We talked about the history of debt, why budgets are flawed, a historical view of bankruptcy, payday lending, loan sharks, debtors’ prisons, debt peonage, why creditors don’t care if you repay your debt and the role of the consumer as a cog in the economy. We also talk about the change in lending in the 1980s when lending changed dramatically so that lending itself became the end goal instead of using lending to move products to generate profits. Once this happened the goal of the lenders was to generate loans to package into large bundles to sell all around the world.
We also talk about the benefits of bankruptcy and why bankruptcy is the critical part of driving capitalism in order to minimize the risk of entrepreneurship. Without bankruptcy, many companies would be significantly less likely to take risks. But over time the purpose of bankruptcy laws have shifted but life has shifted as well. In modern life the need to have access to loans helps to drive the economy. Without bankruptcy, consumers would become so overloaded with debt that at some point the economic engine would slowdown if we didn’t clear the bad loans out of the way. Dr. Hyman shares some significant insights about what has brought people to bankruptcy.
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Steve Rhode: Thanks for joining us. I’m Steve Rhode, your Get Out of Debt Guy from getoutofdebt.org, and this is the Get Out of Debt Guy Show. With me today is Dr. Louis Hyman, a brilliant mind when it comes to the history of debt. When I say the word “history,” some of you might be thinking that the history of anything doesn’t apply to your life today, but you’d be wrong. It’s important for us to look back at the history of debt so we can use those lessons to better understand how to deal with debt today.
So today we’ll be talking about why creditors don’t want people to repay debt; how you are really an investment and not just someone who owes a debt; a bit about debtors’ prison, bankruptcy, payday lenders, and why budgets just are not realistic.
Joining me today is Dr. Louis Hyman, who is at Harvard and the American Academy of Arts and Sciences. He’s a historian who studies the history of debt, and the author of an upcoming book, Debtor Nation. And best yet, he’s an all-around nice guy. Well, welcome, Louis.
Louis Hyman: Thanks, Steve. It’s great to talk with you today.
Steve Rhode: You know there’s a big move afoot right now when we talk about debt and we talk about the recent history, the subprime, and what consumers are going through, and we talk about the little nuances of new regulations, about debt settlement and credit counseling, but there’s a huge history of debt in America. And right now there’s actually a move afoot to restrict the maximum interest rates for payday loans for example. What does history teach us about the consequences of strict bans on interest rates and forcing them downwards in an effort to protect borrowers? Is that a good thing? Or how should we deal with that? What does history tell us?
Louis Hyman: The most important thing is around World War One, when progressive reformers began to see that so many working class people borrowed at exorbitant rates from loan sharks. And when they did, they wondered why can’t they just get loans somewhere else cheaper? And the answer was these maximum interest rates. So there were laws, usury laws, around the country that capped out how much money you could lend legally to someone. And these reformers saw that if they could change the law so that the legal amounts of interest could be raised to about 3.5 percent a month, then these borrowers could go to regular kinds of lenders rather than loan sharks.
Steve Rhode: Have you heard the name Arthur Ham before?
Louis Hyman: I have. He was very important in the creation of these so-called small-lending laws, these model small-lending laws that were very important around World War One. And through his work and the work of the Russell Sage Foundation, they promoted this small lending across America. And by the early 1920s, many states had changed their laws so that working people could just go to a industrial lender or a small-loan lender and get money from them instead of from loan sharks; which, though, at about 40 percent interest rate today is a very high rate of interest, at the time it was considered very low.
Steve Rhode: You know the interesting thing about Arthur Ham is that he was a graduate student at Columbia University who was totally against small-loan lenders and then went and studied the industry and then reversed his position.
Louis Hyman: Yes, that’s the funny thing about academics: we sometimes actually learn from the things that we study. I certainly have. So Arthur Ham and other people involved, like Rolf Nugent and Clarence Wassam, these people all sort of studied the problem and saw that the problem was not with lending itself, but with the fact that the caps placed on lending pushed people into these very exploitative kind of relationships to the loan sharks. And they saw the loan sharks as much worse than the small-loan lending itself.
Steve Rhode: Do you think there’s a need today in order to drive down payday lending? What will happen if we eliminate payday lending altogether?
Louis Hyman: Well, I think people will still need money. The need for money is what drives all this, so if you don’t provide it in the market, they’ll find it outside the market. And people will find that kind of lending is far more dangerous and unregulated than any kind of payday lending.
