Howard Marks recently released some comments on the debt ceiling that contain some juicy tidbits (as always). Mr. Marks discusses how the USA has become a nation of debtors:
“If I wanted to buy something upon my arrival at college in 1963, I had two choices: Icould spend money I had in my pocket, or I could write a check against money I had inthe bank. The one thing I couldn’t do – now here’s a radical concept – is spend money Ididn’t have. As a result, I had no way to buy things I couldn’t afford.
But then, around 1967, Bank of America came out with the first credit card, theBankAmericard, and First National City Bank countered with The Everything Card. (When I was hired into FNCB that year for my first summer job, it was to go door-to-door trying to convince merchants to accept the card. But then volume on the New York Stock Exchange spiked to 25 million shares a day and banks like FNCB couldn’t keep upwith the related paperwork; thus I was assigned instead to a task force whose job it was toeliminate bottlenecks in the back office. But that’s another story.)
Before the BankAmericard and The Everything Card, the only plastic in circulation consisted of T&E (“travel and entertainment”) cards – American Express, Diners Club and Carte Blanche – which generally were limited to people in the upper economic strata and had to be paid off each month. It was only in the last forty years that we’ve seen the morphing of BankAmericard into Visa and The Everything Card into MasterCard. With them came the ability of consumers to maintain an outstanding balance. Now it was easy for people to buy things they couldn’t afford. And so they did.
When I was a boy, as I recall, owing money was considered undesirable and debts were generally expected to be paid off. When people bought homes, they put down 30% and took out thirty-year mortgages to finance the rest. They made level payments that included a substantial principal component that grew over time, eventually extinguished their debt, invited their friends over for mortgage-burning parties, and owned their homes free and clear in time for retirement.But attitudes toward debt underwent significant change, and in the last forty years we’ve seen the following:
- Vast expansion of the use of credit cards, the balances on which are never expected to be paid off.
- Innovative mortgages requiring little or no principal amortization; reverse mortgages, where you owe more at the end than the beginning; declining down payment requirements; and eventually the availability of mortgage loans exceeding purchase prices.
- Home equity loans enabling owners to drain off any equity in their homes. Fifty years ago these were called second mortgages, and people who had them were considered by their neighbors to be in financial trouble.
- Growth in corporate debt, and the extension of borrowing power to companies with “speculative” credit ratings.
- The development of the commercial paper market, where companies could access “permanent” capital with maturities measured in days, on the assumption that the paper could always be rolled over.
- Creation of highly levered investment entities.
- Vastly increased steady-state borrowing on the part of nations, whereas, previously, deficit spending had been limited to occasional efforts to fight recession through stimulus.
What’s the upshot of all of this? For the last several years, as I’ve visited with clients around the world, I’ve described the typical American as follows (exaggerating for effect,of course): He has $1,000 in the bank, owes $10,000 on his credit card, makes $20,000 a year after tax, and spends $22,000. And what do lenders do about this? They mail him additional credit cards.”
He goes on to discuss how this problem translates to the Federal government, the debt ceiling and makes the crucial flaw of comparing a household balance sheet to the Federal government’s balance sheet (they simply cannot be compared!) I think this leads him to some false conclusions regarding the debt ceiling debate, but the comments regarding the private sector are spot on.
Mr. Marks’ story sounds a lot like my own. When I was very young I was taught that debt is very bad. That idea was seared so so deeply into my soul that I have always been obsessively prudent in my spending. But this is not the norm in America. We have become a country that is obsessed with buying things we can’t really afford and haven’t earned.
Obviously, the consumers are ultimately to blame for this, but I don’t think you can remove the Wall Street machine from the equation either (or the government for that matter). Clearly, relaxed regulations have resulted in Wall Street’s increasing ability to add revenue generating products to their shelves. And these products are like dangling candy in front of a small child. The consumers (for whatever reason) have not stopped grabbing it.
The result is that the private sector debt in this country is now a leach sucking the economy of its life. And the worst part, is that neither I nor anyone else appears to have a solution to what looks like a secular (and possibly a generational) problem. I like to try to remain optimistic about the balance sheet recession and its end, but in my darkest thoughts I wonder whether this is really a problem that can be solved quickly. Or is this simply an era of debt that is destined to persist so long as we continue to think that the end (debt driven profits & keeping up with the Joneses) justifies the mean (debt driven consumption & financialization)?
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.