The Culture of Debt and Despair

0:00I put myself first on the program, not just to get it out of the way, but I have such an uplifting talk today about debt and despair that I thought I would get the, I would set the tone for today's conference. It's both the causes of economic crisis. Ludwig von Mises explained that easy money or the result of politically lowered interest rates succeeds in bringing about a booming business, but that this prosperity is artificial, that it cannot last and it must lead ultimately to a slump. Now we've heard this before, anybody who's familiar with the Austrian business cycle is aware that first entrepreneurs borrow at these reduced rates and the entrepreneur assumes that the cost structure for the project will remain the same as it was before the credit expansion.

0:54But as credit is expanded, factors of production are bid to higher and higher prices. Wages go up, material prices go up, and the entrepreneur just keeps borrowing because the banks are eager to lend the easy money. And this is what we've seen through the past few years. Prices and wage rates continue to boom, wrote Mises. Everyone feels happy and is convinced that now finally mankind has overcome forever. The Gloomy State of Scarcity and Reached Everlasting Prosperity." Well, Mises explained that, in fact, all of this amazing wealth is really quite fragile. It's a castle built on sands of illusion and that it cannot last. There is no means to substitute banknotes and deposits for non-existing capital goods.

1:46The artificial boom brought about by cheap money creates the illusion that certain projects will be profitable for entrepreneurs, and in turn the jobs created will be secure. We often talk about these investors who invest with cheap money during the boom. They invest and this money is turned into malinvestments. Ultimately the malinvestments are revealed, the values drop, the debt still remains, and of course the entrepreneur goes broke. But as the investor, entrepreneur and businessman are fooled by the low interest rates and the potential for profit, so is the average wage earner. Not only is capital misdirected into malinvestments during the boom, but labor and consumer confidence is misdirected as well.

2:37How many people quit their jobs to day trade during the stock boom in the 1990s? How many people went to work selling real estate during the boom? Las Vegas, where I spent 22 years, at the height of the boom, one in every 100 people in Vegas had a real estate license. How many people have been lured into the financial services industry? Money management firms still report that they're receiving the same number of applications for entry-level jobs, even though we've had a big, huge bust in that industry. But the financial sector was 45% of the earnings of the S&P 500 back in 2006. So motivated college students were just following the money. That's how they directed their studies and those are the jobs they're pursuing.

3:26But much of the earnings by those financial firms was the debt that was paid not only by corporations and business, but individuals as well, many of whom worked in that same financial industry, an industry that with the help of government creates this illusion, this illusion of wealth and prosperity that Mises spoke about. And as employees believe this illusion, illusory prosperity will last forever, they take on debt because getting the money is easy during a boom. This fiat inflation gives individuals the opportunity to borrow. Professor Guido Hulsman writes, The mere fact that such credit is offered at all incites some people to go into debt who would otherwise have chosen not to do so.

4:15But easy credit becomes nearly irresistible in connection with another typical consequence of inflation, namely, the constantly rising price level. Back in 1980, the head of Bank of America's credit card division, Kenneth Larkin gave a speech quoting two USC scholars. These scholars believed that people born between 1956 and 1975 would have completely different values, such as, number one, it doesn't pay to save for a rainy day. Number two, buy now, not later. Prices will invariably go up and the purchasing power of your dollar will invariably go down. Number three, stretch your financial obligations over as long a period of time as possible.

5:05Number four, borrowing improves your credit rating. Number five, pay your bills as late as you can without jeopardizing your credit rating. Now these truly are the lessons of inflation. Joseph Nosura wrote that in a great book about the credit card industry called A Piece of the Action. So it's, if in the early decades of the century, it was impossible for a working man or a woman to secure a loan from a legitimate lender, in the 80s, he or she could hardly refuse one. Jim Grant wrote, the descendants of the clientele of the loan sharks became the valued credit members of leading banks. In the 1980s, the home equity loan proliferated, personal bankruptcy lost its stigma.

5:55As credit card executive John Decker explained, to make credit card lending profitable, you find people who get into debt, stay in debt, and always pay the minimum balance on time. So household debt reached 13.8 trillion dollars in 2007, with 10.5 trillion of that being mortgage debt. The leading edge of the baby boomers turned 30 years of age in the late 1970s, just as the usage of debt became, began to accelerate. Debt took off like a rocket ship after 9-11, with the President urging Americans to spend, and then Fed Chair Alan Greenspan lowering interest rates to 1%. Imagine a low Fed funds rate like 1%.

6:43See, we have a Fed funds rate of, what, a quarter percent or less now. At the time, Dallas Fed Governor Robert McTeer told the Chamber of Commerce in Richardson, Texas, if we all go out and just join hands and buy an SUV, everything will be all right, preferably a navigator. And at the time, Bill Bonner and Addison Wiggin wrote, thrift came to be seen as an enemy of the state, almost as diabolical as Osama Bin Laden. Later McTeer commented that Americans have been doing something that's probably irrational from the point of view of the individual consumer because they all need to be saving more, saving for retirement, saving for college and all that.

