Paving Stones of the Road To Insolvency

Anyone old enough to remember the facts of economic life as they existed before the 1970s is aware of the many changes that have occurred in how middle-class Americans try to organize their finances. But when you add them all up, as Phillip Longman does in the July/August issue of the Washington Monthly (his essay is tellingly titled “The Hole in the Bucket”), it’s pretty alarming. Real wage growth for most Americans stalled. Retirement security took a big “hit,” thanks in part to a Social Security “reform” package in 1983 that significantly boosted payroll taxes while reducing benefits, making Social Security much less of a great deal for Baby Boomers than for their parents. At roughly the same time, the private pension system began to shift from defined benefit to defined contribution plans which not only reduced the security (and in many cases, the value) of pensions but also made retirement savings largely voluntary.

As low-to-moderate income Americans struggled to make ends meet, something else happened that escaped general attention until subprime mortgages took their terrible toll on the economy: an “epidemic of predatory lending,” as Longman calls it:

Usury law is, in the words of one financial historian, “the oldest continuous form of commercial regulation,” dating back to the earliest recorded civilizations. Yet starting in the late 1970s, some powerful people decided we could live without it.

First to go were state usury laws governing credit cards. Before 1978, thirty-seven states had usury laws that capped fees and interest rates on credit cards, usually at less than 18 percent. But in 1978 the Supreme Court, in a fateful decision, ruled that usury caps applied only in the state where the banks had their corporate headquarters, instead of in the states where their customers actually lived. Banks quickly set up their corporate headquarters in states that had no usury laws, like South Dakota and Delaware, and thus were completely free to charge whatever interest rates and fees they wanted. Meanwhile, states eager to hold on to the banks headquartered within their borders promptly eliminated their usury laws as well.

Later, in 1996, the Supreme Court handed usurers another stunning victory. In Smiley v. Citibank it ruled that credit card fees, too, would be regulated by the banks’ home states. You might think that market forces would set some limits on how high credit card fees and interest can go—after all, there are only so many creditworthy borrowers, and much competition for their business. But with shrewd use of “securitized” debt instruments and hidden fees, banks and other lenders found they could make more money from those who could not afford credit cards than from those who could….

And along with the payday lenders came new, more vicious species of loan sharks: subprime credit card issuers, auto title lenders, private student loan companies charging up to 20 percent APR, check-cashing outlets, and subprime mortgage brokers and lenders. Just the hidden fees—what Devin Fergus of Hunter College-CUNY calls the “trick and trap fees”—on student loans, mortgages, and credit cards sucked billions of dollars a year off the balance sheets of American families.

Meanwhile, of course, expanding mortgage credit, combined with continued generous tax subsidies for those who borrowed to buy a home, drove up home prices beyond all reason, while causing millions of Americans to overinvest in real estate as the bubble grew. And then, catastrophe.

So the housing and financial crises were not disasters that came out of nowhere, but the culmination of decades of bad public policies that stretched middle-class budgets to the limit and then destroyed much of the meager wealth families had managed to accumulate.

We won’t get out of this mess any faster than we got into it, but it’s important to understand that it wasn’t the result of some sort of generational moral failure (as professional scolds like the Washington Post‘s Robert Samuelson like to claim) but of bad collective decisions that created some very wealthy winners and a lot more losers. The July/August issue of the Monthly has some good ideas for turning things around, but Longman’s succinct description of the paving stones on the road to insolvency is truly essential reading.

Ed Kilgore

Ed Kilgore, a Monthly contributing editor, is a columnist for the Daily Intelligencer, New York magazine’s politics blog, and the managing editor for the Democratic Strategist.