Sunday, March 1, 2009

'Til Debt Do Us Part

By Sinclair Stewart (Globe & Mail Report on Business):

Last fall, as Margaret Atwood was promoting her treatise on the culture of indebtedness, Payback: Debt and the Shadow Side of Wealth, I asked her to explain why Americans have always been more willing to borrow than Canadians.

She didn't hesitate for a moment. "Because the Scots came here," she declared.

Since Diners Club revolutionized consumer culture by introducing the first widely accepted charge card in 1950, this attitudinal gap between the two countries has narrowed. Yet it is still there, as was painfully evidenced by the U.S. subprime mortgage meltdown, which laid bare a systemically cavalier attitude toward debt-not just among American homebuyers, but among lenders, investors and the government officials who sanctioned the growth of the housing market.

The average amount of debt per capita in Canada is $35,000, just over half the $62,000 load shouldered by U.S. citizens, according to a recent report by CIBC World Markets. Mortgage debt as a share of disposable income is 80% in Canada, and 120% in the United States. The same disparity shows up on household balance sheets. As of the end of 2007, for every dollar of assets in Canadian homes, there was 20 cents in debt. The average was 30% more in the United States, says Scotia Capital economist Derek Holt. "Clearly," he wrote in a report, "Americans and Canadians have different debt tolerances."

But why? We share a common border, consume much of the same popular culture, and work in economies that are closely tethered by trade. Some of the debt distinction may be chalked up to immigration patterns and ancestral customs, as Atwood intimated with her wry reference to Presbyterian thrift. But the breadth of the U.S. credit crisis hints at a more pervasive difference, one in which the line between consumer culture and government policy slowly blurred, each one reinforcing the other's addiction to easy money.

The term "credit" is derived from the Latin credere, meaning "to trust, entrust, believe." This implies that credit cannot be viewed merely as a lender's "trusting" that someone will repay a loan; it also denotes a borrower's "believing" he can make good on the terms.

Belief, of course-in a better future, in prosperity, in the ability to yank one's self up by the bootstraps-is what undergirds the American Dream. And this dream is inextricably tied to credit, to the ability to generate wealth and procure the things this wealth promises, whether it's a new car, the latest fashions or, most importantly, a home.

America's mythic, almost righteous optimism, inseparable from its willingness to take risks, is no doubt one of the major reasons that its love affair with debt has been much more torrid than Canada's. "You were never lashed to the notion of American exceptionalism," explains Bruce Mann, a Harvard law professor who has studied bankruptcy extensively. "It's the notion unique among nations that Americans are inherently more virtuous; that any move that the U.S. has made in the last 50 years has been justified because we've abided by democratic values, that we champion small producers, and that everyone would like to be like us."

This idea of exceptionalism, of America as the "city upon the hill" that would provide a beacon for the rest of the world, dates back to the country's early colonists, the Puritans. They emigrated with the help of London merchants, who lent to them on a primitive form of instalment plan, and helped develop what was, during the first century of settlement, a credit economy. Although merchants accepted farming goods as payment-hard currency was scarce, and tended to flow out of the country as soon it came in-this wasn't barter. The sellers kept books, calculated their goods in financial terms, and would then request payment in another form of goods with an equivalent value.

As settlers migrated westward, America devised an even more complex form of consumer credit. Merchants on the East Coast would finance purchases from Europe with credit, and then sell to another group of merchants, in the Interior, on credit. These latter merchants in turn sold the goods to consumers, also on credit, marking the birth of a consumer credit society.

Yet even as borrowing became more common, America's relationship with debt was actually uneasy. The Puritan ethic held considerable sway, and many preachers demonized debt as a debasement of virtue, a kind of debit that was drawn against spiritual currency.

Others also recognized the dangers of unrestrained borrowing. In Poor Richard's Almanac, Benjamin Franklin, cribbing a line from Shakespeare's Polonius, admonishes: "Neither a borrower nor a lender be." Later, Poor Richard warns: "But, ah, think what you do when you run in debt; you give to another power over your liberty."

For Franklin and other secular critics, debt was a threat to the individual freedoms that forged American identity. "We think of the first Americans as being penny-pinchers and living by the words of Franklin," says Lendol Calder, an associate professor of history at Augustana College, and author of Financing the American Dream: A Cultural History of Consumer Credit. "But it's pretty clear why he's writing these maxims in Poor Richard-it's because no one is living them."