The problem with payday lending is not that the rates are high. The problem with payday lending is that the people who are borrowing don’t make much money. The problem is not about the debt itself, but the ability of the borrowers to repay that debt, and that’s what has made payday lending come back in such a vicious way in the last 30 years. For most of the 20th century, it was not that bad.
For most of the 20th century, in some states it was outlawed, but in most states you could get a small loan if you were a working person. And though the rates of interest might have been high by today’s standards, they actually helped people get through hard times. You need to borrow money ‘cause someone gets sick; you need to borrow money ‘cause you wanna get some kind of – take a trip or buy a car; or you need money for God knows what, but it’s important for people to have access to that kind of money.
Now, what changed after 1970 was that wages began to stagnate, and with the stagnation of wages, people were unable to pay back the debts that they had borrowed before.
Steve Rhode: So if wages had continued to rise at the same level, it wouldn’t be a problem; it would be a never-ending cycle.
Louis Hyman: Exactly. So that what you see from the period from 1945 to 1970 is that while the amount borrowed by Americans increases steadily, the amount paid back by Americans also increases, so that it’s a virtuous cycle: people borrow; it stimulates factories and shops, creating jobs, enabling people to borrow more. What happens after 1970 is that that system breaks down, and that the money people borrow is now no longer able to be paid back as easily.
Steve Rhode: You know, that’s interesting, because right now we have a need to stimulate the economy, and we want to encourage people to go out and spend in order to drive the economy again. But if wages are not going to increase, then rather than a good thing, that’s just driving in a downward spiral, isn’t it?
Louis Hyman: Exactly. So the virtuous cycle works fine as long as – we all know that we live in an unequal society, that the people on the top have most of the money. And in the post-war period what happened would be they would make the money, and then these large corporations and the people on the top would make the money, but then it would come back to most middle class people, the working people, through wages.
But what you see after 1970 is increasingly a system where, instead of being paid back to the working people, it’s lent to the working people, so that people no longer can spend that money. They have to borrow to spend that money, and it breaks down the system entirely.
Steve Rhode: So how do we change the dynamics to alter the system to make it work for the average person?
Louis Hyman: Well, we need to expand the conversation away from just debt to talk about wages and to talk about what is driving the forces in our economy that it’s making it so unequal that necessitates people borrowing. Some borrowing is great; I mean it’s better to have a car today than to walk for 20 years while you’re saving up for it – don’t get me wrong. But what’s important is that we talk about why people borrow and not just how they borrow.
Steve Rhode: You know, there’s been a tortuous history in the United States with bankruptcy. We’ve passed bankruptcy laws; we’ve repealed bankruptcy laws altogether. At one time, bankruptcy laws were even repealed because people thought it was against the intent of the signers of the Declaration of Independence.
Now, one of more famous Americans who suffered under bankruptcy was Robert Morris. He was a financier of the American Revolution and also a signer of the Declaration of Independence. He found himself in debtors’ prison; they passed bankruptcy. He got out; they repealed it. So, there’s been a long history of it coming and going. Do you see a historical need for bankruptcy in America? And what purpose does it serve today?
Louis Hyman: Bankruptcy’s an essentially American thing. It’s a wonderful invention that Americans provided to unleash the innovation of capitalism so that small businesses could take risks and then, if things went south, the person would not be responsible. And this is really important because for every business that succeeds there’s many, many, many more that fail. But that one that succeeds really makes the economy possible. It’s the Google that succeeds that drives the economy, versus all the other companies. And if that capitalism is going to succeed, we have to encourage risk taking, we have to encourage innovation.
Now, that said, this is what underpinned the thinking behind the ultimately the final bankruptcy act that we work under today, the 1898 bankruptcy act, which assumed that most people who borrowed were borrowing for business purposes. And through this, there is a sense that you wouldn’t – because of these usury laws that we talked about before, people couldn’t really borrow vast amounts unless it was for business purposes. And so that’s what the bankruptcy law was intended to protect.
Now today, of course, nearly 100 percent of bankruptcies are personal bankruptcies, not business bankruptcies, and so the purpose of these bankruptcy laws has really shifted. But also, at the same time, we have to understand that our economy has really shifted; that when the 1898 law was passed, we were still in the midst of a transformation from a society of small business owners to a society of wage workers, and with that, debt changed as well. Debt changed from being something that was about business borrowing to being personal borrowing.
