LouisHyman

BORROW

Louis Hyman attended Columbia University, where he received a BA in history andmathematics. A former Fulbright scholar and a consultant at McKinsey & Co., hereceivedhisPhDinAmericanhistoryin2007fromHarvardUniversity.Heiscurrentlyanassistantprofessor inCornellUniversity’sSchoolof IndustrialandLaborRelations,whereheteacheshistory.

AlsobyLouisHyman

DebtorNation:TheHistoryofAmericainRedInk

AVINTAGEBOOKSORIGINAL,JANUARY2012

Copyright©2012byLouisHyman

Allrightsreserved.PublishedintheUnitedStatesbyVintageBooks,adivisionofRandomHouse,Inc.,NewYork,

andinCanadabyRandomHouseofCanadaLimited,Toronto.

VintageandcolophonareregisteredtrademarksofRandomHouse,Inc.

AportionofthisworkfirstappearedinslightlydifferentforminTheWilsonQuarterly,Winter2012.

LibraryofCongressCataloging-in-PublicationDataHyman,Louis,1977–

Borrow:theAmericanwayofdebt/LouisHyman.p.cm.

eISBN:978-0-30774490-61.Consumercredit—UnitedStates—History.2.Debt—UnitedStates—History.3.Loans,Personal—UnitedStates—History.4.UnitedStates—Economicconditions.5.UnitedStates—Economicpolicy.I.Title.

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CONTENTS

Cover

AbouttheAuthor

OtherBooksbyThisAuthor

TitlePage

Copyright

Dedication

INTRODUCTION

EverythingOldIsNewAgain

CHAPTERONE

WhenPersonalDebtWasReallyBusinessDebt(2000B.C.–A.D.1920)

CHAPTERTWO

EverybodyPaidCashfortheModelT(1908–1929)

CHAPTERTHREE

FannieMaeCanSaveAmerica(1924–1939)

CHAPTERFOUR

HowILearnedtoStopWorryingandLovetheDebt(1945–1960)

CHAPTERFIVE

DiscountedGoodsandDistributedCredit

(1959–1970)

CHAPTERSIX

BringingGoodThingstoLife(1970–1985)

CHAPTERSEVEN

IfOnlytheGnomesHadKnown(1968–1986)

CHAPTEREIGHT

TheHouseofCreditCards(1986–2008)

CONCLUSION

TurningtheMagicofBorrowingintotheRealityofProsperity

Notes

Acknowledgments

IllustrationCredits

INTRODUCTIONEVERYTHINGOLDISNEWAGAIN

“Dick”and“Jane”Smithmetshortlyaftertheyhadbothmovedtothecity,cominguponeachotherintheparkonasunnySundayafternoon.Romantic sparks flew, declarations of love were exchanged, rings andvows followed—and then they began their search for a home of theirown,wheretheywouldstarttheirnewlifetogether.Dickhadn’tgonetocollege,buthehadrecentlyfoundworkinanew

industrywhoseproductsweresweepingthecountry.Thecompany’sIPOafewyearsbackhadbeenoneofthemostsuccessfulinhistoryandhewas going to help manufacture the killer product that, as one of hisexecutives had said in his firm’s annual report, had “given us allsomething worth working for.” Dick and Jane, like the rest of thecountry, were caught up in the heady optimism of what newspaperpunditssaidwasaNewEra.Flushwithloveandshortoncash,theSmithswenttotheirlocalbank

tofindoutiftheycouldgetamortgage.Thehomethattheywantedwasexpensive, likeallhouses thosedays,but theSmithsknew thathouseswere a good investment. Prices had gone through the roof in the pastfew years, and real estate was always a sure thing. “You can’t makemoreland!”Janerememberedherfatheralwayssaying.At the bank, the Smiths met with a well-dressed mortgage officer.

Lookingovertheapplication,themortgageofficeraskedthemfarfewerquestionsthantheyhadexpected:howlonghadDickhadhisjob,howlong had they lived at their current address, howmuch did hemake?After a few calculations, themortgageofficer somberly informed themthat an “amortized”mortgage—one inwhich they repaid against bothinterestandprincipaleverymonth—wouldnotgetthemthehousethey

wanted.Dick’sincomewasjustnotenoughtocoverit.ButtheSmithsdidn’thavetoworry.Thebankofferedanother,betteroption thatmost smart peoplewere using those days: an interest-only“balloon”mortgage.Withaballoonmortgage,DickandJanecouldbuythehouse immediately,sleepingsoundlywiththeknowledgethattheirhouseholdincomehadnowheretogobutup,rightalongsiderealestatevalues.Whenthetimetopayofftheprincipalfinallycameafewyearsdown the road, they could simply refinancewith a new loan thatwasjustasaffordableasthefirst.Whyslowlypaydowntheprincipalwhentheywouldprobably justsell it formore ina fewyears,anyhow?Likethemortgageofficerhadsaid,itwasthesmartthingtodo.Infact,theywouldhavetorefinancesincetheloanwasforonlyfouryears, but that wouldn’t be a problem at all. The mortgage officerexplained, in confident tones, that refinancingwouldnever againbe aproblembecausebankshadstartedissuingmortgage-backedsecuritiestofinancetheircustomers.Investorswerealwayslookingforagooddeal,andrealestatewasasurething.Four years! Dickwould almost certainlymove up in his burgeoninghigh-techindustryinthattime.Janealreadyenvisionedabiggerspace,the envy of her sisters. The couple looked at each other knowingly,trusting in theguidanceof themortgageofficer,andsignedthepapersheofferedthem.Dick and Jane thought they couldn’t go wrong. They were in themiddleofoneofthegreatesthousingboomsinU.S.history,withhomevalues seeming to double every time they turned around. Developerscouldn’t build houses fast enough. Smart buyers would act fast, theythought, before home prices rose evenmore. There was no risk, onlyreward.DickandJanemovedintotheirhouse,andDickwenttowork.Withinthe year, orders began to slow down. He didn’t lose his job, but hisovertimewascut.Thenithit.Atfirstthebigstockmarketcrashdidn’taffect him, but it soon spilled over into the real world. Everywhereconfidenceintheeconomyslid.Thenewspaperstoppedusing“NewEra”except in derision. Then, just as he had to refinance his house,everythingfellapart.House values began to plummet; balloon mortgages becameimpossible to refinance; foreclosures in their neighborhood became,

seeminglyovernight,morecommonthanrare.Likethestockspeculatorswhohadborrowedon themargin,millionsofAmericans just likeDickand Jane were living on the edge of their household incomes so thatthey could “own” their homes. Theywould be fine, though—wouldn’tthey?—because theirmortgage fit their budget. All too late, Dick andJane realized that they were speculating just like those hucksters onWallStreet.Dickwalkedintothesavingsandloanonlytofindthathismortgageofficerhadbeensacked.Hisreplacement,considerablylessfriendlythanhispredecessor,toldhiminnouncertaintermsthathehadtocomeupwiththeprincipalorhewouldbeforeclosedon.Dicksputtered.Hehaddonewhat theman in the suithad toldhim.Howhad thishappened?Before turninghisbackand returning tohiswork, thenewguyat thebanktoldDickthatinvestorsnolongerwantedtobuyrealestatebonds.The well was dry. Without mortgage funds to lend, the bank had tocollect.When thebank repossessed theirdreamhouse,DickandJanedidn’thaveeven themostbasicofpersonal luxuries—no iPod,no tablet,notevenahand-me-downsmartphone.Desperateastheywere,theyliterallycouldn’tevengivethosethingsupinonelastfruitlessefforttosavetheirhome.Afterall,noneofthemwouldbeinventeduntilthenextcentury.Itwas1932.Dick had gotten his manufacturing job at General Motors in Flint,Michigan,onlyafewyearsearlier.LikeJane,Dickwaspartofabroadpopulation shift from the country to the city in the early part of thecentury that tipped the census, for the first time, in favor of urbanAmerica.Aftermovingto thecity,DickandJanedidwhatsomanyoftheirgenerationdid:theyborrowed.Asinvestorsfledthemortgagemarkets,theU.S.housingindustryfellapart—not initially from unemployment but from a credit crisis. By1933, the national foreclosure rate had reached 1,000 homes a day.After four years of withdrawals that withered even the sturdiest ofmortgagefunds,in1933theU.S.housingindustrywaseffectivelydead,having shrunk to just one-tenth what it had been only a few yearsbefore.AthirdofallAmericanfamilieswhoqualifiedfor“relief”attheheightoftheGreatDepressionlandedtherebylosingaconstructionjob.Dickdidn’tworkinconstruction,buthisbusiness,buildingautomobiles,

washitjustashard.The1920sweresimilartotodayintermsnotonlyofyoungloveand

mortgage debt but of all forms of debt. In fact, it was the spread ofautomobile debt that had given Dick his job in the first place.Automobile finance emerged after World War I as one of the hottestindustries,spreading itsmethods in justa fewyears tonearlyallotherhousehold durables. Vacuum cleaners, washing machines, and oilburnerscouldallbehadonthe installmentplan.TheU.S.savingsratedropped precipitously, and nearly all of what would have been savedwentintopayingoffinstallmentcredit.Inthe1920s,Americans,bothborrowersandlenders,discoverednew

ways to finance consumer credit, and of course that was only thebeginning.Debtwaseverywhere,anditsubiquitywasmadepossiblebychangesinfinance,manufacturing,andlawthathadoccurredaftertheFirstWorldWar.Highinterestonconsumerloanshadlongbeenillegalin the United States, but around World War I, progressive reformers,seeking to drive out loan sharks, pushed states across the country toraisethelegalinterestrate.Nowabletolendmoneylegallyatratesthatcould be profitable, a new consumer finance industry sprang upovernight. The changes coincided with a new generation of cars andelectrical appliances that were both expensive and mass-produced.Installment credit allowedmanufacturers to sell these newwonders athigh volume, and consumers could afford them because of the easymonthlypayments.Whatultimatelymadeall this lendingpossiblewasthatlenderscouldnow,forthefirsttime,reselltheirdebt.Networksoffinancestoodbehindeachconsumerpurchase.WhenDick

boughthisfirstcar,thedealerhadhimsignsomepapers.Dickagreedtopay for thecarover twenty-fourmonthsandpaysomeadditional fees,butthatwasit.Heneverknewwherethemoneybehindthecreditcamefrom,andifhewonderedatall,heprobablythoughtthatitcamefromthedealer.Butthedealertookthatagreementandsoldit,thenextday,to General Motors Acceptance Corporation (GMAC). The dealer didn’thave the capital to finance all his customers, but GMAC did. GMACcould issue bonds in the market or use its own profits to finance itsdealers.Asnetworksdeveloped for all formsof debt—mortgages, cars,retail—creditbecamecheaperandeasiertouse.Retailersandfinanciersusedcredit todrivetheirsalesandprofits.Somenetworks,suchascar

financing, emerged from the private sector, while others, such asmortgages,emergedfromthefederalgovernment.Wherevertheycamefrom, the new networks of debt made this consumer utopia possible.Whenthosenetworksfailed,aswiththeresaleofmortgagebondsduringtheGreatDepression,creditcouldjustasquicklyturndystopian.

TheSkinnyManandtheFatManrevealaworldwherelendingisnotprofitable—theoppositeoftoday.(IllustrationCreditsitr.1)

This picture could have hung in any small late-nineteenth-centuryshop—maybeagrocery,maybeahardwarestore—anywhodidn’twantto give more credit to its customers. Though cash loans were illegal,legalcreditinthenineteenthcenturywasretailcredit—butitslogicwasnearly the mirror image of today. Today credit lending is profitable,however, in the nineteenth century itwas anything but. Thewell-fed,prosperousman sold only for cash,while the emaciated, nervousmanwiththemicesoldoncredit.Thepicture’smessagewasclear:wedon’twanttolend.Yetitslogic,like ours today, was grounded in a very particular set of historicalcircumstances. Borrowing is more than numbers, it is a set of

relationshipsbetweenpeopleandinstitutions.Morethananygraph,thispicture, ifwe can understand it, clarifies the differences between thenandnow—andhowdebthaschanged.Shoppingeveryfewdaysforfood—generallythelargestportionofan

1890budget—customerscouldquicklybuildupatab.Onpayday,wivesweresupposedtostopbyandsettlethebill.Yetmanydidnot.Grocerscharged higher prices for credit purchases, but there was no interest,whichwouldhaveviolatedusury laws.So if someonepaideveryweekordidn’tpayformonths,itwasthesameprice—andthesameprofitorlack thereof. Shopkeepers could quickly lose money on credit salesbecausethemoneytheylentwastheirown.Customer credit came out of the grocer’s own pocket not a bank’s

coffers.Asyoucanseeinthepicture,thecreditlender’svaultisemptywhilehisbasketisfilledwithIOUs.Americansdidn’thavecreditcards.Nobankwouldlendtheskinnyguymoneytofinancehiscustomers.Nothirdpartywouldbuythedebtandtrytocollectwhatwasowed.Loanswere not commodities bought and sold as they are today. In oureconomy,financiersfigureoutwaystogetustoborrowandthenresellthe debt to investors. Debt is produced like any other commodity—shoes, steel, computers—for the market. Buyers of our debt—whethermortgages, credit cards, or car loans—evaluate it like any otherinvestment,weighingthereturnagainsttherisk.Today’sdebtiseasytoresell. In the 1890s, consumer debtwas business error. That is to say,bankers andentrepreneursdidn’t thinkdebtwasagood investment. Itwasnotagooduseoftheirscarcecapital.Consumerdebtwasawaytolosemoney.Ifwecanunderstandhowthisgrocerturnedintoourretaillifetoday,wecanunderstandhowsmallloansbecamebigbusiness.Wecanunderstandhowcreditorsbecamefat.Whowouldinvestindebt?Thehistoryofhowcornergrocers,andall

otherretailers,begantoreselltheirdebtisacomplexone,spanningthetwentieth century from the first automobiles to our present financialcrisis.Thoughborrowingmightbeasancientascurrencyitself,marketsfor consumerdebtareasmodernasabobbedhaircut. In the1920s, afewchanges inbusinessand lawcame together tomovepersonaldebtfromthemarginofcapitalismto itscenter, takingapositionalongsidecommercialandnationaldebt.Usurylawshadlimitedinterestratesforcenturies, but progressive reformers, seeking to provide a profitable

alternative to the loan shark, pushed for higher legal rates. As statesraised usury limits and institutions began to buy personal debt fromretailers, debt escaped the personal and became a commodity to bebought and sold. Once debt could be sold, it could be invested in.Personaldebtbecameaplaceforinvestorstoputmoney,connectingitwiththemostbasicoperationsofcapitalism.Though your parents told you that in the good old days nobody

borrowed, this commodifieddebtenabled thegrowthof the twentieth-century economy. In the Roaring Twenties, Americans used thisresellable debt to buy their first automobiles, and, having learned thetrick,retailersbegantopromoteinstallmentcredittosellalltheirothermanufacturedgoodsaswell.The first insight that allowed themodernpersonal debt system to arisewas deceptively simple: though personalloans were never invested in productive assets, the person borrowingmight himself be productive. Personal loans, when they became legalaround 1920, relied on income instead of assets for repayment. Thisinsight reflected the changing way in which Americans lived andworked.Whereas farmersmight seamlessly blend their borrowings forland, crop seeds, and hats for church, urban industrial workers hadfirmerboundariesbetweenhomeandwork.Modernworkersmightnotownassets,butbygolly,theygotpaideverytwoweekslikeclockwork.The ubiquity of the steady stream of wage income, so natural to ustoday,hadbegunonlyinthemid–nineteenthcentury,butittooksometime,andsomelegalchanges,forthenewwayofborrowingtoemerge.Turning that future income into present consumption was whatconsumer credit was all about, but implementing it was anything butsimple.Though the Great Depression ended the party of the 1920s, credit

found a new privileged position as New Deal policy makers usedfederallyinsuredmortgagestorestarttheeconomy.Outofthatcalamity,American politicians, industrialists, and financiers reorganized theeconomy,restraininglendinghereandpromotinglendingtheretocreateapostwarUnitedStates thateconomistsdescribeas“thegoldenageofcapitalism.” The upswing in consumption that defined the RoaringTwenties paused only briefly during the Great Depression to take offwithgustoafterWorldWar II.Thispostwarconsumptioncontinued tobefinancedbydebt,bytakingupincomebeforeitwasearned.Though

postwarconsumers told theirchildrenandgrandchildrenthat theyhadneverborrowedadimeintheirlives,debtwasthelifebloodofpostwarsuburbia.LivinginFHA-financedhomes,drivinginGMAC-financedcars,postwar consumers gleefully shopped on charge cards at theBloomingdale’s branch store that just opened at the new shoppingcenter. In the postwar period, Americans borrowed as much as theycould, living it up in the plush suburbs and paying those debts withgood-paying jobs. The scarcity caused by depression and war endedwhenAmericanscouldborrowagain.Thoughmostpostwarobserversofcreditmarveledatitsabilitytoturnapromiseoffuturepaymentintoaconcretepurchasetoday,critics(ofadifferentveinthanFordfromyearsprior)remained.Installmentcreditsfitneatlyintopostwarbudgetsbut,throughtheirinterestpayments,stillsapped the wealth of the American family. WilliamWhyte, before hewrotehisbest sellerTheOrganizationMan,denounced the“budgetism”oftheyoungmiddleclassinthepagesofFortunemagazine,not,asyoumight expect, for the lack of keeping a budget but for their obsessivezealinfittingthemonthlybudgettothemonthlyincome.1Budgets,forWhyte, were the “opiate of the middle class,” dulling them to thedangers of overspending. Whyte, who had come of age during theDepression,warnedtheyoungcouplesofthe1950sthatsuchfaithinthesteadinessofthefuturewasfoolish.Incomesfalterandmarketsfail.Thedangerofbudgets,ultimately, isbelieving theywill tamenotonlyyoubuttheworldaroundyou.Forthepostwargeneration,however,Whyte’swarningsprovedwrong.Themeaningofdebt,yousee,dependsasmuchonthelargereconomiccontextasonthedebtitself.Economic volatility, it seemed, had been mastered by Keynesianeconomics. Budgeters of the 1950s lucked out. Incomes grew and jobswere rarely lost. Instead of ruining workers, borrowing helped them.Home values rose steadily, and as today, all the interest on thosemortgagescouldbededucted fromone’s taxable income.Unlike today,notjustmortgageinterestbutallconsumerinterestcouldbedeductedaswell.Minksandcarswerejustasdeductibleasamortgage.Thepostwarsuburb was a debtor’s paradise. An earlier era’s anxieties aboutborrowingwereforgotteninthewarmglowofthetelevision.As debt changed, so did we. As consumers, Americans enjoyed asurging prosperity fueled by rising wages and easy credit, but in the

processthefoundationofoureconomychanged.Dollarsinvestedindebtdisplaced dollars invested in factories. Debtors began to rely on creditratherthanincometomaintainarisingstandardofliving.Indoingso,Americans became ever more dependent on the vagaries of financialmarkets,ultimatelyleadingtotheeventsofthepastfewyears.Thepostwarsplendorcameundone,suddenly,intheearly1970s.Asinflationroseand jobsdisappeared,stagflationsavagedthecomplacentworldthatmanyAmericanshadassumedwouldlastforever.The1950snostalgiaembodiedbyHappyDaysextendedtomorethanmilkshakes,as oil priceswent through the roof.Credit assumedanew role in thismore volatile age,making up the difference betweenwhatwewantedandwhatwe had. The dawning age of credit cards and securitizationwouldcontaindifferentlessonsfromthe1920sand1950sbutwouldbejustasdifficulttoignore.Understanding the history of debt gives us a sense of both debt’spossibilitiesanditsdangers.Ratherthanbeinganalwaysevilbogeyman,credithas the capacity to enrichour lives andmakeourdreams cometrue. Misused and misunderstood, though, credit can just as easilybecomethestuffofnightmares.Inthepastninetyyears,Americanshavebothsleptsoundlyandbeenmadesleeplessbecauseoftheirdebt,buttoplan where we need to go now, we must understand debt’s all-too-concreterealitiestodaynowthatweareawake.Thestoryofdebtisequallythestoryofborrowersandlenders.Mostofus,however,simplyborrowfromwhoeverwillgiveusmoney,andletthemsortoutwherethey,inturn,willborrowtheirmoney.Thoughthisisfineforbuyingacar,ifwewanttounderstandthestorybehindcredit,we have to grapple with the source of all that money and how thedecisiontoinvestindebtshapesoureconomyandguidesourlives.Borrow tells the story of how Americans came to rely on expectedfuture income rather thanmoney inhand. It is anarrative thatbeginswith that great American industrial enterprise—the automobile—andcarries through to the financial crisis of today. Showing the hiddenworldof financebehindeverydayconsumption,Borrowwillgiveyouahistorical perspective on what is new and what is not about today’seconomic turmoil. Understanding the changing role of debt requiresmore than economic jargon, it requires a human face or, even moreimportant,ahumanmind.Lendingandborrowinghadbeenstigmatized

andevencriminalized forhundredsofyears in theWest,yet inonlyafewgenerationsbecamecompletelynormal.HowdidAmericanscometobe so comfortable with borrowing? How did they draw distinctionsbetween “good” and “bad” debt—as we might have, until recently,drawnbetweenmortgagesandcreditcards?Borrowwillhelpexplainthewaysthatfinanceandfeelingsintersectedtoproducenewwaysofliving.Freed of the moral categories through which we normally encounterdebt,BorrowwillrevealtheoriginofDickandJane’screditandhowitchangedtheirlives.Borrow is, inmanyways, a uniquelyAmerican tale—but onewith a

globalfinale.

CHAPTERONEWHENPERSONALDEBTWASREALLYBUSINESSDEBT

(2000B.C.—A.D.1920)

Academic histories of debt in America usually start in Italy, theirintroductory paragraphs awkwardly positioning the fourteenth-centuryMedicibankersasCitibankersintunics.Popularhistories,suchasthosescatteredinnewspaperarticles,CEOspeeches,orlenders’pamphlets,goevenfurtherintothepast,likethisaccountfromoneofthelargestU.S.credit card companies: “Credit dates back as far as man’s knownexistence. Clay tablets belonging to the year 2000 B.C. tell of credittransactions, and records indicate that ancient Romans bought homesandotherdurablegoodson installmentplans—justasmendotoday.”1Thoughit’struethatpeoplehavealwaysborrowed,thewayinwhichweborrow in theUnited States today is unprecedented. Never before haspersonaldebtbeensocentral tohowaneconomyworks.Neverbeforehasborrowinginordertoconsumebeensuchbigbusiness.Big business, on the other hand, has always borrowed. Historians

frequentlydatethebeginningofthemoderncapitalist(asopposedtothemedieval)eratowhenstatesandbusinessesbegantoincurlargedebts.Trade,war,andChristianityturnedthedisjointedpolitiesofapeninsulaintothecontinentofEurope.Beginningwithlong-distanceIOUsfortheCrusades in themedieval period, negotiable bills of exchange enabledlong-distancetrade.This tradeslowlyreignitedtheEuropeaneconomy,layingthefoundationofmoderncapitalism.TheCrusadesagainstIslamalltooquicklybecamewarswithinChristendomitself.Warscostmoney.Startinginfifteenth-centuryItaly,Europeangovernmentsbegantoissuedebttopayforthosewars,borrowingvastsumsfromtheirownsubjects.

TheBankofEngland,foundedin1694,enabledBritaintobothfunditswarsandcreateaneasywayfortheBritishtoinvesttheirmoney.Theseliquid, deep debt markets only encouraged other forms ofnongovernmental borrowing, and national central banks underpinnedEuropean commercial banking. Merchants and industrialists couldeventually borrow from commercial banks to invest in their capitalistendeavors. In the United States, central banks had a more checkeredhistory. Though a national bank was founded in 1791, its firstincarnation lasted only forty years, as Jacksonian populism triumphedover federalism. In the United States, commercial banking, absent acentralbank,developed inamorepiecemeal fashionat thestate level.Commercialbankingwasno lesssuccessful inAmerica than inEurope,however, and as in Europe banks enabled the sustained growth of theIndustrialRevolutioninthenineteenthcentury.Thoughfinanciers,merchants,andindustrialistscouldborrowwithoutdifficultyfrombanks—iftheyhadagoodreputationandagoodbusinessmodel—ordinarypeoplecouldnot.Therewasnopersonallendingfrombanksuntilthe1920s.Legalborrowing,sincetheCrusades,hadalwaysbeen for profitable investment or for government purposes (which,depending on how you look at it, may or may not be profitable).Personal debt of an everyday nature was not part of this system.Merchants borrowed to buy inventory to trade overseas. Industrialistsborrowed tobuild rails. Statesborrowed tomakewarononeanother.ButyouandIcouldnotborrowtwonickelsforconsumption,which,byits definition, cost rather than created money. Profits came frominvestinginproductionandtrade,notconsumption.Legal borrowing, like business loans, relied on the idea of theproductive investment. Investors and bankers gave money to shipcaptainsandfactoryownersbecausetheyusedthatmoneytomakemoremoney. That is how investors and bankers knew they would get paidback. The whole enterprise of banking turned on this idea of assetsproducing profits. Loans to deadbeat brothers or aging widows mighthelp theborrowersoutofa jambutwouldnotproduceprofits. Itwasjustbadbusiness—orsotheconventionalwisdomwent.Bankruptcy laws, today nearly always used for personal debt, werecreated tohelp small-businessmen take risks. Before bankruptcy laws,debtsneverwentaway,andbeforethemid–nineteenthcentury,adebtor

couldbethrowninjail.Theinfamousdebtors’prisonswerefilledmostlywith failedbusinessmen,notdegenerate samplersofpleasure.2Debt inthe fifty years before and after the American Revolution served twowildly divergent purposes. As you might expect, loans could be forbusiness,butequallycommonwasdebtasasubstituteforcurrency. Inmostareasofthecountry,particularlyruralareas,cashwasscarce.Storeownersneededtosellonaccountiftheyweretohavecustomers.Everyyear theperiodwhenthecropcameinsawaminor financialcrisis,ascash flowed spasmodically through the economy to settle the yearlongaccounts.Small-time debtors could sometimes not meet their obligations, butevenmorethantoday,thefailuretorepayaloanwasamoralfailure—indeed,suchamoralfailurethatitcouldsendyoutojail.Today,lendingisanimpersonalact.Everylenderknowsthatthereisachancethedebtwillnotberepaidandcaneitherrefusetheloanorincreasetheinterestrate.Intheeighteenthcentury,debt,especiallyonaccount,wasamoralact of charity that happened to enable trade. Borrowing withoutrepayment was seen as a moral failure akin to fraud. Duplicitouscustomers duped store owners. Despite the grip of debtors’ prisons onour popular imagination, such prisons were rare in the United States.Saveforafewdebtors’prisonsmodeledonBritishexamples,suchasthePruneStreetprisoninPhiladelphiaortheNewGaol inNewYorkCity,most debtors would find themselves bedding down with murderers,rapists,andotherreprobates—or,moreaccurately,sleepinginhallwaysandonstonefloorswithothercriminals.Intheearlynineteenthcentury,thatclearmoralvisionofdebtbeganto become murkier. As nineteenth-century students of economy readtheir Adam Smith and David Ricardo, a new rationalism took hold.Lendersoughttohaveknownthatsomeborrowerswoulddefault.Everyloanwasabusinessdecision,notapersonaltrust.Risk,aseverylenderwhocutoffacreditlineknew,hadtobeweighed.Thisnewperspectivedid not supplant themoral viewof debt, but it did temper it. For theeconomytogrowandforinnovationtooccur,riskshavetobetaken.Foreverybusinessthatsucceeds,manymorenecessarilyfail.Wewouldnotwant to live in a society inwhich reasonable risk could not be taken,becausethatwouldbeasocietywithoutgrowth.In1800,thefirstU.S.bankruptcy law exemplified this perspective, as it absolved only large

businessdebts.Practicallyaswell, imprisonmenthamperedrepayment,as the imprisoned could not work. Only loans to the wealthy, whoownedassetsworthselling,couldberepaidiftheywereimprisoned.By1833, federal law eliminated imprisonment for debt. Most statesabolishedtheir imprisonment lawsaroundthesametime, in the1830sand1840s.Even though imprisonment was abolished, bankruptcy as an

opportunity to wipe the slate clean persisted for only a moment. TheBankruptcyActof1800wasrepealedafewyearslater.Anotherversioncamein1841andagainwasrolledback.Ourmodernbankruptcylawsdatebackonlyto1898.Liketheactof1800,this lawwas intendedtoencouragerisktakinginbusinessinvestmentandwasneverintendedtoshelterconsumers.The merchants and industrialists who used these bankruptcy acts,

however,weretheeliteoftheU.S.economy.Thoughthemanufacturedgoods of cities were ubiquitous, the United States in the nineteenthcentury remained an agricultural, rural country.Not until 1920wouldthe census reckon that most Americans lived in cities, and that term,defined as places withmore than five thousand inhabitants, was usedquite loosely. In thisagriculturalworld,Americanborrowingwas farmborrowing.Inthemid–nineteenthcentury,farmersintheWestlivedanddiedby

credit.Theharvestcamebutonceayear,buttheyneededgoods—farmequipment, clothing, groceries—year-round. Independent farmers mayhave owned their land, but they still depended on the manufacturedgoodsofeasterntextilemillsandironworks.Theconnectionbetweenthefarmers and factories was the general goods merchant of the nearesttown.InDavenport,Iowa,thatconnectionwasJohnBurrows.Cashpoorand crop rich, farmers could offer Burrows little butwheat, eggs, andhogs. Burrows wanted to be a grocer, but he ended up as a wheatmarket. Selling on credit to the farmers, at harvesttime Burrows tooktheir farm goods in trade, selling them in far-flung locales north andsouthontheMississippi.Burrows“feltthatthiscountryhadtobesettledup,andtoaccomplishthis,someonemustbuythefarmers’surplus,oritwouldremainawilderness.”3ForatimeBurrowswastheonlygameintownandcouldchargehigh

prices for his services. Fewmerchants possessed the capital to finance

such a business. Running a business for farmers on credit meant thatpayment could come as little as once a year. After the harvest in theNorth, moreover, there was little time left to ship crops before snowblockedthelandandicelockedtherivers.Burrowswouldalwayshaveto store a portion of his goods until spring. Every debt that wentunrepaiduntil autumnandeverybale thatwentunsold till springwasBurrows’s money sitting idle. To run such a business required largeamountsofcapital.Atthesametime,awould-bemerchantwouldneedBurrows’s skill and connections at selling in New Orleans and buyingfromPhiladelphia.Thismerchantwouldalsoneedtobeabletoconvincethesemerchants to trusthim—neveraneasy task.Burrowsenjoyedhisprosperity as the biggest big shot ofDavenport for twenty years, untiltherailroadarrivedandchangedeverything.Withtherailroad, inthiscasetheChicagoandRockIslandRailroad,thebarriers tocompetition thatkeptBurrowswealthyended.With thecoming of the railroad, Chicago was no longer a distant name but aquicktripofonlyeighthours.Riverscouldfreezebutrailcarsstillran.No longerdidmerchantsneedenoughcapital to finance inventoryandcustomersforayear.ShipmentscouldarrivefromChicagothenextday.Hogs didn’t need to be stabled all winter; they could be shipped asquickly as theywerebought.Themerchantsnowdidn’t need to knowwholesalersinNewYork,Philadelphia,andBoston,justinChicago.Thebarriersofcapital,skill,andrelationshipsthatkeptcompetitionoutfell.New merchants opened everywhere in Davenport, “bewilder[ing]”Burrows.Losingmoneysteadily,hefinallyclosedhisbusiness in1860,becomingoneof the farmershehadpreviously gouged.By the endofthenineteenthcentury,atleastwheretherewererailroads,thecreditofnorthernandwestern farmers,whoowned theirown land, fell incost.Creditpricesstillexistedbutcompetitiondrovethemsteadilydown.Credit flowedmore freelynotonlyatstoresbutonthe landaswell.The opening of theWest to rail also opened it tomortgages.WhereasbeforetheCivilWarwesternlandshadgenerallybeenfreeandclear,bythe late nineteenth century independent farmers relied on mortgages.Evenwith the railroad,mortgage creditwas cheaper than store credit,enabling farmers to invest in and expand their cultivation. The newerlands took greater advantage of eastern credit. In the Dakotas, evenbefore statehood, 75 percent of farms were mortgaged, but farmers

turnedthat investment intoarapidexpansionofproduction.Fromjust1880to1885,Dakotawheatproductionincreasedfrom3millionto40millionbushels—ortheequivalentofthecombinedproductionofIllinoisand Indiana,bothofwhichhadbeen farmed fordecades.At the sametime,“mortgage indebtedness,”as theMichigancommissioneron laborwrote in 1888, “operates as a mammoth sponge, constantly andunceasingly absorbing the labor of others.”4 Hard work by westernfarmers became hard cash only for eastern bankers, fostering awidespreadresentmentofmortgages.As longasproductiongrew,however, themortgagesmade sense for

farmer and banker alike. Easy eastern money bid up land values,anticipatingcontinuedfuturegrowthinwheatproduction.Afterall,Godwasn’tmakinganymoreland.Infact,easterninvestorsdemandedsucha quantity of western mortgages that companies sent solicitors west,traveling from farm to farm, offeringmoney to hard-strapped farmers,who happily took it. Some improved their lands, investing in newdrainage tiles that did, in many parts of the West, double and tripleproduction by artificially drying overly wet soil. Many other farmerstookadifferentcourse,havinggrownwearyof thehard life,andwiththeir local knowledge and eastern capital speculated in land or evenstocks. Mortgages sometimes exceeded the value of the land, as thedemand for mortgages in which to invest so exceeded supply.Nonetheless,mortgagerepaymentswentsmoothlyoncecropproductionrose, as did cropprices, becauseAmericanwheat could be sold in thegrowingeasterncitiesandaroundtheworld.IntheEast,westernfarmmortgagesbecamefashionableinvestments.