That didn't stop Franklin from augmenting his wealth by lending money. And even the most zealous religious figures, like the preacher Cotton Mather, recognized that in order for America to flourish, it would need to become a powerful trader-and that trade was impossible without credit.

This ambivalence, between credit's danger and its necessity, was reflected in the language of borrowing. Americans distinguished between "productive" debt (the good kind, which allowed you to buy a new plow, and hence paid for itself) and "consumptive" debt (the bad kind, which enabled you to purchase baubles or other superfluous items). As a farmer says to his son in an old Quaker proverb: "John, never get trusted [indebted]; but if thee gets trusted for anything, let it be for manure, because that will help thee pay it back again."

But by the turn of the 20th century, as durable goods became widely available, America began searching for a new language of debt. Most of these new goods-what we might describe today as "big-ticket" items-were too expensive for people to buy unless they paid in instalments. Suddenly, buying a piano on credit wasn't viewed as an act of profligacy: It could be justified by elasticizing one's notion of productive debt (a master stroke of the early advertising business) and recognizing that the pleasure and rest a piano afforded could ultimately make its owners more productive.

As Calder points out in his book, advertisers really began to fasten onto instalment plans in the 1920s, as catalogue outfits and other retailers sprung up to meet rising consumer demand for durable goods, whether cars, sewing machines or even jewellery. An early ad for Julian Goldman Stores Inc. shows a factory in one picture, and a woman in a fur coat in the other. "A factory or a fur coat (...both of them may be bought on credit)," the copy reads. "What is the difference in these transactions? Nothing-except size!"

The idea was to erase the dividing line between the corporate and the personal: If companies could tap credit, why couldn't households? Weren't they, in effect, a form of business? This was the question facing General Motors Co. in 1925. And the company's novel solution, advanced two years later, would reverberate for decades-not merely in terms of GM's rise to an industrial power, but in the tightening of America's embrace of debt.

At the time, GM was on the verge of overtaking Ford Motor Co. as the world's largest carmaker, a surge partly resulting from the creation, in 1919, of General Motors Acceptance Corp., a pioneer in the business of sales financing. But for all its success, GM had a serious problem: A rising tide of personal indebtedness in the United States, spurred on by the proliferation of loan sharks and other usurious lenders, had led to a backlash against the emerging concept of instalment credit. Critics, ranging from the religious to the secular, warned that the speed with which ordinary Americans were piling on debt for non-essential items (and cars would fit neatly in this category) would bankrupt the country, either morally or economically, or both.

GM chairman John J. Raskob sensed an imminent public relations disaster. If sentiment turned sharply against instalment financing, GMAC could be singled out as a prime offender, tarnishing the image of its Detroit parent. Raskob responded with what was, at the time, an unconventional idea: He hired an academic, the noted Columbia economist E.R.A. Seligman, to craft an independent study of instalment credit. "If we were wrong, we wanted to know it," Raskob said. "If we were on fundamentally solid economic ground, we wanted to know that also."

Seligman went to work and, in 1927, issued a huge, two-volume study titled The Economics of Instalment Selling. He argued that instalment plans merely represented another step in the evolution of credit. And he cleverly dispensed with the old labels of productive and consumptive debt, yoking them together in a new term, consumer credit.

As Calder noted, Seligman counselled that people shouldn't rail against consumption: They should pursue a "productive utilization of wealth as in the positive utilization of all our opportunities." In other words, consuming wisely-finding a bargain, or the like-could itself be construed as a positive, productive act. "[Seligman] removed the stigma of consumption by showing it was possible in many ways for the consumer to be a producer, for consumption to be a form of production," Calder observes.

Advertisers quickly incorporated this reshaping of conventional economic thought: Instalment lending ads mushroomed in the aftermath of Seligman's book, though their growth was dulled at the outset of the Depression. Still, buying on time had sunk into the collective consciousness to such a degree that the ad campaigns likely facilitated President Franklin D. Roosevelt's policies to promote home ownership, which, for the first time, enabled people to buy homes through long amortization mortgages-the ultimate pay-as-you-go instalment plan, and the pinnacle of consumer borrowing.

While Seligman's rationalization may have helped to propel the consumer credit movement, it wasn't until the postwar years that "the American consumer" became the engine of the world's biggest economy-the big spender upon whom Washington, and increasingly other countries, relied to fuel growth.

This was the era in which the United States found its voice; it was the era in which durable goods proliferated, and soldiers returning from the war were looking to buy new automobiles and furniture, colonize the suburbs, and stock their homes with new appliances-all largely thanks to the magic of credit.

