Americans obsessed over personal finance during the last forty years as never before. So how come so many of us wound up broke? Here's the little-known story.
The near majority of workers lacked access to 401(k)s, and only about a third of those whose employers offered the plans participated. This often meant, of course, that workers forfeited the free money offered through employer matching grants. In addition, the workers who joined were often clueless about how to manage their portfolios, alternatively putting their nest eggs into money-market accounts that didn’t keep up with inflation, or speculating in tech stocks.
Also in line with human nature, many also simply failed to save enough. In the years when the stock market was routinely returning 15 to 20 percent, it was easy to believe the hype and conclude that only a small amount of savings would be required to meet your retirement goal. Still more people would cash out their 401(k)s every time they changed jobs or had a short-term financial emergency. Others saw their retirement savings cut in half or worse by divorce settlements.
Meanwhile, the percentage of the population that took advantage of Individual Retirement Accounts was even lower. Partly this was due to inertia or lack of sophistication. But it was also due to the fact that people with little or no income could gain little or no tax relief by investing in an IRA or other defined contribution plan. As the system came to operate, the federal government spent billions of dollars offering tax subsidies to rich people who sheltered their income in retirement accounts while offering virtually nothing to those who most needed to save. As such, the whole system became pure “Robin Hood in Reverse”—which, of course, didn’t much bother Republicans, and many Democrats went along as well.
Another big problem, easy to see in hindsight, was that while we were telling ordinary Americans to trust their savings to the sharks on Wall Street, we also were telling the sharks that there were no more rules. By the end of the 2000s, millions of humble Americans had invested their savings in mortgage-backed securities, believing their broker’s assurances, or that of some raving head on cable, that these were safe. Many who bought even garden-variety mutual funds saw their returns eroded by hidden fees.
In the meantime, financial markets devolved to the point where there were no longer many safe ways to invest that would keep up with inflation, so people took on more and more risk as they chased higher yields, often having no idea what they were doing. Many turned to investing in their houses or buying bigger ones. Many also, in effect, wound up using credit card debt to finance their stock market and real estate speculations—as when, for example, people put money into mutual funds or an upgraded kitchen and then found they needed to use their credit cards to cover routine household expenses, like gas, groceries, or the rising cost of health insurance.
This brings us to the other side of the deteriorating balance sheet of most Americans, and one that was just as consequential in bringing us to where we are today: debt. It’s bad enough that American society blew the plan that was supposed to get Baby Boomers and younger Americans saving much more for their retirement: at the same time, we exposed the same population to an epidemic of predatory lending.
It’s almost impossible to exaggerate the drama of this story. To put it in some historical perspective, for as long as there has been credit flowing in human history—going back at least as far as the code of Hammurabi, circa 1750 BC—there have been laws to prevent usury. The Old Testament tells of the Prophet Ezekiel, who included usury in a list of “abominable things,” along with rape, murder, robbery, and idolatry. Roman law capped interest rates at 12 percent. According to the Qur’an, “Those who charge usury are in the same position as those controlled by the devil’s influence.” Dante condemned usurers to the seventh circle of hell, along with blasphemers and sodomites. Martin Luther argued that any interest rate above 8 percent was generally immoral, and the Puritans who settled the Massachusetts Bay Colony agreed, adopting America’s first usury law 150 years before the ratification of the Constitution.
Most of America’s Founding Fathers thought them right to do so. Notes law professor Christopher L. Peterson, “Throughout the history of the American Republic, all but a small minority of states have capped interest rates on loans to consumers with usury law.” In the Progressive Era, reformers pushed a Uniform Small Loan Law that capped interest rates at 36 percent, and limited them to specially licensed lenders adhering to strict standards of lending. As late as 1979, all states had laws of some sort that capped interest rates.
This short history of usury laws puts into perspective just how bizarre the credit markets of the United States have become over the last forty years. 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 this was only the beginning. By the early 2000s, thanks to the combination of deregulation and “financial engineering” on Wall Street, middle- and lower-class neighborhoods across America were being flooded with what could be called financial crack. In the years between 2000 and 2003 alone, the number of payday lenders more than doubled, to over 20,000. Nationwide, the number of payday lender franchisees rivaled that of Starbucks and McDonald’s combined.
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