In the 19th century, if you were a farmer, you borrowed from the general store for your crop seed, for your tools, but also for your clothes and for your wife’s hat. There was no real distinction between your personal and your business life. In the 20th century there was an incredible distinction, as home and work became increasingly separated; and with that, the kinds of borrowing we did changed, so that if you borrowed for your business, it was completely separate from your borrowing for your personal life; except, of course, for many small businesses today who still act as sole proprietorships. But for most bankruptcies, it’s really based on this personal lending rather than business lending.
Steve Rhode: A lot of people have this big stigma about bankruptcy, and they feel that they have morally failed when they turn to bankruptcy today.
Louis Hyman: Yes.
Steve Rhode: Should they feel that way? And have they morally failed when they turn to bankruptcy?
Louis Hyman: Well, I’m not to tell people how they’ve failed, but, more often than not, people who are in bankruptcy were doing what they were told to do. People paid back their debts; they followed their budgets; they borrowed the ways that socially they were told to do, ways that people lent them the money told them were able to do; and probably over time most people in bankruptcy were able to use their wages to pay back their debts.
What changes is that we’re now a more volatile society, so suddenly you become sick, you lose your job, things of this sort, and then you become bankrupt. It’s really not the case that most people become bankrupt because they go out and buy too many TV sets. It’s the case that they’re dealing with either underpaid wages, or they have a sudden reversal in fortune.
But bankruptcy is a way to deal with that, because most people then borrow to deal with these moments when they need support, and in America we don’t have a social system to really support people in those moments the way they do in Europe, which has, of course, far lower rates of bankruptcy. And because of that, that’s what really causes bankruptcy and drives bankruptcy.
And there’s been lots of studies done on this. There’s been Elizabeth Warren, and you had the Consumer Finance Agency wrote a book about this in the 1980s, showing how all this system worked.
Steve Rhode: Well, luckily today we don’t have what we had at one time, which was debtors’ prison. It’s hard to believe two things, actually: first, that people still think there’s a debtors’ prison in America; and, second, that there was a debtors’ prison in America. Even a couple of very important Americans served time in debtors’ prison: there’s Robert Morris, who I mentioned before, and Charles Goodyear of the Goodyear Tire Company. He was in debtors’ prison. What was life like in debtors’ prison? And what did it take to get out?
Louis Hyman: Well, debtors’ prisons are fascinating because, of course, debt was seen at that time as a moral failure. It was seen as something that should be punished, akin to fraud, as if you had betrayed the trust of those who had given you money. And debtors’ prisons in the States were never really as important as they were in Britain. There were really only a handful of purely debtors’ prisons in the States. There was the New Jail in New York City; there was the Prune Street Jail in Philadelphia. But for most debtors in America, they were just mixed in with the general population.
Steve Rhode: All right, Louis, hold that thought. You’re listening to the Get Out of Debt Guy Show. We’re going to take a little break. We’ll be right back.
Welcome back. This is Steve Rhode, the Get Out of Debt Guy. You’re listening to the Get Out of Debt Guy Show. Today my guest is Dr. Louis Hyman. We’re talking about the history of debt. Before the break, we were talking about debtors’ prison. And, Louis, what was it like in those jails?
Louis Hyman: Within those jails, it was not like a jail today, but there was just a large room where, in many jails, where you would be there. Men and women were mixed together. People of different kinds of offenses would be mixed together. Debtors would be mixed with actual criminals. And of course in some prisons, like the New Jail in New York City, it would be stratified by class, so that the wealthiest debtors would – and of course everyone had to pay for their upkeep in the jail. It wasn’t state subsidized, so the wealthiest debtors were somehow able to buy rooms and rent these large rooms at the top of the jail. So, they could have sunlight; they could bring in desks; they could bring in their papers, conduct their business affairs from prison. They themselves were not allowed to leave, but visitors could come and go as they liked. And, of course, outside of the very wealthy, the middling classes slept in the hall. The very poor – sailors and prostitutes – might be in a damp basement.
But it’s important to realize that debt in this period, in the time of the Founding Fathers, was not like debt today; that it was in a lot of cases a substitute for currency. There just wasn’t enough money – hard, actual cash – in the economy to deal with a growing American economy, and so people used debt as a way of keeping accounts. At the same time, it was also used for businesses, so this longer idea of business. This is how most of these wealthy people came to be in debtors’ prison.
