Visa, Not Welfare
Issue #32, April 1997
In America, instead of unions and a civilized welfare state, we have VISA cards and home equity loans.
Back in the 1980s, you used to read about the rising debt burden on households. Hard-nosed analysts viewed this as a portent of troubles for the financial system: whatever the short-term profit kick of lending to profligates, sooner or later reality would bite hard, in the form of deliquencies and defaults. Soft-hearted analysts looked at the same facts and emphasized instead that something was seriously wrong with household finances; why, with job growth strong and unemployment relatively low (at least by the standards of the last 20 years) were people still borrowing so manically? Of course, both sets of questions were hardly mutually exclusive, and those analysts who had no problem mixing hardness and softness expected that when the 1980s boom ran out of steam, things would get really ugly.
Well, they did, for a while; personal bankruptcies zoomed to record levels as the decade turned, and a strange and persistent recession set in and lasted for George Bush's entire presidential term. But all hell didn't break loose. The financial system, thanks to an extended period of indulgence by Alan Greenspan and his Federal Reserve, creaked and sputtered, but didn't implode. The public mood turned sour, very sour, but revolution was safely kept at bay. And here it is 1997, six years into one of the longest business cycle expansions in U.S. history, and all those worries about killing debt loads seem a faint memory.
Which is strange, because personal debt loads haven't themselves become a faint memory, even if the worries have. In 1952, household debts of all kinds (mortgages, credit cards, bank loans, whatever) was equal to 36% of after-tax income. That ratio grew relentlessly, hitting 40% in 1952, 50% in 1958, 60% in 1962, 70% in 1980, 80% in 1988, and 90% in 1994. At the end of last year, personal indebtedness was equal to 95% of after-tax income, and is on track to hit 100% sometime in 1998. Consequently, the share of household income devoted to servicing these debts has also swollen. At the end of 1996, U.S. households spent a total of 17.1% of their after-tax incomes on debt service — $975 billion in all, covering both interest and principal — just a smidgen below 1989's record of 17.4%.
Why hasn't the debt service figure grown as dizzily as the debt principal figure has? There are at least two reasons. First, interest rates are much lower in 1997 than they were in 1989. Second, people are simply carrying larger debt loads; how many of us think that our credit cards are under control if we can make the minimum payment every month?
All this borrowing has been a tremendous stimulus to consumer demand; between 1950 and 1996, the growth in consumer credit (excluding mortgages) financed 21% of the growth in consumption; since 1992, over 42% of the growth in consumption has been courtesy of credit cards and the like.
Why do people borrow? Studies of bankrupts show that many of them ran up their debts during periods of unemployment or medical crisis. But those are dire events, and couldn't be responsible for the great upward thrust in indebtedness. There are more mundane reasons for going into hock, too. Robert Pollin, an economist at the University of California at Riverside, concluded from a study of the Federal Reserve's periodic Survey of Consumer Finances that the bottom 40% of the income distribution borrowed to compensate for stagnant or falling incomes (what Pollin called "necessitous" or "compensatory" borrowing), while the upper 20% borrowed mainly to invest (or speculate, if you prefer). Pollin's findings find an echo in British experience: a 1992 survey of that country's households concluded that "[C]redit fulfills two different roles in household budgets. Poorer families, on the whole, use credit to ease financial difficulties; those who are better-off take on credit commitments to finance a consumer life-style. Both would use it to improve their lot: one to reduce their poverty; the other to increase their prosperity." A minor distinction, of course, easily overlooked in the search for theoretical consistency.
Economically, then, consumer credit can be thought of as a way to sustain mass consumption in the face of stagnant or falling wages. But there's an additional social and political bonus, from the point of view of the creditor class: it reduces pressure for higher wages by allowing people to buy goods they couldn't otherwise afford. It promotes and individualistic response (personal borrowing) in place of collective action (union or political organizing). It helps to nourish both the appearance and reality of a middle-class standard of living in a time of polarization. And debt can be a great conservatizing force; with a large monthly mortgage and/or MasterCard bill, strikes and other forms of troublemaking look less appealing than they would otherwise.
Not only is debt a wonderful political strategy, creating an atomized army of the indentured, it can be tremendously profitable. So far, we've looked mainly at one side of the great polarization — the pinch on the working class and the poor. Because of the decline in real hourly wages, and the stagnation in household incomes, the middle and lower classes have borrowed more to stay in place. But where do they borrow the money from? Institutionally, from the bankers who extend mortgages and issue credit cards. But where do they get their money from? From the surplus funds deposited by the very rich, ultimately. Financial institutions do the messy (but lucrative) job of matching borrower and lender, but they're really just intermediaries. As the rich have gotten richer, they've lent a good bit of their surplus funds to everyone else, who's gotten poorer.
Just how this works out can be seen in data from the Fed's Survey of Consumer Finances. (Unfortunately, these figures come from the 1983 survey; the Fed hasn't published the relevant figures for more recent surveys.) In 1983, leaving aside the primary residence and mortgage debt on it, over half of all families were net debtors. Families (and the term is the Fed's, not mine; I prefer the broader category of "household," but apparently the central bank doesn't share my preference) who are net creditors are rare, and those who are creditors in any size rarer still; in 1983, fewer than 10% of families accounted for 85% of the personal sector's net lending. Or as William Greider put it in Secrets of the Temple, the few lend to the many.
It's tempting to conclude from this that the growth in debt is unsustainable, and that something, somewhere has to give. Undoubtedly that's true, someday. But financial history has shown that there's no magic point at which debts become unsustainable and things go badly wrong. Maybe we can sustain mass consumption through mass borrowing forever, or at least until the ozone hole does us in. But it's a pretty wacky way to run an economy, isn't it?