In the first quarter of 2011, the average American household carried $115,000 of mortgage, credit-card, and other forms of debt—a huge sum, but less (because of the recession) than the figure for the third quarter of 2008, when the average family owed more than $125,000 to financial institutions and other organizations. This enormous ocean of red ink has become big, big business. In both the go-go years of 2006 and 2007, for example, the nation’s largest credit-card issuers earned more than $18 billion—more than Wal-Mart or Microsoft.
In Debtor Nation: The History of America in Red Ink, Louis Hyman, Ph.D. ’07, reconstructs the history of personal debt in modern America. This is a fascinating, important, and at times ominous story. It begins around 1917, when personal indebtedness existed at the fringes of the economy, the province of struggling merchants and loan sharks, and ends in our own time, when personal debt has become a cornerstone of economic and capital-market activity, and the center of the recent financial crisis.
How did petty, scattered loans to workers become transformed, as Hyman writes, into “one of American capitalism’s most significant products, extracted and traded as if debt were just another commodity, as real as steel?” He answers these questions by offering a (generally) careful analysis of the evolution of modern lending practices—from installment loans to universal credit cards to mortgage-backed securities.
Corporations, commercial banks, and government agencies, he argues, played vital roles in creating our “debtor nation”; so, too, did financial-product innovation and the evolution of debt markets. In different ways at different moments, these factors greatly increased the profitability of consumer lending during the twentieth century and into the twenty-first. This growing profitability was not, he writes, the result of a sinister cabal or conniving scoundrels, but rather of countless choices that lie at the heart of a market economy. “The same banal investment decisions—where can this dollar get the greatest return?” that “produced our nation’s wealth-producing farms and factories also produced our omnipresent indebtedness.”
The first half of the book examines the origins of installment loans, national mortgage markets, and credit cards. Although business owners historically extended informal loans to their customers, Hyman explains, most did so reluctantly. Recordkeeping was cumbersome. Butchers, bakers, and candlestick-makers lacked information about a given customer’s finances, and few had excess capital to tie up in such loans. In the early 1900s, only self-financed companies such as Sears, Roebuck or Singer Sewing Machine could afford to offer installment-buying plans—and even they generally lost money on such loans, making the losses up on larger volumes and the economies of scale that powered their business models.
In the 1920s, however, lending practices and attitudes began to change. One factor behind this shift was the emergence of the finance company, which first appeared in the automobile industry, to help dealers fund their inventories and later, to help customers who could not pay cash for a car. Over time, some of these companies began diversifying, buying up the consumer debt of refrigerator, radio, vacuum-cleaner, and other appliance manufacturers.
The breadth and magnitude of finance operations spread quickly, helping power both the mass production of durable goods and their consumption by millions of American families. By the end of the decade, companies such as General Motors and General Electric had absorbed retail finance as a core aspect of their businesses, and installment credit had spread throughout the retail world. Not surprisingly, collective attitudes toward credit began to shift. By the eve of World War II, a quarter of American families were using installment loans to buy cars and other consumer durables.
The making of national mortgage markets was a second key development—the result of government initiatives intended to expand home ownership and thus jump-start construction during the Great Depression. At the center of New Deal programs like the Federal Housing Administration (FHA) was a new instrument that enabled borrowers to repay their home loans with a long-term mortgage. This innovation was a decisive break from older, prevalent forms of mortgages by which borrowers took out loans for three to five years and paid back some or all of the principal within that time, refinancing or rolling over the balance when the loan came due. (The bank that had issued the loan could choose whether to renew the mortgage when the note came due.) The stock market crash brought such lending to a halt as nervous investors and bankers pulled their capital from the mortgage market, making refinancing impossible for many homeowners and triggering a wave of foreclosures.
The FHA aimed to guide private capital into a new, government-enabled market for home lending; public guarantees would undergird privately issued long-term mortgages that would be amortized as buyers paid back both principal and interest. If a buyer defaulted, the insurance program would repay the principal to the lender. Interest rates were regulated at levels below 5 percent. Lenders’ profits were assured because virtually all risk had been transferred to the government.