According to a study by David Steigerwald, an associate professor at Ohio State University, consumer indebtedness in the U.S. ballooned almost 200% during the 1950s. The amount of credit Americans used to buy appliances and cars between 1940 and 1960 soared 550%, in part because of the emergence of credit cards, which could be used to make purchases from virtually any seller.

In 1958, the Canadian-reared economist John Kenneth Galbraith identified the widespread acceptance of consumer credit as a tipping point, a definitive rupture with long-held notions of thrift: "There has been an inexplicable but very real retreat from the Puritan canon that required an individual to save first and enjoy later," he wrote.

Of course, that rupture only widened in the most recent decades, finally opening into a chasm in the subprime-fuelled economic meltdown. By the 1960s and 1970s, as some observers have pointed out, credit had become so ingrained in the collective consciousness that the shame of running into debt troubles was dissipating; not only was debt not frowned upon, it was actively encouraged.

Although the credit movement may have taken hold earlier in the U.S., it didn't skip Canada; we, too, have latched onto longer-amortization mortgages, and stuffed our wallets with high-interest credit cards. One of the crucial differences-and this may seem odd to those on the American right, who think of Canada as their liberal, flaky neighbour to the north-is that the Canadian financial system tends to be much more conservative.

The Canadian government never made home ownership such an explicit part of its policy objectives. It never relaxed rules as presidents Carter and Reagan did, in the 1980s, inadvertently inciting the subprime boom. Ottawa, unlike Washington, didn't allow people to deduct interest from their mortgage payments, thereby turning homes into de facto automated banking machines. Nor did Canada maintain the precariously low interest rates that goaded an asset bubble into existence in the U.S.

Perhaps most importantly, the financial regulatory framework in Canada harbours a relative bias toward prudence and soundness, while its American counterpart tilts more in favour of consumer choice and the laissez-faire flow of capital.

Just take a look at the securitization business, which served as an incubator for the U.S. housing collapse. When the Canadian Big Five banks issue mortgages, they tend to keep the bulk of them on their balance sheets. This practice has its own built-in risk control: If you're holding on to a loan, you'll be a lot more picky about your borrowers.

U.S. banks, however, participated in an orgy of securitization. Loans, once issued, were packaged in opaque products that were then sold off piecemeal to pension funds, hedge funds, life insurers, municipalities, and just about any other large investor looking for a decent rate of return. This meant that when the bottom fell out of the subprime market, the damage migrated to virtually every corner of the global economy.

The lack of government oversight-a reluctance to rein in shady mortgage brokers, Wall Street firms and exotic lending products-fuelled a debt binge that left many consumers without basic protection, say some critics. "Because of the absence of government regulation," says Mann, the Harvard professor, "we have a financial industry that for a long time now has treated consumers as the feast at the Thanksgiving dinner table."

While Mann acknowledges that cultural and regulatory differences help shape divergent attitudes toward debt between Canadians and Americans, he also highlights some less visible factors. Universal health care in Canada, for instance, exaggerates the divide. According to his figures, 54% of U.S. consumers who file for bankruptcy do so because of medical debt-and a full two-thirds of those actually had medical insurance. It just wasn't sufficient. "This is not a nation going into debt because they're buying Michael Jordan sneakers," Mann insists. "The biggest household debt items have been the mortgage payment, and also medical and educational costs."

That mortgage payment is no small matter, though-not when housing prices are cratering and hundreds of thousands of people are being forced from their homes by foreclosure. The subprime mortgage collapse, which is metastasizing into the worst global recession in a generation, is in some ways an inevitable reckoning: the unravelling of the pay-as-you-go philosophy espoused by Seligman, embraced by American consumers and nurtured by Washington. It also brings a belated recognition that the fears of the founding fathers contained more than a kernel of wisdom.

To put a spin on that old Quaker proverb, Americans who rushed into the housing market also agreed to "get trusted" for manure, albeit by a different name. And this version didn't help pay itself back.

***

LIFE, LEVERAGE AND THE PURSUIT OF HAPPINESS

DEBT PER CAPITA

CANADA: $35,000

UNITED STATES: $62,000

CONSUMER DEBT AS SHARE OF DISPOSABLE INCOME

UNITED STATES: 120%

CANADA: 80%

MORTGAGE DEBT AS SHARE OF DISPOSABLE INCOME

UNITED STATES: 66%

CANADA: 52%

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