Justasanearliergenerationinvestedinwesternrailroadbonds,easterninvestorsofthe1880spouredmoneyintowesternmortgages.Insurancecompanies as well as individuals bought into the western mortgageboom. To satisfy all the investors, New York financiers began torepackage western mortgages into that quintessentially easterninvestment vehicle: the bond. “Bond houses” bought mortgages frombrokers,called“mortgagebankers,”andinturnissuedbonds.Investors’capitalpaidforthemortgages,andthebondhousesissuedpaymentstothebondholdersasiftheyownedarailroadcorporation’sdebt.Asmuchas possible, thesemortgage bondsweremodeled on the language andpaymentsofrailroadbonds.Slowly,beginningafter1900,themortgage

bankers began to bring their western financial schemes to the easterncities,offeringmortgagebondstobackcommercialandresidentialrealestate. Their national organization, the Farm Mortgage BankersAssociation of America, spread the mortgage bond across the UnitedStates.IntheSouth,KingCottoncontinuedtoruleasithadbeforetheCivil

War, but instead of slavery, sharecropping now organized cottonproduction. Sharecropping is remembered as a particularly gruelingeconomic arrangement, but what is less well known is the incrediblecreditsystemthatunderpinneditandcotton-producingslaverybeforeit.In sharecropping, a farmer contracted with a plantation owner for asectionof land.Inexchange,thelandownerhadtherighttoashareofthecrop.Becauseofsoutherncroplienlaws,thefirstclaimonthecropwent to the landowner. This legal rightmeant that the farmer had torepaythelandownerbeforeanyothercreditor.Withthevagariesofcropproduction,much less cropprices, lending to farmerswasavery riskybusiness—unlessyouweretheplantationowner,whohadthefirstrighttothecrop.Butwherecouldaplantergetenoughmoneytofinancenotonly crop production but also the personal lives of his tenants andcroppers?5Even by 1860, the entire cotton South had only about a hundred

banks—less than the total number of banks in Massachusetts alone!Southern agriculture was financed through coastal middlemen calledfactors.Atthebeginningofeachseason,theplanterwouldwritetohisfactor, inaplacesuchasSavannahorNewOrleans, torequestcashaswell as crop seed, goods, and all themiscellany that a remote cottonplanter would need to get through the year. Cash could be used atnearby merchants, such as a Montgomery store that advertised“Wholesale and Retail Dealers in Dry Goods, Clothing, Groceries,Hardware,Boots, Shoes,Hats,Caps,Bonnets,Cutlery, Flowers,Combs,etc.,etc.,etc.,”6Thefactorwouldlookattherequestandinturnrequesta loan from a banker inNewYork. The bankerwould in turn borrowfromabanker inGreatBritain.Capital could flowhalfwayaround theworld, fromEurope to northGeorgia. After the CivilWar, this systemsurvived largely intact, despite the end of slavery. Only the last stepchanged.Insteadofprovidingforhisslaves,theplantationownersimplyloanedmoneytohissharecroppersthroughhisfarm’s“commissary.”

Farmers, especially small independent farmers, could also borrow atthelocalcountrystore,butpriceswerehighnomatterwhereyouwent.Ifthelocalmerchantcouldn’tgetfirstrighttothecrop,priceshadtobehighertocoverthatrisk.Ifyoucouldn’tgetcreditatthelocalstore,theplantercouldchargemonopolyprices.Eitherway, the farmerpaid toomuch. But accounts had to be in credit. Harvesttime was a momentwhen all the year’s debts were settled. Before that, cash was scarce.Borrowers needed access to credit to get through the seasons, andstorekeepers had to give it to have a viable business. Only those toodisreputableoruntrustworthycouldnotgetanaccountatthestore.Itisfrom this that we get our colorful terms for an untrustworthy person—“no-account” and “good-for-nothing” as in “no-account, good-for-nothing, lazy cuss.” Shopkeepers accepted repayment either in cash(whichwasrare)orcotton(whichwasexpected).Storeownersthussoldfactorygoodstofarmersandfarmgoodstofactories,formingakeylinkin the distribution chain,moving cotton aswell as credit through thesoutherneconomy.TheMontgomerystorethattradedallthosebonnetsand cutlery for cotton did well as an intermediary. Opening in 1845,when the first of three brothers came from Europe, H. Lehman andCompany changed its name to Lehman Brotherswhen the second andthirdbrothersarrivedin1850totaketheirpartinthefamilybusiness,andsoonthereafteropenedabranchinManhattan,followingthecottonmoneyfromMontgomerytoNewYork.As in theNorth, railroadschanged themovementofgoods.Between1860 and 1880, overland cotton transportation increased from 2.3percent to 19 percent of all cotton. Seventy-two percent of cotton fornorthern manufacturing went overland. But because of the control ofsouthernlandbythefew,unlike intheNorth, thebalanceofpowerincredit changed little. Debt kept tenant farmers and sharecroppers inthralltomonopolisticcountrystoreswhereeachyear’scropneverquitemade enough to free them from last year’s debt.Without paying theirdebts,sharecroppersfoundthattheirfreedomtomove,topursuelovedonesornewopportunities,wasalegalfictioncomparedtodebt’sreality.Debtpeonageinwhichalifetimewasspentindebttoalandowner—alltoorealeven into the twentiethcentury—trappedmanysharecroppers,especiallyAfricanAmericans,ingruelinglyoppressivelives.7The samecredit thatmade farmingpossible in thecottonSouthand

the wheat North also enabled personal consumption. Private andbusiness purchasing were jumbled. The money borrowed for farmers’wives’hatsinGeorgiaultimatelycamefromaBritishbank.Agriculture,alongwith railroads,was thebigU.S. business. In the cities, however,theinterminglingofworkandhomenolongeroccurredasitdidonthefarm,particularlyforthosewhoworkedforsomeoneelse,asAmericansincreasinglydidover the lasthalf of thenineteenth century. For thosesplit into consumer and worker, personal lending became morenecessary. In the cities, moreover, the reselling and refinancing ofeverydayborrowingthatmadeallthosecountrystorespossibledidnothappen.No cotton grew inManhattan, but of course LehmanBrothersknew that when they moved there, and started to become, by 1900,moreofaninvestmentbankthanacottonanddrygoodsmerchant.Bankcapitalneverwendeditswaytofinancingtenementworkers’wives’hatsinquitethesamewayasinAlabama.Asfarmers’childrenmovedtothecitiesaroundtheendofthecentury,they brought their ideas ofwhat debtmeant: itwas dangerous, illicit,andimmoral.Theirthinkingwasbornofanagriculturalworld.Whethermortgaged to a bank or in debt to a store, the farmer borrower feltsomewhatlessthanfree.Thepromiseofhardworkforagoodlifewasunmetaslongastherewerebillstopay—andthosebillsseemedneverto end. One way out, at least for farmers’ sons and daughters, wasmovingtothecity.The industrial world offered them, and the people who lent themmoney,opportunities for credit that couldnotexiston the farm.Legalpersonaldebt,then,hasamorerecentvintagethaneithercommercialornational debt. Though personal, commercial, and national debt are allcalled“debt,”personaldebt is really somethingapart fromthoseotherformsofborrowing.WhereascommercialandnationaldebthavealwaysbeenapartofthecentralflowofcapitalinWesterneconomies,personaldebt has been consigned to its margins. For business and religiousreasons,duringmostofWesternhistory,thoughloansexisted,charginginterest on them—usury—was a sin, forbidden to most members ofsociety.Our countrywas born into aworld already capitalist, and theauthority of our federal government, in one sense, emerged from theneed for somebody to deal with the debts incurred during theRevolution.Foreverydaypeople,however,usurylawsremained,andan

untenablylowinterestrateceilingrestrictedtheflowoflegalcashloansto a trickle. This debt—installment credit, ethnic lending circles, andloan sharks—existed outside the main flows of capital, yet for theborrowers involved—whether from rural Illinois or rural Sicily—accesstocreditmadetheirlivesinthecitypossible.Americans came to the cities not only fromourhinterlandbut from

acrosstheseaaswell.Thelatenineteenthandearlytwentiethcenturieswere theheydayof European immigration.8Newarrivals cameby themillions until 1924, when the Johnson-Reed Act, reflecting nativistanxiety about all those oddly speaking foreigners, cut off immigrationacross the Atlantic. Like those from American farms, they werepredominantly rural in origin, and they, like native-born Americans,encountered a new commercial world. Rural folks, whether from theAmericanMidwestor theEuropean shtetl, begangreat journeys to theAmericancity.Andforboth,arrivaltheremeantincurringdebt.Immigrants’ credit, except for retail, occurred in a shadow economy

disconnected from the largemovements of capital. The legality of theborrowingvaried,butthepricewasalwaysthesame:high.Creditaccesswasalsouncertainandhighlypersonal.Whatsomebodythoughtaboutyou mattered as much as, or more than, your finances. Credit scoreswouldn’texistuntildecadesinthefuture,andintheturn-of-the-centurycity, character and collateral mattered most. For recent immigrants,lendingalwaysbeganintheneighborhoodandwasalwayspersonal.Theonlyway togetmoneywas toknowsomebody.Whether the loanwaslegal or illegal, personal connections were the foundation of urbanlending.Though cash loanswerehard to comeby, credit could anddid take

otherforms.Themostcommonformofborrowingwasfromretailers.Asin the country, urbangrocers lentmoney to shoppers, charginghigher“creditprices”butnotinterestassuch.Evenso,thecommonwisdomofthenineteenth century,when the thin, anxiousmerchant frettedabouthisloans,wasthatcreditwasthesurestroadtoretailpenury.Scribblesina leather-bound ledgerwerenotenforceable inanycourt. Ina timebefore credit agencies, debtors could easily skip out. Yet the cornergrocery, desperate for customers andwilling to extend credit until thenext paycheck, helped the newly arrived to bridge the weeks. Creditprices might have been higher than cash prices but were rarely high

enough to cover the skips and deadbeats. The only science in retaillendingwasthecertaintyofloss.For recent immigrants, cash loans could come from ethnic lending

circles,suchasJewishaxias(fromtheYiddishwordfor“shares”),whichoffered many new Americans a source of money for home downpaymentsortostartnewbusinesses,similartotheWestIndiansususorKoreankyestoday.Likemicrofinancebanks,theselendingcirclesreliedonthetrustbornofclose-knitgroupstomakeindividualsresponsiblefortheir debts. Lending ranged in formality from a few friends poolingmoneyforanother tobuyasewingmachineto full-fledgedbanks—butwithoutthebankingregulations.Axiasandotherlendingcirclesdidnotmake a profit, just as frequently losingmoney as enabling dreams, asunemployment could hit a group of people all at once. The commonethnic and occupational background that underpinned a group alsomadethemvulnerabletoadownturninaparticularindustryorevenacompany. More disappointed were the credulous members whosetreasurersfledwiththegroup’ssavings,asMaxTeicher,treasurerofoneLowerEastSideaxia,didin1928.Whenhedisappearedfromthecircle’sheadquarters at 179 Suffolk Street with $40,000, Teicher left the twohundred members, all Jewish immigrants, with only $8.74. Outsidebanking regulations, members had little recourse but social pressure.Teicherandthe$40,000wereneverfound.9

Repossessionwasalwayspublicinthecity.Debtcollectorstakeapianoandothergoodsboughtonthe

installmentplan.Repossessedgoodswerethenresold.(IllustrationCredits1.1)

For those whose needs weremore immediate ormore private, loansharks provided another source of money. Not all borrowers wantedtheir neighborhoods to know that they needed money or that theywanteditforlesshonorablepursuitsthantostartanewbusiness.Unlikeretail and lending circles, loan sharking was immensely profitable. Inone month loan sharks could charge a year’s worth of legal interest.Withusuriousrateslikethese,loansharks’revenuescouldovercometheriskinessoflendingtourbanworkers.Borrowingfromaloansharkwasrarelyadebtor’sfirstchoice.Loansharks,aslendersoflastresort,morefrequently than not refinancedmore conventional loans for borrowerswhohadexhaustedothersourcesofcredit.Formany urban borrowers, the road to the loan shark began at the

furniture store. Installment credit—that is, borrowing in monthlypaymentssecuredagainstthegoodsbought—flourishedlongbeforecashlendingwaslegal.Inthenineteenthcentury,pianos,furniture,andotherconsumerdurablescouldallbeboughtonthetimepaymentplan.Likethe corner grocer, retailers self-financed these loans. For honestmerchants, the credit helped them sell more goods. But, limited torelativelylowratesofinterest,furniturehousestypicallypriced10or20percent higher than the goods would have cost in a credit-free store.Even fora successfulmerchant, the loanswere repaid,but the interestitself was not profitable. Installment credit enabled merchants to selltheirexpensivewaresandconsumerstobuythem.Creditbuyingwasthenorm. A Federal Trade Commission survey done in the early 1920sfoundthatof556dealerssurveyed,only78setpricesbasedonacashsale and only 13 sold only for cash.10 Colloquially, credit furniturestores, which sold low-to midgrade goods on installment, were calledBorax Houses. The origins of “Borax” are uncertain. Some writersclaimeditcamefromtheYiddishwordborgs forcredit,butotherssaidthat,likethecleanerBorax,theplacescleanedyouout.11This systemhadsomeseriousdangers forbothborrowerand lender.

Lenders faced enormous expenses if a borrower stopped paying.Repossession was expensive. City marshals would have to becompensated for their time in overseeing the repossession, workmenhiredtoremovethegoods,andofcourseahorseandwagonrentedto

carrythembacktothestore.Ifthegoodsweredamaged,theycouldnotbe resold. For the unscrupulous Borax House, however, repossessionrepresented an opportunity for profit. Selling overpriced furniture tocustomerswhocouldprobablynotaffordthepayments,thestorecouldcollectthedownpaymentandafewinstallmentsandthenrepossessthegoods.Thefurniture,withalittlespitandshine,couldthenberesoldtothenextsucker.Inaworldwherethecostofgoodswashigh(i.e.,beforeIKEAcouldmass-producebedsinAsia),suchasystemwasprofitable.ThecaseofadeckhandnamedJohnS. in the late1920swasall too

typical. For a borrower like John, the financial costs of repossessioncouldbestaggering.Livingwithhiswifeand fourchildren,heworkedonaferryboatinNewYorkCity.Withhissmallsavings,hehadboughtahouse with an interest-only mortgage.12 He had outfitted the housethrough the installment plan with furniture and a radio. He hadborrowed tomake a comfortable life forhis family, andonhis salary,couldafford thepayments.For fivemonthseverythingwentwell; thenJohn fellonan“icy sidewalk”andseverely sprainedhiswrist.Hewasout of work for twomonths, and the family quickly went through itssavings.FinallyJohnwentback towork,andafter twoweekswent toget his paycheck, which he found, to his surprise, had been totallygarnished by the Borax House. Wage garnishment was commonplace,andtherewerenolawslimitinghowmuchofapaychecklenderscouldtake.Johnowed$240,whichmeantthateverypaycheckforthenextsixweekswouldgotothefurniturestore.Withoutsavings,hehadcountedonhiswages topayhis currentbillsand the interestonhismortgage.Because of the garnishment, he could lose his house and be unable toeat.He could afford his debts but could not afford to be out ofwork.JohnappealedtotheprobonoLegalAidSociety,whichwasluckilyabletoworkoutadealbetweenJohnS.andhiscreditors,butJohn’sgoodfortunewasrare.TheLegalAidSocietynoted in itsannual report thathiswasoneofthefewcasesabletobeadjustedthatyear.Morecommonwas garnishment followed by repossession. Repossession meant thatdebtors lost not only their bed, couch, and table but also all theinstallments that they had paid thus far. Installment debtors had noequity. Missing payments meant losing everything. Installment creditcreatedacrisis thatonlyquickcashcould solve.The loan sharkcouldeasilystepinatthismoment,offeringasolutionthatwouldnotinvolve

garnishmentorrepossession.Mostloansharksoperatedinaquasi-legallimbo.Afterall,itwaslegal

tolendmoney,justnotattheratesthattheydid.EdwardErd,aturn-of-the-centuryChicago loan shark, for instance, advertised in theChicagoTribune every afternoon for twenty-five years and even had hisborrowersfilloutelaborateyetboguscontracts.Lendingmoneywasnotillegal, just the rates that Erd and other loan sharks charged. Forexample,whenaChicagocarpenter,OscarNorman,borrowed$30fromErd,hemeticulouslypaid$65ininterest,$1.50amonth(54percentayear) for four years, never managing to pay off the principal. AfterNorman tried to stop paying—having paid backmore than double theoriginal loan—Erd threatened him with a “bum notice,” claiming therighttorepossesshisbelongings,asifNormanhadboughtfurnitureonthe installment plan. Frightened by the legalistic language, Normannearly let Erd take all his alleged repossessions.13 Only throughinterventionofacrusadinganti–loansharklawyer,enlistedbyNorman’swife,wastheaccountsettled.Yetthetacticsofthefakecontractandthethreats continued, if not in Norman’s case, then in the cases of otherborrowersfromloansharks.

Beforethe1920s,personalborrowingofferedmoreshamethanprofit.(IllustrationCredits1.2)

Borrowing remained shameful for some and disreputable for many.

Americans of the 1920s may have witnessed a titanic change in thepracticessurroundingdebt,butstillthereremainedremnantsofanolderrural moral order. John Raskob, the creator of the General MotorsAcceptanceCorporation(GMAC),whodidasmuchasanyindividualtoinaugurate this new era of borrowing, reflected in 1927 on the creditpracticesofhisyouth:“Iwasraisedinacommunitywhereamortgageonyourhomewasconsideredadisgrace.Ifahomewasmortgaged,thechildren didn’t know about it, usually for fear they’d tell the otherchildrenabout it and let loose the family skeleton.”14Thepersonwholent themortgagemoneywasa“tight skinflintwhochargedextremelyhighratesofinterestandmadethehousebuyerfeelthathewaslendinghim themoneymoreasa favor thanasa soundbusiness transaction.”“The old-time banker,” as a banker’s picture was subtitled in a 1926issue of Collier’s, “loaned money with the beneficent air of a charityworker.”Lendingwaspersonalnomatterwhatitscontext,andtheneedtoborrowremainedpersonallyshameful.EdwardErd,whocouldsmuglydefend his methods to the Chicago Tribune that carried hisadvertisements,learned,intheend,thetruemeaningofdebt.Heneverdeniedthathehadpreyedonborrowers,butdidnotthe“improvident”spenderdeservesuchtreatment?InErd’sview“peoplewhoborrowarefools” and even he “wouldn’t employ a man or woman who found itnecessary todobusinesswith the shark.”Butuntilhis interview,Erd’snamehadneverbeenintheTribune,hesaid,exceptforadvertisinghisbusinessintheclassifieds.Afterward,however,hewasknownforwhathewas:aloanshark.Theshameofbeingexposedquicklybroughtonanervouscondition.AmonthafterthepiecedescribinghistacticsranintheTribune,hewas founddeadbyhiswife inhisapartment,killedbyhis own handwith a revolver. The social significance of debt, despiteErd’s insistence on blaming the borrower, applied to him as well.Whetherlendingorborrowing,debtremainedashamefulaffair.Nonprofit alternatives to loan sharks, called remedial loan societies,hadbeenattemptedforyears,butwithlittlesuccess,partiallybecauseofhow they were organized and partially because they exacerbated theshameofborrowing.In1893,forinstance,theProvidentLoanSocietyofNewYorkCitywasfoundedtoprovidesmallloans,withinthelimitsofusury law, toNewYork’sworkers.Thoughother similarorganizations,suchastheWorkingmen’sLoanAssociationofBoston,predatedit,none

matchedthesuccessandgrowthoftheProvidentLoanSociety.15Intereston loanswas a third to a half of the rates charged by pawnbrokers.16Ratescouldbesolow—12percentperyear—becausetheProvidentLoanSociety,largelyfundedbygenerousNewYorkphilanthropists,requirednoprofit.By1909,therewereatleastfourteensuchorganizationsacrosstheUnitedStates.17Reformist lenders believed that there was as much need to reformworkers’ financial habits as to provide themwith emergency access toborrowing. Understandably, debtors were loath to go to the remediallenders,fearingapatronizinglectureonhowtheyoughttolive.ArchieChadbourne, a Colorado trucker writing about his financialcircumstances, complained that such a loan had an interest rate of 12percentandhadtoberenewedeverythreemonths. Insteadofevadingmanystoreowners,therewouldbeonlyonelenderwithafirmscheduleofrepayment.Moregratingthantheinterestcost,Chadbourneclaimed,wouldhavebeenhaving“toswallowall[the loanofficer’s]advice justlike[he]enjoyedit.”Theoversightbysomeonetowhomthedebtorwaspayinginterestwasthemostgallingpart.Chadbournedescribedatriptothe loan office as less a business action than a social supplication: “Igave themanagermypedigree,mybudgetplans, and itemizedwhat Iwoulddowiththemoney,andcrawledabouttheofficefurnitureonmyhandsandkneeswhilehepuffedata lazypipe.”18Consolidatingdebtswithacharity lenderwaspossible,butdoingsowouldcost thedebtorboth money and self-respect. Loan sharks, whatever their drawbacks,neverlecturedborrowersontheirmoralfailures.The realities of capital ultimately constrained reform lenders morethan theirmoral vision. Limited to only a 6 percent annual return bytheir charters, investors contributedmoneyas a formof charity ratherthan an investment. Remedial loan societies were not entrepreneurialopportunities. By 1925, they totaled only forty nationwide and neverexceededthatnumber.19Twoyearslater,theirnumberhaddroppedtoonly twenty-eight.20 Though rhetorically important, they never reallyaffectedtheratesornumberofloansharks.Withoutprofitstoreinvest,such nonprofit lenders could never grow to meet the ever-surgingdemandforloans.Likeretailers,theyself-financedtheirloans,and,likeretailers’,theirloanswerenotprofitable.Toendloansharking,alegal—andprofitable—alternativewouldhavetobefound.

The1910s and1920swere ripewith change in thewaysAmericansborrowed.Newimpersonaleconomicpressuresbegantoforceborrowingto become less personal. Borrowing began to seem more like aneconomicchoicethanadepravedsituation.Ashardasitwastocollectfrom borrowers, even more restrictive was retailers’ inability to reselltheir debt. Everydebthas a chanceof repayment anda certain value,but until the 1920s it was not possible for ordinary retailers to reselltheircustomers’debtstoinvestorswhohadmoneytospare.Capitalismdepends on investment to function; self-financed business simply isn’tpossible in a developed economy. Though retailers today can borrowagainst the debts owed by the customers or even resell that debt to athird party, back then no corner grocer could resell the debt in hisledger,making that debt expensive for the retailer and in turn for thecustomer.Withoutresale,consumercreditcouldnotexpand.In the 1920s, reformers succeeded in removing usury restrictions inmany states so that legitimate businesses could lend cash to workingpeople.With higher legal rates, small-loan businesses could profitablydisplaceloansharks.ReginaldSmith,alawyerwiththecolorfullynamedLegal Reform Bureau to Eliminate the Loan Shark Evil, complimentedthe“well-intentioned”peoplewhosupportedusurylawsto“preventthepoormanfrompayingexcessiveratesofinterest,”but,hesaid,thelimitson interest rates made life worse.21 In this brief to theMassachusettslegislature,Smithwaspartofavastsmall-loanreformmovement.Bytheearly1920s,workingpeople couldborrowcash inmost statesandusethatcash forwhatever theyneeded.By1930, thenonprofit think tanktheTwentiethCenturyFundestimatedthattheaverageAmericanfamilyborrowed from a small-loan company every other year.22 Yet, just aswith loans taken from loan sharks, 40 percent of them refinancedexistingloans.Debtrolledoveryearafteryear,earninginterest.Yet the outrage and reform surrounding small loans and usury hadlittleimpactonwhatwouldbethegreatestsourceofdebtinthe1920s:the installment plan. Unlike usury laws, which regulated cash loans,installment plans were for goods and usury laws didn’t apply.23 Themoralneedtoprotectthedesperateandpoordidnotapplytoconsumersinwantof luxurygoodssuchasvacuumcleaners,gramophones,and—most important—cars. In the 1920s, the retailers that lent their ownmoneywouldfindnewsourcesofcapital.Thescarcecapitalthatlimited

grocery stores and furniture houses would be found. The car—thatquintessential installmentpurchase—wouldusher in aneweraof debtthroughitscreationofthefinancecompany.Anonymousinvestment inanonymousborrowingwas something thathadneverhappenedbefore.Thousands of years of personal lending intuitions ended when aborrower’snumbersmatteredmore thanhisname.This resaleofdebt,liberating consumers and retailers from the restricted world of self-financed personal debt, began when selling an automobile requiredlendingwould-bedriversmoney.Therestrictionsonusurypaledbeforethe restrictions on capital and, freed from that constraint, themoderncredit system arose as borrowers and lenders learned how to lend toworkerswho had only their incomes and how to resell that debt. Theresale of debtwould end theworld inwhich the SkinnyMan and FatManpostermadesense.

CHAPTERTWOEVERYBODYPAIDCASHFORTHEMODELT

(1908–1929)

Thesecondmostexpensivepurchasemostofusevermakeisacar,andwhenAmericansthinkofcars,wethinkofHenryFord.ThoughfewerofustodaydriveFordsthanHondas,HenryFord’snameisforever linkedtotheautomobile.Yettheautoloan,whichmakesbuyingcarspossible,hasnothingtodowithHenryFord,despitebeinginventedatjustaboutthesametimeashiscarcompany,FordMotorCompany.Indeed,HenryFordfoughttoothandnailnottosellhiscarsthroughinstallmentcreditandintheprocessnearlydestroyedhiscompany.Wheredidautoloanscome from, if not from the father of the car? And why did he resisthelpinghiscustomersbuyhiscars?Before1919,nearlyallcars,includingtheModelT,weresoldforcash.

As one General Motors executive remarked, the car had “given us allsomethingworthworkingfor.”1Itwastheultimateluxurygood,givingpurposetothesavingsofmillionsofAmericans.Thebest-sellingcar inthe United States and the world was the Model T from Henry Ford,whose innovative production techniques transformed the car from ahobbyistcuriointoamass-marketloveaffair.BeforeHenryFord,theautomobilelanguishedasahobbyist’sgadget,

a rich man’s plaything. Usually the Germans Karl Benz and GottliebDaimlerarecreditedwithitsinventionin1885,andbythe1890smanyvarietiesofcarproliferated inEurope. In theUnitedStatesalone therewere around 2,500 automobile companies. But none of these start-upsmanaged to transformcars intoamass-consumption item.Hand-tooledand built one by one, they were expensive oddities. A few guys got

together and made cars piece by piece. The parts were neverinterchangeable.Eachonerequiredagreatdealofskilltoproduce,andthepricesofthecarswereunbelievable.IntheUnitedStatesthestorywaslargelythesameasinEurope.Inthe1890s, there were already about thirty companies building cars. By1909, the low-volume,high-pricemodelof automobileproductionwasstandardforthenearlythreehundredAmericanautomobilecompanies.Allexceptforone:FordMotorCompany.The introduction of the Model T in 1908 changed U.S. industryforever. But the Model T was not the first car Ford worked on. Thecompanyhadstartedin1903.Whathappenedinthosefirst fiveyears?ModelsA,B,C,F,K,N,R,andSallcameandwentasFordstruggledtofind the right car for the American market. He aimed for a car thatwouldsuitnotonlyahigh-endnoveltyaudiencebutamassmarketaswell. He wrote in 1906 that “the greatest need today is a light low-pricedcarwithanup-to-dateengineofamplehorsepower,andbuiltoftheverybestmaterial.”2FordsoldtheinitialModelTsfor$850butby1924droppedthepricetoonly$290,whichisamazingconsideringtherisinginflationoftheperiod.Qualitywaskey,butsowasprice.Howtoreconcilethetwo?Workingalongsideasmallgroupofothermechanics,HenryFordbuiltthefirstModelTsimply.Theenginecouldbecastinonepiece,outofarelatively inexpensive but light vanadium-steel alloy. The process ofproductionoftheModelT,aswellastheproductitself,wasnovel.Theyoung mechanics Ford arrayed about him drew on the organizationaltechniques of many different industries, from meatpacking to gunmanufacturing,toinventanewwayofbuildingcars.Theoddlyspacedheaps of parts that defined garage manufacturing were replaced withgravityslidesandorderlyarrangementsofmachinesandmechanics.Likethemortgagebond,theassemblylinehadcomefromtheWest.WilliamKlann, the head of the engine department, remembered later that theidea for theassembly linehadoccurredtohimashe touredaChicagoslaughterhouse’s “disassembly line,” where pigs and cows hung fromoverheadhooks asworkers sliced: “If they cankill pigs and cows thatway,wecanbuildcarsthatwayandbuildmotorsthatway.”3Ford quickly adapted the methods to a much larger factory atHighland Park in Detroit, which opened for production on January 1,

1910.Afour-storybuilding,865feetlongand75feetwide,thefactorywould produce only the Model T. Four models—the runabout, thetouringcar, the towncar,andthedeliverycar—wouldallbebasedonthe same interchangeable chassis. The carwas brought to theworker,nottheworkertothecar.AcompleteModelTemergedfromthefactoryeveryfortyseconds.Bymergingproductiontechniquesfromavarietyofindustries,aswellaspushingthelimitsofmachining,ForddroppedtheproductiontimeofaModelTfromtwelveandhalfhoursin1908tolessthan thirty minutes by 1914. The car stayed the same while themachinesused toproduce thecars constantly improved. In1915,FordMotorCompanycelebrateditsmillionthsale.ThoughHenryFordlovedbuildingcars,hehatedbusiness,especiallyfinance.Amechanicbytraining,hestartedhiscompanyin1903withacapitalof$28,000 fromtwelvepartners.By1920, itwasworthoverabillion dollars. After the initial investment, nomore investmentswerereceived.Nostocksweresold.Nomoneywasborrowed.By1919,Fordhadboughtoutallhisoriginalpartnersandthecompanywascompletelyprivate. With profits of $750 million by 1920, Ford Motor Company,ownedentirelybyHenryFord,hadnoneedforoutsideinvestment.Thecompany, for better or for worse, reflected the unique vision of itsfounder,andheranitwithouttheinterferenceofWallStreet.HenryFord’svisionreflectedthepopulistpoliticsofhisyouth,whichcelebrated those who produced over the “parasites,” such as railroadexecutivesandfinanciers,whotookmoneyfordoingnothing.Populism,the largestpoliticalmovementof the latenineteenth century, emergedfrom the unequal relationship of eastern capital and western farmers,particularly the dependence of western farmers on eastern-controlledrailroads and mortgages. From the end of the Civil War until around1900, the U.S. economy was deflationary. A dollar today was worthmore—notless—tomorrow.Mortgagesthusbecameevermoreexpensiveto pay back over time. Populists described bankers as unscrupulous,“hyena-faced Shylocks” who represented the “Money Power.”4 TheMoney Powerwas, as the 1892 Populist platformdescribed it, “a vastconspiracy against mankind … if not met and overthrown at once itforebodes terrible social convulsions, the destruction of civilization, ortheestablishmentofanabsolutedespotism.”Fordthoughthimself—withhis privately held, stockholder-less corporation—apart from this vast

conspiracyofcapitalists.Fordalwaysthoughtofhimselfasamechanicfirstandabusinessman

last. While “business men believed that you could do anything by‘financing’ it,” Ford “determined absolutely that [he] neverwould…joinacompanyinwhichfinancecamebeforetheworkor inwhichbankersorfinanciershadapart.”5Ford,morethananythingelse,wasabuilderofcars.He liked toknowhowtheyworked.He liked toimprovethem.Sellingcarswasgreat,butthatwassecondarytobuildinga qualitymachine. Once you had a greatmachine, hewould say, theonly thing left to decidewas its price, and a lowerprice for the samequalitywasallthatmattered.Following World War I, however, the meaning of the car changed.

