The Great American Credit Machine

Lending money has always been the second oldest profession and not always the most admired.”

Charles R. Geisst

Lender – Borrower” … a most acrimonious love nest by nature and one detailed by Charles R. Geisst in Collateral Damaged. Each side denounces the other as evil, but seek the partner, often in the middle of the night. How does the scorn of “being in debt,” give way to the prestige of a “line of credit?” Geisst describes the journey, and provides insight into how we arrived at our present consumer debt crisis.

What a journey it has been, bouncing right onto the slippery slide of deterioration. From the highly regulated and separation [banking, stock brokers, insurance sales] of financial services of the first part of the century, particularly those imposed under the Glass-Steafall laws; to the boutique of 2000, with one business providing all financial services from lending, to the making, selling, and purchase of securities. The all out assault on regulations and business limitations by financial institutions and the transition of the borrow’s changing perspective on housing and consumptions all contributed heavily to how we arrived at today’s financial predicament.

Geisst identifies many players in the last third of the past century [Paul Volcker, Allen Greenspan, Milton Friedman, serving presidents Reagan, both Bushs, and Clinton] who all thought that the deregulations, hands off policies toward financial institutions would lead to better, more trustworthy companies and allow them to meet the needs of all kinds of borrows and compete in the global economy.

“And not all loan sharks wore dark raincoats and did business in dark alleys. Many simply were unlicensed loan companies, some with branches, preying on the cash-strapped working man.”

The great investment in the American infrastructure and mass distribution system of the post civil war industrial nation (railroads, electric powers, etc.) took huge amounts of financing (corporate credit); and of course, someone had to buy this production, hence the need for consumer credit. Geisst spends most of the book describing how these two complementary needs for purchasing power evolved.

Industrial (production) capital – distribution capital – consumer credit

The author tackles the complicated problem of explaining the process of securitization head on. He makes it plain how this technique of combining bad mortgages (sub-prime) with a sprinkling of good ones into a negotiable package could be sold to eager investors around the world. In 2005 the bloated stock market which consisted in a huge part of these feeble securities, begin to plunge.

Providing an excellent history of “usury,” Geisst traces the religious and legal view toward usury [“ancient racket” (New York Times)] from the middle ages to modern times. This review provides an understanding of why this interest greed is now denounced and is cited as blame for most of the ills which plague our economy. Just how lenders sought to usurp the usury restraints by off book transitions, pawnbrokers, and “unlicensed lenders” such as loan sharks, paycheck loans, charging “fees” on credit cards, and maneuvering around the rules makes for very interesting reading. Geisst also points out that because of discrimination and ostracization money lending was often the only avenue for some groups to support themselves.

The consumer was part, actually a key second, of the equation. Society and politicians’ progress from a call for thrift (1914) and the promotion of savings, to the “installment loans” originating in the 20s and during the great depression. These types of loans were perfected to buy big ticket items like automobiles and refrigerators (Sears, General Motors). Initial credit sources were different then the modern “credit line,” in that they were backed by the reputation of the borrow and with some tangible repossessable item such as appliances, autos, or “lay-away” plans. The first bank credit card was offered by the Franklin National Bank in New York in 1951. Like American Express, up until the late sixties the first wave of cards were pay-on-demand programs used mainly for convenience. However, this changed as computer technology give the industry the speed necessary to process the transaction volume which bloomed in the 70s and brought about the now popular “minimal payment” and famous “line of credit.”

Of course, the housing bubble and the resulting tapping of the perceived equity buildup to support the life style of overextended consumers, plays a major role in our current economic situation and Geisst covers this point quite well.

“The increase in house prices and the increased use of credit cards was accompanied by low growth in real wages, as had been the case for two decades. In order to achieve the American Dream, average American families, were going into more debt given the low growth in incomes, factoring in inflation.”

Although general accountability and responsibility is needed by both the lender and borrow, Geisst recommends some specific cures:

  • Change the tax law reading(sic) capital gains on housing.
  • Using computer models, revolving debt (credit cards, personal loans) should be limited to 10-15 percent of gross income; tighter credit scores for mortgage eligibility; and limited home equity to no more that 20 percent of the equity in a home as based upon a third party, not the bank.
  • Passing and enforcement of anti-predatory laws and minimum regulatory standards for lenders.
  • Banks that securitize shoddy mortgages and rating agencies which give good ratings to bad financial institutions must bear financial responsibility for their action.
  • Regulatory limits applied to all forms of financial derivatives.
  • The book was topic oriented [usury, borrowers, securitization, home equity] and at places occasionally a little difficult to follow the timelines as the author sometime bounced from 1920s to 80s in the same paragraph. However, the book is well laid out and provides an excellent overview of how we arrived to the financial situation faced today. Collateral Damaged is highly recommended to anyone interested in learning just how we got into this economic mess.

    Collateral Damaged The Marketing of Consumer Debt to America

    Charles R. Geisst

    Bloomberg Press, NY; Aug 2009