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Personal Debts and US Capitalism
Source News for Social Justice Action
Date 05/10/20/00:37

mrzine.monthlyreview.org
Monthly Review
October 15, 2005

Personal Debts and US Capitalism

By Rick Wolff

There is no precedent in US -- or any other -- history
for the level of personal debt now carried by the
American people. Consider the raw numbers. In 1974,
Federal Reserve data show that US mortgage plus other
consumer debt totaled $627 billion. By 1994, the total
debt had risen to $4,206 billion, and by 2004, it
reached $9,709 billion. For the second quarter of
2005, the Fed announced that the nation's debt service
ratio (debt payments as a percentage of after-tax
income) was 13.6%, the highest since the Fed began
recording this statistic in 1980. Past borrowing now
costs Americans so much in debt service that more
borrowing is required to maintain, let alone expand
consumption.

These facts raise two questions: what caused this
mountain of debt to arise and what are its
consequences? Answering these questions is an urgent
matter since, as has been known for centuries, the
risks of high debt include economic collapse.

Since the real wages of most workers stagnated or fell
since 1975, they responded partly by borrowing to
maintain or raise their living standards. Over the last
twenty five years, ever more enterprises (stock
brokers, insurance companies, lending branches of
industrial corporations, etc.) are seeking high profits
by offering easier loans (credit cards, basic
mortgages, home equity lines, mortgage refinancing,
tax-refund advances, etc.). After the stock market
bubble burst in 2000, the Federal Reserve tried to
contain the damage by drastic, sustained cuts in
interest rates. Already debt-addicted, US households
responded to cheap, available credit by borrowing much
more.

Historically low interest rates and intense competition
among lenders drew millions of Americans into borrowing
to buy a first home. Not only the native-born exchanged
rental apartments for "the American dream." Millions of
immigrants borrowed to partake of that dream too.
Millions of other Americans borrowed for costly home
expansions and renovations. The resulting boom in
residential construction and its dependent industries
partly offset the depressive economic effects of the
stock market bubble burst in 2000. A stock market
bubble gave way to a housing bubble. As housing prices
were bid up, homeowners' "equity" in houses rose, and
that allowed them to borrow still more with their
higher "home equity" as collateral.

In all debt-based economic upswings, the crucial issue
is: How long will lenders keep feeding rising debt
demands? Nowadays, banks lending to US homeowners
usually resell that debt to investors in the form of
"mortgage-backed securities." Because the US government
is believed to guarantee those securities, more or
less, investors around the world have been buying them.
The two biggest buyers recently have been banks in
Japan and the People's Republic of China. They are
therefore -- and note the irony -- among the biggest
ultimate recipients of the monthly mortgage payments
made by American homeowners. The US housing bubble
postpones bursting only so long as Americans keep
borrowing and the major housing lenders, including the
Japanese and Chinese banks, keep the cycle of rising
home prices and rising home indebtedness rolling.

Nothing guarantees that the lending and borrowing
binges will continue. Americans' rising debt levels may
frighten them into slowing or ending their borrowing.
Countless other possibilities from political shifts to
military reverses to cultural changes -- including the
tougher bankruptcy laws that will take effect on
Monday, October 17 -- could likewise reduce Americans'
abilities or willingness to borrow. Similarly, all
sorts of considerations may dissuade lenders, foreign
or domestic, from continuing to provide credit. If and
when either the borrowing or the lending slows, the
housing bubble will likely burst. As home buying slows,
housing prices will stop rising. Inventories of new
homes will become difficult to sell, resulting in lower
home prices. Housing construction will stop, raising
unemployment in that industry and all others dependent
on it. Rising unemployment will likely further depress
home prices since the unemployed cannot maintain
mortgage payments, and so on.

The economic optimism required to keep the Bush regime
afloat regularly issues from economists and
politicians. They offer reasons why American homeowners
will keep borrowing and why lenders will keep providing
the credit. Because rising home prices have made
American homeowners richer, they are willing to keep
borrowing. Likewise, lenders are willing to provide
more credit to richer borrowers. Yet these "reasons"
explain nothing; they merely describe the bubble
itself. Identical predictions in 1999 promised that
rising stock prices enriched stock owners who could
then afford more stock purchases at higher prices and
so on. Yet, the stock market bubble burst. Why should
the same not happen to housing prices?

Some optimists try another line of reasoning. Japan and
China will keep lending to US homeowners because, if
they do not, a collapse in the US housing market will
hurt them. Japan and China depend heavily on sales of
their goods to Americans. An economic downturn here
will cut demand for their goods and so spread to them.
Thus, they have no choice but to support the US economy
by endless lending to Americans.

This argument's flaw emerges from a brief look at
capitalism's history. Every previous capitalist
depression, including the devastating one in 1929, was
thought to be impossible because everyone wanted to
avoid it since everyone foresaw how a depression would
hurt everyone. Today again, US homeowners, businesses
and the government want to avoid a burst housing
bubble. The Japanese and Chinese banks and government
as well as all the other lenders into the US housing
boom want the same. The history of capitalism teaches
us that what everyone wants provides no guarantee that
it will happen. Everyone may want to keep the boom
afloat, but because everyone is also hyper-vigilant to
get out of a market that seems to be on the way down,
once a downturn starts, it can quickly become a
collapse.

It has happened many times. Once again, capitalism
brings us to a precipice. Surely the human race can
devise a better system. And if not now, when? Rick

Wolff Rick Wolff is Professor of Economics at
University of Massachusetts at Amherst. He is the
author of many books and articles, including (with
Stephen Resnick) Class Theory and History: Capitalism
and Communism in the U.S.S.R. (Routledge, 2002).

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