These and other New Deal policies helped increase home ownership and revive the construction industry: in 1936, almost a half-billion dollars was lent in FHA-guaranteed mortgages; by 1939, about $4 billion in insured mortgages and home improvement loans were issued. As mortgage practices changed, Hyman writes, “the stigma of mortgage indebtedness receded over the course of the 1930s.”
In the 1940s and 1950s, the growth of revolving credit laid the groundwork for the modern credit card. Revolving credit, in which buyers pay back a given amount over time with interest but without a specific end date, emerged in retailers’ efforts to avoid World War II-related restrictions on installment lending. During and after the war, department stores and other businesses hustled to protect their sales, issuing an increasing volume of revolving debt to consumers in the form of charge cards. Merchants and manufacturers quickly recognized the resulting benefit: in the mid 1950s, to take one example, the Boston Store in Fort Dodge, Iowa, calculated that the average revolving-account customer bought 62 percent more than the average cash customer.
The proliferation of all this credit and the dependence it engendered—on the part of both businesses and households—had important consequences. Most noticeably, it helped fuel material prosperity for millions of middle-class consumers who could not otherwise have attained the trappings of “the good life” for which higher-income consumers paid cash. For most households, “credit had become an entitlement.” Homebuyers, Hyman continues, “borrowed their mortgages, financed their cars, and charged their clothes.” Between 1970 and 1979, the amount of debt outstanding tripled as buying and borrowing became “thoroughly entangled.”
Hyman notes several times that the growth of credit between 1960 and 1980 occurred against the backdrop of large-scale economic change. As the U.S. economy transitioned from manufacturing to service provision—and, one might add, as stagflation and increased global competition challenged historically high levels of national prosperity—income inequality grew rapidly and the future of middle-class incomes, upon which so much of the postwar credit expansion had been predicated, became much less stable. In this context, the logic of borrowing against those future incomes “began to unravel.”
The last chapters of the book examine how issuers, households, and government dealt with debt in an increasingly insecure economy. Hyman’s explanation of the origins of mortgage-backed securities in the late 1960s, the collateralization of these assets, and the advent of subprime lending reads like an eerie prelude to the 2008 financial crisis. So does the history of home-equity loans, which consumers used to fund not only what they bought but also the credit-card debt (and attendant interest rates) they incurred when they originally purchased all kinds of goods and services. For their part, legislators and other policymakers (like the Federal Reserve) consistently “pushed credit to rectify income inequality. Credit,” Hyman writes, “appeared to close the material gap between the American reality and the American Dream, but without rising real wages the debts remained.”
The result of almost a century of financial innovation, intermittent government policymaking, and increased real borrowing by households is our current economy—critically dependent on credit in a volatile world. “The relative danger of relying on consumer credit to drive the economy,” Hyman observes, “remains a macroeconomic puzzle to be solved.” Will we invest the profits from borrowing productively to create jobs and sustainable purchasing power on the part of most households? Or will we distribute economic returns to a small number of Americans at the top of the food chain and then lend those profits to everyone else in the form of credit-card debt and mortgage-backed securities? “American capitalism,” he concludes, “is America, and we can choose together to submit to it, or rise to its challenges, making what we will of its possibilities.”
Hyman has written a hefty book on an important subject. One closes its covers more knowledgeable and more thoughtful about the role of credit and our current economy. But such understanding does not come cheap. The dense chapters and sparse, at times inconsistent, statistics make high demands on the reader. And Hyman’s reconstruction of complex financial history, though incisive, would have been stronger with additional attention to how consumers viewed the tentacular growth of credit in their lives. But despite these shortcomings, this is a book well worth your time and energy.
Historian Nancy F. Koehn is Robison professor of business administration. Her most recent book is The Story of American Business: From the Pages of the New York Times.