But debt was so different then. Debt could not be sold, so it couldn’t be invested in, and so the kinds of debts were comparatively small. And also, these debtors who were in prison, there was a saying at the time that the jail paid no debts: that people who were in jail couldn’t work, so how could they pay off their debts. So it was a very complicated system of trying to extract money from people, particularly the wealthy, who would then be forced to sell off assets.
But for people who were less well off, it was a difficult system to really pull off. And by the 1830s, debtors’ prisons in the States were gone – definitely at the federal level – and by the middle of the 19th century were gone all over.
Now, that said, debtors’ prisons as buildings, as places to go for debt, may have gone away, but imprisonment, in the larger, more metaphorical sense continued well into the 20th century, so that a very important form of debt after the Civil War was something called debt peonage. So if debt was stopped being a building it becomes a field, particularly in the South, where people would be – through corrupt judges and sheriffs – put in jail and then released with a bond to a plantation owner and then forced to work off this debt, which, like today, could never be repaid. And people would spend their entire lives trying to repay debts they incurred 20, 30, 40 years ago to a landowner. This system occurred well into the 1930s and in some more isolated parts of the South until the 1950s.
Steve Rhode: Well, thankfully we don’t have that any more.
Louis Hyman: Yeah, it could be much worse.
Steve Rhode: You know, that’s a good point. It could be much worse. I deal with people all the time that feel like they’re at the end of their rope and actually some people that are thinking about committing suicide because they can’t deal with their debts. But the reality is that as bad as it is today, it was historically much, much worse.
Louis Hyman: It was much worse, but you have to also understand that today, when someone lends you money, they know that sometimes you’re not going to pay them back. They calculate that into the interest payments; they calculate that into everything that goes into the decision to lend to you. And so I feel that this moral problem of debt is really a business problem of debt, really an economic problem. And the morality we ascribe to debt I would hope that most people would not feel. I would really hope no one would kill themselves over debts, and that’s exactly why we still need personal bankruptcy in this country; because, ultimately, the companies that lend can calculate that you’re not going to pay them back. They never expect everyone to pay them back.
Steve Rhode: That’s interesting. If a company is crying that people not paying them back – which is always a small percentage out of the total lending pool –
Steve Rhode: Yeah.
Steve Rhode: If people aren’t paying them back – it’s really hurting them; it’s going to drive them out of business – I guess the lesson to be learned from that is that the companies just didn’t price their product appropriately to begin with, and I guess that’s their fault, isn’t it?
Louis Hyman: That’s definitely my perspective: that they’re mismanaged; they miscalculated risks; that the interest rate is meant to provide a profit to the company and to offset the risks that someone will not pay them back, right? And if they feel like there’s too much of a chance that someone will not pay them back, then they don’t lend the money at all. This is a business decision, right? This is not a moral decision.
Steve Rhode: So businesses today, creditors today, make it really tough to repay a debt that you can’t afford according to contractual terms. Do you have any sort of insight or point of view on whether or not creditors should allow for some flexibility for people who can’t make the minimum payment? Or should they just drive people into bankruptcy when they can’t afford to repay?
Louis Hyman: Well, this system really arose in the 1970s and ‘80s, and to understand why they don’t want you to repay the debt, you have to understand what this money is doing. This money is being lent. Money became very easy to lend, this easy credit to Americans, in the ‘70s and ‘80s and ‘90s through something called securitization, where a company could lend you money and then resell it as a bond in the capital markets and around the world.
And once they were able to do this, a huge amount of money flooded into the consumer debt markets, and the purpose of that money was to make money. The purpose of that money was to create interest. It was not to have that debt easily repaid. And for lots and lots of these companies, that is what is driving, ultimately, this state of affairs where they don’t actually want you to pay off the debt. It’s because there’s – if you paid off the debt, they would have nowhere else to put that money. You are an investment to them; you are an investment that’s supposed to produce a revenue stream. And if you paid it back, then they would get no more interest out of you.
This is the real difference between what the economy was like in the post-war period – the ‘50s and ‘60s – and our period – the ‘70s, ‘80s, ‘90s and today. In the ‘50s and ‘60s, people lent money to consumers so that they could buy other products, so that it was a means to an end. It was a way to help people buy cars, to buy furs, fur coats, to buy houses; and those products provide the real profit. The financing was incidental. Today, those kinds of products don’t provide much profit. The real profit is in the lending, and it’s because of that that our economy is so screwed up the way it operates around that in terms of financing consumers.