“Pleasure cars,” as a GM executive put it, became “economicaltransportation.”6 For manufacturers to keep growing in the 1920s asthey had through the 1910s, the market would have to expand toinclude those who could not save up for their cars. Despite the clearincentive to provide consumer financing, however,manufacturers onlyaccidentallydevelopedwaysforconsumerstoborrow.Selling goods—not just making them cheaply—quickly became the

chief challenge of the automotive industry and of American industrymoregenerally.Ifthemainproblemofthenineteenthcenturywashowtoproduceenough,theproblemofthetwentiethcenturywouldbehowtosellenough.The“producerism”ofFord’syouthbegantogivewaytothe “consumerism” of the new century. Whereas Ford romanticized amechanic’sabilitytobuildacarfromapileofboltsandchains,hisownworkersgaveuptheircontrol intheworkplaceformorecontrol inthemarketplace. Though it could be kind of fun to assemble a car fromscratch,itwastheworstkindofhelltotightenthesamenutninehoursaday.Fordhimselfwrotethat“repetitivelabor—thedoingofonethingover and over again and always in the same way—is a terrifyingprospect to a certain kind of mind. It is terrifying tome. I could notpossiblydothesamethingdayinanddayout,butotherminds,perhapsI might say to the majority of minds, repetitive operations hold noterrors.Infact,tosometypesofmindthoughtisabsolutelyappalling.”7Yet even for the majority, the work was intolerable. In the early

1910s,Fordhadtorehirehisentireworkforcethreeorfourtimesayearbecauseeveryonequit.The“five-dollar-day,”startedin1914,whenFord

paidhisworkers$5aday—twicethemarketwage—virtuallyeliminatedabsenteeismandkept theassembly line running.Thehigherwagealsoenabled a new generation of American workers to privilege theirconsumer identity over their producer identity.8Wagesmatteredmorethanworkplace control as longas theworkwas steadyandwell paid.But in this contextofhighwagesandhighproductivity, sellingall thegoods could no longer be taken for granted. Consumer finance wouldthusassumeanewimportance.Economichistorianshavecalledthisnewhigh-wagesystem,whereworkerscouldbuythegoodsthattheymake,“Fordism” because the five-dollar-day is so closely associated with itsinauguration. Yet, rather than the first Fordist, Henry Ford should bethoughtofasthelastmechanic.HewaslikeMosesonthevergeofthePromisedLand:hecouldtaketheHebrewstherefromoutofEgyptbutcouldnothimselfenter.Hewasaprisonerofhispopulistorigins,unabletoaccepttheimportanceoffinance.Hisupstart rivalGeneralMotorswould teachFordabout thatand intheprocessnearlybankrupthim.UnlikeFordMotorCompany,GMwasfoundedbyaman,WilliamDurant,whoknewlittleabouthowtobuilda car and couldn’t care less. In 1885, young William Durant was atwenty-four-year-old insurance salesman in Flint, Michigan. Buying apatent for a new kind of two-wheeled cart, he had gone into businesswith a local hardware salesman. Since they were both salesmen, theysubcontractedtheactualbuildingofthecartstolocalcarriagebuilders.Flint,atthatpoint,wasoneofthelargestcentersforcarriagebuildinginthe country. With so many builders around, it made more sense tocontract the work out than to build a factory themselves. Without afactory, Durant could concentrate on selling, which was what he didbest.9Andsellhedid.Hesetupdistributors.Hepeddledinthecity.Hesoldin thecountry.Allacross thenation,Durantandhispartner sold theirtwo-wheeled carts. Then Durant took this model of subcontractingdeveloped for carriages, ditched his hapless partner, and set aboutbuildingacarcompany.Whereas Ford grewhis company through innovation,Durant boughtoutcompetitors,preferablywhentheywentbankruptandcouldbehadon the cheap. While doing so, however, he maintained small cashreserves. Unlike Ford, who financed everything internally by saving,

Durantspenthiscapitalonacquisitionsandborrowedtothehilt.Durantwasawildoptimistwhothoughtdemandwouldalwaysoutpacegrowth.Heproducedasmanypartsandbodiesashecould,anticipating risingdemand. Such a strategy works well in an expanding market, but in1910 there was a sudden drop in demand that even Durant, thesupersalesman,couldnotovercome.Helostcontrolofhiscompanytoagroup of East Coast bankers from Boston and New York, who pushedDurantoutandreorganizedthecompany.Though Ford remained in the hands of the original mechanics who

built cars, by 1920 GM, through a series of corporate intrigues, hadpassedintothecontroloftheDuPontCorporation,famedforitsabilitytoorganizefinanceaswellasproduction.SoontheonehandtherewasFordMotorCompany,headedbyoneman,whobelievedinnothingbutproduction,andontheotherhandtherewasavastcorporation,drawingon the organizational resources ofmany differentmen and predicatedentirelyonprofit.Fortheautoindustrytocontinuethebreakneckgrowthofthe1910s,

newwaystosellcarswouldhavetobefound.ThoughHenryFordsawfinance as antithetical to production, GeneralMotors saw salvation infinance.Then,asnow,mostAmericansboughttheircarsinthesummer.Yetforfactoriestoberunprofitably,theyhadtoberun24/7,eveninthewinter.Whowouldpayforthestorageofalltheexcessproduction?Once production began to seriously outpace seasonal demand, GM hituponacleveridea.GMwould finance dealers’ purchases of cars from the factory. Then

the automaker wouldn’t have to deal with the excess inventory, anddealerswould have stock on hand for any potential customers. If youthinkthedealersgottherawendofthedeal,youwouldberight.Theyhadtopayforcarsthatcouldnotbesolduntil thesummer,whileGMgot the interest on the financing, plus the profitable operation of thefactory. But a dealer had little choice in the matter, since GM couldeasily stop selling its cars and simply findanotherdealership thatwaswillingtoplayball.One of Du Pont’s vice presidents, a finance expert named John

Raskob, set up a new subsidiary corporation to handle this newfinancing plan, General Motors Acceptance Corporation (GMAC).Though originally created to handle wholesale dealership financing,

GMAC eventually realized that consumers had financing problems oftheirown.ThoughdealerswereloathtogointodebttodealwithGM’sexcess inventory problem, consumers clamored to borrow. In the firstfew years of the 1920s, small finance companies across the countryrecognizedtheopportunityandbegantoofferconsumers theoptiontoborrow against their rising wages. Recognizing the possibilities to befoundinlendingtoconsumers,GMACexpandedbeyondjustlendingtodealers.This reorientation to consumers was hard for a large manufacturer

such asGM. Itwas accustomed to caring only about production; saleswerethedealerships’problem.Thus,itwasnotuntil1924thatGMused“sales to consumers” as its “fundamental index” formeasuring successinsteadofjustsalestodealers.10Still,by1924,GMACprovidedabout5percentof the totalannualprofit forGMand itssubsidiarycompanies.Whereas the General Motors Annual Report for 1919 describes theprimary purpose of GMAC as “to assist dealers in financing theirpurchase of General Motors’ products,” by 1927, the GMAC annualreportdescribes“provid[ing]credittotheconsumerofgoodsasitsmostimportantfunction.”11ThoughwemightthinkofGM’sshifttofinancingasarelativelyrecentphenomenon, its longroad fromamanufacturingcompany to a finance company began nearly at its outset. By 1927,GMAC’s annual gross revenues totaledmore than $40million, and itsassetstotaledmorethan$300million.In1926,GMACconnectedhighfinancewithconsumerfinanceforthe

firsttime.Tomaintainitsgrowth,GMACissueditsfirst6percentbondin February 1926. The investment bank J.P. Morgan sold the bonds,raising$50millionincash.12Begunonlysevenyearsearlier,GMAChadassets of $275million, or 30 percent of GeneralMotors proper.13 Thesuccessful1926bondissuewasfollowedin1927byanother$50millionsale, giving GMAC the capital it needed to grow.14 Ford, in contrast,reliedon itsownprofits—calledretainedearnings—to fund itsgrowth.In1926,itdispersed62percentofprofitstostockholdersandreinvestedan ample $64 million in its operations. Automobile companies, inparticular,didnottendtorelyonloans.Carcompaniestendedtofundonly2.3percentoftheircapitalfrombondissues,comparedto9percentin other industries. Yet even among that relatively debt-free industry,Fordstoodout,withonly0.02percent—$145,000—ofitscapitalbacked

bybonds.15Finance enabled GMAC to expand, which in turn allowed GM toexpand.Raskobimaginedconsumercreditasanalternativetosocialism,since credit might make possible “the dream haven of plenty foreverybodyandfairshakeforall,whichthesocialistshavepointedouttomankind. But our route will be by the capitalist road of upbuildingrather than by the socialistic road of tearing down.”16 Financing alsomademoney:by the late1920s,autosales faltered,but thenumberofcarsfinancedbyGMACgrewfrom646,000in1926to824,190in1927.In1927,GMACfinancedslightlyoveronemillionGMcars.Henry Ford, meanwhile, fought back against putting Americans indebt.AsGMbecame the leadingAmericancarcompany in1927,Fordgroused,“Isometimeswonderifwehavenotlostourbuyingsenseandfallen entirely under the spell of salesmanship. The American of ageneration ago was a shrewd buyer. He knew values in the terms ofutilityanddollars.ButnowadaystheAmericanpeopleseemtolistenandbe sold; that is, they do not buy. They are sold, things are pushed onthem. We have dotted lines for this, that and the other thing—all ofthem taking up income before it is earned.”17 He realized that creditdrovesalesbuthedidnotwantapartofit.Hetookaprincipledstance.Hestoodforold-fashionedways.Despitehisprinciples,hecontinuedtolosemarketshare.In all things, Ford, like the homesteading pioneer of a generationearlier, pushed for self-sufficiency. The triumph of this urge was hismagnumopus:theRiverRougeplant.Begunin1918,itwassituatedinthe country seven miles from Dearborn, allowing Ford to imaginelayoutsatascaleneverpossibleinacity.WhileinDetroit,limitedspacehad forced Ford to rely on elevators; at River Rouge he could lay outeverybuilding inone story.Productioncouldbe flatterand thusmoreefficient.Itcouldalsobeself-sufficient.Fordhadfumedattheshortagesof World War I. Unlike GM, which continued to outsource wheneverpossible, as Durant had done from the very beginning, Ford pushedtowardfullverticalintegration.TheRiverRougePlantcouldtakeinraworeanduncutlumber,andthen,thirty-threehourslater,turnoutanewcar.NothingcouldcompetewiththemechanicalapotheosisoftheRiverRouge plant. River Rouge lowered automobile production costs to theabsoluteminimum.Forddidn’tneedanyoneelse.Hehadattainedwhat

was in his mind the ideal product and the ideal way to make thatproduct.Butthatwasnotenough.By1927,whenRiverRougewasfullyfunctional,employing100,000workersandsprawlingover1,100acres,FordMotorCompanynearlywentunder.Nobodywantstobeseeninyesterday’sride,andbythemid-1920s,nomatterhowlowthepriceontheModelTdropped,peopledidnotwanttobuyit.Bytheendofthe1920s,GMhadbecomethedominantautomanufacturerinAmericaandFordstruggledtokeepupasitrapidlylostprofitsandmarketshare.BythatpointtheModelTwasnearlytwentyyearsold,anditslow-pricedesignhadneverchanged.Ithadnoroof.Ithadnoshockabsorbers,noelectricstarter,nobattery-poweredignition.It came in any color you liked, as long as that color was black.Americanswerenowwillingtopaymoretogetacarwithacolor—anda roof.And theywerewilling toborrow todo so.Within ten years ofWorldWarI,installmentsalesofautomobilesroseto60percentoftotalcar sales—from zero. Ford resisted consumer choice and consumerfinanceateveryturn.Withhissuccessbeginningtosour,Ford’shostilitytofinancestretchedintoahostilitytofinanciers,whichtoFordmeantJews.ForFord,allthetroubles hewas having in his companywere caused by the financiers(suchasthedecidedlynot-JewishduPontswhoranGM)whowerepartofthe“invisiblegovernment,”bywhichhemeantthesecretconspiracyofJewishbankersthattrulyrantheworld.Hisbeliefwasinspiredbyafabricated bookhe encountered sometime aroundwhenhe bought thelocalnewspaperTheDearbornIndependentin1920.FabricatedbytsarstojustifyRussianpogroms,TheProtocolsoftheEldersofZionclaimedtobeanauthenticmanualonhowJewsweretouseinternationalfinanceandCommunistrevolution—that is,capitalismandcommunismatonce—tooverthrow the Christian world. In Ford Ideals, Ford wrote that “thisconcealed international control of theworld flourishes because peopledo not believe that it exists. They don’t see how it can exist.” TheDearbornIndependent,whichwasanythingbutindependentduetoFord’sintrusions,wasFord’swaytogetthewordout.HisobsessionwithJewsbecame public with an article entitled “The International Jew: TheWorld’sProblem,”inwhichheoutlinedthetroublescausedbyJewsinallaspectsoflifearoundtheworld.Butitdidnotstopwithonearticle.Every week, Ford published articles in the Independent: how Jews

corrupted politics; how Jews had causedWorldWar I. The newspaperbecameamouthpieceforhisanti-Semitic-inflectedcritiquesoffinance.Now, Idon’tdiscuss thisbecause Iwant toslander thereputationof

Henry Ford. Such xenophobic and anti-Semitic thinking was all toocommonat the time.After all, itwas in1921and1924 thatCongresspassed immigrationacts to stop thecontinued immigrationofJews,aswell as all other kinds of eastern and southern Europeans, who werebelievedtobeunassimilableanddestructivetotheAmericanwayoflife.Hisanti-Semitismmighthavebeenonlyahistoricalcuriosityexceptthathis monomania blinded him to the shifting currents of business. Hebelievedthatthemoneysupply,controlledbytheMoneyPower,wasthesource of all U.S.woes. Andwho controlled themoney supply, in hisview? Jewish international financiers. He was not going to put hiscompanyorhiscustomersinhocktotheJews.Fordnevertookoutsideinvestorsbecauseofhisantipathytofinance

andhisbeliefinself-reliance.Hedidn’twantanymoneyfromanyNewYorkfinancier—readJewishfinancier—affiliatedwithhiscompany.Andin the1920s,whenAmerican consumerswere first beginning to enjoythebenefitsof installmentcredit,Ford’sresistancetoconsumerfinancealmostundidthecompany.Insteadofconsumerfinance,Fordoffereda“Fordweeklypurchasing

plan” through his dealerships, starting in 1923. In this scheme, apossiblebuyerwouldstartasavingsplanatthedealership,whichwouldbe credited with interest only if, in the end, the consumer used thesavings to buy a Ford. Advertisements reassured depositors that theywouldreceive“interest…computedatourregularsavingsrate.”18Sucha savings plan accorded with Ford’s moral vision of Americanconsumptionanddidnot sendmoneybackeast tobankers—Jewishorgentile.ButAmericansdidnotwantanewsavingsaccount,theywantedanewcar!Thoughtheprogram’sfailureisnotthatsurprising,thefactthatthousandsofpeopledepositedtheirmoneyataForddealershipis.Forddidnotunderstandthatahigh-quality,affordableproductwasnolongerenough.Hehadtosell,andconsumerswantedcredit.Ford’s anti-Semitism sprang from mechanic ideals, I believe, rather

thanadeep-seatedhatredofJews.Atonepointin1922,heremarkedtohis biographer that he was concerned that there was “toomuch anti-Semitic feeling. I can feel it around here. If wewere to keep this up,

somethingmighthappentotheJews.Idonotwantanyharmtocometothem.”19ManyFordemployees,afterall,wereJewish.Nodoubthehadmany Jewish acquaintances. Thoughhewas a greatmechanic, hewasoftennotaclearthinker.Therewasananecdoteinthe1920sthatconveyedFord’soddmixture

of industrialist and populist: Two Wall Street “personages” werediscussingHenryFord.“ ‘FordtalkslikeaSocialist,’saidone. ‘Yes,butheacts likeoneofus,’ repliedtheothersoftly, ‘andhegetsawaywithit.’”20Finance—the real issue—and Jews became muddied in his mind.

Within a few years, Ford told the editor of his paper, “Put all yourthought and time to studying and writing about this money question.TheJewsareresponsible for thepresentmoneystandardandwewantthemonoursidetogetridofit.”AndwithaquickwordfromMr.Ford,theanti-Jewishscreedsstopped.Fordpublishedaretractionofhisyearsofpropaganda:“Theso-calledProtocols…Ilearntobegrossforgeries.”Healsoexpressedregretforhisyearsof“contendingthattheJewshavebeenengagedinaconspiracytocontrolthecapitalandindustriesoftheworld.”21ItwasnotJewsbutJewishfinanciersthatultimatelydistressedFord.Thisfinancialworldthatproducednothingandyetreapedprofitswas the real enemy. Newspapers across the country supported Ford’schange of heart. The Atlanta Constitution was typical in its editorialopinionthat“althoughmanlyandcourageous,theretractionisnomorethanMr.Fordshouldhavemade.Thepityisitwasnotmadelongago.”More conciliatory was the statement by Samuel Stern, a lawyer andformer president of theWashington Bar Associationwho thought thatFord’s“effortsshouldbeand,Ithink,willbereceivedbymypeopleinthetrueChristianspiritsowellexemplifiedbytheJew.”Theruggedindependenceofthemechanic,whichHenryFordvalued

most (while, ironically, doingmore thananyotherman todestroy it),had been sapped from the American people through borrowing andsalesmanship.Ford,inakindofprincipledstance,realizedthatsalesandcredit were driving consumption, but he did not want any part of it.Despitehisprinciples,hewaslosingmarketshare.WhileGMgrew,FordMotor Company collapsed. Ford’s market share plummeted from overhalfofallcarssoldin1921tolessthanafifthbytheendofthedecade.The company’sprofits, once stellar,werenegativeby1927, showinga

net loss of $30million. In contrast, GM earned $262million on $1.3billioninsales in1927.WhileForddominatedthe1910sasa low-costcarwasneededforagrowingmarket,GMdominatedfromthe1920stothe 1980s, as its superior corporate strategy dominated the stumblingFord.FordismwasreallyGM-ism.By 1928, forced into it by unyielding market pressures, Ford

reluctantly started a subsidiary credit company called the UniversalCreditCorporation.Buyers couldputdown10percent and finance foruptoyear.Butbythatpoint,Fordhadmissedmostofthe1920s,asGMexpandedsalesthroughitsbetterproductsandfinancing.Indeed,HenryFord,thoughforcedintoofferingconsumercredit,couldnotabideitandsoldoffthesubsidiaryafewyearslater,in1933,toCIT.Meanwhile,GMexpandeditsrelianceonconsumerfinance,consolidatingGMACintotheprofitandlossstatementsofGMin1929.Demonstratinghowimportantconsumerfinancewastoitsbusinessmodel,when,in1929,GMboughtthe German car manufacturer, Adam Opel, it immediately founded anewentity,OpelFinanzierung,tobetheGMACofGermany.22SoasGMenjoyedthefatprofitsofconsumerfinancethroughtheDepressionandindeedthroughtoday,Fordretreated.HenryFordsoldoffthefinancingarm, which could have provided his company with additional profits,thus hampering the growth of Ford as both a finance company and amanufacturingcompany.23Henry Ford produced the first car for the masses, but by the late

1920s, themasses no longer existed. Consumermarkets had begun tosegment,fragmentingalongdifferentlinesofincome.GMofferedcarsatevery price point and the financing that made those points possible.Americans started to be paid enough to exercise choice, no longerchained to whatever was cheapest. Masses became consumers. In theprocess,thecarforthemasses,producedforthecheapestpossibleprice,lost out.Hardscrabble independencewas nowhere near as comfortableasacar.Aswagesrose,so toodidexpectations.By1929,workersexpecteda

car.Theywanteda radio.Theywanteda standardof lifemuchhigherthan their parents had had in 1900. A survey in 1929 found that theaverage Detroit-area Ford worker earned $1,712. But what wasconsidered “necessary” by 1929 called for an income of $1,728—$16short. And Fordworkers, aswell as any of the semiskilledworkers in

growing industries such as automobiles, electrical goods, and othermass-production industries, were relatively well paid. Progressivesworriedthat“dollar-downserfdom”would“delivertheworkmantohisemployer swathed in the tightly binding bandages of payment duedates,”preventingstrikes.24Consumptiononcreditwasthesureroadtolower wages. Only by borrowing from the future could that $16difference be made up, though, and in the 1920s, Americans chosecomfortableserfdom.By the late 1920s, nearly all goods could be had on the installment

plan.Carsandradioscouldbeboughtontime,andsotoocouldvacuumcleaners,phonographs,washingmachines,cabinets,clothes,andnearlyanythingelse.Conservativesworriedthatallthisborrowing—implicitlya lack of saving—reflected a failure of the American character.Republican senator James Couzens of Michigan, an early investor inFord Motor Company and lifelong friend of Henry Ford, was anoutspokencriticofinstallmentcredit.The“growingevil”ofinstallmentcredit, he said, “results in weakening of character and neglect of themore substantial things of life.”25 Budgeting to spend instead ofbudgetingtosave,Couzensthought,underminedthepurposeofbudgets.Echoing today’s denunciations, he could “say from [his] personalknowledge that the education of children, their physical well-beinggenerally, even the care of their teeth are being neglected to enablefamilies to purchase on instalments many luxuries [sic].” “If this issound,”hesaid,“thenlettheorgyproceed.”It did. Retailers and manufacturers, ignoring politics in favor of

profits, learned to lend, creating finance companies not just forautomobiles but for everything, linking consumers’ desire with banks’capital.Oneofthemainjustificationsforallthislendingwas,ofcourse,the character of the people who borrowed. Early-twentieth-century“Credit men” evaluated borrowers by what they called the four Cs:“character,capacity,capital,[and]collateral,”ofwhichcharacter,itwasclaimed,wasthebasicrockfoundationofthefourbigCs.26Ifborrowingrequiredcharacterandtheactofborrowingitselferodedcharacter,thenallthosecreditmenwereinquiteafix.Luckilyitwasnotjustcharacterbut theotherCs thatmatteredaswell.More important thancharacterwas the stability of income. Even the Saturday Evening Post couldexplain, in1928, thatacar loan“cannotbe soldwith safety toaman

with even a large income if he has no stability and no character.”27While character, depending onwhat one thinks, iswithin our control,stability often is not. Couzens’s “warning against the continuance ofpracticeswhicheveryonewhohashadanyexperienceatallknowstobeunsound, unwise, anddangerous”went happily ignored as long as theeconomychuggedstablyalong.Thosewhogrumbled,liketheeconomistC. Reinhold Noyes writing in the Yale Review, about “financingprosperityon tomorrow’s income”and the inevitabilityof thebusinesscyclewereunheeded.28Noyesheld“themotorindustrytobethestormcentreofthenextperiodofdepression,anditwillbeentirelytoblame”for infusing installment credit so thoroughly into the economy. TheDepression, which he correctly predicted in 1927 to be “two or threeyears”away,wouldbe“automaticandinevitable”asitwastheresultof“retribution for economic sin.”29 The “various bubbles” of cars andhouses would burst and drag down the economy. Noyes, like allbellyachers, was blissfully ignored. The celebrated economic punditspronounced the late 1920s as a New Era forever free of recession.Expansion, made possible by the electrical age and enabled throughcredit,wouldcontinueforever.AnotherYaleeconomist,IrvingFisher—muchmore famous thanNoyes forhis optimism—pronounced in1929thatstocks,inthisneweconomy,wouldneverfallagain.Andthen,threedayslatertheworld—includingYale—watchedslack-

jawedasthestockmarketcrashed.

CHAPTERTHREEFANNIEMAECANSAVEAMERICA

(1924–1939)

If owingmoney to a bank on a car threatened the yeoman ideal thatHenry Ford held so dear, imagine howhe felt about homemortgages.The “homestead” was at the center of the nineteenth century’sindependentideals,yetinthetwentiethcenturyitwassimplytruncatedto “home.”A farmwasmore thanaplace to sleepandkeep things; itwasaplaceofproduction.Modernemployees,ineitherafactoryoranoffice, produced nothing at home and always had a boss. Farmersworkedathome.Unlesstheyhadamortgage,theydidn’thavetoanswertoanybody.Iftheyhadamortgage,itwassomethingtobeashamedof.AwriterinHouse&Gardenin1931“remember[ed]asasmallboybeingcalledupontodeliver the interestmoney for[his]grandmother.”1Therelationship was personal and terrifying. Knees knocking and handstrembling, he rapped on the door of the old man, whose “rough,whiskeredfacepeeredout”tocollecthisinterest.Sincehisyouthonthefarm,“sentimentandusage”hadchanged.Yetthefeelingofindependenceinowningone’sownhomepersisted.

Anotherwriter, inThe National Republic, could casuallywrite in 1932that“today,asitwaswiththeFoundingFathers,theAmericanhomeisthe cornerstone of American prosperity, and one of the nationalbulwarksofournationalliberties.”2Thereadyavailabilityofmortgageshad catapulted U.S. home-ownership rates to the highest levels in theworld—but thatownershipcameataprice.ThedangersofAmericans’obsessionwithhomeownershiparenothingnew. In the1920s, averysimilar set of financial services, such as the balloonmortgage and the

mortgage-backed security, helped lead to the collapse of the housingmarketintheGreatDepression.Everynightmare,however,beginswithadream.If I told you that two young people fell in love, got married, andboughtahouse,youwouldnotbesurprised.IfItoldyouthatthehousewasboughtwithaballoonmortgageonlyafewyearslongandfinancedthrough mortgage-backed securities, you would probably shake yourheadbutwouldn’tbesurprised.ButifItoldyouthatthiswas1925andnot 2006, you would probably be shocked if you hadn’t read theintroduction. Though we consider mortgage-backed securities andballoonmortgages to be the recent inventions ofWall Street wizards,they have, in fact, a far longer history. In the 1920s, both kinds offinancialinstrumentswerewidespread,underpinningtheborrowingandlending of millions of Americans. Then, as now, the nature of thesefinancialinstrumentsledtotragedyashomeownersacrossthecountrydefaultedontheirmortgagesduringtheGreatDepression.Likethestockspeculatorswhoborrowedonmargin,homeownersof the1920s livedon the margin of their incomes to own their homes. How did theinherently unstable mortgage system of the 1920s become the stablethirty-year fixed-rate mortgage that we now remember to be “old-fashioned”?Ayoungcouple,flushwithloveandshortoncash,mighthavegonetoalocalsavingsandloanbankin1924.Thiscouplemighthaverecentlycome to the city from the countryside, which in fact lingered in adepression, beginning in 1921, that would not fully abate until afterWorldWar II. In the cities, however, theUnited States’manufacturingeconomy flourished. Factories turned out all the appliances thatinstallmentcreditcouldsell.Withthehusbandfindinganewjobatthecarfactory,thecouplecould,afterayearortwo,applyforamortgage.Lookingovertheapplication,theS&L’smortgageofficerwouldexamineonly a few key qualities: how long had he had his job, how long hadtheylivedattheircurrentaddress,howmuchdidhemake?Thewife’sincomeandworkhistorywouldcountfornothing.Lendersassumedthatassoonasshehadachild,shewouldnolongerwork.Attheendoftheinterview,themortgageofficerwouldtellthemthattheycouldgetthelongest possible mortgage—the ten-year mortgage—paying off theinterestandtheprincipaleverymonth,butdoingsowouldnotgetthem

thehousethattheywanted.Inthehousingboomofthe1920s,budgetswerepushedtothelimittoaffordtherapidlybuilt,shoddilyconstructedurbanhouses.An amortizedmortgagewas available butwould reducethepriceofthehousethecouplecouldbuy.Whatthemortgageofficersuggested and the couple cheerfully accepted instead was an interest-onlyballoonmortgage.Balloon mortgages preyed on the optimism of 1920s home buyers,who, caught between resurgent prosperity and rising urbanization,bought into one of the great housing booms of the twentieth century.Thewartimedemandforcityhousingandcitybusinessesdroverentsashighastheskyscrapersthemselves.Pricesseemedasthoughtheywouldrise forever. To make the monthly payments affordable, home buyerswould pay only the interest on the mortgages. Every few years, theballoonmortgagewouldhavetoberefinanced.Borrowersrarelypaidoffthe principal of themortgage, counting on good job fortune or risinghomevaluestomaketheinterest-onlypaymentsworthwhile.Followingthecrashin1929,thatgoodfortunewouldbealongtimeincoming.The collapse of the housingmarketwas so catastrophic because theU.S.economyhadcometodependonitsunendinggrowth.Alongwithautomobiles, houses propelled the United States to a new prosperity.WritinginMIT’swell-regardedbutseldomreadReviewofEconomicsandStatisticsin1930,W.C.Clarkremarkedthatwhenthe“economistofthefuturecompilesthebusinessannalsofthepastdecade,hewillfindthekey to our prolonged and unprecedented prosperity in the stimulusprovidedbytwogreatindustries—buildingconstructionandautomobilemanufacturing.”3Looking back, it is hard to disagree with Clark’s assessment, butnonetheless it seems odd. Houses and cars could not have beenmoredissimilar.Houses stay put; carsmove.Houseswere built on-site; carscame frommassive factories on the other side of the country. Houseswere made of wood, cars of metal. Houses were built to last; cars,despite what the salesman told you, would be around for at most adecade.Despitethesedifferences,economicallycarsandhouseswereperhapsuniquely similar. The United States had the highest rates of carownershipandhouseownershipanywhereintheworld,1carforevery5.3people.InFranceandGreatBritaintheratiowasmorelike1carper

44 people.Houses and cars both consumed not just one kind of laborandonekindofmaterialsbutanearlyuntoldmultitude.Housesneededwood and nails, but they also needed insulation, appliances, wiring,pipes,stone,andglass.By1927,theautoindustryconsumed64percentof plate glass manufactured, 60 percent of upholstered leather, 14percentofrolledfinishedsteel,22percentoftin,17percentoflead,12percentofcopper,29percentofnickel,and13percentofhardwood,aswell as paints and other products.Houses needed carpenters, but theyalso needed architects, real estate agents, ditch diggers, masons, andgeneral contractors. Therewas anotherway, too, inwhichhouses andcars were similar: their reliance on consumer credit. Cars and houseswere both bought on installment, and it was this crucial connectionbetweendemandandfinancethatbroughttheU.S.economytoitsknees.Morethanmostotherproductsintheeconomy,buyingahouseoracarmultiplied demand, as the dollars trickled down through the economythrough all those hands and companies.When the demand for housesand cars fell, as it did in the early 1930s, the effect was multipliedthroughouttheeconomy.Afterthecrashof1929,however,evenClarkwonderedifconstruction

couldregainitsfooting.Hiswondershouldhavebeencertainty.In1925,500,000newhomeswerebuilt.4By1934,only22,000newhomeswerebuilt,despiteanadditional400,000familiesneedingsheltereveryyear.Toputitintoperspective,morehomesburneddownin1934thanwerebuilt.5 Housing was at the center of the American economy, andrestoringthebuildingboomwasnecessarytoanimatingit.Theconstructionboomofthe1920swasbasedoneasycredit.Banks

and other financial institutions made more money available formortgages than ever before. State and federal regulators attempted tocontainthelending,butinthemidstofabubble,whereopportunityiseverywhere,itisalwaysdifficulttobepessimistic.Andlenderswillfindaway to lendmoremoney.Banks lentasmuchas theycould. InNewYork,forinstance,state-charteredbankswereallowedtolendupto70percent of their deposits asmortgages,whichwas liberal compared tothe 50 percent limit imposed by the Federal Reserve on federallychartered banks. In 1925, only 13 percent had reached this limit. By1929, two-thirds of New York banks had 65 to 70 percent of theirdepositslentout.Balloonmortgages,then,werefinancedthroughlocal

savings and loan banks, which depended, to a large extent, on thedeposits of savings accounts to lend money out. Without today’s CDs(whichdidn’texistuntilthelate1950s),drawinginsufficientdepositstomeet demand formortgage funds could be difficult. Running short ondeposits,banksinnovativelyturnedtobonds.Inthe1920s,savingsandloanbanksbegantorelymoreuponanothersource for funds: the participation certificate (PC). The PC was like abond.Aninvestorboughtitandreceivedamonthlyinterestpayment.Attheendofapredeterminedtime,usuallyafewyears,theprincipalofthebondcouldbe redeemed.Unlikenormalbonds,whichwerebackedbythegovernmentoracorporation,thesebondswerebackedbymortgagepayments, usually balloon mortgages. There was not the complicatedfinancial machinery that exists in today’s mortgage-backed securitymarkets, but the basic ideawas the same:money came into the bankfromthemortgagesandwentoutof thebank topay thePC investors.Whether enough money was available at the bank to refinance theballoonmortgagesof all thosehomeownersdependedonwhether thePC investors decided to reinvest their money. In good times, when itseemed that mortgage borrowers could make their payments, PCsseemed like a reliable investment.Timemagazine reassured readers in1926that“realestatebondsarebynomeansjeopardousinvestments.Infact, they should be the best of all securities, for they are backed bytangible buildings and real estate.” The familiar fallacious reasoningreassured investors then, as now, of the inevitability of rising houseprices.Ashouseswentup in value, the investmentbecameevenmoresecure. “The scheme,” as one banker writing in 1925 describingparticipation certificates, was “ingenious, convenient, self-sustaining,andextraordinarilysafeandsound.”6Thatis,untilhousepricesfell.Americanshad learnedduring thewar, through thewartimeLibertyBonddrives,howtosavebybuyingbonds.In1918,likethemanyotherbond houses advertising their broker services in Scribner’s, Herrick &Bennettcelebratedthepatrioticandpersonalvirtuesofpartialpayment:“ThrifthashelpedFrancetoholdbacktheHunhordesandsavefreedomtotheworld.Youcanacquirethehabitofthriftinnobetterwaythanbyourpartialpaymentplan.Thisplanwillalsoenableyoutosubscribetothe Fourth Liberty Loan.”7 Buying bonds on the “part-payment” planreinforced installment plan–like habits for millions of Americans. This

newplanhelpedborrowersadjusttopayingsmallamountseverymonth,whichinturnpartiallyenabledthemortgageboomofthe1920s.Evenmorecuriously,realestatebondscouldbeboughtbutcouldnot

be sold now. Real estate mortgages could be traded, and seasonedmortgagebonds—theonesthathadbeenaroundawhileandforwhichdefaultseemunlikely—evenmoreso.Yetfewofthosebondseversawatrading floor. From the get-go, theywere toxic.Unlikehouses or evenmortgages,realestatebondscouldbesoldonlytothebondhousesthathadissuedthem(andthenonlyiftheywerebuying).Formostinvestors,thislackofasecondarymarketdidn’tmatter;theywereunsophisticatedsmall-timeinvestorswhobelievedinholdingabondtomaturity.Abondwas a prudent investment compared to the margin accounts of thosewhospeculatedinstocks.Thoughwetossstocksandbondstogetherinourordinary,madmoney–laden speech, “bond”hasothermeaningsaswell: fidelity, connection, trust, promise. A bond is a promise to aninvestor.Awordcanbeabond.Likehonorandland,itismeanttoberelied on to support you, even into your twilight years. Bonds had amoral valence that stocks lacked. Moral or not, without a secondarymarket,ifthebondhousewentbankrupt,thebondwasworthless.

