‘Borrow’ Traces the Roots of the US Debt Crisis

The drama leading up to the real estate crash of the mid-00s is becoming as familiar as the Wall Street crash that sparked the Great Depression used to be.

There are plenty of villains: social engineers and market ideologues in Washington; lying bond traders, conflicted credit analysts, careless bank bosses and investment funds on Wall Street; lenders and builders and borrowers across America: All found it profitable not to worry about shaky loans, until they blew up.

Cornell University historian (and ex-McKinsey & Co. consultant) Louis Hyman has written a breezy book that goes deeper. Skimming decades of news, testimony and arcane trade reports, he reminds us that this has happened before, and that there was nothing secret about the public and business decisions that led to cheap money, price inflation, collapse, mass foreclosures, and bailouts.

Americans’ refusal to worry too much about history is a national strength in some ways, but it also makes our recurring financial crises more emphatic.

In the early Republic, Hyman tells us, borrowed money was for rich people only; for everyone else, it was a sign of weakness and impending doom. Speculators, gamblers, and other marginal figures who gave in to weakness and borrowed were liable to wind up in debtors’ jails.

Railroads opened the way for farmer-investors willing and able to borrow. Bankruptcy law eased the finality of failure. Personal consumer lending, as we know it, began in the ’20s, as pioneering loan financiers, instead of sitting on borrowers’ notes, packaged and sold them to spread the risk and finance new loans. Henry Ford insisted on cash for his Model T’s, but his rivals, led by DuPont Co. financier John J. Raskob, set up General Motors Acceptance Corp. to finance auto sales to the working masses.

President Franklin D. Roosevelt’s New Deal planners, frustrated by surviving banks’ reluctance to lend again, created the Federal Housing Administration and Fannie Mae to boost the prostrate home-building business. After World War II, they financed the new suburbs.

As other nations recovered, the US economy came to depend less on factory production and more on the home market for homes, cars, consumer goods. To help consumers buy now, pay later, banks formed Visa and MasterCard; industrial companies such as Jack Welch’s General Electric sold factories and bought into the retail finance business, too.

Hyman confuses cause and effect when he writes that “the rising profitability of finance came at a devastating cost as the largest industrial corporations began to see finance as the road to growth” instead of making stuff. In fact, US factories were becoming uncompetitive compared with those of Japan and other low-cost rivals; it’s no wonder corporate America sought more solid returns in financial services.

Fannie Mae and Freddie Mac pushed home-loan finance costs down when they started large-scale home-loan sales through Wall Street banks. Credit card and student lenders did, too. Home prices and consumer debt were soon rising far more rapidly than worker incomes. But since homeowners were worth more, on paper, every year, the new debt seemed to get absorbed, until it didn’t, and the economy froze.

Hyman shows how the Supreme Court, President Jimmy Carter, and Congress effectively gutted state usury laws, giving the credit card business its greatest spur to growth; he ranksAdvanta Corp. and First USA Bank among the fastest-growing card lenders of the ’90s, though he misses the biggest such lender, MBNA America, and the lone, much enlarged survivor of that period, Capital One. He incorrectly claims the card banks didn’t take deposits; insured (and, in the case of Advanta’s hard-luck investors, uninsured) deposits were an important part of how credit card banks raised billions to lend.

More substantially, he misses the question of why credit cards, which lack the tax deductibility and government financing aid that home loans enjoy, haven’t blown up nearly as badly or with the same evil consequences as home loans.

Hyman warns us we’re in the “eye of the storm.” The nation is still heavily leveraged. The economy could freeze again when interest rates finally rise and variable-rate debt payments overwhelm borrowers.

So, in the most provocative note in his book, Hyman urges the government to set up new FHA and Fannie Mae-like structures to resell business loans, as a spur to vastly increasing business credit. His “Bureau of Business Security” and “Bobby Mac” would create a “secondary market” for business loans to “bootstrap us to a level of prosperity.”

Yet Hyman’s book tells enough about the abuses of the FHA-Fannie model to make us wonder how much government support business lending really needs. An old-fashioned tax on financial transactions, or even Ronald Reagan’s proposal to end special tax treatment for home purchases by stopping the mortgage tax break, would discourage finance for finance’s sake. (There are signs Wall Street is finally contracting, as big firms cut bonuses and close trading desks, while American manufacturing exports are making a modest recovery.)

His is an accessible and well-written primer on a vast history, with plenty of cautionary tales for those who would fix what’s broken in our financial system, as well as what isn’t.