7:30But we'd be in bad trouble if they started doing the rational thing all of a sudden. We're happy they're spending. We wish that they didn't run up a lot of debt doing it. But the problem was it's that the money supply has grown a hundred since 1980 has grown four hundred and sixty percent. Meantime, the median family income has barely budged. So running up the debt has been the only way for patriotic Americans to keep on spending. Personal savings rate fell from 11 percent in 1980 to a negative one percent in 2007. Of course, it's rebounded into positive territory, which has analysts on the TV fretting about Keynes' paradox of thrift and nonsense like that.

8:18But in the wake of 9-11, consumer confidence was supremely confident. That fall, consumer confidence took its biggest jump in more than a decade. Consumers kept buying and buying on credit. And for the credit card companies, they put the power of plastic in most everybody's hands. But for those who didn't have a credit card, well, the payday loan business was there for them. Now, I don't know if anybody in the room frequents payday loan lenders. I'm going to assume not many, but this is kind of the way it works. If you want to borrow 400 bucks for two weeks because your car breaks down, you would write the payday lender a check for $460, post-dated check for the day you get paid.

9:06When the two weeks rolls around, if you want to pay the loan off, then they would cash the check, and you paid 60 bucks on the 400, which is annual percentage rate of a smooth 390 percent. Now, if you can't pay it off, you would flip the loan. You would write a new check for another 460, or you would give the lender $60, write a new check for 460 and start this all over again. And of course, states weigh in on this, states, state governments, local governments hate payday lenders and so they're subject to numerous laws that are growing every day. But most payday lenders have somewhere between, you know, the 390 percent rate that I mentioned or a 650 percent annual percentage rate in some cases.

10:01And plenty of people are going to payday lenders. According to the Dallas Morning News, 2008, the U.S.'s largest payday lender, Advanced America, made $4.2 billion in payday loans. And they charged $676 million in interest and fees. Cash America, a pawn shop operator and payday lender based in Fort Worth, recorded income of $81 million last year, income that's has grown 132% in the last four years, total revenue of $1.3 billion, so plenty of people are going to payday loans to try to catch up, but as I said, local politicians hate these payday lenders, but they don't realize that the real villain here is the inflation-making Federal Reserve.

10:50But really the largest source of debt is mortgage debt for home purchases, until recently, home Home ownership was only a dream for most Americans. From 1900 to 1940, fewer than half of all Americans owned their homes. Home ownership rates in fact fell in the first three, three of the first four decades of the 20th century. Whereas young people today, they have a job, halfway stable source income, they're immediately going to take out a mortgage and go buy. Their great grandfather might still have accumulated savings for 30 years and then bought his House. But today two-thirds of America's own their home because as Thomas Segru says we are a nation of homeowners and home speculators because of Uncle Sam.

11:39For 1929 the government paid very little role in the housing market other than mortgage interest being made tax deductible in the 1913 Federal Tax Code. In fact having a mortgage was a case for stigma. Mortgages were hard to come by The interest rates were high with lenders, lenders wanted 50% down and on top of that the interest rates were high and the term of these loans were very, were very short, they were only three to five years. So there are typically only two types of homeowners at the time, the wealthy who paid cash and working folks who built their own homes. The Segru pointed out even the richest rented because they had better places to invest than the volatile housing market.

12:26But that all changed with the Depression as a lot of things changed with the Depression. New housing starts had fallen and Herbert Hoover, contrary to what you may read, he didn't sit idly by. He signed the Federal Home Loan Bank Act in 1932 and was the first of many interventions in the housing market. In his first 100 days, FDR introduced the Homeowners Loan Act, which would extend relief to homeowners who couldn't pay their mortgages With them, they'll take ownership of the home and you can pay them rent and stay there.

13:23We see various programs that are very much the same. Now this Homeowners Loan Act actually was geared for poor and middle class homeowners. The top loan was only $20,000, but that's the equivalent of $317,000 today. So it did capture, it captured a number of homeowners at the time. But then four years later the big creation was made and that was the Fannie Mae, Federal National Mortgage Association, it created a secondary market for mortgages and it was given the mandate to help make home ownership more available throughout the United States.

14:09Now these programs boosted home ownership in a hurry. 1950, 55% of people owned their own home. By 1970, home ownership was 63%. But beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages to low and moderate income borrowers. For 1996, the Department of Housing and Urban Development gave Fannie and Freddie an explicit target, 42% of their mortgage financing had to go to borrowers with income below the median for their area. That target increased to 50% in 2000 and 52% in 2005. Then Fannie Mises launched its American Dream in 2000, American Dream Commitment.