Steve Rhode: You know, I’ve been in the debt world a long time, and the last two minutes of the information that you just shared I think changed my life. I had not made that connection before. That’s fascinating.
Louis Hyman: Thank you. I’m glad that there’s still something to be said new about that.
Steve Rhode: What would life be like, looking in your crystal ball? I’m asking a historian to look forward, which is a little bit unusual, but –
Louis Hyman: We don’t like to do that.
Steve Rhode: No, no. But what would life be like if we severely restricted credit and lenders cut back to making loans that people could appropriately qualify for?
Louis Hyman: Well, first of all, a lot of finance companies would go out of business, so that this huge driver of profit in our economy would go away. And it would, first, wreck Wall Street. It would wreck capital markets, which might be a good thing in the minds of many people. For consumers, I think it would mean that they would be unable to borrow for many of the things that they want to borrow for today.
And for many of them – you know for those for whom it would be discretionary purchases – then it would be just kind of annoying, but for a lot of people, particularly ones in hard places – they lose their job, they’re living off credit cards – it would really be a way to push consumers back into the grips of the loan shark. And I think it’s hard to really grasp how widespread and pernicious loan sharks were before the availability of legal credit. It wasn’t just a sort of romantic Sopranos kind of environment. It really was something that preyed on average people every day, and something we really do not want to move back towards.
We need to think about why people borrow rather than whether or not they should pay back what they borrow. We need to think about ways we can help them without them getting into debt in the first place, and we need to help companies lend to people who can pay back their debts while still making a reasonable profit. I think part of it is that maybe if they couldn’t make so much money, if companies couldn’t make so much money off consumers, they would be forced to innovate. They’d be forced to look for other ways to use their capital, and perhaps that would be better for the economy as a whole. Now, in the short run, it might hurt.
Steve Rhode: You know, it’s a real love-hate relationship between debtors and creditors. Using history as our guide, is there a need for easy credit at all?
Louis Hyman: I think easy credit is important in the sense that it’s easy to get credit if you deserve it; so that in terms of getting rid of discrimination, to appraising people just on their economic ability to borrow, I think that’s really important.
Steve Rhode: So one of the situations I see every day of people who are in deep debt, and they feel such a need, a personal need, to repay their debt that they leave themselves in terrible situations for the next five years trying to repay, not able to save, making it month to month; versus using something like bankruptcy to put that debt behind them and to do better moving forward. Do you have any sort of opinion about that?
Louis Hyman: Yeah, I mean, of course, as soon as you file bankruptcy, you immediately get flooded with credit offers because you’re suddenly a very good prospect: you have no debt on your back. So it’s obviously not a moral thing; it’s a risk thing. Yeah, Elizabeth Warren’s work has really shown how people, even when they know they can never pay back what they’ve borrowed, still try to. And I think it speaks to the American character that people really want to be honest, and they want to get by, and they want to believe that the system can work for them. And unfortunately that’s just not true.
Unfortunately, most people are unable to pay back – a lot of people are unable to pay back money they borrowed ‘cause their situations have changed, right? You have a good paying job at a factory or an office, and you get downsized, and you’re never going to make that money when you get another job. You’ll get another job, but you’ll never make the same amount of money again, and you still have the house payment, the car payment, all the credit card bills. You did everything you could.
In a lot of ways, budgets are really dangerous things, because they make you believe – they create order in your finances, but they don’t create order in the world; they don’t create order out there where you’re actually working and buying. They make you think you have control, but you don’t.
Steve Rhode: You are a freaking rock star. I just want you to know that somewhere in this world a group of people, including my readers, are going to think that you are a rock star.
Louis Hyman: Thanks so much, Steve. I appreciate that.
Steve Rhode: Did you like this show and want to hear more? Just subscribe via iTunes, or subscribe to the free RSS feed from the getoutofdebt.org site. You’ll find the links for all of this on the right hand side of the website. Do you have a question you’d like to ask? No problem. Visit getoutofdebt.org and follow the links to ask your question online right now. Thanks for joining us. This is Steve Rhode, your Debt Out of Debt Guy, urging you to practice safe debt till we meet again. Bye for now.