Mortgagebonds,suchasthisone,helpedtofuelthe1920srealestateboomandwereoneofthecausesofthe1930smortgagecrisis.(IllustrationCredits3.1)

Mostbuyerswerenotwealthy.Bondissuescameindenominationsaslowas$100.Mostbuyershadneverownedacorporatebondbefore.Asalarymanorevenaunionman,thetypicalinvestorlivedmodestlyandregular savings inbonds fitneatly into themonthlybudget.Moreover,theinvestorbelievedinhisbondhouseaboveallelse.Everymonththeinvestor receiveda complimentarymagazine fromhis bondhouse thatmixed investment advice on the virtues of its bonds over thecompetition’s with fascinating articles on medieval architecture or

ancientarchaeology. Ifnothingelse, it should teachyounever to trustanyonewhomixeshistoryandfinance,especiallywhentheyaresellingbonds.For the small investor, the financial realitiesmattered less than thefeeling of being part of history and part of the big game. Many realestatebondsbackedcommercial realestate.TheWaldorf-Astoriahotel,then as now one of the most famous hotels in the world, issued realestate bonds bought by everyday Joes. At work, they could brag thattheyownedpartofthenewWaldorf-Astoriahotel.Evenifthebondlaterdefaulted,forawhile,atleast,theinvestorfeltlikeabigshot.Right from theoutset, the real estatebondwas trouble, formanyofthe same reasons that the mortgage business is in trouble today: thepeoplesellingthemortgagesdidn’tputanyoftheirownmoneyatrisk.Banks that issuedmortgage bonds frequently insured themwith largeinsurance companies—generally United States Fidelity and GuarantyCompany,theNationalSuretyCompany,orMarylandCasualtyCompany—andusedinvestors’capital.8Moredubiouswerebondsissuedoutsideof banks and brokered through “real estate bond houses.” The bondissuers advertised aggressively and employed salesmen who receivedcommissions on their sales volume. Volume, not reliability, droveprofits.Despitethe“guarantees”offeredbythebondhouses,usuallytheonly guarantee was that of the bond houses’ assets, which rarelyconstituted even a small fraction of the value of the mortgages theyfinanced.Shoestringdeveloperspaid theirarchitectsandcontractors inmortgagesratherthancash,promisingthemapieceoftheactiondowntheline,puttingnoneoftheirownmoneyatrisk.Thelargestcompanies—U.S. Mortgage & Title Guaranty Company (New York), MortgageGuarantee Company (Baltimore), U.S. Mortgage Bond Company(Detroit), American Home Security Corporation (Chicago)—may havespread across the country, but wherever they were, the financialinstruments they sold, and the companies themselves, encountered thesamedesperatefateintheGreatDepression.9TheFederalReservewas,inprinciple,opposedtobanksissuingbondsbut inpractice tacitlycondoned it.For instance, inJuly1925, theFedsent a scolding letter to the Lincoln Bank and Trust Company inLouisville, Kentucky, explaining that in “principle, the FederalReserveBank is strongly opposed to any method of banking which combines

with the business of commercial banking the business of issuingdebentures or selling real estate loans with the bank’s guarantee.”10ThoughtheFederalReserveActof1913allowedbanksinsmalltownstoact as investment brokers, banks were not allowed to guarantee theinterestorprincipalofsuchloans.FederalReserveofficialsbelievedthat“such business should be conducted by an institution other than oneengaged in commercial banking.”11 Investment banking, which issuedsecurities,wasdangerous toblurwithcommercialbanking,which lentmoney. Despite those beliefs, the Fed granted the Louisville bank anexceptionandallowed it toenter thesecuritiesbusinessundera setofprovisions so loose as to be meaningless. Lincoln Bank and TrustCompanywastolendnomorethantentimesitscapital.Itshouldspinitsmortgagebusinessoffintoaseparatecompany“assoonasitisable.”Most tellingly, if it sold mortgages but maintained the guarantee, themortgagescouldbemovedofftheaccountbooksentirely.LincolnBankandTrustCompany,likesomanyotherbanksacrossthecountry, got caught up in the real estate excitement and by 1929hadlentmore than ten times its capital. The Federal Reserve Board, afterconsultingwith the bank, decided that the earlier limits had been toostringent and the current lending levelswere not “amatter of seriousconcern.”12 In short, the Fed protested the fusion of commercial andinvestmentbankingbutdidnothingtopreventitfromhappening,evenwhenithadthepowertodoso.Tradeassociationsalsofailedtocontaintherealestatebubble.At the height of the excitement, in September 1925, the FarmMortgage Bankers Association of America, at its annual convention(whichthatyearwasinNashville,describedadorablyasthe“dimpleofthe universe”), voted to become the Mortgage Bankers Association ofAmerica (MBAA).13Though theFMBAhadbeendenouncedasbig-citybankers from the East (and that was true of the investors if not thebankersthemselves),openingthememberstourbanlendingmarkedthenew primacy of urban lending. No longer would they just sell farmmortgages. The “great progress” in “standardizing and stabilizing thefarmmortgage”meantthatlenders,themselvesincities,begantotakeacloser look at their own concrete backyard. The bankers felt that “anational organization of city loan companies will develop andstandardize the city loan business, increase the marketability of city

loans and in many ways improve the service to both borrowers andinvestors.”Yet for all their visionary talk, the mortgage bankers were playing

catch-up. Even after a brief recession in 1920–1921, urban Americaenjoyed PresidentWarren Harding’s “return to normalcy,” while ruralAmericalanguishedinanenduringdepression,whichdidnotenduntilWorld War II. Mortgaging and expanding, farmers had expected foodpricestoriseforever,butin1921,thepriceofcornfellfrom$1.85perbushelto$0.41perbushelandstayedthere.14Grainandlivestockprices—the mainstay of Great Plains agriculture—dropped similarly.15Presaging what was to come for the entire mortgage market in the1930s, western farm mortgages in the 1920s hit unprecedentedforeclosure levels.16 Nationally, farm foreclosures rose. From 1913 to1920,lendersforeclosedon3.2farmsperthousand.From1921to1925,thatnumber tripled to10.7. In theWest thenumberswereevenmorearresting. In 1926, North Dakota had 46.3, South Dakota 52.5, andMontana 60.8 foreclosures per thousand compared to themuch lowerMassachusetts5.5,Ohio11.2,andCalifornia14.2.Theovervaluedfarmscollapsedinvalue.From1920to1940,afarmacreinSouthDakotalost77percentofitsvalue.17Necessarily,then,mortgagebankerslookedtothecitiesfornewmarkets.Inthecities,themortgagebondreachednewheightsofpopularityin

the mid-1920s. The MBAA estimated that in 1925, investors bought$675millioninmortgagebonds.Infiveyears,thevolumehadincreasedmore than 1,000 percent. According to the bankers, “the real estatemortgage bond is now firmly established as a standard form of safeinvestment,andthepossibilityofdevelopmentinthisfieldcanhardlybeexaggerated.”18Over the next year, editorials in the trade press pounded home the

notion that including lenders who sold real estate bonds would only“develop thequality andmarketabilityof their securities and they canprevent unreliable fly-by-night companies from continuing in thebusiness.”19The followingyear inRichmond, attendeesdenounced the“European corn borer” (a parasite) and “socialistic schemes” as thegreatest coequal threats to the U.S. mortgage system.20 By includingurban lenders in their organization, they felt that the market wouldinevitably be safe,without the need for further government oversight.

Confidently,theconventioneersretiredtoplaygolfatthenearby“courseonthesiteofthebattleandsurrenderatYorktown.”Thefirstteewasatthe “breach in the Cornwallis fortifications,” while the “sixteenthfairway [was] the ground over which Alexander Hamilton made hisattack.”On“thisspot[where]thefreedomofAmericawasestablished,”themortgagebankerscelebratedtheirnewlyexpandedmembershipandthe stability it would bring to the U.S. mortgage system. The flow ofcapitaltothecitiesfollowedtheflowofpeople.Asthedecadeworeon,theinevitabilityofrisinghousepricesseemed

less and less certain.When, in 1925,Walter Stabler,who oversaw theinvestments of the Metropolitan Life Insurance Company along withthoseofprominent institutional investors,expressedsuspicionofarealestatebubble inNewYork,anequallyprominentdeveloperdenouncedStabler’scommentsas“moretobefearedbythecommunityinwhichwelivethantheutterancesofBolshevists.”21Suchwords,thedeveloperfelt,“carr[ied]possibilitiesofgravedisaster to theprogressofourcityandthenation.”Pessimismaboutrealestatewasjustun-American.DespitetheapparentBolshevismofoneofAmerica’slargestinsurance

companies, the system worked fine for a few years, as rising rentsproppedupprofitsandthebuildingsthemselves.Thefirstportentcamein1925,astheFloridarealestatemarket,fueledbyNewYorkmortgagebond funds, began to burst. With the Miami Hurricane in 1926, thedevelopmentssankbackintotheswamps,alongwithinvestors’capital.In1926,a financialhurricanehitNewYorkasoneof the largestbondhouses—G. L. Miller & Company—collapsed after $50 million indefaults.22Mortgagebankers around the countrywrung their hands inanxiety but consoled themselves that the system itselfwas sound. TheMortgageBankersAssociationrolledouttheill-named“6–6–6program”toreassureinvestorsthatwithsixguidingprinciplesformulatedoversixmonths, the realestatebondmarket couldbedisciplinedwithinahalfyear.23 Even amid these crises, Americans invested approximately $1billion in mortgage bonds in 1926. At their peak, real estate bondsfundedone-quarterofallurbanmortgagedebt,equal involumeto thebondsofindustrialcorporations.Particularexamplesoffailurecouldnotdampenmostsmallinvestors’

faith in the reason of real estate. Yet by 1927, even conservativeprobusinessgroupssuchastheRotaryClubfoundnaysayerscastigating

mortgagebondsinthepagesoftheirofficialpublications.A1927issueof the The Rotarian warned its membership that “under the old andestablished system of lending money on real-estate security it rarelyhappenedthattoomuchmoneywasloaned…fortheborrowerandthelenderwereclosertogetherthantheyarenow.”Thearticle’sauthor,theHarvard graduate, World War I naval officer and investment bankerMalcolmLayHadden,describedtheflowofmortgagefundsasa“magicspring” of money, not unlike that famous Floridian fountain of youththat also poured forth the hope of eternal health. Florida, whether infountains of youth or in real estate, always seems to disappoint. Thecrucialdifferencebetweentheoldmortgagesystemandthebond-backedsystem,henoted,wasthethepersonalconnectionofborrowing.Whenlendinghappenedatadistance—impersonally,throughbondissues—theoldsocialchecksofpersonalobligationbrokedown.Withoutmoneyatrisk,abondsalesman’spromisewasascertainaseternalyouth.Without risk, intermediaries such as bond salesmen and shoddy

contractorsquicklyerectedbuildingssoldonbondstotakeadvantageofthe opportunity for profit. The construction of the mid-1920s wasnotoriouslyunsound,butnotasunsoundasthefinanceunderpinningit.By1935,80percentofthe$10billioninrealestatebondsoutstandingwould be in default. That the Securities Act of 1933 also discouragedreal estate bonds mattered less, as one contemporary economistobserved,thanthe“distastealreadyacquiredbyinvestors.”Theregulationofrealestatebondswas,ofcourse,butonepartofthe

sweepingfederalizationofconsumerfinanceduringtheNewDeal.IntheaftermathoftheDepression,thefederalgovernmentfeltthatthestates,which until the establishment of the Securities and ExchangeCommission in1934 regulated stocks andbonds, couldnot adequatelyoversee financial markets. “Blue-sky” laws, instituted by states in the1910sand ’20s toprotectborrowers against stock frauds,workedonlyagainst thosewho peddled outlandish investments such as nonexistentoilwellsandtherightstotheeponymousbluesky.Bondshadtheveneerofreality,backedupastheywerebybuildingsandland.Realestateis,for better andworse, real. You can go to a house, tap itswalls, walkaround it, and even see how tall young Billymight have been on hiseighthbirthday.Blue-skylawscoulddolittletoaffectbadappraisalsorunderestimated risks. Though buildings are concrete, their values are

not,andlawscannotsetprices.Theycanonlycorrectforbadintentionsandmisinformation—ofwhichtherewereplenty.

Themortgageracket—oldhattoday—wasnewin1931.(IllustrationCredits3.2)

The“MortgageRacket,”asitwastermedina1931Collier’sexposébythe assistant attorneygeneral,NugentDodds, had “taken advantageofthetraditionalreputationforsafetywhichtherealestatemortgage[had]justly enjoyed.”24 That reputation was no more. Many fraudulentmortgagesecuritieshadbeenissuedagainstexistingsecurities—liketheCDO2andCDO3oftoday,collateralizeddebtobligations(CDOs)madeofCDOs (squared)made of CDOs (cubed). In a boom era,when demandoutstripssupply,itisalltooeasytofindthenextsucker.TheforeclosurecrisisoftheGreatDepression,itturnedout,wasmore

a problem of mortgage funds than unemployment. The “permanentmortgage,” as the balloon mortgage was described, turned out to befleeting.25 After the crash, investors became bearish. Mortgage bonds,like all investments, seemed riskier. As the participation certificatescame due, skittish investors stopped reinvesting and the amount ofmoneyavailableformortgagesdriedup.Whereasthroughoutthe1920s

homeowners couldexpect to refinance theirballoonmortgages,banksnowdemandedthattheypayofftheloanorfaceforeclosure.Fewhomeowners could pay the principal on theirmortgages all at once, havingspent the 1920s simply paying the interest everymonth. Since all thelenderswantedtheirmoneyatonce,propertiesacrossthecountrywereforeclosed on, further depressing the real estate market and makinginvestment evenmoreunwise.Rather thana smoothdecline inprices,therewasacollapse.AsBusinessWeekstyleditina1930article,“thesinsofthemortgagebondsarevisitedonthebuildingfield.”26Whenthecrashhappened,speculatorsdesperatelytriedtocovertheir

marginaccounts.Suddenly,$195millionwaswithdrawnfromAmericanbanks—the first decline indeposits in twentyyears. In1933, federallychartered banks alone held $1.2 billion in mortgage bonds andparticipation certificates.27 If anything, $1.2 billion underestimates theloan volume before themortgage crisis since just from 1932 to 1933,805banks,one-thirdofwhichofferedmortgagebondsorparticipationcertificates, left the Federal Reserve System. Banks offering such loanscollapsed at twice the rate of banks that did not.28 Locales with thehighest proportion of lending—in Texas, for instance,mortgage bondsbacked 53 percent of all loans—were hardest hit.29 Luckily for banks,the bulk of that lending was insured, which, even if it doomed theinsurancecompanies,savedthebanks.PresidentHerbertHooverlaunchedagrouptostudythehousingcrisis

in 1931, the White House Conference on Home Building and HomeOwnership,whose ideaswouldprovide theseedbedformany ideasweusuallyattributetotheNewDeal.Hooverinauguratedtheconferencebyremindingtheattendeesaboutthemeaningofhousing:“Thoseimmortalballads, Home, Sweet Home; My Old Kentucky Home; and the LittleGray Home in the West, were not written about tenements orapartments.Theyaretheexpressionsofraciallongingwhichfindoutletinthelivingpoetryandsongsofourpeople.”Whilethepurposeoftheconferencewasto“facilitatetheownershipofhomesand…protecttheownersofhomes,”thislargerculturalambitioncouldnotbeignored.30Theconferenceproducedmanyideas—includingHoover’sproposalforasystemof“homeloandiscountbanks,”whichwouldbecomethenucleusofNewDealhousingreform—butnotenoughaction.Foreclosures,whichhadbeen rising since the peak of themarket in

1925, accelerated in1931 and1932.By1933, the foreclosure ratehitone thousand homes a day. After four years of withdrawal-witheredmortgage funds, the housing industry in 1933 was effectively dead,dropping to a tenth of the size it had been only a few years earlier.Without a viable housing industry, millions of skilled and unskilledconstruction workers filled the unemployment lists. One-third of thefamiliesonrelieffoundtheirwaythereduetothelossofaconstructionjob.Restoringthemortgagemarketswascrucialtotherestorationoftheeconomy. But to put the economy back onto a sound footing, thefinancial instruments that had gone so awry in the face of recession—balloonmortgagesandparticipationcertificates—wouldhavetobedoneawaywithandanewwayfoundtofinanceconstruction.The collapse of the real estate bondmarket begged for governmentintervention. InNew York State,where nearly half of themajor bondhouseswerelocated,amortgagecommissionwassetuptohave“controlofmortgagesandunderlyingcollateral”thatwasliquidatedbythestatesuperintendent of insurance or the superintendent of banking. The“public,”inthiscase200,000certificateholderswhohadinvested$685million,couldnotbeheldresponsiblefortheirsituation.Theyhaddoneno wrong save trusting in a supposedly sure thing. Just to be sure,however, New York State outlawed real estate bonds completely in1936.Ofcourse,bythatpointtherewerenolongeranybondsalesmenpeddlingthem.Indesperation,Americanswrote toEleanorRoosevelt, the first lady,nearly every day. The pleas encompassed all varieties of human needfrom simple justice to abstract theology (“Mrs. Roosevelt, what isspirit?”). Many letters to Mrs. Roosevelt concerned money, especiallymortgages. In her monthly page in Women’s Home Companion, sheexplainedhow the newgovernment program, theHomeOwners’ LoanCorporation, could help them.31 TheHomeOwners’ LoanCorporation,inauguratedin1933,arrestedthecollapseofthemortgagemarkets.Ouryoungcouple,iftheyfoundthemselvesunabletorefinancetheirhouse,couldturntotheHOLCforanewmortgage.TheHOLCdidn’tpayoffthemortgagebutswapped4percentbonds for themortgage in trouble,sothat the home owners now owed the HOLC instead of the bank.Applicants had a fifty-fifty chance of getting a new HOLC mortgage.Somepeoplewerejustnotgoodenoughrisks,andtheHOLChadonlya

limitedamountofcapital.Equallypossible,asMrs.Rooseveltexplained,amortgageholdermight simply refuse theHOLCbonds.Givingbankslong-termgovernmentbonds in return for their toxic assets, theHOLCtook the bad debt of millions of young couples off the books of thebanks, refinancing one-fifth of all U.S. mortgages and injectingmuch-neededliquidityintotheU.S.mortgagemarket.Thefreefallofhousingpricesstopped.Theyoungcouplecouldtradeintheirballoonmortgagefor a longer fifteen-year amortized mortgage that kept monthlypaymentsthesamebutguaranteed,attheendofthosefifteenyears,thatthecouple,notthebank,wouldownthehouse.YettheHOLC,withits20percentforeclosurerate,couldonlystanchthefallofthemarkets.ToputAmerica’shousingmarketsonasoundfooting thewholemortgagesystemwouldhavetoberebuilt.During theGreatDepression, Americans rethought their relationshipto credit. The morality tale of borrowing began to change, largelythrough the new legitimacy of borrowing accorded by governmentprograms.Changecameslowly,however.InJosephineLawrence’s1935best-sellingcautionarynovelaboutconsumerdebt,IfIHaveFourApples,the Hoe family, nominally in the “white-collar class,” confronted thelimitsofborrowinginthemidstoftheGreatDepression.32InherbookLawrencebroughtherownperspectivetobearasa financialcolumnistfor theNewark Sunday Call, where week in, week out, she counseledletterwritersonhowtobestconstructtheirbudgets.Thenovel,inmostways, was a veiled critique of her readership, expressing both theiropinionsandwhatLawrencesawastheirmistakes.InthefictionalMr.Hoe’sopinion,arenterwasnothingbuta“shiftlesscuss”whoselackofself-reliancewaswhathethoughtwas“fillingupourinstitutionswithpaupers.”33Yet,inhishopeofbeingagoodcitizenandhome owner, Mr. Hoe has mortgaged himself, like so many realAmericans in the late 1920s, beyond his ability to repay. The Hoefamily, burdened by mortgage debts exacerbated by Mr. Hoe’sunemployment, struggles to make the payments on the numerousinstallment credit purchases made by Mrs. Hoe, even as Mr. Hoeincreasingly locates his self-worth in his ever-more-perilous homeownership.In desperation for advice on how to maintain her family’s lifestyle,Mrs.Hoewritestoanewspapercolumnist,Mrs.Bradley,who,basedon

Lawrence’s own real-life work, publishes sample family budgets everyweek.The solution for theHoes,Mrs.Bradleyopines, is simply to livewithintheirmeanswithoutborrowing.ForMrs.Bradley,thearithmeticofbudgetswasinvariant—“twoandtwomakefour”—applesdespitetheHoes’wishthattheymakeeightapples.If IHaveFourApplesbecameabest sellerbecause theproblemsMr.Hoeandhis family confrontedasindividuals besiegedAmericans as awhole in the 1930s and offered awaytounderstandthecrisisinmoraltermsthatreaderscouldviscerallyfeel.Yet the problem of “living within one’s means” is never asstraightforward as it might appear. If one’s life is stable, then yes, abudget is very straightforward. If you know what is happening nextmonthandevennextyear,planningiseasy,andthosewhoexceedtheirmeanshavenoonetoblamebutthemselves.Debtandbankruptcycouldeasilybeseenasafailureofcharacter.Most people do not live in such ideal circumstances. Nature canintrudeinunexpectedways: forexample, throughpregnancyor illness.Evenmoreunexpectedly,a jobcanbe lost,evenafteryearsofdiligentservice. Economies lurch forward, and not everyone is brought along,despitehowhardworkingtheymightbe.Wagesmightnotriseasfastasinflation.Eventhehardestworkersmightfindthatifandwhentheydoget a job, it doesn’t pay as much as the old one. Was this borrowerirresponsible? Shouldwe live our lives preparing for theworst?Whatshouldthebalancebetweenoptimismandpessimismbe?Theanswerstosuchquestionsdepend lessonthe individualandmoreonthe times inwhichthatindividuallives.IntheGreatDepression,itbecamestrikinglyapparent that evenmenwho played by the rules,who did everythingtheyweresupposedtodo,couldstillloseout.Mr. Hoe’s fictional problems were all too common real ones. Hisboom-erahousewas“flimsy,”andalthoughitcouldbe“easilyimprovedifheonlyhadafewhundreddollarstospendonit,”allhisincomewentto the mortgage.34 Because he had paid too much for his shoddilyconstructedhouseduringtheboomofthe1920s,Mr.Hoecouldbarelymeethismortgagepaymentsashiswagesfell.DesperateappealstotheHomeOwners’LoanCorporationwentunansweredformonthsandthenwereultimatelydenied.Despitehisowndesire toworkand topayhisbills, Mr. Hoe fell prey to forces beyond his control. He had done

everything right, yet everything had turned out wrong. Though thebook’s narrator seems to support the budget as an economic panacea,Mr.Hoehadfollowedhisbudget.HehadsimplylosthisjobintheGreatDepression.MillionsofAmericans,followingtherules,hadhadthesameexperience,andsuddenlyitwasnolongersoclearthatindividualswerecompletely responsible for their economic lives. Structures, notspendthrifts, may have caused the Great Depression, but ideas abouteconomiclifewereslowertochangethancircumstances.Installment credit, like mortgages, helped consumers “follow therules” while still getting what they wanted. Budgets promulgated byhomeeconomistsinthe1920stocurbconsumptionandpromotesavingunwittingly helped promote installment credit. Planned expendituresweremorevirtuousthanunplannedexpenditures.Ofcourse,thisadvicewasgiven tohelp fit themanycompetingdemandsonaworking-classhousehold’s dollar into a tight budget. Our Colorado trucker ArchieChadbourneearned$100amonthin1927,ofwhich$87.45wasalreadybudgeted:“Groceries,$48;fuel,$7;rent,$23;lights,$2;’phone,$2;Lifeinsurance, $1.45; auto upkeep, $4.35With $12.55 to spare, his budgetofferedsomewiggleroom.But$12.55,evenin1927,wentquickly.Thebudget didn’t include furniture, clothes, doctor’s bills, Christmaspresents,eyeglasses,orschoolbooks.Apropermiddle-class1927budgetwould have included all those additional expenditures, as well as amarginforsaving,butinpractice,suchthingscouldnotbeshoehornedinto a $100 budget. Installment credit allowed families like theChadbournestoenjoytheamenitiesofthemodernworldwithouthavingto save for them in advance. Money already budgeted for installmentpaymentswasmoneythatwasn’twasted.Whilecriticsofinstallmentcreditlamentedhowmuchmoneyfamilieslostbynot savingup inadvance for theirpurchases, financialadvisersemphasizedthatconsumption,aslongasitwasbudgetedfor,wasfine.Installmentcredit,whichspreadpaymentsovermanymonths,fitneatlyinto this scheme, even as the interest costs sapped wealth. Familiesallocatedmoneynotovera lifetimebut frommonth tomonth.Overallcostsmatteredlessthanfittingexpendituresandsavingsintothebudget.Consumers could buy through installment credit without violating themoralrulesofthebudget.Aphonograph’sinstallmentpaymentsbecamethebudgetaryequivalentofrentorfood.Billsarebills.

In the New Era economy of the late 1920s, a lack of thrift, thoughmorallydubious,wouldnotthreatenthecountry.Intheaftermathofthestockmarket crash,whathadpassed asmerelyprofligatenow seemedtraitorous. The very centrality of installment credit to the New Era iswhatmade it so susceptible to blame for that era’s demise.HistorianstodaydonotbelievethatoverextensionofinstallmentcreditcausedtheGreatDepression—theydon’tevendiscussitasaviablepossibility—butto those who lived through the Great Depression, installment credit’srolewasmorecertain.36Installmentcredit,inthisview,wasakintothespeculativecreditthathadfedthestockmarketbubble.The“artifice”ofinstallmentcreditattractedmuchblame.In1932,forexample,aJohnsHopkins economics professor identified credit among the three maincauses of the Depression: “perversion of the stock exchanges,”“degradationofbanking,”and“recklessinstallmentselling.”37Hearguedthatbyhamperingsavings,America’s installmentcredit“retard[ed]thegrowth of its productive capital” and “morally … it loosened therestraint upon recklessness in optional expenditures.” By enabling thedemandforgoodsthatconsumerscouldnototherwiseafford—orworse,forwhichtheycouldbudgetinstallmentpaymentsbutrefusedtosave—installment credit encouraged overinvestment in productive capacity,whichcouldbemadeprofitableonlybywhatTheNewYorkTimescalledthe “continuing and increasing doses of the [installment credit]stimulant.”38 Unearned and not quite real, this “artificial stimulus”smacked of excess. As in the stock market bubble, there was only asymbolic value, not a real one. The shocking experience of the crashemergedfromtheeconomy’sveryunreality.AstheundersecretaryoftheTreasury wrote in 1932, the “sweeping decline was … inevitable”because“thecountrywas livingtoomuchoncredit.”39Thedirectorofthe Federal Reserve Bank of St. Louis,MaxNahm, argued that “if wecould pay the debt of the world today, the depressionwould be overtomorrow.”40 Saving, not spending,would bring prosperity.Only afterthereckoningandtherestorationofamoralandeconomicorderbasedon real values could recovery begin. A 1932 National IndustrialConferenceBoardstudyfoundthatthemostcommonsolutionofferedbybusinessexecutivesforendingtheDepressionwas“areturntotheearlyprinciples of individual thrift.” The denunciation of borrowing held somuch weight because it felt so ethically right—even if it was

economicallywrong.Economists argued, backed by sound reasoning, that by committing

theirpayments togoodsalreadypurchased,consumerscouldno longerbuynewgoodsorservices.Theexpansionofpurchasingpoweringoodtimesthroughinstallmentcreditworkedonlytopreventspendinginbadtimes,hamperingrecovery.Accordingto thisview,payingbackthe$3billion of installment debt owed in 1929 required forgoing newpurchases, condemning the U.S. economy to years of languishingdepression.41 Substantial fractions of purchasing were done on theinstallmentplan.Evenifthelenderswerehappybecausetheloanswererepaid,fortheeconomistsconcernedwiththelargerpictureandnotthelenders’profits, itdidnotobviatethefactthatconsumerdollarsrepaidinterestanddidnotbuyreal, tangiblecommodities.Withoutconsumerdemandtoday,theeconomywouldnotrecovertomorrow.Thoughcriticsof installmentcredit in the1920sexpected its lenders

to go under in a serious depression and the borrowers to be punishedthrough repossession, much to their chagrin, reality differed.42Surprisingly, lost jobs and tighterbudgetsdidnot lead themajorityofconsumers to default on their payments. For example, in 1931, thecustomers of the large finance company Commercial Investment Trusthadrepaid95percentoftheiroutstandingloanswithinoneyearofthecrash.43 The next year, a finance industry analyst claimed thatconsumers had repaid more than 99 percent of the money loaned byfinancecompaniesin1929.44EvenHerbertHoover’sassistantsecretaryofcommerce, theHarvardeconomistJuliusKlein,announcedthat“thealleged weaknesses in the system had failed to materialize.”45 Kleinprovided the clearest rejoinder to critics of consumer credit: “theinstallment plan, with all its flourishing growth, has created no neweconomic danger. As a system, it has now been put under the mostgrilling of tests by aworld businessDepression of almost unparalleledintensity and it has demonstrated its right to survive.” Americanconsumersofthe1930scouldbecountedontofulfilltheirobligations.But even if Americans kept their promises, they did restrain theirspending,particularlywhentheylosttheirjobs.Durablegoodsspendingfell by half and durable goods manufacturing, on which most ofinstallmentcreditwasbased,felltoafifthofits1929levelby1932.46Americans across the country had unemployment stories like Mr.

