Three Financial Myths That Need to Be Changed, Now

No, it wasn’t 9/11 that changed everything: it was Lehman Brothers.  With that firm’s failure, the plug was pulled from the warm bath that we imagined ourselves to be living in.  Now we’re seeing industries fail faster than Congress can stuff money into them, and our major creditor, China, is warning us about piling up too much debt and threatening to take away our car keys.

We are saving too little and piling up too much debt.  And the rationales voiced by the politicians for their bailout plans are starting to wear thin.  We need to free ourselves of myths that have sustained too much national economic policy.

1. Consumer spending will lift us out of trouble.  Actually, consumer spending is getting us into worse trouble.  It may turn out that Detroit’s problems began before the First World War when Henry Ford raised his employees’ wages generously, correctly calculating that this would not only buy loyalty but also turn them into consumers able to buy their own company’s products.  The trouble is that when you encourage consumer spending, you are diminishing the real value of wage increases.  If we mindlessly pump money into the consumer sector, it may generate business but soon will lead to demands for more wage increases from the same employers who are about to go under now.

2. Consumer and mortgage debt is good.  The subprime loan phenomenon is only a small part of the mortgage balloon that has expanded beyond recognition since 1935.  Federal policy shifted the standard mortgage from 15 or 20 years to 30 years, reducing the monthly payment and enabling house prices to rise.  Federal support of homeownership grew dramatically as a way to boost housing construction for returning veterans of World War II.  Mortgage industry demands led Congress to authorize variable rate mortgages and other exotic products in the 1980s, leading directly to no-money-down financing and “no-documentation” loans in the 1990s.  But when all these policy decisions cause home prices to rise, the amount of house you can afford stays the same — it’s just that the price has gone up, the mortgage payment has gone up, and you have been made able to afford it by deducting the interest and spreading out the payments.

Even apart from the current crisis, these props for the homeownership policy no longer make sense.  No one stays in a home for 30 years anymore, so there is absolutely no pretense that a 30-year mortgage will ever be repaid on schedule.  And allowing a tax deduction for interest makes owned housing more affordable, but does nothing for those who have chosen to rent their housing — either because they cannot afford to buy, or because their jobs require them to move frequently.  What these loan products do is to force consumers to invest a large part of their net worth in a single highly leveraged investment, a home which may rise in value (especially in a bubble) but which may also decline in value, disastrously.

Nor is credit card debt a good way to make consumers more secure.  Thanks to Congress, state usury laws have been wiped out as constraints on the amount of interest credit card issuers can charge.  Much of the debt that winds up on credit cards carries a rate of interest that would be considered loansharking if the banks were not licensed — and recent changes to the bankruptcy laws make it much harder to wipe out credit card debt in bankruptcy.  (Astoundingly, even those giveaways have apparently not rendered credit card issuers immune to the financial crisis.)  Any bailout “solution” that increases the debt load on ordinary consumers should be regarded as suspect.

3. All spending is equal.  We measure our economic health by gross domestic product, consumer spending, and other macro measures that fail to distinguish between buying a new refrigerator or buying a video game system.   There is nothing in our economic policy that encourages people (or businesses, for that matter) to spend money on necessities rather than on discretionary items.  We saw this recently when failing banks continued to fund lavish conferences at exclusive retreats for their executives.  It’s all deductible as a business expense, so why not?

It’s hard to construct a federal policy that encourages saving.  The only real way to do so is to end the federal policies that discourage it, and force lenders through better state and federal regulation to do their job of granting credit only to those who can repay it.

1. Lower Credit, Increase Saving. One first step in countering the pernicious effects of these myths would be immediately to repeal the two most significant federal laws that protect the credit card industry — federal preemption of state usury laws and federal bankruptcy laws that treat credit card debt differently from other types of debt.  This would result in a vast reduction of consumer credit, and in the short run would reduce consumer purchasing.  In the long run it would increase consumer saving as a means of accumulating the money needed to buy things that are truly necessary.

2. Make Mortgages Solid; Make Renting An Option.  Allow a tax deduction for rent paid to a landlord.  Reestablish standards that require a 20% down payment for most mortgages.  Make the “slicing and dicing” of mortgages illegal and force a licensed bank or mortgage lender to keep its money on the line for the entire amount of the loan.  End federal preemption of state laws that regulate the more exotic types of mortgages.  These four measures would reduce the volume of mortgage money available and channel it into loans that really can be paid back, stablizing home prices at a more realistic level while putting the rental option on an equal footing with homeownership.

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