American homeowners. The US housing bubble postpones bursting only so long as Americans keep borrowing and the major housing lenders, including the Japanese and Chinese banks, keep the cycle of rising home prices and rising home indebtedness rolling.
Nothing guarantees that the lending and borrowing binges will continue. Americans’ rising debt levels may frighten them into slowing or ending their borrowing. Countless other possibilities from political shifts to military reverses to cultural changes — including the tougher bankruptcy laws that will take effect on Monday, October 17 — could likewise reduce Americans’ abilities or willingness to borrow. Similarly, all sorts of considerations may dissuade lenders, foreign or domestic, from continuing to provide credit. If and when either the borrowing or the lending slows, the housing bubble will likely burst. As home buying slows, housing prices will stop rising. Inventories of new homes will become difficult to sell, resulting in lower home prices. Housing construction will stop, raising unemployment in that industry and all others dependent on it. Rising unemployment will likely further depress home prices since the unemployed cannot maintain mortgage payments, and so on.
The economic optimism required to keep the Bush regime afloat regularly issues from economists and politicians. They offer reasons why American homeowners will keep borrowing and why lenders will keep providing the credit. Because rising home prices have made American homeowners richer, they are willing to keep borrowing. Likewise, lenders are willing to provide more credit to richer borrowers. Yet these "reasons" explain nothing; they merely describe the bubble itself. Identical predictions in 1999 promised that rising stock prices enriched stock owners who could then afford more stock purchases at higher prices and so on. Yet, the stock market bubble burst. Why should the same not happen to housing prices?
Some optimists try another line of reasoning. Japan and China will keep lending to US homeowners because, if they do not, a collapse in the US housing market will hurt them. Japan and China depend heavily on sales of their goods to Americans. An economic downturn here will cut demand for their goods and so spread to them. Thus, they have no choice but to support the US economy by endless lending to Americans.
This argument’s flaw emerges from a brief look at capitalism’s history. Every previous capitalist depression, including the devastating one in 1929, was thought to be impossible because everyone wanted to avoid it since everyone foresaw how a depression would hurt everyone. Today again, US homeowners, businesses and the government want to avoid a burst housing bubble. The Japanese and Chinese banks and government as well as all the other lenders into the US housing boom want the same. The history of capitalism teaches us that what everyone wants provides no guarantee that it will happen. Everyone may want to keep the boom afloat, but because everyone is also hyper-vigilant to get out of a market that seems to be on the way down, once a downturn starts, it can quickly become a collapse.
It has happened many times. Once again, capitalism brings us to a precipice. Surely the human race can devise a better system. And if not now, when?
Forum posts
18 October 2005, 21:13
When you speak of "Capitalism" as the culprit of economic problems, and not the over supply of cheap money (thanks to the Federal Reserve System), you mislead your readers. Inflation, which is really a hidden tax, is not caused by the "Free Market." Inflation, or price hikes, is a result of an over abundance of fiat money (no intrinsic value) competing for the same products and services.
Honest reporting would tell its readers that America is really a Socialist-Corporate kind of country because its Central Bankers, who are hired by government, are ivy league thinkers beholden to John Maynard Keynes ideology. And our government officials are bought and paid for by large corporate interests. Hence, war in Iraq helps create money for Lockheed Martin; Medicare creates huge profits for the Pharmaceutical industry.
Until America goes back to a Gold standard, or a relatively static form of short term interest rates, we will never be free of the pandering politicians who easily sell the public on unsound ways using our children’s money. Borrowed money, at the levels we are witnessing, WILL hurt our children’s future.
You see, what makes an economy last for generations is not cheap money but Capital, or savings. The harder money is to produce, the less of it will be wasted and the more of it will be saved. The more money saved means less dependence on lying politicians. If that fails, and only then, may you honestly bash Capitalism as the problem.
Carl
18 October 2005, 23:41
Free market? What are you talking about? The global players rule the market and they dictate the price and not the demand!
Buying homes is the only option for Americans - even if they don’t really own it - everybody needs shelter and companies, governments or the stock market make false promises. Pension funds are erroding, Social Security might be taken away and stocks may be down.
The real problem arises when house prices become so high that even the interest can’t be paid. America has a growing crowd of working poor.
Finally the U.S. economic pattern - short term profits or three month economy - faces more and more problems of a wrecked infrastructure. The lack of investment etc..
And by the way America and Socialist-Corporate? The Fed is a private Bank!
19 October 2005, 05:23
Yes, the Federal Reserve System (FED), setup in 1913, is owned primarily by very wealthy powerful shareholders and their families (Chase, Morgan, Warburg, Rothschild, Rockefeller, etc.). But understand that most of its profits go back to the US treasury - from the interest collected on bonds and notes borrowed directly by the treasury. But this profit is peanuts when you understand how these soul-less Bankers really make their money.
Most important though, a Central Bank is not based on Free Market principles. This is because the government, unlike you me and businesses, has its own money tree right in its backyard. As you know, it is shaken down for the slightest sign of a "slowing economy" (housing bubble is due to historically low interest rates immediately following 9/11) and never really allowed to blossom. If it did, Bankers would stand to make far less profits on savings accounts - very competitive. What they thrive on is interest collected on debt and when money, new or existing is deposited into their banks.
When new or existing money is deposited into a bank, it can borrow from the FED at the "short term rate", which is currently 3.75%. Also, they get to borrow using the FED derived discount window, currently 4.5%. Meaning, that for every 4.5 dollars deposited into their bank, they can borrow 95.5 from the FED and lend it out at whatever. This is ridiculous and harmful to the public because it is Inflationary. But try and convince the powerful lobbyists of that point and they will laugh in your face or have you removed, indefinitely.
I am just learning all this, and the powerful people "pulling the strings", by self-education methods. Obviously, this is not taught in public schools. I just want to point out, if Capitalism was really given the chance, personal or corporate favors would not be permitted. Protecting large corporations, and their wicked directors, from bankruptcy is not free market. We can definitely agree on that point.
You can learn most of this stuff from The Creature From Jekyll Island by Griffin. Or, take the time and read articles from www.mises.org. I used to call myself a die-hard Republican but not anymore. At least the Democrats tell the truth when they say they are for big government. But I know in my heart that big government is not the answer but is the problem. Understand that one dollar printed in 1913 is worth only 4 cents in 2002. This obviously hurts everyone but impacts the poor far greater than we can imagine.
Carl