Hoe’sthattangledausterebudgetsandunfortunatejoblosses,althoughtheir desperation, unlike his fictional account, was all too real. Forpolicymakers confronting the economic ruin of the Great Depression,wheretostartrebuildingandhowtodoitwerethegreatestquestionsofthe day. Should programs focus on the poorest, or should they try tomobilizethestillextantmoneyofthewealthy?Shouldthegovernmentrelyontheprivatesector,orhadcapitalismfailed?Thecorrectpathwasuncertain,butapathhadtobechosen.Itwasatimeofexperimentation.Common sense and recent experience were dead set against using

credit, in any form, to get out of theDepression. Therewas even lesssympathyfordebtreliefforthoseliketheHoefamilywhomismanagedtheirmoney,prioritizingluxuriesoversolvency.Lawrence’smouthpiececharacter,Mrs.Bradley,echoes,nodoubt, the feelingofmanyreaders:“Must the taxpayers who haven’t as yet been ruined, be forced toundertake the support of five people who couldn’t struggle through aworldthatdidn’tincludeoilburnersandVenetianblinds?”47OilburnersandVenetianblindsweretheiPodsandgranitecountertopsoftheirday,and,asnow,thosewhoavoidedeconomictroublesblamedtheinsolventfor their own poor decisions. Decisions prudently made duringprosperity took on a new cast during a recession. Yet if sophisticatedbankers could not handle the Depression, how could a housewife’sbudget?Somemembers of President FranklinD. Roosevelt’s inner circle, the

New Deal Brain Trust, saw real American families’ needs for betterhousing and financing not as a tragedy but as an opportunity. TheysharedMrs.Bradley’sbeliefthattheHoefamilywere“notcharitycases,”thatthefamilyhad“afoundationonwhichtobuild,”andifthepromiseofAmericawastobeameaningfulone,“theymusn’tbeallowedtoloseout.”48Governmentplanners answeredMrs.Bradley’s, andLawrence’s,question, “Suppose the economic system is cock-eyed, need we scraparithmetic? Isn’t it stillapracticalscience?”butnot in themannershewouldhaveliked.IntheHoefamily,FHAplannerssawahugeuntappeddemand for better housing as a possible solution to the Depression. Afixedwagecouldbeturned,throughtherightpolicy,fromaconstraintinto an opportunity. FDR and his advisers—the famous Brain Trust—would figure out ways to enable American home owners to borrowmore, not less, hoping to harness that magical possibility of deferred

payment—ofturningfourapplesintoeight—torestarttheeconomy.In 1934, the Federal Housing Administration (FHA) rolled out an

audacious plan to remake, from the ground up, the entire wayAmericansborrowed.UnliketheotherNewDealhousingprograms,theFHA didn’t directly build anything; it simply provided a newway forcapitaltobeinvestedinhouses.TheFHAchanneledprivatecapitalbackinto the construction industry—without spending any taxes. Withoutnationalizing the housing industry, the government fashioned a newfinancial system to replace the inherentlyunstablemortgage systemofthe1920s.The leaderof this transformationwas JamesMoffett.Moffett, unlike

the ivory tower–drawn Brain Trusters, had been a vice president ofStandardOilofNewJersey(theforerunneroftoday’sExxonMobil)andsobroughtahard-nosedbusinesssensetotheFHAthatwasperceivedtobe lacking in other New Deal agencies. No stranger to Washingtonregulators, Moffett had helped write the National RecoveryAdministration’s oil codes governing prices, wages, and other tradearrangements.Inwritingtheoilcode,hehadevenworkedsidebysidewith the prominent Brain Truster Secretary of the Interior HaroldIckes.49As today, in 1933 private capital piled up in the coffers of bankers,

whowere tooafraid to lend it.PresidentRooseveltandMoffettagreedthatfortheeconomytoreignite,capitalneededtoflownationally.FDRbelieved that a nationalmortgagemarketwouldbe amore stable andjustmortgagemarket.WritingtoMoffett,hereaffirmedtohim“thattherefunding of existing mortgages in long term, amortizedmortgages…willresultinasafermortgagestructureforthecountry.”50But FDR’s vision was not just about market stability. If Hoover hadpromised a chicken in every pot, then FDR took it to the next level,believing that “lowering the cost of homes to the great mass of ourpeople[was]worthyofourbestefforts.”NotallthoseintheBrainTrustagreed.AsMoffettheadedtheFHA,so

toodidIckesgoontoadministerthealternativetotheFHA,thePublicWorks Administration (PWA). Ickes wanted billions of dollars ingovernmentfundstobuildpublichousingthroughthePWA,declaring:

I’ve seennoevidence that theholdersofprivatecapitalare

ready to use it.We can’t sit around indefinitelywaiting forprivate capital to get going.… If private industry chargesrates socially too high, why shouldn’t we compete?…Wecould build very attractive houses at a low rate of interest.We’vebeenpaying3%formoney,whereasprivatefinanciershave to pay much more. Conceivably we can make anagreement with labor so that we can pay lower rates andofferyearroundwork.51

As Ickes told the press his position shortly after Moffett hadannounced the FHA’s program, Moffett could not have been moreoutraged.Moffetthadashortfuse(hiswife,Kim,woulddivorcehimin1937 for his “ungovernable temper”) and quickly called a pressconference.52Theplan,asannouncedonlyafewdaysearlier,wasnothingshortofa

revolutioninfinance.Nolongerwouldhomeownershavetoborrowonballoonnotes for a fewyears. Instead they couldborrow for fifteenortwentyyears—aperiodoftimethatbankershadpreviouslythoughtwasan immoral length of time to keep a borrower in debt.Moral or not,long-termmortgages stabilized the housingmarkets and increased thequalityofU.S.housingstock.Theloanscouldbeonlyforgoodhousingthatwouldlastforthatlongaperiod,andthegovernmentwouldinspectall thehousestomakesuretheymetapprovedstandards.Finally,withguaranteed mortgages, the risk fell to nothing, and FDR wantedmortgagerates—ashighas12percent—to fallaswell.FHAmortgagescostafixed5percentnationwide.Themost imaginative part of the FHA planwas that, unlike for the

HOLC,thegovernmentwouldnotpayforanyofit.Lenderswouldchipinto an insurance pool, organized by but not paid for by the federalgovernment,andiftherewasadefaultonamortgage,thelenderwouldbepaidoutofthepool.Paidinlow-yieldingbonds,thelenderwouldnotlosetheprincipalofthemortgage,butneitherwouldthelenderhaveanincentive to wildly lend to the uncreditworthy. With such a longrepayment period, the monthly payments could incorporate both aninterest payment and a payment on the principal. Amortizing themortgage, as suchaplan is called, eradicated theneed for refinancingthathadmadetheballoonmortgagessoprecarious.Alongperiodmade

themortgages independent of short-term fluctuations in the economy.Borrowerswouldnothavetoweatherunemploymentandrefinancingatthesametime.TheFHApreservedprivatechoicewhileaccomplishingapublicgood.Lendersdidnothave tocomplywith theFHA,but if theydid, theirbusinesswassomucheasier toconduct.Risk-free loanswithguaranteedbuyersprovidedan incredible—andnoncoercive—incentivetolendprivatecapital.UnlikeIckes’splans,whichwouldhavecompetedwithprivateindustry,Moffett’sfosteredprivateindustry.Confidentinhisnewsystem,Moffettsummonedreporterstohisoffice,

denounced Ickes, and told them that “such a planwouldwreck a 21-billion-dollar mortgage market and undermine the nation’s real estatevalues.IftheGovernmentstepsinnowtofinancehousingprojectswhenprivate capital is able andwilling todo it, ourwholeprogramwill bewrecked.”53 The press naturally had a field day reporting the rancorwithin the administration, and theWhiteHousewas forced to issue apress release claiming that therehadbeena “misinterpretation”of thedifferences in policy. But those differences were real, and they werebased on whether or not one believed that all that idle capital couldonce again be mobilized to drive the economy. The two men’stempestuous relationship reflected the difficult personality of Moffett,the stubbornnessof Ickes, and their substantiallydifferentperspectiveson the future ofAmerican capitalism after the failure of themortgagemarkets.TheAmericanpublicembracedtheFHAinawaythattherestofthe

New Deal was viewed suspiciously. Seeing “federal mortgage,” manybelievedthatthegovernmentwaslendingmoney.Forapublicthathadelected FDR on a platform of balanced budgets, government spendingwas an outrage. After some considerable public outreach, however,middleAmerica came to embrace thenewmortgage system.Magazinearticles, like one in Time, described the difference between the “old-fashionedmortgage thatwas renewed in good times and foreclosed inbad” and the new FHA loans, outlining the differences in repaymentperiod,interestrates,andamortization.54MoffettauthorizedpamphletsexplaininghowthebuildingandbankingindustrycouldbothprofitfromtheFHA.AnimositytowardgovernmentspendingremainedbutsupportoftheFHAgrew.PublicopinionlashedoutagainstIckes’sPWAhousingplanasnothingbuta“rentdole”insteadofawagedole.Hisprograms

divertedtaxestopayforthe“chiselers.”55Todirectlyspendtaxdollarswas Ickes’s way, but Moffett’s way, which didn’t spend governmentdollars,wasaneasierselltotaxpayers.Tomake the FHA successful, however, requiredMoffett to sell “the

excellence and security of this type of investment”—as FDR describedthe homemortgages—to the banks and insurance companies that hadjustwatchedtheirsure-thingmortgagesevaporate,notjustthepotentialhome owners. When the FHA remade borrowing, it also remadeinvesting.TheFederalReserve,aswellasthenewagencytooverseethesavings and loan banks, the Federal Home Loan Bank Board, forbadeparticipation certificates. Banks would have to find a new source ofcapitaltolendthatwouldnotdependonthecapriceoflocalbigshots.Thegovernmentcreatedanewentitytofundthesemortgages—Fannie

Mae or, as it was officially named, the Federal National MortgageAssociation (FNMA). FannieMae acted as amiddleman between largeinstitutional investors and local lenders, buying and sellingmortgages.Whereasinthe1920sbankswouldholdontothemortgagesandreceivefundsfrominvestors inparticipationcertificates,underthenewsystembankswould sell themortgages to FannieMae,which, in turn,wouldresell them directly to investors. Since the mortgage bonds had beenvaluelesswithoutaplacetosellthem,FNMAcreatedaplacewhereanymortgage—as long as it complied with FHA regulations—could beresold. Within a year, FNMA bought $285,000 ($4.4 million in 2010dollars)worthofmortgageseveryday.Whereasalocalsavingsandloanwas dependent on local investors, Fannie Mae could resell thosemortgagesanywhereinthecountry.Largeinstitutionalinvestors,suchastheNewYorkLife InsuranceCompany,began tobuy themortgages inlargenumbers,andthoseinstitutionalinvestorswouldnotrunscaredatthefirstsignofadownturn.Untilthe1930s,themortgagebusinesshadbeenalocalbusiness,butnowitbecamenational.Realtorsandbankerslobbied for all mortgages to be resold, but Fannie Mae held firm(conventional mortgages would not be resold until Freddie Mac’schartering in 1970).56 Roosevelt’s dream of a low-cost mortgage forAmericanswasrealized.Moffett,whowastemperamentallyunsuitedtopoliticalwork,retiredquicklyfromtheFHAtoreturntotheoilbusiness,but not before telling the president that in just a year, the FHA hadgenerated $351 million in building construction and created 750,000

jobs—allwithoutspendinganytaxmoney.57Thetwofinancial instruments thathadcausedthemortgagecrisisof

the early 1930s—balloon mortgages and participation certificates—disappeared, replaced by long-term, amortized mortgages and thenationalnetworksofFannieMae.Thenewmortgagesysteminaugurateda new stability upon which postwar prosperity was built. Withsubstantialdownpaymentsandenoughtimetopaybackthemortgages,foreclosures plummeted. The suburbs, where the postwar Americandream would flourish, were built through this new mortgage system.InsurancecompaniesboughtbillionsofdollarsinmortgagesfromFannieMae, enabling home owners to borrow to buy their piece of theAmericandream.Never againwouldayoung couplewant for ahousesimplybecausetheydidn’thavethemoney.IftheFHAandFannieMaesavedtheAmericanhouse, italso,atthe

same time, saved the American car, that other crucial element ofAmericans’ aspiration. Ickes’s plan for public housing in cities wouldhave produced a landscape ripe for mass transit. Instead, the FHAprogram promoted the 1930s ideal of housing: suburban cul-de-sacsaccessible onlyby car.Better-planned subdivisionswouldhave amore“favorable loan rating” and be easier to sell and finance.58 The FHAplanners preferred colonials and lawns, and their regulations on whatdetermineda“good”investmentreflectedtheirideals.Inonefellswoop,W.C.Clark’sfearsfortheU.S.economy,reliantasitwasonhousesandcars,couldbeassuaged.Anunfortunate—butsignificant—sideeffectoftheplanners’idealsled

their suburban cul-de-sacs to openly condemn occupancy by minoritygroups, especially African Americans. FHA policies encouraged deedrestrictionstoensureall-whiteneighborhoods,seenasnecessaryforthestability of the investment. Because of those policies, even well-intentioned racial liberals found it difficult to find financing forinterracialorevenAfrican-American suburbs. Inone simpledocument,theFHAplanningmanualcreatedthesuburbforwhitesandtheghettoforblacks.59Thestatehasgreatpowertoreshapecapitalism—forgoodandforbad.If the big purchase had been fixed by Fannie Mae, other kinds of

purchases remained outside government regulation. Thoughnot nearlyas important in terms of credit volume, credit for clothes and other

goods constituted the everyday world of credit. Though Moffett mayhave returned stability to mortgage markets, his own life remainedtumultuous.Ironically,afterhisdivorcein1937,hisdaughter,describedbyTimeas“BeauteousAdelaideMoffettBrooks,[the]widowed24-year-old socialitewho sometimes sings in nightclubs,” filed for bankruptcy.Owingnearly$10,000, she claimed, “I guess Iwas too fondofbuyingclothes.”60 Her story, the story of clothes, department stores, andultimatelycreditcards,istheotherthreadofborrowingthatwillleadusintopostwarAmerica.

CHAPTERFOURHOWILEARNED

TOSTOPWORRYINGANDLOVETHEDEBT

(1945–1960)

Tuning in to the first episode ofTheHoneymooners in 1955, suburbanAmericans gladly watched everything that they had left behind. Nolongerdidtheyliveinthecramped,hotapartmentsoftheirurbanyouth.Freezers that could hold a month’s food had replaced antiquatediceboxes.Sittingintheirspaciousdens,viewerswatchedAliceKramden,theexasperatedworking-classwife,explaintoherbus-drivinghusband,Ralph,what she reallywantedandwhat the suburbanviewersalreadyhad:

I…wantatelevisionset.Now, lookaroundyouRalph.Wedon’t have any electric appliances. Do you know what ourelectric bill was last month? Thirty-nine cents! I want atelevisionset,andI’mgoingtogetatelevisionset.Andwhatdoyoucareabout it?You’reoutallday long.Andatnightwhatareyoudoing?Spendingmoneyplayingpool,spendingmoney bowling, or paying dues to that crazy lodge youbelongto.AndI’mleftheretolookatthaticebox,thatstove,that sink,and these fourwalls.Well Idon’twant to lookatthaticebox,thatstove,thatsink,andthesefourwalls.IwanttolookatLiberace!1

Suburbanites could not only enjoy Liberace, the piano-playingsensationofthe1950s,ontheirtelevisionsets,buteverythingelsethat

the suburbs offered.PostwarAmerica entered a twenty-five-yearboomthat,unlikeanyboombeforeorsince,raisedthelivingstandardsofthemiddlemorethanthoseat the top.Povertystillabounded,particularlyin the cities and the country, but in between, in the suburbs, a new,prosperous America was being created. Though the suburbs exudedconformity, for most people the conformity was welcome. After thehardshipsoftheGreatDepressionandWorldWarII,Americans longedforcomfortandstability.Ifthemonotonoussuburbslooked“likeRussiawithmoney,” as 1950s intellectuals claimed, thatmoneymade all thedifference. The money that made the difference, however, was nottheirs.The postwar dream of suburban living was made possible throughdebt. Living in mortgaged homes, driving in financed cars, postwarAmericans relaxed at new shopping centers—where they purchasedtelevisionsoncredit.Whilemanybabyboomersremembertheirparentswheeling that new Zenith into the living room, few know how thattelevisionwaspurchased.Thatfirsttelevisionset,boughtaround1950,wasbought, formostpeople, on credit. Televisionswere expensive. In1946, the first year TVswere on themarket, only 0.02 percent of allhouseholdshadone.Twoyearslater,in1948,theystillcost$440—notincludingtheinstallationofthatrooftopaerial.Thevolumeoftelevisionsales necessary to bring down the price relied on consumer credit.Americansdidn’thave$400foratelevision,buttheycouldborrowit.By1955, two-thirds of households had a nice black-and-white. Americansborrowed so much that department stores, which sold televisionsalongside clothes and furniture and which had branched into thesuburbs to follow their formerlyurban clientele, hadmoremoney tiedup in consumer charge accounts than in their inventory. Televisions,cars,andrevolvingcreditmadeeverythingbetterthaninthosecrampedapartmentsinthecity.The borrowing began as soon as you left the city to tour an as-yet-unbuiltdevelopment.Lookingover floorplans inasmallofficenext tofieldsofsemibuilthouses,prospectivehomeownersreviewedthemanyborrowingoptions in easy-to-readpamphlets.Returningveterans couldborrow easily thanks to the VA loan program, through which, withnearly nothing down, a family could purchase a new home. Even fornonveterans,theFHAprovidedeasyfinancingwithrelativelylowdown

payments. Fannie Mae bought and resold the mortgages for bothprograms,makingallthoseFHAandVAloanspossible.Halfofallnewconstruction was federally financed after World War II. Such federalprogramsprovidedreadyfinancingformillionsofborrowerseven longafterthewarended.Forsuburbanbuyers,mortgageswereeasytocomeby,whetherfederallyinsuredornot.Ifahousewasgoodenoughtobefederallyinsured,localsavingsandloanbankswouldbewillingtolendon it. Meeting FHA building standards meant that subdivisions couldeasily sell off their homes and home buyers could easily borrow forthem.

Macy’sofferedtelevisionsontheir“cash-time”plan.(IllustrationCredits4.1)

Oncethehousewasbuiltandthehappyfamilymovedin,theywerefacedwithanimmediatedilemma,uniquetoprosperity:howtofillthehouse? If JaneAustenknew that a singleman inpossessionof agoodfortunemustbeinwantofawife,theMacy’screditmanagerknew,justas certainly, that “nowomanmoveswithoutwanting to redoher newhouse.”2 To make sure that Macy’s and not a competitor got herbusiness,creditwasusedto lureher into thebranchdepartmentstore.Intotheroomierhousescameatroveofgoodsbought,toalargedegree,on credit. After buying a home, of course, you got an address and amailboxnext to the curb. In thismailbox, shortly after youmoved in,you found your very first Charga-Plate vying for its slice of consumerdollars.ThestoryoftheCharga-Platedidn’tbeginwhenpostwarhomeowners

movedintotheirnewranchhousesbutfarawayinNewYorkCity,atBloomingdale’s on Lexington Avenue and 59th Street. To understandwhatwasdifferentaboutthepostwarcreditcard,wehavetounderstandwhatcamebeforeit.Fromthe1910stothe1930s,middle-classwomenshoppedatdepartmentstoressuchasMacy’sandBloomingdale’sandahundred other local retailers. What those stores had in common, asthey’dhadsincethelatenineteenthcentury,whenthedepartmentstorewasinvented,wasthattheyhaditall.Thedepartmentstoreinthelatenineteenth century was the Amazon.com of its time. Before thedepartment store, shoppers had to travel all over town to specialtyshops, where, in dark rooms filled with musty shelves, storeownerswould show pricey merchandise. At the department store, shoppersmovedamongcolumnsofmarblelitbysunlightbeamingthroughbroadsheetsofwindowglass.Goodswereencasedinperfectlycleardisplaystobe admired and fawned over. Awoman could go there for everythingfrom kid gloves to evening gowns. A hundred clerks—often handsomeyoungmen—served the vast throng, offeringmerchandise identical tothat of the specialty stores but for far less. Away from the floor, in aroomplushwith leather, themanager oversawhismany departments,eachreplicating—andultimatelyreplacing—aspecialtyshop.Inthecity,thedepartmentstoreofferedconvenience.Onesubwayor

taxirideandtheday’sshoppingcouldbefinished.Therewasnoneedto

wade through the slush of a Boston winter. Shoppers knew that theprices were fair. Many department stores, after the advent of phones,even took orders. Perhapsmost importantly for our story, departmentstores—owing to their sales volume—offered copious credit. In thosestores, shoppers—generally women—charged their purchases to anaccount, which was billed at the end of the month. Those chargeaccounts had to be paid each and every month—promptly. From itsinception in the nineteenth century until World War II, this chargeaccount, thought of as a shopper convenience like gift wrap, defineddepartmentstorecredit.In the 1910s and ’20s, another form of credit was developed bydepartmentstores:thecouponbook.Unlikechargeaccounts,thecouponbookoffered shoppersanoptionnot topayat theendof eachmonth.Likeinstallmentcredit,paymentscouldbespreadout.Togetthatkindoflong-termcredittookalongdiscussionwiththecreditmanager,whowouldjudgeyou,yourbudget,andyourwholelife.Thecreditmanagerwouldbedoingyou,thecustomer,afavor.Inreturnforthisinspection,acustomercouldgetacouponbookforaverylimitedamountofmoney,suchas$25.Everytimethecouponbookranout, thecustomerhadtogothroughthesamerigamarole,injuringtheborrower’spride.Forthosewith less money, begging for credit limited the appeal of the couponbooks,which,thoughwidelyavailable,wereseldomused.Moral lectures were inevitably part of meeting with the creditmanager.Enforcingrepaymentfelltothestore’screditdepartment,butthe credit manager’s tone would be considered inappropriate. Ratherthan just bean pushers, credit managers considered themselvesreplacementhusbands forwomenshoppersgoneastray—almost in locohusbandis.3 In theabsenceofhusbands, creditmanagerswereexpectedtomanagewives’ spending.Weakhusbands couldbe called to taskbycreditmanagersfornotbeingableto“control”theirwives’spending.Acredit limit, when it existed, reflected not a credit rating but theextended household authority of a husband, who asked the store tocontrolhiswifeinhisstead.This idea of the responsible husband and spendthrift wife had longexistedas a truthof themiddle class. For theworking class, however,thegenderroleswereinverted.Workingmenwereconsideredtobethespendthrifts,passingtheirtimeatsaloonswhilesmokingcigars.Oneof

the main arguments for Prohibition had been banning not alcoholconsumptionbut the placewhere somanyworking-classmen fritteredawaytheirincome:thesaloon.In1915,afewyearsbeforeProhibition’senactment in 1920, The Washington Post had a Valentine’s Day lettercontest on the question of “whether husbands or wives were moreextravagant.”Thetop letter, fromMrs.MarieRoye,won$1bywritingthat“the fact remains that ineverycity in theworld, saloons, redlightdistricts, billiard rooms, poolrooms, bowling alleys, cigar and cigarettestores … are all kept up by men.… No matter what women spendfrivolously, theyhavea longways togo to evenupwith thenotonlyuseless,butpernicious,extravagancesofmen.”4Throughoutthe1920s,privateclubsmaintained legalrepositoriesof liquor.Only theso-calledworkingman’s club felt the strong arm of the law.Working-classmen,unlike middle-class men, could not be trusted to keep to the budget.Household instructional books and pamphlets of the 1910s and 1920saimedat responsibleworking-classwives encouraged them to take theentirety of their husband’s paychecks, distributing the cash amongenvelopeslabeled“rent,”“groceries,”andthelike,andreturningonlyasmall amount to him to placate him. The idea of women as naturalspendthrifts applied only to women with money. Department stores,which catered to the middle class, reinforced this idea of women’sspending, but it was only well-to-do women who needed to becontrolled.The creditmanagerwould control amiddle-classwife’s spending so

that the debt would never run too high and wreck the respectablehouseholdbudget.Thoughthecreditmanagerwasseenaspowerful,inpractice he was not. Castigating as he called the customers into hisoffice,thecreditmanagertrulyfearedthatcustomerswouldnevershopthereagainor,worse,neverpaybackthedebt.

Articleslike“HowtoMoney-TrainYourWife”reinforcedtheideathatahusbandwastheonlyrestraintonawife’sspending.Onlybytraininghertobudgetcouldher“spendthrift”waysbeheldincheck.

(IllustrationCredits4.2)

Despite what customers were “supposed” to do, bills often wentunpaid formonths, as customersused chargeaccounts to finance theirpurchases over a long period of time. Credit managers who were tootightwith lending scared off customers. The only thingworse than anunpaiddebtwasacustomersooffendedbythecollectionthatshenevercameback.Itwasbettertowriteoffabaddebtthanto,asonefinancialadvice magazine put it, “get a reputation for being hard with chargeaccount customers.”5 Stores needed charge account customers. Whileregularcustomersboughtsomethinginonly37percentofvisits,chargecustomers bought something 57 percent of the time.6 To keep thatgoodwill,storessentcollection,or“dunning,”lettersinachoreographedmanner, designed to remind borrowers that they had a moral andfinancialobligationtorepay.Whileextrememeasurescouldbetakentorepossessdurablegoods,in

thesofter linesofdepartmentstores,debtcollectionreliedonamoral,notacontractual,relationship.Departmentstoreswouldinevitablylosemoneyiftheytookeveryslow-payingcustomertocourt.Butmoneyhadto be collected somehow.Debt collectionwas an elaborate dance thatbeganwithagentlereminder.Ifthecustomerstilldidnotpay,afollow-

up letter used stronger language, as in this example from a 1922collection guide: “It grieves us to be forced towrite you again in thematter of the delayed payments on your account. You have shown noinclination whatsoever to abide by our monthly settlement terms,established forallalike,andaftercarefulconsiderationof theaccount,we are obliged to withdraw credit privileges.”7 Even in 1922, whenfurniturestoresregularlyemployedateamofstrong-backedmenandacitymarshaltodenudeaworking-classapartment,thedepartmentstore,catering to a more affluent clientele, felt the need to be gentle. Thetrouble with such letters was that middle-class propriety was verysensitive. A customerwho lost her credit at a storemight never shopthereagain—perhapseven loudlycomplainingtoher friendsaboutherill treatment. Credit could be a public relations nightmare. Slow paysandno-payswerealltoocommonbuthadtobeenduredforthesakeofcustomerrelationships.Thecreditdepartment, likeotherconvenienceservices,wasamoneypit.Unpaidaccountspaidnointerest.Whenabillwasoverdue,thestorehad to carry the debt. Slow-paying customers and defaulters cost thestore money. All customer credit was financed internally, as clothingstores—thenknownasdraperies—haddonesincetheyhadsoldnothingbut calico and silk. Like the gift-wrapping department, the creditdepartment was a service the store offered to woo customers in fromcompetitors.Itlostmoney,butithelpedsales.Customerswithalineofcreditshoppedatthesamestoreweekin,weekout.In1938,a little-noticedprogramatBloomingdale’s, the famousNewYorkdepartmentstore,wasabouttoendthecreditdepartment’sinferiorstatusandbegin tochange theways inwhichAmericansborrowed. In1938,Bloomingdale’srolledoutanewcreditprogramforitscustomers:the permanent budget account (PBA). “A new type of extendedpayments,” the PBA allowed customers the flexibility not to pay theirwhole bill everymonth.Of course, not paying their bills everymonthwas what many already did. The PBA institutionalized an existingpractice. The slowpay became standard. It incorporated rule breakingintotherulesthemselves.InthePBA,paymentscouldrunaslongassixmonths.Unlike installmentcredit,noteveryindividualpurchasewouldbespelledoutoncontractbutaggregatedintoonebill.Whowouldwanttorepossesssocks?Inreturnforthisflexibility,thestorewouldchargea

small amount of interest.No longerwould dunning letters go out andoffend slow-payingcustomers.Thecustomers, for the first time,wouldbeincontroloftheirspendingandrepayment—forafee.Thisnewkindofcreditwascalledrevolvingcredit,andthePBAwasthefirsttime,butnotthelast,thatconsumershadaccesstoitspossibilities.World War II initially interrupted this grand scheme as thegovernmentinstitutedwidespreadcreditcontrols.Likeotherdepartmentstores,Bloomingdale’sshutdownthePBAprogramin1941alongwithitsothercreditprograms.Thefederalgovernmentfrozechargeaccountsand installment credit alike to control inflation as commodities ranscarce. Toward the endof thewar, however, retailers less law-abidingthanBloomingdale’s realized that thegovernment’s regulationsdidnotapplytothisnewkindofrevolvingcredit.Bywartime’send,theideaofrevolving credit had spread across the country. As peace returned,revolving credit, like the PBA, found its place alongside preexistingformsofcredit.Unlike those other forms of credit, revolving credit was uniquelysuited to postwar America. Whatever one’s budget, revolving creditmade all purchases possible by splitting up the payments over manymonths. With revolving credit, rich women and poor alike could say,“Charge it!” at the checkout line and hand the cashier a shiny metalCharga-Plate with their account number. There was no need to handovertheinstallmentcouponbookandshowthatyoucouldnotafforda“regular”chargeaccount.Theothershoppers,andtheclerk,wouldnotknow the income difference between the rich and the middling. Theflexibilityofrevolvingcrediteliminatedtheinsultingmomentswiththecreditmanageraswell.Neveragainwouldawomanhavetogrovelformore time from a male credit manager; she could pay just a smallfinancechargeandtakecareofitnextmonth.Onlyoncewouldshehaveto go up to that well-advertised credit office on the sixth floor. AtBloomingdale’s,thePBAchangedthemoralmeaningofborrowing.In return for this flexibility, shoppers expanded their purchases. Thecredit manager of Bloomingdale’s proudly told his colleagues that ifanything,thebiggestproblemwascustomersdevelopinga“tendencytooverbuy.” By 1949, 75 percent of major stores had revolving creditprograms, whose 13 percent annual interest rates went a long waytoward filling the credit department’s money pit. In the competitive

retail environment of postwar America, shoppers flocked to the storesthatofferedthemthisaffordableandflexibleformofcredit.Christmaswasasopportuneatimetogointodebtinthepostwarera

as it is today. “Bloomingdale’s Is My Santa Claus!” proclaimed theheadlineofa1946Bloomie’sadvertisement.AnnSmith,a“galfromtheMiddle West keeping herself in rent, clothes, meals, and recreation,”needed $96 to meet all the demands on her gift list, but “short ofwinning a quiz program she didn’t knowhow she’d do it.” Through apermanentbudgetaccount, that’show!Suchadsofferedcredit tomeetfamily obligations. That such advertisements were always directed atwomenspeaksvolumesaboutmen.Bloomingdale’srananadvertisementin 1949 offering to help aunts with their “18 children” (nieces andnephews) through the PBA. Overcoming her “seasonal shoppingproblems,” the loving aunt was encouraged to buy that “specialone…thepertred-headeddoll” for$5.98and“another…anexcitingBubble-O-Matic gun” for $2.98 on a PBA.8 Her $75 limitwouldmorethancoverpresentsfortheeighteenchildren(thoughitmighttakeuntilthe next Christmas to pay it off!). Credit “makes it Christmas everymonthwithaPermanentBudgetAccount.” Spendingher$16amonthfor the next six months, “Ann said it for thousands of PBA addicts,‘Bloomingdale’s is my Santa Claus.’ ”9 But it was the morning afterChristmas, as an article inLife explained in1953, that you couldhearSantaurgeon the real reindeerwhopulledhis sled: “OnBergdorf!OnGoodman!OnNeimanandMarcus!”10

Christmaspermanentbudgetaccountadvertisement(1946).(IllustrationCredits4.3)

Oneholdout in retail, akin toFord in the1920s,wasMacy’s. ItwasfoundedbyaformerNantucketwhaler,RowlandHusseyMacy,in1858,and the red star from his sailing days became the symbol of thecompany, representing his personal promise of low prices to hiscustomers.Partofthatlowpricecamefromhisatypicalpolicyofcash-only sales.Beforehecame toNewYork,hisattemptsat runningcash-onlystoresinMassachusettshadendedinfailure.ButinNewYorkthereweresufficientpeopleandcompetitionthatalow-price,cash-onlystore

couldprosper.Fast-forwardingtothepostwarera,Macy’scontinuedtoprivilegecash

over credit, offering a 6 percent discount to cash buyers. Echoing theFordsavingsplan,customerscoulddepositmoneyinthe“Macy’sBank.”AtMacy’sthisbank,holding$9millionin1948,actuallyworked.11Thespan between deposit andwithdrawalwas not nearly as lengthy as insaving for a car. Moreover, deposits were another way in which ahusband could exert control over hiswife’s spending. Jack Straus, thepresident ofMacy’s,was no fool.Macy’s had a credit department likeanyotherstore’s. Itmanagedtosell the largestvarietyofgoods in theworldandtohavethelargeststoreintheworld.InChristmasseason,ascelebrated in 1947’s classic Miracle on 34th Street, a quarter millionpeopleshoppedtheredaily.TherealmiracleofMacy’swasnotSantabutitsabilitytoreachouttobothcashandcreditcustomers,bothofwhomwerelookingforthatspecialdeal.Ontheoutskirtsofcities likeNewYork,shoppersandstoresmadea

newlife. In1954,Abraham&Straus, thevenerableNewYorkretailer,announcedthatitwasopeningthelargestdepartmentstoreintheEast—but it would be on Long Island, just a five-minute drive fromLevittown.12 Christmas on 34th Street at Macy’s no longer meantshopping in the largest store in the world. Coupled with the grandadvertisementforthestorewasanequallygrandsolicitationforcredit.Inthesuburbs,credit,notcash,wouldbeking.Revolvingcredit,intheformofthepermanentbudgetaccount,hadarrived.All suburban credit managers agreed that the key to the success of

their branch storeswas revolving credit. Revolving credit, particularlyforyoungcouplesindesperateneedofoutfittingalltheirrooms,boundcustomers to the stores. Families with a mortgage borrowed twice asmuchasfamilieswithoutamortgage.Constrainedfinancesdidnothavetomeangoingwithout.Department stores bought lists of newarrivalsfromutility companies and sent out Charga-Plates.Despite the lack ofcredit applications, these shoppers, screened only by neighborhood,turnedout tohave the samedefault rates as other suburban shoppers.Suburban department store shoppers were roughly the same:homemakersunderthirty-fiveyearsold,withtwotothreechildrenandahigherincomethanthosewhostilllivedinthecity.ThefreshCharga-PlatearrivinginthemailwouldenticethatnewlywedintoMacy’s.