14:59I was to provide $2 trillion private capital for 18 million underserved Americans to own or rent a home by the end of the decade. In 04, Fanny expanded the American dream, pledging to help 6 million families become first-time homeowners over the next decade. Well, what this is, is really a social engineering experiment. Because the thought at the time was one fact, one survey said that consumer finances found that Low-income homeowners had a net worth 12 times that of renters at the same income level. Other studies found that children of homeowners are more likely to graduate from high school and college. And they are more likely to go on and own a home of their own. Also, there was research that showed that homeownership keeps communities attractive, safe, and vital, generating higher property values and other economic activity.

15:54So, voila, we need to make everybody a homeowner. and everything will work out better. This is like the studies that show that college graduates make more money. So we need to make everybody a college graduate. So they'll make more money. Well, of course, not everybody can be a college graduate. Not everybody can be a homeowner. But President Bush did his part. December 16, 2003, he signed a law, the American Dream Down Payment Act, 2003, helped approximately 40,000 families a year with their down payment. and further strengthen America's housing market is what they said. It complemented the president's aggressive housing agenda announced to dismantle the barriers to home ownership and putting down payment down was well it was a it was a barrier. So the Bush administration said at the time the strong housing market is beneficial for communities across the nation. So the whole down The non-payment idea was very much passe, and because of that, from 1997 to 2005, the average price of a home in the United States doubled.

17:03And with this doubling, the subprime mortgage market was born and nurtured. Fannie and Freddie played a significant role in the explosion of subprime mortgages and subprime mortgage-backed securities. Without the implicit government guarantee of the GSEs, it's unlikely that the subprime market would have taken off. Home ownership jumped from 64% in 1994 to 69% in 2004 because of the increased loans to low-income, high-risk borrowers. Both Bill Clinton and George Bush trumpeted the rise in ownership as it occurred. Well, what's the result of all this? According to a new report from First American Logic, nearly a third of all mortgages are now underwater.

17:55Of course, by underwater, we mean the amount of the mortgage is more than the amount of the value of the home. A new Deutsche Bank report predicts that by 2011, 48% of all mortgaged Americans will be underwater. But underwater is no problem for Fannie and Freddie. In July, the two GSEs received regulatory approval to refinance mortgages at loan-to-value ratios as high as 125%. Remember when Alan Greenspan said, go out and get that adjustable rate mortgage? Well, now the government has, in the words of Grant's interest rate observer, blessed, subsidized and institutionalized the state of underwater home ownership.

18:40But the GSEs can modify all they want, doesn't mean that distressed homeowners can or will pay. According to mortgage metrics report published by the Comptroller of the Currency and the Office of Thrift Supervision, 28% of all modified loans were 60 days delinquent within 60 days of their modification. Now what that means is that more than one in four people who modify their loans because they can't pay under the original terms don't make a single payment after they modify and as analyst David Rosenberg explains now that lenders have started to respond to their record high delinquency rates by rationing credit a mad scramble for cash is occurring to replace loans food stamp usage is up 22% year-over-year pawn shop business is up nearly 40% and there's a tidal wave about and allocations for social security disability benefits that were not explained alone by workplace mishaps.

19:44It's the lost generation, Business Week says. Unemployment nationwide is now 10.2 percent, but for young people it's 18 percent. And for those of you who follow John Williams, shadowstats.com, his alternative unemployment rate is 22 percent. Now, John Williams tracks unemployment the way unemployment used to be tracked before the Clinton years, where they changed the way some people were counted. So, John Williams may yet have the most accurate measure of unemployment. Foreclosure crisis affected nearly 938,000 properties in the last quarter. That was up from 890 properties the prior three months. That puts us on a rate to hit 3.5 million foreclosures this year, up from 2.3 million foreclosures last year.

20:39Personal bankruptcies rose steadily from 300,000 per year in the early 1980s to peak at over 2 million in 2005. The reason they peaked in 05, bankruptcy laws were changed in 06, but now we're starting to see more and more bankruptcies. In fact, over a million people filed for personal bankruptcy in 2008. That number has already been surpassed through the first nine months of this year. Now, as Hans-Hermann Hoppe pointed out in his wonderful book, Democracy, the God that Failed, it is savers that initiate the process of civilization. By generating a tendency toward a fall in time preference, he and those that exchange with him, Quote, matures from childhood to adulthood and from barbarism to civilization.

21:31Well instead, what we have now is the reverse. The debt accumulation of government, business and individuals reverses progress and is leading to barbarism. Professor Holzman explains, the net effect of the recent surge in household debt is therefore to throw entire populations into financial dependency. The moral implications are clear. Towering debts are incompatible with financial self-reliance and thus they tend to weaken self-reliance also in all other spheres. The debt-ridden individual eventually adopts the habit of turning to others for help rather than maturing into an economic and moral anchor of his family and of his wider community.

22:19Wishful thinking and submissiveness replace soberness and independent judgment. And what about the many cases in which families can no longer shoulder the debt load? Then the result is either despair or alternatively scorn for all standards of financial sanity. The constant creation of fiat money, instead of encouraging savings and thrift, has created personal fiscal insolvency on a massive scale. And this fiscal insolvency now threatens to lead this country and the entire world to moral insolvency. Thank you very much.