Market Overview

Louis Hyman, Author of Borrowed, Sees Fundamental Flaws in the American Economy

While many pundits have called the recent economic downturn an unprecedented event, economics historian Louis Hyman disagrees. In his recent book, Borrow: The American Way of Debt, Hyman traces the development of consumer borrowing throughout the twentieth century, arguing that a concentration of wealth amongst the upper echelon caused the most recent crisis. I spoke with Professor Hyman about the history of debt in America and the impact that American banks, particularly Citigroup (NYSE: C), had in rising consumer debt in the past half century.

According to Hyman, a lot of discussion about consumer debt has been misguided by a focus on demand for debt. In fact, higher debt was the result of a greater supply of consumer debt in the latter half of the twentieth century. "All the big banks are instrumental to America's debt reliance," according to Hyman. "I write about Citibank extensively in the book. I interviewed former CEO John Reed who developed Citigroup in the 1970's. On the basis of his success in credit cards, he was able to become CEO of the company."

Reed's success with credit cards was backed by stagnant wages and a demand for higher yields from high-wealth investors. "While demand for debt increases because wages stagnate, the supply of debt increases also because wages stagnate. Since 1969 average wages have grown 3 percent while GDP has grown exponentially. Meanwhile, more capital is being concentrated at the top of society that needs to be invested," Hyman said. "The way we justify inequality in capitalisy is that it's okay because we need investment. Every macroeconomic class teaches that savings equals investment. But what is lost in that simple idea is that it actually matters what we invest our money in."

According to Hyman, stagnant wages and the demand for investment created a perfect storm that motivated investment in consumer debt instead of more productive ventures. "With securitization and the declining profit of other kinds of investments, people invest extra capital concentrated at the top into consumer debt rather than into business debt," Hyman said. "You can see this in who is buying consumer debt. In the 70's and 80's small banks were the biggest buyers of mortgage-backed securities. They used to invest in medium-sized businesses, but it suddenly became easier to invest in MBSs from somewhere far away."

This move towards financing consumer lifestyles is unproductive, Hyman says. "There is this pernicious process by which easy investment in consumer debt strangles productive investment."

This is not the result of government-led or market-led activity, but is the result of a worst of both worlds compromise between libertarianism and liberal economics. "There was a wave after the Great Depression when business people recognized that unregulated capitalism was bad," Hyman says. "For example, the aerospace industry had government-led corporations encourage growth for private companies related to the industry. Government and private sectors need to work together to create profitable structures that grow the economy. We've lost sight of that--that the cooperation between both is what helped the economy grow after World War II."

At the same time, government and private-sector cooperation has facilitated the financial world's move towards a focus on consumer-led debt. "In the book, I talk about how investment bankers facilitate in close collaboration with the government. It's the government and Wall Street collaborating that transforms lending practice." Instead, Hyman would like to see "bipartisan reform that moves away from either Wall Street or Washington to rebalance the scales to get the money going back to productive enterprises." In other words, a stronger investment in productive activity like manufacturing and job creation and not in consumer debt such as mortgages and credit cards.

Consumer debt, Hyman insists, is the inevitable result of stagnant or fallen wages and skyrocketing service costs. "A lot of debtin America isn't just people buying televisions and necklaces, but it's because they have medical debt. We don't have a national health service. The Europeans and Japanese don't have to worry about that. Americans have to pay for those premiums; even if you are living within your budget and you get sick, now you're in debt. American debt goes beyond Americans buying too much stuff. There are structural questions at play," he insists.

The structural flaw in America's current economic system is perhaps Hyman's most bonechilling argument. From his perspective, the market crash of 2008 didn't happen because of a few rogues breaking the rules--in fact, most people were following the rules quite closely. In reality, the crash was because the rules themselves lead to economic disaster. "We focus on prosecuting bad apples--the people who did insider trading and defrauded people and submitted incorrect reports and those kinds of things," Hyman said. "I think it makes us all feel good to think that the rules work, but what actually happened was that most people--mortgage bankers, consumers, and regulators--followed the rules. There was probably no more fraud in the last decade than at any other time, but the rules were structured such that we had terrible outcomes."

Hyman believes that "regulations that move capital towards profitable enterprises that produce jobs" would fix the problem. Credit "is a good thing to help people who are going to buy goods in the future, but it will only work if people improve their wages in the future."

He doesn't think that's what we will see, however. "We're going to focus on putting a few people in Wall Street in jail and we're not going to have the real conversation about jobs for average people in America, and until we have that conversation it's not going to get back to the way it used to be. As long as we produce an economy that pays people with Ph.D.s from MIT a lot of money, our economy is not going to improve."

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