Creditmatteredmore to suburbandepartment stores because one oftheir main urban services—delivery—was no longer relevant. Thedowntowndepartment store’s success,much less thatof themail-ordercatalog,was predicated on the tremendous hassle of shopping in boththecityandthecountry.Carryingall thosegoodshomefromthestoreorridingone’shorsetothestoretookallday.Delivery,intheerabeforewidespread automobile ownership, was essential. In the new suburbs,delivery mattered not a whit since to live there you needed a caranyway.Branchstoresofthedowntowndepartmentstoreswerebuiltinshoppingcentersat the intersectionsofhighways.Thoughmanyof theexampleswereintheNortheast,thesedevelopmentswerenational.TheTexan department store Sanger’s built its branch seven miles fromdowntownDallasattheintersectionofhighways67and80onthelooparound the city. The branch stores had all the parking customersdemanded. From 1945 to 1955, the parking lots of FederatedDepartment Stores increased in area from 65,000 to more than 2.5million square feet.For the first time,department storesdevotedmoresquare feet to parking than to merchandise. Credit promotions,importantinthecity,becameessentialinthesuburbs.Bythe1950s,departmentstorescaredlessaboutprotectingcustomers

from their owndesires than sellingmerchandise. The protective creditmanagerof the1920swastotallyabsent in theeraofrevolvingcredit.Since the average charge sale was three times the average cash sale,stores pushed credit for all the customers. Since the new forms ofrevolvingcreditbecameprofitable,forthefirsttime,whenthemonthlyinterestratewasraisedto1.5percent,no longerwerecreditmanagersworried about limiting customers’ borrowing. The more credit issued,thebetter theoverallprofitsof the store.FederatedDepartmentStoreswas the first to abolish limits on revolving credit, in 1958, but otherstoresquickly followed.Thecustomer,not thecreditmanager,decidedhow much to borrow. Such an arrangement gave customers theflexibility theywanted (aswell as escalating borrowing costs) and thestores the large sales volume they wanted. These revolving creditaccounts, called option accounts, for the first time gave shoppers theoption of paying back their debt or not.No longerwould accounts bepastdue;borrowerswouldjustgetfinancecharges.By1960,mostmajorretailersconsolidatedalltheircreditplansintooptionaccounts.

Flexibilityinrepaymentwasessentialforpostwarconsumersbecauseso much of their income was already allocated to mortgages, carpayments, and the like. How did postwar Americans balance all thisborrowing? With budgets. Budgets had been promoted by scolds andknow-it-alls since the turnof the centuryas thebestway todealwithconsumption. Primly outlined accounts detailing the smallest dollarspent, budgets are supposed to rein in our insatiable desires and free-spending ways, rendering our economic life orderly and moral. YetbudgetshavealltheauthorityofaNewYear’spromise.Sincewemakethem,wecanbreakthem.ThefirstgoodsaleatBarney’s,andoutgoesthebudget!Contracting for abudget through creditmight seem like agoodwaytodisciplinespending.Insteadofallocatingacertainamounteverymonth to a grocery bill,which can vary,why not sign up for afrozenfoodplantofillthefreezer,asmanyhouseholdsdidinthe1950s?Both freezer and food could be paid for every month on installmentstogether,makingtheexpendituresbudgetable.Even following a budget is not a sure recipe for financial safety.

Counterintuitively, the real danger of budgets is not in breaking thembut in believing in them.Aren’t budgets supposed tohelpusmaintainourfinances,tokeepusontrack?Theyare,butthoughabudgetcanbeclear-cut,economicrealitycanbefarmessier.Confusingtheorderofthebudget for an orderly world is the first step toward the precipice ofbankruptcy. William Whyte, before he wrote his best seller, TheOrganizationMan,denouncedthe“budgetism”oftheyoungmiddleclassnot for itsprudence (hewasno libertine)but for its lackofprudence.Insteadof controlling their spendingand savingmoney,youngcouplesborrowed on the installment plan as much as they could, fitting themonthlypaymentsintoabudget.Neatlyarrangedasmonthlypayments,thebudgetlegitimizedinstallmentborrowing.Budgets,forWhyte,werethe “opiate of the middle class,” dulling them to the dangers ofoverspending. The interest was still paid to lenders, depleting theseyoungcouples’savings.Whyte,whocameofageduringtheDepression,warnedtheyoungcouplesofthe1950sthatsuchfaithinthesteadinessof the future was foolish. This critique of budgets runs counter togenerations of financial planners, but its evidence surrounds us today,when well-planned borrowing has collided with sudden marketdownturns and unemployment. The danger of budgets, ultimately, is

believingthattheywilltamenotonlyyoubuttheworldaroundyou.For most of the postwar generation, however, Whyte’s warningsprovedwrong. The economy had been tamed. Budgeters of the 1950slucked out. Unlike today, the stability of the economy then allowedborrowing to the very limits of one’s budget. Incomes grew, and jobswere rarely lost. Instead of ruining them, borrowing helped postwarAmericansleavetheruinsoftheDepressionfarbehind.In the stably growing economy of the postwar era,more Americanscouldborrow thaneverbefore.A1953article inLife ranked forty-twooccupationsaccordingtotheirriskiness.Whatmadesomeonealowriskwasthe“steadiness,notsize,of[their]income.”Peoplewithfluctuatingincomes, like lawyers, ranked lower than might be expected. At thebottomofthelist,at42,wasfarmlaborer,thatoldstandbyjoboffiftyyears earlier.With their low, seasonal wages and a tendency to drift,collectingadebt from themwouldbedifficult.Goodcredit requiredastablejob.Someunfortunates,evenduringthepostwarboom,couldnotmakeendsmeet.Withallthenewfoundopportunitiestoborrow,lendersalsobegan to learnnewways toget theirmoneyback.With revolvingcredit,aswiththepermanentbudgetaccount,thedebtitselfneededtobecollected;repossessedtoyshadnovalue.Suburbanites at every income level borrowed more than theirequivalents in the cities. Naturally, debt collectors, such as WalterMuller, flocked to that quintessential suburb—Levittown—to ply theirtrade. Muller had begun his career in the credit department of thePhiladelphiadepartmentstoreStrawbridge&Clothierbutbythe1950shadbeen runninghis own collectionbusiness for some time.His rateswere typical: in most cases, he took half of whatever he collected.Focusing on larger, older uncollected bills whose debtors had alreadymoved—“skips”—Muller offered department stores more than thenothing they were going to get without his services. He framed hiscollections in moral terms, explaining that “the thing that gives mepleasure isgettingthesepeopletofaceresponsibilities,gettingthemtostart a different kind of life.”13Moral suasion and houndingwere themain tools thatMullerandotherdebtcollectorsemployed.Repaymentof the debt was what mattered—not the underlying merchandise.Manufacturingwas efficient and storemarkupswere high, so the realcostwasinbaddebtlosses,notthecostofthegoods.Byoutsourcingthe

debt collection, stores could keep annoying debt collectors at arm’slength.Noself-respectingpersonwouldcomplainaboutadebtcollectorcomingtoherhouse,evenifshemightcomplainaboutBloomingdale’srefusinghercredit.

Alistofcreditriskbyoccupation.(IllustrationCredits4.4)

Thoughthe1950sfamilyluckedoutonbudgets,theyalsoknewthattheyhadsomethingevenmorepowerfulthanluckontheirside:thetaxcode.BeforeWorldWarII,thetaxcodedidnotmatterformiddle-classAmericans. Between the tax brackets and the standard deduction,incometaxeswerepaidonlybythewealthy.Overthecourseofthewar,however, the federal government steadily raised the rates and loweredthetaxbracketstopayofftheenormousfederaldebt.Afterthewar,thehigh taxes remained. The top bracket (inconceivable today) was 91

percent fornearly the entirepostwarperiod.Even for thosebelow thetop bracket, federal taxes had for the first time become something foreveryonetoreckonwith.But though the middle class now had taxes to pay, it also haddeductions to take. As today, all the interest on a mortgage could besubtracted from a family’s yearly income. Unlike today, however, notjust mortgage interest but all consumer interest could be deducted aswell. Thoughmortgage interest was the largest interest paid for mostmiddle-class families, addingup all the interest onCadillacs, furs, andtelevisionsstillmadeasizabledentintheyearlytaxbill.All forms of interest were deductible because when the income taxwas created in 1913, through the Sixteenth Amendment, interest wasnearlyalwaysabusinessexpense.Considerwhocouldlegallyborrowatthat time. Since small-loan laws did not yet exist, everyday borrowingwas on the gray or black market. Farmers mortgaged their land,entrepreneurs borrowed for their businesses, but in one’s personal life,therewasnoborrowingtobehad.Theideaofpersonalborrowingwasinconceivable to the framers of the tax code, and thus all interestwasdeductible.OnlywhentheincometaxbegantoencompasseveryoneafterWorldWar II did the interest deductions begin to affect taxes—and for thepostwarhomeowner,theywerefantastic.Alltheinterestpaidcouldbededucted.What incentive, then, was there not to borrow? Only thosewho took the standard deduction—that is, most renters—lost out. Forhomeownerswhotookthemortgage interestdeduction, thedeductioneffectivelycutthecostoftheirborrowingbyathirdorahalf.Interestontopofthatwasalsosubsidized.Borrowingwasn’tsaving,butitwasnotnearly as pernicious as it would have been in the absence of thededuction.Unsurprisingly,betweentaxincentivesandrisingincomes,themiddleclass borrowed far more frequently than either the poor or the rich.Through this borrowing, it created a lifestyle of fantastic materialaffluence.Minksandboats,housesandcars, televisionsand radios, allformerlytheprovinceofthewell-to-do,becamethenormforthemiddleclass. Americans embraced debt. The percentage of households usingcreditroseafterWorldWarII,from38percentin1949to54percentin1958.Forthemiddleclass,themoralvalenceofdebtbegantochange.

Learning to love the debt involvednot only things but ideas. ScoldingintellectualjournalssuchasTheNewRepublicandTheNationmayhaveprinted articles like “Do You Owe Too Much?” and “Charge-AccountProsperity,” but more mainstream publications such as U.S. News &WorldReport,Newsweek,GoodHousekeeping,andChangingTimesranjustasmanyarticlesduringthepostwarperiodexaminingthecurrent“debtcrisis”—andultimately taughtpeoplehow touse it to theiradvantage.Onecreditexecutiveremarkedthat themeaningofcredithadchangedfrombeing a signof beingunable topaywith cash tobeinga signofbeingtrusted,evena“markofcharacter.”Revolvingcreditwasdepartmentstorecredit,anditwasforeveryone.Department stores that took advantage of this new revolving creditsystem experienced fantastic sales growth. It’s no coincidence that thestores that most fully exploited the new charge systems—Filene’s,Abraham&Straus,Bloomingdale’s,Foley’s,Burdines,andothers—grewin the postwar era to become America’s largest retail conglomerate:Federated Department Stores. Even its nearest rival department storeconglomerate,MayDepartmentStores,wascomposedofavidrevolvingcredit retailers such as Marshall Field’s, Kaufmann’s, Meier & Frank,Famous-Barr,andLord&Taylor.Inthe1950s,thesedepartmentstoresfollowedtheircustomersouttothesuburbs,offeringrevolvingcredittofurnish all those new suburban homes. With revolving credit, morepeoplecouldborrowatdepartment stores thaneverbefore.Youdidn’tneed to be able to pay off a purchase this month. Whereas chargeaccountshadbeenassociated since the1920swithhigh-end stores, bythe early 1960s, the majority (61 percent) of consumers surveyedbelieved that there was no difference in quality between stores thatofferedrevolvingcreditandthosethatofferedonlychargeaccounts.Inthenewdemocracyofdebt,all levelsofconsumptioncouldfitintothebudget. Permanent budget accounts, the forerunner of today’s creditcards,wereheretostay.Historians circulate an anecdote that in 1950, Diners Club founderFrankMcNamara, realizing he’d forgotten his wallet while enjoying afineNewYorksteakdinner,thoughttohimself,“Whyshouldpeoplebelimitedtospendingwhattheyarecarryingincash,insteadofbeingabletospendwhattheycanafford?”Morelikely,infact,isthatwhenFrankMcNamarareturnedfromNewYorkhegottheideafromlisteningtohis

wifeon thecar ridehome. (Itwouldnotbeuntil theearly1970s thatMrs. Frank McNamara, a married woman considered an economicdependent,couldapplyforcreditinherownname.Thecreditcontrolinthe family that had existed under the creditmanager continued underrevolvingcreditaswell.) IfaMr.McNamaracouldusehisDinersClubcardatafewselectNewYorksupperclubssuchastheCopacabanaandthe Latin Quarter, Mrs. McNamara could use a charge card in nearlyeverydepartmentstore intheentirecountry.14As lateas1961,only1percent of stores took universal bank cards. Americans shopped atdepartmentstoresmorethanatanyotherretailer,andthestores’credit,not banks’, was what mattered most. The real history of credit cardsbeginswithdepartment storechargeaccounts in the1930s,notDinersClub.Creditcardswerereally invented tosellhousewives’dresses,notbusinessmen’ssteaks.ThoughDinersClubisoftenhailedasthetrailblazingfirststeponthe

roadtocredit,evenaFederalReservereportpublishedin1957todetailtheentiretyof consumercredit topolicymakers,hundredsofpages inlength, detailing minutiae of all forms, neglected to mention Frank’s“invention.” Alongside Diners Club, major banks, including Bank ofAmericaandChaseManhattan,hadlauncheduniversalcreditprogramsintheearly1950s.Asenvisionedbythebankers, thecardscouldhavebeenusedanywhere.Yettheywerenot.Theyfailedwithinafewyears,and bank credit cards were taken off the market. As Mrs. McNamaracouldhavetoldthem,Bloomingdale’sdidn’ttakeanycardbutitsown.Ifallthesekindsofcreditseemedthesametocustomers,forretailers,

theywerenot.Behindeachpurchasestoodacomplexnetworkoffirmsthatprovidedthemoneyforthelending,whichwasusuallyhiddenfromthe customer. Insurance companies bought VA and FHA mortgages.Automobile finance companies tookon cardebts from thedealers. Fordepartment stores and other retailers, however, the expansion ofconsumerborrowingpresentedaseriousdilemma.Themajorityofsaleswerenowdoneoncredit,butproviding that creditateupprofits.Theprofitmarginsoncredit,whilereal,wereslim—onlyinthesingledigits—compared to the profit margins on merchandise, which were all atleast30percent.Thecapitalofdepartmentstoreswastiedupinbarelyprofitableconsumercreditwhen it couldbe invested inmore lucrativemerchandise. If a department store hasmoremoney invested in credit

thanclothes,isitstilladepartmentstoreorisitabank?Lendingcouldnever be as profitable as selling but stores found it difficult to getfinancingforconsumerdebt.Few banks were willing to lendmoney to the stores to finance the

revolving debt.Whatwould the collateral be? A pair of slacks?Manybanksdemandedstrictaccountingforwhatmoneywas lent for,andinthe flexible world of revolving credit, such reckoning was impossible.Whenacustomerpaid$20ona$100debt,weretheslacksbeingpaidoffor the television?The solution to thispuzzle,discussed in thenextchapter,transformedtheU.S.retaillandscape,preservingthesupremacyofdepartmentstoresforawhilebutalsoallowingrevolvingcredit,moregenerally, to expand throughout the economy.Once department storescould resell their debt, so could any retailer.Without a lock on creditanddelivery,departmentstoreslosttheedgeofunmatchedservicethathadmade them successful. The customer loyalty that revolving creditwasintendedtocreatelastedonlyaslongasdepartmentstoresweretheonlyplace toget revolvingcredit.The firmgraspofdepartment storeson revolvingcredit endedasanewkindof storeemerged in theearly1960s:thediscountstore.

CHAPTERFIVEDISCOUNTEDGOODS

ANDDISTRIBUTEDCREDIT

(1959–1970)

In 1963, the Harvard Business School professor Malcolm McNairaddresseda roomfulofdepartment storeaccountants inaPhiladelphiaSheraton.Thoughthey listenedpolitely, it ishardto imaginethat theyreally believed himwhen he told them that themost successful retailmodelofthelasthundredyears,thedepartmentstore,wasover.“Inthepasttenyears,”McNairsaid,“thetraditionaldepartmentstorehasbeenfacing twomajor challenges: first, the problem posed by the trend tosuburbanliving;andsecond,theproblempresentedbythemeteoricriseof the discounter.” Though nimble chain department stores, such asthose owned by Federated Department Stores and May DepartmentStores,hadbranchedintothesuburbstofollowtheircustomers,itwouldnotbeenoughtoescapethediscountmeteor.Theriseofthediscountstoremarkedthefallofthedepartmentstore.

Discounters, such as Target, provided the convenience of departmentstores but at lower prices. Few discount stores, unlike all departmentstores,offeredcredittotheircustomers.Atthesametime,anoldkindofretailer that had been sidelined by the department store in thenineteenthcenturyreemerged:thespecialtystore.Specialtystores,suchas The Gap, provided a narrow selection that focused on just onecustomersegment,withadeeperinventorythananyonedepartmentofa department store could possibly provide. Between these two retaildevelopments the centralized shopping of the department storewanedandnewkindsofcreditarosetofilltheneedsofthisnew,decentralizedlandscapeofconsumption.

Inthelate1950sandearly1960s,newdiscountstorespoppedupalloverthecountry.ThoughtodaywethinkfirstofWal-Mart,Target,andKmart (all founded in 1962), hundreds of such discounters—nowforgotten—dotted the landscape.Nearly three thousanddiscount storesspannedthecountry,butmostofthemwereone-storeoperations,suchasBigM inMiami andBigC inCincinnati. (Evidently, usingonly thefirst letterwas cheaper.) For those at the top of the department storegame,aswellas those startingoutat thebottomof thediscount storebusiness,McNair’smeteorwasnotnewsatall.Theyallhad theirowntelescopesandcouldseewhatwascoming.Target, for instance, was founded by Douglas Dayton, the youngestson of an esteemed line of midwestern retailers. Douglas’s father andgrandfather had successfully steered Minneapolis’s Dayton departmentstorechaintosuccess.Douglas,likemanyothersinvolvedindepartmentstores, noticed the disturbing difference between discount anddepartment store sales. Whereas department store sales had risen 27percent during the 1950s, discount store sales had risen 700 percent.Douglas, like other department store heads,made the plunge, openingthe firstTargetstore inMinnesota.Andyes,eventhenpeoplecalled itTarzhay.1 Douglas maintained the quality of his department store atdiscount prices, and though the name might have sounded French—reflecting the better quality of its discount goods—the store was all-American.Thefirstdiscountersofthe1940sand1950sboughtfactoryseconds—possibleonlyinasystemsoproductivethatevenslightlyirregulargoodscould be discarded. Lodged in abandoned industrial buildings such asformer mills and factories, discounters had clothes, shoes, andeverything else heaped throughout a vast industrial space. Thediscountersof the1950shadasuspiciousreputationforshoddygoods,which“caveatemptor”wouldnotevenbegintocover.Yetshoppersstillflocked,greedy for lowerpricesas the inflationof themid-1950sgaveeverybody sticker shock. The discounters had more in common withnineteenth-centurywholesalersthanTargettoday.Buttheyperformedavital function, showing consumers and retailers alike that therewas ademandforcut-ratemerchandise.The new discounters of 1962, however, marked a break with thosehucksters and wholesalers. Their low prices relied on organizational

innovation,notsleightofhandordamagedgoods.Modelingthemselvesonthesupermarketsofthe1920sand’30sthathadcrowdedouttheoldgrocers, the discounters ran a cash-only, self-service business.Rejiggeringpricesandserviceintheneweraofcheaptransportationandproduction, discounters reinventedU.S. retail by de-skilling traditionalsalesworkandcuttingprices.Thediscountstore’srisewasmadepossiblebythecollapseofanolderretailmodelbracedbylaw—inthiscasethefair-tradelawsofthe1930s.Statelegislatureshadpassedthelawsduringtheearly1930sinresponseto what was called the “chain store menace.”2 Chain stores, all toofamiliar today,were thehottest things in town in the 1920s. In 1920,chainstoressold4percentofallgoods;by1929,theysold20percent.Alongside installmentcredit, chain stores represented themost strikingtransformation of American consumption in the 1920s. The anti–chainstore movement—perhaps the last gasp of populist politics—could befoundineverystate.Onewingofthemovement,ledbyRepresentativeWright Patman, aDemocrat fromTexas, pushed for an outrageous taxderivedbymultiplyingthenumberofstoresbythenumberofstatesinwhichastoreresided.Echoingthepoliticsofthe1890s,Patmanwrote,“Willthecountry’s interestbepromotedinabetterwaybythemillionand a half retail stores being owned by more than a million localcitizens,orwillthecountrybebetteroffifthesemillionandhalfretailstoresareownedandcontrolledbyafew?”TheGreatAtlantic&PacificTea Company (A&P)—which even to this day is the nation’s largestchainstoreever—wouldhavepaid$471millionintaxesunderPatman’splan,despitehavingprofitsofonly$9million.ThoughafewstatespassedmorerestrainedversionsofPatman’splan—taxing companies by the number of stores that they operated butwithout the insane multiplier—more important were the widespreadfair-trade laws. Fair-trade laws allowedmanufacturers to set prices fortheirproductsinastate.Ifmanufacturershadasetpriceagreementwitheven one retailer, other stores could not discount that product. Chainstores, despite their higher volumes, could not demand a lower pricefrommanufacturers.Forprice-protectedgoods,thelowermanufacturingcosts resulted in profits for the manufacturers, not lower prices forcustomers.Theendofmanufacturer-controlledpricingbeganwithathirty-eight-

year-old New Orleans grocer named John Schwegmann, who, havingworkedinhisfamilygrocerysincetheageoffourteen,believedthat“bykeepingpriceslowthepublic[would]reward[him]bybuyingmore.”3He refused to cooperate with the pricing schemes of liquormanufacturers and went to court to fight for his right to set his ownprices. The court agreed. Beginning in 1951with Schwegmann Bros. v.Calvert Distillers Corp., which struck down Louisiana’s “nonsigning”provision, the fair-trade laws in forty-five states began to wobble.Emboldened by his victory, Schwegmann became the poster child forfreepricing, continuinghis fight inEli Lilly&Co. v. SchwegmannBros.Giant Supermarket, which pushed for the right of retailers to set theirown drug prices.4 By 1958, one of Schwegmann’s top executives wastestifying in Congress before Arizona department store owner—andarchconservative—Senator Barry Goldwater. To a retailer likeGoldwater, the discounters’ cost of goods was only 7 percent of theirrevenue, compared to department stores’ average cost of goods,whichwasnearlytentimesasmuch.Goldwatertoldtheexecutive,“Ifwecouldgetmerchantsinthiscountrytooperatethiswayatsevenpercent,youwillbethesavinggraceforthemerchantsinthiscountry.”5Cheapgoodsmeant high profits for retailers—or so Goldwater thought.Whether ornot the fair-trade laws saved merchants, discounters certainly killeddepartmentstoreslikeGoldwater’s.Macy’s,whichneversignedagreementswithmanufacturers,seizedon

this opportunity in 1951 to cut its prices by 6 percent for nearly sixthousand items,kickingoff apricewar inNewYork.Though thenextyear Congress reaffirmed the validity of fair-trade laws through theMcGuireAct—whichempoweredstatestobindnonsigningretailerssuchasMacy’s—the stagewas set for the slowdeathof the fair-trade laws.TheMcGuireActonlyallowedstatestohave“nonsigner”clauses;itdidnotrequireit.Bytheearly1970s,onlytwelvestatesstillhadfair-tradelaws on the books.6 In 1975, President Gerald Ford finally ended theforty-year experiment in manufacturer-controlled pricing with theConsumer Goods Pricing Act, “enabling,” as he wrote in his signingstatement,whichsoundsoddlylikeanadvertisement,“consumersinall50States to shop for thebest products at the lowestpossibleprices.”7Therewasnotacleanendtothefair-trade laws,buttherewasaclearrise in free-market pricing in the 1950s and 1960s that allowed

discounters to take advantage of lower manufacturing costs. Withoutpricestability,manufacturershadto lookforotherwaystocutcosts—such as manufacturing overseas—to maintain profitability. Even withsuchmovements,manufacturingprofits tookahit,which inturnmadeotherformsofinvestment,suchasfinance,moreappealing.The discount store grew so fast not only because of its prices butbecause of the way it changed how Americans shopped.Incomprehensibleasit is,self-serviceinstoresdidnotexistuntil1917,when an enterprising southern grocer named Clarence Saundersreorganizedhis store,PigglyWiggly, toallowcustomers to select theirownfoodfromtheshelves.Theinnovation,obvioustoday,wassonovelin 1917 that Saunders actually patented it. Self-service allowedcustomers,forthefirsttime,tobuyonimpulsewithoutanyoversightbyclerks. Though self-service spread through the grocery business in the1920s,eventuallyforcingeventhelargestgrocerychain,A&P,toadoptthemodelby1930,other typesofretail storesresisted it.Merchandisewastooexpensivetohavegrubby-handedcustomerspawingit.Thehighcost of manufacturing meant a high cost of goods. Department storeskeptclothessafelybehindcounters,andhighlytrainedemployeesservedcustomers.

ClarenceSaundersfirstpatentedtheself-servicestorein1917.(IllustrationCredits5.1)

Intheworldofcheapgoods—manufacturedintheU.S.Southorevenoverseas, where cheap land and nonexistent unions allowedmanufacturerstocutcosts—somemerchandisecouldbebroken,stained,torn, ripped, and manhandled by customers. It didn’t matter; it wascheap. Instead of gazing through glass-paneled counters, customerscouldflipthroughracks.Inmanycustomersurveys,self-serviceactuallyoutranked lowprices inwhycustomerspreferred thediscounters. Self-service (40 percent)was themost cited reason—evenmore than price(23 percent)—consumers who liked discounters shopped there.8Retailersalsohadcause to like self-service.Without theneed forwell-trainedemployees,wagescouldbecut.Whereasdowntowndepartmentstores paid 30 percent of their sales volume inwages, discount storespaidas littleas8percent.Self-service, itwasthought,alsoencouragedimpulse buying since shoppers could emotionally connect with freelycaressedmerchandise.Centralizedcheckoutmeantthatacustomerpaidonly once, not many times throughout the store, thus trimming themoment of pain. In this world of cheap goods and de-skilled labor,discounterscouldthrive.Theirpricescouldbeloweryetstillprofitable.For discounters, innovative merchandising drove growth, whiledepartmentstoresreliedoncredittoexpandsales.9Onediscounter,however,stoodapartfromtherest,and,unlikeKmart

and Target, it beganwithout a department store or dime store parentcompany.Atitsoutsetin1962,thisdiscounterwassosmall-timethatitwasnot evenmentioned ina comprehensivenational surveyofall thediscountersintheUnitedStates.Thisoutfit,barelydistinguishablefromtheothersatfirst,settledonadifferentwayofdoingthings.Whileotherdiscountersfocusedoncities,thisretaileraimedatthecountry,countingonthenewpostwarcompressionofspacebroughtaboutbythehighwaysystem, and then the container ship. In Japan, production was beingreinvented.Toyotahad justperfected “just-in-time”production,where,instead of piles of carburetors and shocks waiting to be installed, thecarburetorsandshocksarrivedat the factory justbefore theywereputinto cars. As Toyota’s inventory costs dropped to nearly nothing, thecosts of production plummeted. Inventory, after all, should always bethought of as an investment with a zero-interest return. All thosecarburetorsand shocks sittingaroundcostmoney, in that they tiedupcapitalthatcouldnotbeinvestedprofitablyelsewhere.Toyotainvented

just-in-time production, and the rest of the world, since that day, hasstruggled to keep up. Just-in-time production enabled a lower-costmanufacturing process by eliminating unprofitable stored inventory—partsarrivedatthefactory“justintime.”Lesswellacknowledgedisthatat that same moment, in the United States, an equally importantinnovationoccurred—just-in-timedistribution—andeveryotherretailerin the world continues to this day to catch up to the company thatperfectedit:Wal-Mart.Wal-Mart grew formany reasons, but none of them involved credit.

