Have you ever wondered how we got where we are today, in this financial jam? Are you willing to go on a little economics journey with me? I hope so.
This story starts in the late 1970s. Before that, if our parents needed to buy something beyond what they could pay cash for, they went to their local bank for a loan. The banker knew them, knew their reputation and work ethic, in short, knew what the chances were of getting paid back. And loans were usually taken out to start a business or buy a house.
Late in the 1970s, the lending function was extended to the national banks, and suddenly face-to-face acquaintance no longer played a role. To make things more convenient, credit cards became the loan vehicle du jour. Over time, not only were loan and credit card applications faceless, lenders also got more and more lenient as they realized what a gold mine they were sitting on. (Especially when they could charge huge interest rates for people with weaker credit.)
Once everybody’s wallets were fat with credit cards, shopping went from being something people did out of necessity, for food and supplies, to being a form of entertainment. Look at the malls that were built: they had perfected the psychological triggers for impulse shopping. No wonder it was hard to keep your wallet in your pocket!
Eased credit requirements soon extended to the personal mortgage market as well. And, since consumers believed they had the wherewithal (with endless credit cards) to buy whatever their hearts desired, they could also buy whatever house they wanted. So the demand for mortgages grew, and the creditworthiness of borrowers diminished.
As lenders accumulated mortgages, they realized they could “bundle” hundreds of them together and turn them into a bond. They’d “guesstimate” the risk that those mortgages carried. (Remember, borrowers weren’t as qualified as before and defaulting on loans was becoming more common.) And they’d sell the bonds as “mortgage-backed securities.”
Bundling and selling mortgages meant the lenders no longer had to worry about any losses from default, since the bonds had been sold to others. The risk had been pushed off on someone else. So they’d take whatever they got for the sale of the bonds and make that money available for new loans, now maybe with even greater risk. Until we got to “No Doc – No Income Verification” creative financing.
All this easy mortgage money put pressure on the housing market, as more and more people sought to buy. So house prices increased. And the people already sitting in houses, with newly increased value? What did they do? They pulled the new equity out of their houses and spent it. A few may have smartly paid off some higher-interest credit cards, but most used it to buy new flat-screened TVs, bigger cars and bigger toys.
Then one day, triggered by a series of financial events, someone decided to look into those mortgage-backed securities. Hm, housing prices had fallen and foreclosures were up. And massive numbers of those bonds were sitting in portfolios everywhere, worldwide. As banks and financial institutions discovered the real value of the securities they were holding, the whole economic foundation began to tremble.
That was late 2008.
Since then, starting with TARP, we’ve watched an over-sized shell game as money has moved from one bailout mechanism to another. The finger-pointing has been fast and furious…and we’re a long way from being out of the woods.
Here’s something to put it all in perspective: when this story started in the late 1970s, U.S. total household debt was a little under $1.3 trillion. By 2010, it had reached $13.4 trillion. That’s a 931 percent increase, while inflation in that period was only 165 percent. And that $13.4 trillion was made up of $10.1 trillion in mortgages and $3.3 trillion in car loans, student loans, credit card debt, etc.
I know this is a gross oversimplification. And it totally ignores the role of government, greedy bankers, lousy politicians, pensions on steroids, and “who did what to whom.”
But, in my mind, our present crisis started years ago with the demise of personal responsibility, when we stopped having to sit across the desk from our friendly local banker and ask for a loan for anything we couldn’t pay for in cash.
Now, regardless what is done on the global or national scale, it’s time for us to bring back personal responsibility. It’s time to be watching our money decisions: how we spend, how we live, how we save, how we earn.
What do you think?