Yet credit’s absence, as for Ford, had startling ramifications for bothWal-Mart and American consumers. From the outset, SamWalton didnotofferhiscustomerscredit.Unlikethediscountdescendantsof largedepartmentstoresandfive-and-dimes,Wal-Martbeganfromthegroundup. SamWalton had stores andmerchandise, but he did not have thecapital or expertise to offer credit. The store’s lowprices reflected thelargerlackofservice.Nofreegiftwrapping.Nocomplimentarydelivery.Nomoney-losingchargeaccounts.Thoughthecreditpracticesdidn’twincustomers, the prices did. But prices weren’t—despite what we mightassume—everything.As in the rise of the department stores, homemakers’ need for ease

drove the change. A survey of suburban discount shoppers from 1961revealedwhatmotivatedtheshifttodiscountstores.Regardlessofclass,momsloveadeal—butespeciallyfortheirownclothesandthoseoftheirchildren.Eventhoughtheycontinuedtobuytheirhusband’sclothesatdepartment stores, discount store shoppers virtually abandoneddepartment stores for women’s and children’s clothes.10 For mostshoppers the discount appeal was just as much about the shoppingexperience as about price. Among the younger set, self-service wasactuallypreferredbecause it “spe[d]upshoppingand let thecustomerbrowsewithoutinterference.”11Salespeopledidn’tact,accordingtoonediscounter,as“thecustomer’sconscience.Thecustomernolongerhadtojustify to herself or anyone else a purchase that she would enjoymaking.”Not interactingwithstaffmeantnotbeingwatched,whichinturn allowed shoppers to dress comfortably—a consideration almostinconceivabletoday,whenwewearjeanstoeverything—but1961wasamore formal time. One discounter remarked that his clientele “like toshop us in a very leisurely way. If a person wants to shop in a

departmentstoretheyusuallycannotwalkininslacksorshorts.…Inadiscount store, you can see all types of people … the slacks … theshorts … the pedal pushers, or even dungarees.”12 As another said,“We’reworkingonbreakingdownallthetraditions.”Whenyoucangoshopping in shorts, is there any going back? Convenience extendedbeyond attire. In the suburbs, you could go shopping at night, whiledowntown the stores were open late only one night a week.13Discounters may have lacked the formal convenience services ofdepartment stores, like credit, but they offered other informalconveniencesthatmatteredjustasmuch.14The discounters that came out of existing retailers, such as Kmart,tended to offer credit, while those invented as discounters, like Wal-Mart,didnot.Onlyhalfofdiscount storesofferedcredit in the1960s,buteven then, fewcustomersused thestores’creditplans.Though themajorityofdepartmentstorepurchaseswerechargedbythemid-1960s,only 13 percent of discount store purchases were. Few stores had thevolumetorunsuchaserviceprofitably.ThelackofcreditatWal-Martand many other discounters marked a break in the long history ofcouplingretailerstocredit.Thoughretailershadlongbeenabletoreselltheir customers’ debt, the customers still got the credit at the retailer,creating customer loyalty. The discount store, on the other hand, toldconsumerstolookelsewhereiftheywantedtoborrow.Whereas department stores had promoted their own creditdepartmentsandpolicies,manydiscountershada farmoreambivalentapproachtoconsumercredit.PartofwhatkeptpricessolowatTarget,DouglasDaytonexplainedin1969,wasthatitoffered“nocredit.”Self-service enabled low payrolls, suburban locations enabled vast big-boxparking, and the lack of credit enabled capital to be invested inexpansion—notcustomers’bills.Unlikeotherdiscounters,Targetsoldnolargeappliances,completelybreakingthelinkbetweenitsbusinessandthatofthe1950smillstores.Anditdidtakechecks.“That,”Daytonsaid,“isthewaywewantittobe.”15The appeal of the discounters, despite the lack of credit, weighedheavilyonthemindsofcreditprofessionals.Amongdiscountshoppers,60percentconsideredchargeaccounts important.16 If itwas importantto60percentoftheshopperswhodidshopatthediscounters,imaginehow important it was to those who didn’t shop there at all! A Life

magazinestudyin1962foundthatthe“chargeaccountfacilities[werean] important reason for shopping in department stores.”17 Credit hadbecomeaprimary reason to shopat department stores. Price certainlywasn’t.Butwasquality?The biggest challenge to discounters, the survey concluded,was thelingering perception of lower-quality goods, aided and abetted by thejunk heaps found in the discount stores of the 1950s. Though only asmallpercentageof regulardiscount store shoppersbelieved the storeshadlower-qualitygoods,infrequentshopperscitedlow-qualitygoodsasthe most important factor in avoiding discounters.18 If a store could“successfullyimpresscustomerswiththequalityofmerchandiseanditscompetitive value, [then] there remains a very large additionalmarket.”19Meteorsmovequickly.By1961, since theprevioussurvey twoyearsearlier, discounters had begun to shed the perception of lower qualitywhilekeeping the lowprices.Theeaseof returnshelped,aidedby thefact that the layoutsof thenewstoresappearedmore like thoseof thefamiliardepartmentstoresthantheseriesofheapsintheoldmillstores.Marginsondiscountgoodswerelower—closerto20percent,ratherthanthe traditional department store margin of 35 percent. But the newdiscountersreorganizedtheirinventories.Byfocusingonthegoodsthatcould be sold in high volume at lower prices—such as dresses—andeliminatingtheinventory-cloggingitemsrarelybought—suchassewingsupplies—they could cut prices. In just one year, from 1960 to 1961,discountstoresalesrose65percent.20Ifthediscountstoremeteorhadbeennamedbyscientists,theywouldhavecalleditKmart.Thebiggestdiscountstoreinthe1960swasKmart,which leveragedthe legacyof itsparentcompany’s traditionofqualitytobecomeadiscountgiant.Liketheotherdiscountstores,onevisionarywasbehindtheshift:HarryCunningham.Workinghiswayupfromstockboy, Cunningham became the president of S. S. Kresge, a venerablechain of dime stores. Kresge, by the late 1950s, was cash-rich butgrowth-poor. Various attempts to grow the chain produced additionalvolume but not additional profits. Discounting offered anotherway ofdoing business, and when he became president in 1959, CunninghamseizedtheopportunitytoremakeKresge.Cunningham was able to use all that cash to explode out of the

starting gate. For a time, Kmart was a meteor of its own. While 60percentofdiscounterswereone-storeoperations,Kmartopenedeighteenstores in just its first year, 1962.21 Kmart, like Target, was started todefend a retail chain. Its sales volume per store grew as fast as thenumberofstoresitoperated.Between1963and1970,Kmartincreasedits sales volume per store eighteen times. The fastest-growingdepartmentstore,J.C.Penney,grewitssalesvolumeonlyfourtimes.With deep pockets and organizational experience that other

discounters lacked,Kmartwasable toexpandnationally fromtheverybeginning, strategically picking cities with fewer discounters, such asAtlantaandDetroit,andavoidingheavilyservedareas,suchasChicago,NewYork,andBoston.Inthosecities,however,Kmartclustered,placingstores roughly fivemiles apart to encircle a city.Detroit, for instance,got eight Kmarts nearly all at once, enabling a synergy between theiradvertising efforts, as well as increasing the efficiency of their supplychain. By 1965, Kmart had more stores than any other discounter inAmerica.By1967,ithadahighersalesvolume—alittleover$1billion—thananyotherchain.22Kmartalsobrokewiththedepartmentstore’sshoppingcentermodel.

Many shopping centers excluded discounters, since they attracted adisproportionately lower-income group. Where to open a store?Surveying the demands of a population could be expensive. But, ofcourse,asonediscountstoreownersuggested,“theeasiestthingtodoisto open up near a shopping center because you know darn well theymade an expensive survey and, if they thought it is right, it must beright.”23Kmart turned itsexclusion intoanopportunity,opting insteadforfreestandinglocationswithitsown1,000-carparkinglots—thefirstbig-box stores.24 Shoppers appreciated the free parking, which waslargelyabsentatdowntowndepartmentstores.Insomeways,Cunninghamrodethebaby-boomwave.Youngpeople

andyoungfamiliescameofageatadisproportionaterateinthemid-tolate 1960s, and itwas always the youngwho needed good deals. Thegood deals also helped those of more moderate means. Opinions ondiscountstoresstronglyreflectedincomedifferences.Intheearly1960s,while 67 percent of households earning under $5,000 shopped atdiscountstoresmorethanhalf thetime,only43percentofhouseholdsearningabove$5,000did.25Thegooddealsreflectednotonlyashiftin

generational culture but an already slowing prosperity. The cheapmanufacturingwould, soon enough, produce fewer of the good-payingjobsthatmadeshoppingatdepartmentstorespossible.Bytheendofthe1960s,Cunninghamhadprovedthefutureofretail

was in discounting. The blue-light special was still in the future, butKmart’sparentcompany,S.S.Kresge,bettheproverbialfarmonKmart,sinkingmillionsofdollarsintoitsexpansion,siphoningdollarsoutofitsdime store business.When other dime store chains went down in the1970s,KresgesurvivedinitsnewguiseasKmart.Whilediscounterscutatthedepartmentstorefrombelow,otherstores

begantopopupthatstruckatdepartmentstoresfromabove.Forlowerprices, customers turned to discount stores, but for better service andselection, they turned to specialty chain shops. While discount storestookcareofshopperslookingforabargain,specialtychainstoresgaveshoppersgreater inventories. Specialty shopshadcontinued, evenwiththedepartmentstores’dominance,buttheydidnotbecomechainsuntilthe 1970s. Evenmore than the discount stores, specialty stores revealthecentrifugal forces tearing thedepartment storeapart.Consider thatthedepartmentstoreofthenineteenthcenturyhadconsolidatedallthedifferentkindsofshoppingunderoneroof in thenameof lowerpricesandbetterservice.Bythe1960s,thosedifferentkindsofshoppingbeganto spread out again, as shoppers, nowmobile in their cars, could flitfromstoretostoremoreeasily.Atdiscountstores,shoppersfoundlowerprices.Atspecialtystores,theyfoundabetterselection.Thedepartmentstore broke apart for the same reason it had come together a centuryearlier.TheGap,forinstance,wasfoundedbyDonaldFisherin1969.Atfirst

itsoldonlyusedLPsandLevi’sjeanstotheyouthsofSanFrancisco.Folkandrockplayedoverloudspeakers.Thisnewretailerhadafocusedbutdeepinventory.Unlikedepartmentstores,whosecapitalwastiedupincredit,TheGaphad75percentofcurrentassetsinvestedinmerchandiseinventory.26 Unlike most places that sold Levi’s, The Gap offered anysizeyouwanted.Ifyouwereshortortall, fatorskinny,theLevi’syouwantedwere there. Ifyouwereyoung in1969,youwantedLevi’sandnothingelse.DonaldFisherwasbornin1928.Hewasnobabyboomer,buthesawtherisingpotentialofthatgeneration’sspending.Cateringtothisnichegroupandprovidingexactlywhattheywanted,storeslikeThe

Gapbegan todisplace the clothingof thedepartment stores.By1974,TheGaphadintroduceditsownlinesofclothing,manufacturedinAsiaanddomestically, toreduceitsdependencyonLeviStrauss.27By1977,the little shop in SanFranciscohad expanded to248 stores across thecountry. The postwar one-style-fits-all gave way to the generationalnichesoftoday.TheprimarycompetitorofTheGap,asitsfinancialfilingsattest,was

the “units of large national department, specialty or discount, storechainswhich [had] considerably larger sales andassets.”28YetdespitetheDavid-and-GoliathqualityofTheGapversusFederatedDepartmentStores, itwas TheGap that turned out to have the advantage—and itknew why. In the first few years of The Gap, Fisher hired seniormanagement fromboth traditional department stores (RogerMarkfieldfromMacy’s)andthenewdiscounters(JackEugsterfromTarget).29Forit and theothernew specialty chains, thedepthof selection, the storelocations, and the inventory control all made them competitive. LikeWal-Mart,TheGapinvestedearlyanddeeplyincomputerizedinventorycontrol.30 Every size was always available in every store. In 1969, itaccomplishedthisinventorycontrolbyhavingsalespeopletearoffapartofthejeans’saletagthatlistedthestyleandsizeandtossitintoabox.31EverydayFisherknewexactlywhathadsold—andwhatbuyerswanted.Withinafewyears,thiswasdonebycomputerstrackingpurchases.TheGap’smanagementknewwhatboomerswantedand sold it to them inplaceswheretheywantedtobe.MostofwhatTheGapsoldwasLevi’s(69percentin1977),butitbuiltonthatfoundation.Andoncash.AGapemployee from theearlydays remembered that

“back in the early seventies, credit and charge cards were not widelyused.…Soattheendofthedayyoucouldseehowmuchwassoldinanundeniablyconcreteway:awadofcash.Therewasthekindofcashflowthatinstilledconfidenceintheentireenterprise.”32StoreslikeTheGapdidn’toffercreditasdepartmentstoresdid,buttheydidn’tneedto.Theyoungpeopletheycateredtodidn’thavecreditcards,anymorethantheworking-classpeoplewhoshoppedatdiscountersdid.Cashwasking.Theriseofworkingwomen—atleastamongthemarriedmiddleclass

—ledtoarevolutioninfashion,asolderwomendressedfortheoffice.AnnTaylor,alongwithotherstoressuchasTalbot’s,foundanewnichein a changing economy. Fashion reflected a cultural shift—casual at

home,elegantintheworkplace—aswellasaneconomicshiftofwomenat work. The discount store supplied clothes for home, while thespecialtystoresuppliedclothesforwork.The Gap offered the self-service of a discounter but with better

merchandise.SodidAnnTaylorandBrooksBrothers.Jeansofeverysizewerearrayedonawall so that a self-conscious shopperdidn’thave tohaveherwaistmeasuredbyatoo-loudclerk.33Clerksmanaged,butdidnotprotect,theinventory—refoldingitafteritwashandledbutallowingcustomerstotossasmanypairsofjeansastheylikedonthefloorofthedressingroom.Specialtyretailersacrosspricepointsoperatedthesameway.Thedepartmentstore,then,begantofragmentunderthiscompetition,

as lower-cost orbetter-selection retailers tookon eachdepartmentoneby one. Basement overstocks became Wal-Mart. Children’s becameTarget. Men’s became The Gap. Businesswear became Ann Taylor,Talbot’s,andBrooksBrothers.Eachspecialtystoreofferedbetterpricesandinventoriesthanthedepartmentstore—butdidnotoffercredit.Caldorwasatypicallysuccessfuldiscounterthatdidn’toffercredit.It

was founded in 1951 in Port Chester, New York, by a World War IIveteran named Carl Bennett, who named the store by combining hisnameandthatofhiswife,Dorothy.34By1963,Caldorwassolidlyinthetoponehundreddiscountersinthecountry,withannualsalesof$15.5million. But its growthwas nothing special. Its sales, like those of theentirediscountstoreindustry,hadgrown65percentfrom1962to1963.Moreover, the largest discounters, such as E. J. Korvette, had annualsalesof$257million.Moredistressing,nodoubt,wasthatwhileCaldorsold $2.5 million worth of goods per store, Korvette was able to sell$12.2million.35HowcouldCaldorcompetebetter?Americans loved low prices but they also loved revolving credit.

Customerswithchargeaccountsboughtmorethancashcustomers,evenwhentheypaidcash—andthatcouldnotbeignoredinthecompetitivefield of discounting. Shoppers also paid closer attention toadvertisementsofstoreswheretheyhadaccounts.ForstoreslikeCaldor,whichreliedprimarilyonaweeklycolorcircularinthelocalnewspaperto attract shoppers, these differences mattered. As they becamedesperate to attract more customers, revolving credit began to spreadoutsidedepartment stores.Consumersbegan to expect revolving credit

at all kinds of retailers, even at places where installment credit hadtraditionallyfinancedtheirpurchases,suchasappliancedealers.Asthediscount stores’ lower prices rippled through the suburban economy,competition increased. Credit was an important weapon against themoresuccessfulstores,butCaldorcouldn’tfinanceitsowncredit.By the mid-1960s, retailers wanted to know how they could boost

sales without offering credit themselves. In their monthly magazineDiscount Merchandiser, store managers could read a report by themanagementconsultingfirmToucheRossthatcredit,despitewhattheyhad heard, was not profitable.36 Of course, Touche Ross vastlyunderestimated the interest rate that stores charged borrowers—ahypothetical6percentversusareal20percent—inafitoffrom-the-hipassumptions only consultants could be paid for. Yet themain point ofthe report, which was widespread in the industry, was that sales, notcredit, drove profits, and if stores could find a way to increase theformerwithoutofferingthelattertheywouldbebetteroff.Discountershadtobeconvincedthatofferingcreditwouldhelpthem,

astheyhaddoneprettywellwithjustbare-bonesservice.In1962,asallthenewdiscountersstartedup,BernardKorn,acreditexecutivewithaNewYorkfinancecompany, laidouttheadvantagesanddisadvantagesof lending tocustomers in theDiscountMerchandiser.37Theadvantagesfor discounters were the same as for department stores: increasedcustomerloyalty,higherspending,andmorefrequentshopping.Butthechallenges for department stores were multiplied for discounters. Onevery cut-rate sale, they had to pay for the same billing machines,accountingcosts,andcollectionfeesasaregularstore—butwithalreadyslimmer margins. Korn estimated that stores that offered six-monthrevolvingcredit—theonlykindhethoughtmadesenseby1962—wouldneedadditionalcapitalequalto40percentofthesalesvolume.Ifastoresold $1million in a year, itwould need to borrow $400,000. A storewouldneedto lookoutsideitself forthenecessarycapital. If thatstorecould borrow from a bank at 6 percent—nomean feat—then just theinterestontheplan,beforealltheoverhead,wouldcost$24,000ayear.A discounter’s increased revenue would need to cover the cost ofinterest,aswellasalltheothercostsofsuchaprogram.Thetrickythingaboutacreditprogram,though,isthatitisallornothing.Ifastorehada little extra cash, it could experimentally invest in some additional

sweaters.Butifastorelaunchedacreditprogram,itcouldveryquicklydevourallofaretailer’scapital.Insteadofborrowing$400,000,astoremightsuddenlyneed$4million!WhatKornencouraged,wherepossible,was tomake arrangementswith a local finance company to resell thedebt.Muchmorethandepartmentstores,discounters likeCaldorreliedonoutsidefirmstoprovidecredittotheircustomers.Wheneverbankcardspenetrated a new market, department stores resisted them butdiscounterswelcomed them. But duringmost of the 1960s, creditwasrun through the store and financed by a third party. A 1966 surveyfound that 80percent of discounters’ credit planswere runbyoutsidefinancial institutions.Creditproviders couldbe localbanksornationalfinance companies, but either way, the private label provided arelationshipbetweenthestoreandthecustomer,drivingsales.Take,forinstance,therelationshipofCaldorandGeneralElectric,whichtypifiedthewayinwhichdiscountersofferedcredit,iftheyofferedcreditatall.Caldor’s credit dilemma was solved by the unlikely industrial giantGeneralElectric.GeneralElectrichadprofitablymanufacturedlightbulbsandwashingmachines since the dawn of the electrical era, selling itsproducts through specializeddealershipsaswell as regular stores. Likeautomobile manufacturers, General Electric helped its dealers financetheir sales inventories,aswellasunderwritingcustomers’purchasesofall those washing machines. Financing dealers’ inventories helped GEkeep its factories humming twenty-four hours a day year-round andforced the dealers to pay for all those gizmos sitting on the shelves(rather than in GE’s warehouses). And of course, financing theinstallment credit of consumers helped sell goods, which helped GEmakemoneyfrommanufacturing.Despite the virtues of credit for General Electric, the financingbusinesswasnotsexy.TheunitofGEthathandledthecreditwascalledGeneralElectricCreditCorporation(GECC),and,forexecutives,itwasacareer stopper.Year after year, sinceGECC’s founding in the1930s, ithad reliably helped the important part of GE—the part thatmanufactured things—expand its profits. Yet the profits ofGECC itselfremainedrelativelystagnant.Withoutprofitgrowth,itwasagoodplacetoendapromisingyoungexecutive’scareer.Allthatchangedin1961.Shopperswhohadbecomeusedtobuyinga

littlebithereandthereonrevolvingcreditatdepartmentstoresbalkedatfillingoutanewinstallmentcontractforeachnewwashingmachineor vacuum cleaner.While GE’s sales continued to expand, credit salesactuallyfell.SoGErolledoutanewrevolvingcreditprogramin1961.Revolvingcredit fordurablegoodsflewinthefaceof theconventionalwisdomthatrevolvingcreditwasforsoftgoodssuchasshoesandsocks.Butshopperswantedwhattheywanted,andGEwashappytogiveittothem.Installmentcreditdidn’tpayanyhow.MostofGECC’swrite-offsbytheearly 1960s were not for unpaid debts but for unsellable repossessedgoods. The highly productive manufacturing that made goods cheapenough for the discount store also meant that there was no longer aviable resale market. The world of cheap goods not only destroyedtraditional retail, it also destroyed traditional credit—as well as theoccasional lunch. Consider the plight of a local refrigerator dealer in1959,who, in addition to themisfortune of having to attend a creditmanager’sconvention,hadtositnexttoH.A.Jaffe.Managingthecreditdepartment of the New York–based department store chain S. Klein,whichhadheavilypromotedtheuseofrevolvingcreditbyitscustomers,Jaffehadconsideredthechangingnatureofcreditdeeply.Heknewthatinstallmentcreditwasperfectforaworldofexpensive,durablethings.Ifyou missed a monthly payment on a refrigerator, the debt collectorcouldcomeandgettherefrigerator.Inaworldofexpensivegoods,thatrefrigeratorcouldberesold,althoughperhapsatadiscount,andsomeoftheoutstandingdebtcouldberepaid.Thisrefrigeratordealerseatednextto Jaffe at lunch was the biggest in the state, proudly selling twentythousand refrigerators a year.Making small talk, the dealer told Jaffethat for every refrigerator sold, he had to register the installmentcontractatcityhall,sothat,incaseofdefault,therefrigeratorcouldberepossessed. Every time he registered a contract, it cost $1. Perhaps abetter accountant than conversationalist, Jaffe simply asked him howmany refrigerators hehad repossessed that year. StaringdumbfoundedatJaffe,thedealergotupfromthetable,saying,“Oh,you,youspoiledmy whole luncheon. We have repossessed twelve and spent over$20,000onrecordingfeesthroughtheyear!”Forcheapgoodsinaneraofnear-constantrepayment,repossessionandinstallmentcontractsweremoney losers. Many stores stopped filing their contracts and even

stopped repossessing, since the goods could not be resold, and simplyusedthethreatasapsychologicalleverforcollection.Collecting the debt, not the merchandise itself, was what mattered.Themerchandise, once sold,wasbasicallyworthless.GECC’s dilemma,then, was not unique. Repossession and resale—outside of cars andhouses—could not replace repayment of debt. Without the ability toreclaimthevalueofthedebtthroughresale,therewasnoadvantagetothe lender of having a secured installment loan. A borrowermight aswellhaveanunsecuredrevolvingcreditaccount.Revolvingcredit requiredmuchmorecapital than installmentcredit,asitcouldnotbeeasilyresoldtofinancecompanies.Thoughdepartmentstoreshadledtheway,habituatingconsumerstoborrowontheircardsand innovating organizational techniques to make revolving creditprofitable, other retailers balked at investing their capital in theircustomers’ debts.More important to the rapidly expandingdiscounterswas where a borrowed dollar would best be invested. Banks couldfinance more stores, or they could finance receivables. Even specialtychains,suchastheregionalJ.B.RobinsonJewelers,benefited.Withoutfinancing its own customers, the chain was able to use its capital toexpand from two stores to thirty-one between 1969 and 1977.38Financial institutions—like GECC—took notice. Unlike most retailers,GECChadaccesstolargeamountsofcapital.Alsounlikemostretailers,GeneralElectrichadafabulousbondrating.GECCfinancedalltheloansbyissuingcorporatedebt.Thebondswouldpay5percentayear,butuntil theearly1960s,GECCcouldcharge itscustomersonlythepriceforinstallmentcreditofabout6percentayear.With revolving credit, GECC could charge customerswhat departmentstoresdid:20percentayear.SuddenlyGECCbecamewildlyprofitable.Within a fewyears,GECC found that its credit sales recovered.Andbecause of the higher interest rates on unsecured debt, its profitsactuallyincreased.TheoncestagnantGECCbecameahotbedofactivity.GE opened regional computing centers to track all the debts, computethecomplicatedinterestontheloans,andautomatecollections.GeneralElectricdidn’tdothingshalfwayandfounditselfwithmorecapacitytoprocessrevolvingcreditthanitsdealersrequired.ExactlyatthemomentwhenGEhadthecapacitytolend,discountersfoundthemselveswithaneedtoborrow.In1966,GEbegantoofferits

creditservicestoretailersthatwereinneedofacreditsystembutlackedtheabilitytoprocesstheloansorprovidethecapital.Itofferedprivate-label credit services to retailers, especially discount retailers. Caldorcould offer the “Caldor credit card,” but GE would take care ofeverything.Caldorcouldprofitonthesales,andGeneralElectricwouldprofitontheloan.Itwasawin-win.Consider,however,themeaningofthisnewdirectionforGECC.WhenGECCwas founded, it facilitated the profits ofmanufacturing. Financewasameanstoanend.Withtheriseofprivate-labelconsumerfinance,however,financebecameanendinitself.GECChelpedsellnotjustGEproducts but all products, even thosemade by competitors. Consumerfinance became a source of profit in itself, not ameans to profit frommanufacturing.Adollarisadollar.Fortheinvestorthesourcedoesnotmatter,evenif the larger consequences for theeconomycouldbedire.EverydollarGEinvestedinconsumerdebtwasadollarnotinvestedinafactory.GEfactories had been the mainstay of the good postwar jobs. Consumerfinance,incontrast,createdhigh-payingjobsforafewatthetopandalotof low-paidclericalwork foreverybodyelse.Themiddlegroundofmiddle-classmanufacturingjobsbegantodisappear.The private-label schemes of General Electric and other financecompanies enabled discounters to match the department stores’ creditofferings.By the late1960s,department storesoffered little tobudget-constrainedcustomersbesidescredit.Theirpriceswerehigher.Creditatdiscount stores was just as liberally granted by department stores—though surreptitiously financedbyGE. In1960,department stores, theleading category of retailers, had four times the sales volume ofdiscounters,butonly fiveyears laterdiscountstoreshadahighersalesvolume than any other kind of retailer, including department stores.39Thehigh-priced,centralizedretailerahadended.Sincethendepartmentstoreshavestruggledtodefinetheirniche.Therewas,however,analternativetoprivate-labelcredit:bankcreditcards. Bank credit cards had failed in the 1950s because they wereimpossible to use at the places where people wanted to shop—departmentstores—andbecausenobankexecutiveknewhowtorunacredit cardbusiness.By themid-1960s, thepracticesdeveloped to runthe department store businesswerewidely known. Bank cards offered

discountersmanyoftheupsidesandnoneofthedrawbacksofrunningtheirowncreditprograms.Bankcardsmightnotincreaseloyalty,butifshoppers liked a store’s prices, they would return and spend more—using the bank’s capital. Banks and their specialized credit personnelwouldscreenoutthebadrisksandtakecareoftheexpensivebillingandcollections,whichforthebankwouldbecheaperbecauseofeconomiesof scale. The only real disadvantage was that the bank took a cut ofeverysale;butweighedagainsttheadvantages,itwashardtoseehowitcouldbeabadidea.Theproblemwithbankcreditcardswasthatsofewpeoplehadthem.

Thoughcredit spreadout spatially, itdidnot spreadouteconomically.For thewealthy,who frequented the new specialty chains, bank cardsbegantodisplaceretailcredit.Thoughthebankcardsofthe1950shadfocusedontravelingbusinessmen,bankcreditcardsofthe1960sbegantospreadintothehandsofwell-to-dohomemakers.Consumerslovedtheeaseofuse;theywereabletoborrowatanyoftheirfavoritestores.Butthough credit cards were everywhere by 1970, they were not foreveryone.Middle-andworking-classpeople longed to shoponcreditatthe new niche storeswithMaster Charge or BankAmericard, but theirfinances remained tied to the old retail stores such as Sears, Roebuck.Half of American households had a Sears card in 1979, and one-thirdhad a J. C. Penney card.40 LikeGE, Sears funded its credit operationsthrough the bondmarket. Its captive finance company, Sears RoebuckAcceptance Corporation (SRAC) began to issue bonds in 1959 to fundSearscustomers’credit.LikeGECC,SRACquicklybecameaprofitcenter,earning over $100million a year by 1967.41 The Sears card could beused only at Sears and was thus just like the store credit of old. Formany young Americans, their first—and frequently only—credit cardwasfromSears.Bankcreditcards,whichcouldbeusedinmanystores,remained in thewalletsof thewell-to-do.Discounters, then, continuedtooffercreditthroughfinancecompanieslikeGEbecausemostoftheircustomerscouldn’tgetbankcards.Average people were simply too risky to give bank cards. In 1975,

only half of Americans had bank-issued credit cards.42 Capital, asalways,was limited. Lending techniques could not profitably ascertainthecreditworthinessofmoremundaneborrowers.Though it ishard tobelievetoday,eventhemostprofitablecreditcardsonlybrokeeven.In

the late 1970s, a combination of legal and economic changes andentrepreneurial vision would transform the credit industry to makecreditcardsnearlysynonymouswithconsumercreditforeveryone.Formore Americans to get their piece of the plastic dream, lendingtechniqueswouldneedtoberefinedandnewsourcesofcapitalfound.OnceMasterChargeandBankAmericardwentnationalandbegan to

penetrate deeper into the population, as will be discussed in the nextchapter, discounters could begin depending on plastic to finance theircustomers’purchasesandfocusonwhattheydidbest:selling.Oncethecredit card became ascendant, discounters could abandon their creditprograms.Bythemid-1970s,forinstance,Kmartnolongerofferedcredittoitscustomers.43Asretailers’marginserodedfromthecompetitionofthediscounters,theircreditoperationscouldnotabsorblosses.Breakingevenwasnolongergoodenough.Thoughmanyretailershadprofitedontheircreditoperations since the1950s, thoseprofits stilldidnotequalthoseofselling.Whenmerchandisingwassuccessful,italwaysprovideda retailer more profit than finance did. Kmart eliminated its creditprogram because investing money in its racks of clothes made moremoneythaninvestinginitsconsumers’debts.Retailersthatknewhowtoruntheirbusinesses,likeKmartinthe1970s,shouldalwayshavemadethatchoice.44Thenewdistributionofretailrequiredanewdistributionofcredit thatcenteredon theconsumer,not the store.While shoppingbecamemoredecentralized,credit—atleastforthosewhohadaccesstobankcards—couldbecomemorecentralized.At the endofhis career, oncehehad retired fromHarvardBusiness

School,ProfessorEmeritusMcNairsummarizedhisthinkingonpostwarretail and the rise of thediscount store: “Toomanydollars are taggedbeforetheyareeverreceived,andoneoftheconsequencesisagreatlyincreased receptivity topricebargains.…Hencewe find the seeminglyincongruoussituationofrisingincomesand…aheightenedinterest inbargain merchandise.”45 Rising incomes had enabled Americans toborrow more than ever before. But because they locked up all theirfutureincomeinhouses,cars,andfurniture,theyneededeverythingelseto be cheaper. Borrowing claimed dollars before they came in, andAmericans could no longer afford to pay full price. The meteor thatMcNair had so presciently predicted had struck, but it was not adiscountermeteorafterallbutameteormadeofcredit.

CHAPTERSIXBRINGINGGOODTHINGSTOLIFE

(1970–1985)

As credit cards began to enter society in new places, The Wall StreetJournal followed theiremergence.Manystories focusedonpeoplewhoshouldnothavehadcards.Thesystemsinplacetokeepcardsamongthewell-to-do sometimes didn’twork. A Pittsburgh grocery clerk in 1965,for instance, on receiving a card through a background check error,floutedhiscard toareporter,declaring“Howabout this?Just like therich people.”1 Credit cards connoted class—and classiness.With cards,youcouldlivethelifeyoualwayswanted.Theultimatestoryofthissorthappened in 1959, just as travel and entertainment (T&E) cards wereabouttobegintolosetheirgroundtothebankcards.Theadventuresofa $73-a-week clerk from the Lower East Side named Joseph Miragliaillustrated both the limits and the possibilities of credit cards. In onemonthoforgiasticspendingheranupa$10,000billwhileentertaininghimself across three countries, four girlfriends, and one rhinestone-collaredcockerspaniel.It all began in September 1959,when Joe happened to duck into a

fancyNewYorkrestaurantandspiedapileoftravelandentertainmentcardapplicationsfor“menofresponsibility.”HefilledoutHiltonHotels’Carte Blanche application—complete with his real salary—and to hissurprise received a card a fewweeks laterwith a letter that told him“thiscardisyourkeytoeveryluxuryHiltonhastooffer.”Indeeditwas.BeginningwiththeWaldorf-AstoriainManhattan,MiragliahitMontreal,LasVegas,andHavanabeforerunningoutofsteam.Heboughtfurcoats,finewines,dogs,meals,suits,andevensilkshirtsfromthesametailoras

Cary Grant.With only the cash he won at the craps tables and somechecks he wrote against the card, he lived, as he said, “like amillionaire’sson.”2Whenthepolicecaughtupwithhim,hesimplysaid,“Ialwayswantedtoseetheworld,andIlikenicethings.”3Although Joe could live the high life on his Carte Blanche card, hecouldn’tliveanormallife.AtravelingbusinessmanwithaCarteBlanchecouldeatinafewswankyrestaurants,buyhiswifeormistressafurcoatinanaffiliatedshop,maybeevengetasuitfromaneighborhoodtailorwhohadarelationshipwiththehotel,buthecouldn’tgotoKmart.Hecouldn’tbuygroceries.Onlyplacesthatcateredtotheexpenseaccountcrowd tookAmerican Express, and for everything else therewas cash.Yetwhile Joe could spend$10,000 to live like amillionaire, itwouldhave been nearly impossible for him to spend $10,000 to live like amiddle-classperson—much lessaworking-classguy fromaLowerEastSidetenement.Thewaywe use credit cards today—to pay for groceries, fast food,and coffee—was heralded as futuristic in the 1960s—a hallmark of awondrous cashless world of tomorrow! It would be a distributedlandscapeofcreditwherecardswouldreplacecash.Oneofthereasonsthisvisionof the future seemedso impossiblewasbecauseof theveryreal technological limits onwhere credit could be used and themorallimitsonwhere it shouldbe.Joe’s storyreflected those limits,and thestoryweareabouttoexamineshowshowthoselimitsdisappeared.Howthecreditcardchangedfromaplaything for therich intoaneverydayaccessory explains a great deal about why so much credit suddenlybecameavailablefortheaverageAmericaninthe1980s.There have always been Joes who wanted some better things, butthere have not always been lenders willing to give them credit.Americansbegantoborrowmuchmoreinthe1970s,notbecauseweallsuddenlybecamespendthriftsbutduetomanystructuralchangesintheeconomy, a few industrious young executives, and one chance shift inthelaw.The postwar period had been a time of remarkable growth andstability. Slowly, inexorably, thatworld fell apart in the 1970s, as theinternational economic order shifted from postwar recovery back toglobalcompetition.TheseeminglyunendingdemandforU.S.dollarsinthe postwar period,when thewholeworldwanted to buyU.S. goods,

gavewaytoadollarthatwaslessindemand.Theeconomicdislocationsofthe1970s—inflationanddeindustrialization—fundamentallystemmedfrom this return tonormalcy.The stablegrowthof thepostwarperiodthat had rewarded budgeting and borrowing fell apart. With surginginflation and stagnating pay, real wages began to fall. Making up thegap, more married women than ever before entered the workforce,trying to make ends meet. But consumers also began to rely onborrowing to make up the widening gap. Since World War II, theamount borrowed byAmericans had been rising, but the amount theycouldpayback—fromgood-payingpostwarjobs—hadkeptpace.Inthe1970s, that carefully budgeted balance between rising debt and risingincomecameundone.At the same time, the demise of department stores created a newopportunity for bank credit cards to flourish. ThoughmostAmericans’retailcreditinthe1970swasstillfromSearsorMacy’s,moreshoppingoccurred at places like Kmart. Discounters and specialty chains haddisplaced department stores. While their lower prices and deeperinventoriesluredshoppersawayfromdepartmentstores,creditwasstillneeded, ifnot to solidifycustomer loyalty, thensimply toputoffuntiltomorrowwhatcouldnotbepaidfortoday.The early 1970s witnessed the beginning of a titanic shift in theAmerican economy, but the cultural attitudes with which Americansgreetedthenewdecadereflectedthepast.Bytheearly’70s,bankcreditcards had spread across the country. In every city, at least one bankoffered plastic. Yet their use was still only for a few, and those fewdivergednotonlyinincomebutinoutlookfromthosewhodidnothavecredit cards. A 1968 sample found that only 17 percent of Americanshad credit cards, as opposed to the 62 percent who had gasolinecompany cards. Men who used credit cards, moreover, weredisproportionately affluent, urbane, and more likely to agree withstatementssuchas“IliketothinkIamabitofaswinger.”4Thecreditcard reinforced a lifestyle of aspiration for better things, even for theboss’s job. Those who didn’t use credit cards had more restrainedlifestyles. Men without cards disproportionately believed that “hippiesshouldbedrafted,”that“liquorisacurseonAmericanlife,”andthat“awoman’splaceisinthehome.”Those who didn’t use credit cards were not only disproportionately

poorer,theyalsosawtheworlddifferently.Theireconomicoutlookwaslessoptimistic.Theydidn’tbelieveininvestinginstocknearlyasmuchasthosewhohadcreditcards.Buttheyalsodidn’tbelievetheywouldbeexecutivesinafewyearsorthattheirfamilyincomeswouldgoup.Theoptimism that underpinned the credit expansion in the postwar periodfounditsexpressioninthecreditcard,andthosewithoutthatoptimismcontinuedtofindcredituse“unwise.”Unsurprisingly,givenhowcreditwassocompletely intertwinedwith

women’s everyday life, more women than men found borrowingacceptable.Though62percentofcreditcard–havingwomenthoughtitwas “good to have charge accounts,” only 33 percent of credit card–having men thought it was good. More women who didn’t use creditcards(41percent)thoughtthat“itisgoodtohavechargeaccounts”thanmenwhodid(33percent)!Creditwasmoreofaneverydayexperienceforwomenthanformen,andwherecreditwasused,itwasappropriate.The habit of using credit made it more legitimate, so more womenthought it was okay to borrow. Appliances were okay to borrow for;swimmingpoolswerenot.Moralityfollowedthemoney.SoifwearetounderstandtheshiftinhowAmericansjudgedtheuseofcredit,weneedtounderstandnotjustwhattheysaidbutwhattheydid.Sincethemid-1960s,Americanshadfounditeasier toacquirecredit

cards. Big coastal banks such as San Francisco’s Bank of America andNewYork’sMarineMidland Bank offered cards, but banks in PhoenixandPittsburghdid aswell. Everywhere, it seemed,banksweregettinginto the credit card business. Deposits had been piling up in thecommercialbanks’cofferseversincethefirstcertificateofdeposit(CD)was created in1961, drawing in funds that had traditionally beenputinto smaller savings and loan banks. For banks, credit cards seemedideal.Merchantswouldpaythebanksacutofeverythingtheysold,andconsumerswouldpaytheminterest.Itwasawin-win.Yet,fromtheget-go,bankshadstumbled.Intheearly1950s,theyhad

attempted such schemes and had,within a few years, closed up shop.Thebankprogramsofthe1950sfailedformanyreasons.Banksreliedonincomefrommerchantsmorethanfromborrowers;merchantsgottheirmoneyfaster,butatastiffprice.Onaverage,banksgavemerchants95centsforeverydollarcharged.Skimmingoff5percentofeverypurchasewasaslucrativeaschargingcustomersinterest.Retailerswithoutcapital

or inclination to lend paid the 5 percent in the hope that it wouldincrease sales volume. Limited to conventional consumer credit rates,bankstookahighcutofeachcredit transaction, limitingtheappealtomerchants.At the same time, they reliedonmerchants topromote theprograms, as stores had traditionally promoted credit programs. Yet,unlikewithtraditionalprograms,storeshadlittleincentivetorejectbadcredit risks. With the default risk on the bank and not the retailer,retailers didn’t provide as much “negative information” as the bankswouldhaveliked.5Promotionalcostswerehigh,sincethisformofcreditwas brand-new.6 Perhaps most important, the programs could notcapture economies of scale. The per transaction costs were extremelyhigh and, without sufficient scale, made profits impossible. For smalltransactions, low processing costs were the key to success.7 Theprogramsflopped.Whilebankcardsfailed,T&Ecards—whichsuperficiallyseemedverysimilar—flourished. The business behind the two cards couldn’t havebeenmoredifferentdespitetheirsurfacesimilarities.ThoughT&Ecardswereprofitable,theirscopewaslimited.AmericanExpress,DinersClub,andothertravelandentertainmentcardsremainedrelativelyexclusive.Few members earned less than $10,000 a year in 1967 ($66,200 in2011). T&E cards charged annual fees. Merchants who catered totravelersknew that credit cardswere competitivelynecessaryand thattheycouldneveroffercredittopeoplefromtheothersideofthecountry—or the world. Most important, the cards were issued by nonbankinstitutions and relied on the bond and commercial paper market forlendingcapital,notonsavers’deposits.8Fewretailersparticipatedintheprograms—airlines, hotels, and restaurants that catered to expenseaccounts. Despite the similarities, bank cards and T&E cards werefundamentallydifferent.Auniversal bank-financed card, the aspirationoftheearly1950s,remainedelusive.Tosucceed,banksneededascaleoflendingthatwasnotpossiblethroughincrementalgrowth.The banks confronted a serious chicken-and-egg problem: retailerswouldn’tacceptacreditcarduntilmanyoftheircustomersdemandedit,and customers wouldn’t apply for a card until many of their favoritestoresallowedthemtouseit.Somehowbankshadtosimultaneouslygetretailers to offer credit and shoppers to have cards. And that had tohappennearlyinstantaneously!

As in the 1950s, the credit card emerged out of the relationshipbetweencommercialbanksand localretailers.Thesameprosandconsappliedinthe1960sasinthe1950s.Findingretailerswillingtoacceptcards, however, proved easier than getting cards into the hands ofconsumers. Unlike traveling businessmen, everyday shoppers didn’texpecttohaveaccesstocrediteverywhere.Localsalreadyhadcreditatthe stores where they expected it. Expectations of where credit wasappropriatemattered.Peopledidn’t lack credit in theirneighborhoods;they needed it in places they hadn’t already gone—both distant shopsandinstoresthathadnottraditionallyofferedcredit.Convincing people to expect to be able to borrow for grocerieswas

harder than convincing grocers to offer credit. People’s ideas of whatkindsofpurchaseswereokay toborrow forandwhatkindswerecashonlywere shockingly inconsistent. According to data from 1968,mostcredit card users felt it was okay to borrow for appliances, furniture,clothing, gasoline, and sewing machines but not for furs, restaurants,jewelry,hobbies,orgroceries.Bothappliancesandjewelryaredurable.Bothgasolineandgroceriesarenondurable.Bothfurnitureandfursareexpensive.Bothgasolineandhobbiesareinexpensive.9Whatdecidedtheacceptabilityofborrowingwasnotthethinginandofitselfbutwhetherborrowershadusedcreditbeforetobuyit.Acceptabilitywasdrivenbynotreasonbutbyexperience.Banks pushed their existing customers to adopt their credit cards.

Initially, these localcredit systems,orbank interchanges,as theywereknown, strainedagainst the constraints of the localmarket.Thebankswith the largest preexisting retail networks thus had a decisiveadvantage in the chicken-and-egg problem. Bank of America, with itspresence across California, beganwith sufficient territory to overcomethe initial problems that theNewYork banks couldn’t. Banks of everysizehadcreditcardprograms,butitwasthelargestbanksthathadthemost clients and thus the largest initial networks. BankofAmerica, inparticular,hadalonghistoryofconsumerfinanceacrossCaliforniaandeasilytransitionedintothisnewformoflending.InSeptember1967,forinstance,58percentofallcreditcarddebtwasintheCaliforniaFederalReserve district. New York, that long-standing bastion of financialinnovation,hadonly13percentofthebalances.10Bank of America (BofA) launched BankAmericard in 1959. It was a

disaster.Itgrewtooquickly,anditsexplosionmeantthatgoodaswellasbadcreditrisksreceivedcards.Therewaswidespreadfraud.BankofAmerica,confidentintheprogram’spromise,keptupdespitelossesandby1961wasabletorunitprofitably,provingtheviabilityofbankcreditcards.11 Regional banks looked to the BofA as a model for theirprograms. “When [BofA] turned the corner,” a spokesperson fromPittsburgh’sMellonBank said, “wecould seewhatawell-runprogramcould do.”12 Pittsburgh’s Mellon Bank offered its first credit card in1965.Itwasnotalone.SeeingBofA’sprofits,otherbankslaunchedtheirownprogramsinthemid-1960s,anxiousnottobeleftbehind.Afterall,BofAhadalreadyenrolled1.2millionpeoplewhenthoseotherprogramsstartedup.13Eachcityinitiallyhaditsownnetworkofbanksthatissuedcreditcards.Forsmallerbanks,theonlywaytosolvethechicken-and-eggproblem

wastostartwithcustomers,notmerchants.Tocreateaninstantsupplyof credit card–wielding consumers,many banksmailed out unsolicitedcards. Take, for instance, the experience of Marine Midland bank, arelatively largeNewYorkbank. In1966, thebank tested twodifferentways of promoting its credit cards: it mailed out 33,357 applicationsand, at the same time,731credit cards.Thekindsofpeople receivingthecreditcardsandthosereceivingtheapplicationswerenotdifferent,exceptinhowtheyrespondedtoacardinthemailversusanapplicationin themail. Though 19 percent of the cards were in use within sixtydays,only0.7percentoftheapplicationswereevenreturned!Thecardsgottwenty-seventimestheresponseoftheapplications.MarineMidlandcouldonlyconcludethatdirectmailingwastheonlypracticalwaytogetshopperstousecreditcards.Thechoicetouseacarddepended,mostofall, on whether it was in your hands.14 Unsolicited cards got a muchbetter response rate than applications.15Whether or not the recipientsusedthecards,bankscouldtellretailers—inanefforttoconvincethemtojointheirnetwork—thatalltheholdersofunsolicitedcardswereonlywaitingforaplacetoshop.As theBankAmericardnetwork grew, the pressure to join increased.

From 1968 to 1969, the number of merchants that accepted the cardincreasedfrom394,000to646,000.From1965to1966,incontrast,thenumber of merchants had increased only from 50,000 to 61,000.BorrowingthroughBankAmericardsurpassed$2billion—anincreaseof

$1.2billion in justoneyear.BofA’sannouncement in1966that itwasextending itsnetworknationallymade theotherbanks’need toactallthe more desperate.16 With the expansion of the network outsideCalifornia,LouisLundborg,thechairmanofBankofAmerica,notedthatBankAmericard “[would]be the first totallybank-oriented credit card”availablenationally.17LicensedbankswouldadministertheircardsindependentlyfromBofA,butborrowerswouldbeabletousethecardsanywhereBankAmericardwas accepted. BofA would provide not the lending capital but thenetworkonwhichthe lendingcouldoccur.ThoughshopperscouldusetheirBankAmericardwherevertheysawitsinsignia,theactualoperationwasabitmorecomplexthanjustborrowingfromBofA.Retailerswouldremitthechargeslipstotheirbank,whichinturnwouldpaythestore.Then the bank would send the slip to the cardholder’s bank, whichwould pay the retailer’s bank. All the slipsmoving around required ahigh degree of coordination and compatibility. Credit card numbersneeded to be the same length. Just as important, the amount paid tomerchants needed to be standardized. Like standardized railroad trackgauges,thestandardizedcreditnetworkallowedcapitaltomovearoundthecountry.Inreturnforprovidingthenetwork,BankofAmericawouldreceivean initial licensing feeaswell asa cutof futureearnings fromthe local bank. As a gold rush mentality kicked in, enthusiasm ranroughshod over prudence. Chicago, in particular, for many years wasshorthandforhowaggressivelendingcouldgoseriouslywrong.In Chicago, the aggressivemove of some banks into the credit cardfield had particularly calamitous results, highlighting the challengesfacinglendersinthe1960s.InChicago,asinmanyregions,agroupofbanks banded together in 1966 to form the Midwest Bank CardSystem.18 Thougheachbankenrolled its ownclients, a card issuedbyBankAcouldbeusedataretaileraffiliatedwithBankB.Inthatway,anetworkeffectcouldbecreatedsimilar tothatenjoyedbymuchlargerbanks suchasBofA.Customersand retailersalikewould findBankA’sand Bank B’s cards more convenient than either one of themindependently. And when a bank got a customer in 1966, it wouldprobably keep that customer even after BankAmericard came to town.Balancescouldnotberolledoverfromcardtocardaseasilyastheyaretoday,andaslongasyouhadabalanceyouwerehooked.

Eager to lock down Illinois before Bank of America got there, thebanks issued five million plastic credit cards willy-nilly in November1966.19 First National Bank of Chicago’s enthusiasmwas evident as itboughtout theperennialOscarMeyerbillboardby theLoop,replacingthe hot dog sign with its slogan: “FirstCard: The Nicest Thing SinceMoney.”20ThoughFirstCardmighthavebeenniceforcustomers,forthebanks, theirblitzkriegassaulton spendinghabitswasa strategicerror.The banksmade three crucialmistakes.Mistake number onewas thattheChicagobankers,intheirhungerforcustomers,losttheirtraditionalrisk aversion,mailing cards to anyonewho did not have a bad creditrecord. Though a good credit record meant that someone wascreditworthy, not having a bad record could mean that—or it couldmeansomeonejustdidn’thavearecordatall.Mistakenumbertwowasnot checking for overlaps amongmailing lists. Every one of the sevenhundredbankshadalistofitsowncustomers,whichwouldhavebeentroubleenough,buteachbankthenwentoutandboughtmailinglistsofpeople who did things that signaled wealth: owned stock, droveexpensivecars,ownedbusinesses,hadclubmemberships,andthelike.21One small-business man with a few shares of stock, a recent carpurchase, and membership in the Chicago Commerce and IndustryAssociation received seven credit cards on the same day. He was nodoubt prudent, but even if he was good for one card, he could haveeasilymaxedout seven.22Anotherman receivedeighteen credit cards,includingonesforhissonsagednine,eleven,andthirteen.23Thelimitsonmostcardswererelativelylow—$350(about$2,300in2011dollars)—but though most people might have been able to handle the creditlimit on one card, few could handle the credit limit on so many.24Mistakenumberthreewasannouncingthatmillionsofcreditcardswerealltobeputinthemailatonce,duringthebusyrun-uptotheholidayseason, when mailrooms were staffed by low-paid seasonal temps.Chicago’scriminalelementabscondedwithcardsstolenfrommailboxesand, in some cases, mailrooms. One Chicago store owner wasapproachedbya“ganglandemissarybearingabaleofcreditcards”whoproposedthattheyfilloutfraudulentchargeslipstogether.Whilenationallybanks chargedoff2percentof all debt, inChicagonearly6percentofalldebtwasuncollectable.25Theeager-beaverbankshadtorecallallthosecards,andthoughtheydidnotholdtherecipients

responsible, they did attempt to hold retailers accountable for all thefraudulent card usage. Though the Chicago snafu was outrageous, thenational average of 2 percent was still double the highest historicallosseslendersincurredonpersonalloansandinstallmentcredit.FraudwasrampantnotjustinChicagobuteverywhere.Eventhough

theChicagobankswereabletogenerate$80millioninrevenuenearlyovernight, the bad-debt losses made profits impossible. To expand soquickly, banks had relaxed their standards of creditworthiness. TheChicago debacle was the most egregious, but not particularlyextraordinary. Newspapers and magazines reported that theuncreditworthy, from disreputable “narcotic addicts” to innocentchildren,receivedcardswiththeirnamesalreadyembossedonthem.26Only 20 percent of banks investigated the credit records of potentialapplicants before mailing them cards (credit reports such as thoseoffered today by Experian and Equifaxwere a decade away).Withoutpoint-of-saletechnology,creditcardswereusedwithcarbonpaper,andstolen cards were not discovered until the fraudulent slips weresubmitted. Spending sprees on stolen cards became epic. Banks keptrecordson theaccounts,ofcourse,butaccessing themrequiredcallingsomeoneandhavinghimorherlookuptherecordinacomputer,whichwas expensive in terms of both labor and equipment. For largepurchases, some banks required an authorization. But for everydaypurchases, usuallyunder$50, therewasno such requirement.Chargescouldgoonforamonthbeforealltheslipswereaddedupandthethiefwasdiscovered.27Ill-gottencardscirculatedformonths,asthievesknewthatonlychargesover$50wouldbecheckedwiththebank.Moneywassimply stolen “$49 at a time.”28 Chicago’s kind of widespread abuseunderscoredthepitfallsofthecreditcard’suniversality.AsBetterHomesandGardenstolditsreadersin1967,creditcards’greatestadvantagewas“versatility,” allowing shoppers to “purchase goods and services—fromcorsages to car repairs—at any retail establishment.” In 1967, whenChicago was fighting off the advance of BankAmericard, Better Homesand Gardens told its readership that “more than 60,000 merchants inIllinois,Indiana,andsouthwestMichigan”acceptedbankcards,enablingconsumers to borrow whenever they might be in the greater Chicagoarea.29 Unlike with a traditional charge account, where a shopperapplied in person for credit, the anonymity and universality of credit

cards—theveryfeaturesthatmadethemappealing—alsomadeexistingsystemstocontrolfraudulentandexcessiveborrowingobsolescent.Endlesscourtcasesmadetheirwaythroughthedocketsasvictimsof

credit card fraud found themselves liable for hundreds of dollars incharges. Unlike today,when credit card companies can easily transferthe risk of such theft to third parties, banks endured the lossesthemselves and often forced the victim to pay them back, even if thecardhadbeen stolen from themail inoneof thebank’sneighborhoodblanketingcampaigns.Butascompetitionamongissuersroseinthelate1960s,banksdecreased cardholders’ liabilities, and retailers andbankswerestuckholdingthebagforfraud.30Tofurthershoreupthesystem,Congressbannedunsolicitedmailingsin1970.31Overthefirstfewyearsof the 1970s, banks unveiled the magnetic stripe on the credit card.Ratherthananumberbeingmanuallykeyedintoaregisteroracarbonimprintbeingmade,acardcouldsimplybeswiped.Acomputercouldthenconnectthataccounttoacentralcomputer.Thisinnovation,whichmadeeachtransactioninstantlytraceable,enabledbanksandretailerstoendtherampantfraudofthe1960s.32Notallspendingsprees,likeJosephMiraglia’s,wereduetointentional

fraud.More typical was the case of an Atlanta janitor, earning $55 aweek, who received a BankAmericard in the mail from First NationalBank of Atlanta. In a fewmonths he racked upmore than $3,000 indebt. Like many other people accustomed to the firm control of thecreditman, this janitor thought that if thebankwaswilling to extendhimthecredit,hewasgoodfor it.Hewasnot.ForBankAmericardhisdefault and eventual bankruptcy were a calculated risk, but for thejanitor, First National Bank’s easy credit ruined him.33 As onegovernment official remarked, banks used “a statisticalapproach … rather than individual analyses of the financialresponsibilityofapplicants.”34Banksexpectedsomepeopletobeunabletopayandtogobankrupt,butthecostofverifyingthecreditworthinessofallborrowersexceededthecostofwritingoffthebaddebt.Therisksthatalargeinstitutioncouldbearandthebankruptciesthatindividualscouldendure,however,wererarelythesame.Many working-class Americans, like this janitor, were less able to

handleaccesstocreditcardsbecausetheirentire livestheyhadhadtobegandscrapeforcreditaccess.Abankruptcyattorneytoldastoryofa

couplewith“menialjobs”whocameintohisofficeoneday.Goingovertheir spending, he found all the usual purchases except for one: an$1,100 electronic organ. They had bought it because it “made ‘nicemusic.’ ” The attorney then asked themwhy theyhadbought itwhentheywerealreadyunderwaterwiththeirotherobligations,towhichthe“husbandturnedto[thelawyer]somewhatinangerandblurtedout:‘IfIcouldn’taffordit,whydidtheyletmehaveit?’”Onsomelevel,manyborrowers trusted salesmen toomuchand lacked the financial skills todecide for themselves what they could afford. Particularly for banks,their conservative imagemadeborrowersbelieve theycould spend thecredit thatwasofferedthem.35 Inacasheconomy,whereyoucanbuyonlywithwhatmoneyyouhave,financialskillsdon’tmatterasmuchasin a credit economy, where a few bad choices can quickly destroy acouple’s life.36 Betty Furness, President Lyndon Johnson’s specialassistantforconsumeraffairs,describedthecreditcardasthe“modernAladdin’slamp”throughwhichallofone’sdreamscouldcometrue.Yetshe also believed that with wider access to credit cards, “those leastequippedtocopewithcredit…becomethehopelessaddicts.”37Though banks tended to give credit cards to the well-to-do, some

peopleoftheworkingandmiddleclassalsohadaccess.Thoseborrowersusedcreditcardsverydifferentlyfromthewealthy.Thelowertheclassoftheshoppers,themorelikelytheyweretousecreditcardsasaformofinstallmentcreditratherthanconveniencecredit.Only18percentoflower-class credit card users paid off their balances every month,comparedto48percentofupper-classusers.38Whatissurprisingaboutthosenumbers isnot that thewealthycouldpayoff theirbalancesbutthatlessthanhalfdid!Manyofthosewhohadmoney—andthosewhodidn’t—used credit cards in the sameway. Still,most of thewealthierborrowers paid their bills every month. In the 1950s, the well-to-dogenerally paid off their credit in a month or two in comparison to anationalaveragetimetorepaymentofaboutayearandfourmonths.39Credit cards were used like installment credit, but with much higherinterestpayments.Wider access came in the late1960sas the regional creditnetworks

coalescedintoBankAmericardandMasterCharge.Itishardtoconceivethat in1967 theFederalReserve found it remarkable thatConnecticutand Massachusetts had two credit card systems linked together. The

network synergiesofCaliforniaenabledBankAmericard togonational,and, followingthat,everybodyelsehadtoeithergetwiththeprogramor start their own. In response, eighty-one other commercial banks inCalifornia banded together to form a competing credit network—Interbank Card Association—soon to become Master Charge.40 MasterCharge banks learned from BankAmericard’s mistakes and incurredfewer bad-debt losses. Through all the promotions of the two systems,Californians became more exposed to the new plastic than any otherAmericans.One-fifth of independentCalifornia retailers honored creditcards,50percenthigherthanthenationalaverage.41Therestof thecountry followedCalifornia. Itwasn’tuntil1969that

NewYorkbanks issuedBankAmericardandMasterCharge.Even then,thesecondlargestbankinthecountrybehindBankofAmerica—ChaseManhattan—still did not offer a credit card.42 In 1968, less than 10percentofbanksofferedcreditcards.43Theconsolidationofanationalsystemtookafewyears,buttheadvantagesofjoininganetworkbecameapparent,evenifitmeantsendingalongsomeoftheprofitstoBankofAmerica. A few local programs remained in New York City and incertain states such as Georgia and Michigan, but by the early 1970s,mostbankswerealignedwitheitherBankAmericardorMasterCharge,44whichdramaticallyincreasedtheusefulnessofcreditcards.Creditcardstookoffbecauseofthosenewnetworks.45The network effect is evident in the proliferation of card programs

from 1967 to 1968 as BankAmericard and Master Charge spread. InSeptember1967,197banksofferedcreditcards,andbyJune1968—justninemonths later—thatnumberhadmore thandoubled, to416.46Yetdespitethegreateravailabilityofbankcards,mostretailborrowing(93percent)remainedthroughthestoreandnotthebank.47MasterCharge turnedout tobegood forBankAmericard,whichwas

threatening to look like a monopoly. Whenever credit networksattempted to prevent retailers from accepting competitors’ cards, theJustice Department stepped in to restore competition—or at leastduopoly.48With strong competition fromat least one other group, thenational networks were allowed to exist. Even the Federal Reserveconsideredthecreditnetworksapossible“naturalmonopoly”wherethebenefits of one or two networks outweighed the benefits ofcompetition.49Infact,whatBankAmericardandMasterChargedidwas

makeanational creditdistribution system, likepower lines,andallowanybanktoproducecapitalforthatnetwork,likeapowerplant.Intheview of many economists, this is the most efficient way to run anetwork,beitelectricity,railroads,orcredit.Thenetworksenabledevensmall banks to profitably run credit cards in a way that withoutBankAmericard or Master Charge would have been impossible—byaddingthevalueofanetworktothevalueoftheircapital.The network not only made retailers and shoppers want to join, it

allowed a scale of lending that was unprecedented. What made thispossible was that BankAmericard was backed not just by Bank ofAmericabutby thousandsofbanksacross thecountry.BankAmericardwas the first credit card issued by banks using only bank capital. Thepotential capital available from banks, both in their own coffers andwhat they could borrow from capital markets, far surpassed anythingthat even GE or Federated could raise. It was the franchise quality ofBankAmericard and Master Charge that made the credit revolutionpossible.Retailersnaturallywantedtotapintothatexistingnetworktodrawin

themost customers.For smallbusinesses, inparticular, theadvantageswerelegion.Theeliminationofreceivablesandallthecapitaltiedupinunpaid bills had a real consequence. For instance, C. F. Baumann, ofCalifornia’s Bermuda Pools Service, loved credit cards because theyreduced his unpaid bills by 50 percent. The owner of a small Atlantaslacks retailer, The Bottom Half, liked that he got paid byBankAmericardwhetherornotthecustomerpaidBankofAmerica.Thefee he paid the bank was less than his previous bad-debt losses.50Though it may have reduced their overall profitability, for manygrowing small businesses cash flow can ultimately matter more.Supplierstodaywantcash,notapileofIOUs.Smallchains,suchaslocalgrocery store chains, found that they could once again offer credit,something stores hadn’t done profitably since the 1920s. Customerstended to buy more and buy more regularly, eliminating the paydayinventorycrunchthatmanygrocersfaced.51In Buffalo, for instance, E.H.Gugliottamanaged a small shoe store

thatregularlylostbusinesstothedepartmentstoredownthestreet.AssoonashebegantoparticipateinMarineMidland’screditcardprogram,his “store went into the black and it’s all because of the credit card.

Peopleusedtolookintothewindowandthenkeepwalking…nowtheyseethecreditcarddealandcomein.”Shoppersalsotendedtobuytwoor three pairs at a time instead of just one.52 Small stores andindependent chains benefited the most from the credit card, enablingthem to compete with the big stores.53 Credit cards helped a moredecentralized retail landscape to flourish. InNewYork alone,Citibankenabledmorethan21,000retailers tooffercredit to theircustomers.54Overnight, credit returned to the New York economy. That cornergrocerythathadhadtocutoffcreditinthe1920scouldofferitagain.By 1970, 90 percent of the retailers accepting credit cardswere smallbusinesses.55Thebig chainsdominated the salesvolume,but the littleshops used credit to compete. For retailerswho could not offer creditlikethebigdepartmentstoresdid,whetherfancyclothingboutiquesorneighborhood pet shops, credit cards allowed them to compete moreaggressively for every consumer’s dollar.56 By 1970, 600,000 retailoutlets accepted either Master Charge or BankAmericard. The MasterCharge and BankAmericard networks, started only in 1967, were innearlyeverystate.Thoughdepartmentstoresandtheirretailprogenystillofferedcreditbasedontheinstitutionofthe1950s—thecreditsubsidiary—Americansfound hundreds of thousands of alternatives made possible byBankAmericard and Master Charge. Yet for all the worry, all theattention,creditcardsaccountedforonly2percentofconsumerdebtinthe early 1970s.57 Compared to retail credit, car loans, and homemortgages,itwasastatisticalfluctuationsmallerthantheChristmastimebump in borrowing. Credit cards could be used everywhere, but theystillweren’tusedasmoretraditionalformsofcredit—yet.Despite the low numbers, something seemed different about creditcards,not the leastofwhichwashowquickly theyhadpenetrated theAmerican marketplace. By 1970, around 40 million Americans hadcredit cards, nearly all of which were either Master Charge orBankAmericard. While credit card lending grew, other forms ofborrowingprovedmoredifficult,particularlyafter thecreditcrunchof1966 nearly choked off American mortgage lending. A letter to theeditorsofLifemagazinein1970fromanAngelenonamedC.C.Copleydescribed the situation facing the United States far better than nearlyanyscholarlyor journalisticanalysisof the loomingcreditcrisis facing

the country. Copley explained that “businessmen with solid creditratingshavedifficultiesinborrowingforsuchlegitimatecausesasplantexpansion,meeting payrolls or building seasonal inventories.… At thesame time, we, as consumers, are enticed, cajoled and arm-twisted tobuynickelanddimeitemsandluxuriesontheinstallmentplan.Thereisnomoney shortage there!Of course, the18% interest is an irresistiblebonanzaforthebanks.”58Formostbanks,creditcardswerenotanirresistiblebonanza.Lenderswanted to expand, but the law and costs constrained them. Theseemingly inevitable profits were sapped by fraud, default, andmismanagement. What seemed like an opportunity to print moneyturnedout,formostbanks,tobeadrainonresources.Processingallthepapercreditslipswasexpensive.Asmorebanksjoinedthenetworks,thecorrespondencebecamemorecomplicated.59Formostofthe1960sand1970s, credit cards’ profitabilitywasblah,despite theirhigher interestrates.IfFirstNationalBankofAtlantawastypicalinitsintroductionofBankAmericard in 1968, it was also typical in that the credit carddraggeddown itsearnings for severalyears.60EvenatCitibank,whichwasalways inthevanguardof lending,creditcardswereamixedbag.From1967,whenitintroducedacreditcard,until1971,thecreditcardunitwasintheblackforonlyafewmonths.61Though consumers demanded more credit, banks found themselveslimitedbythe law. Inthemid-1970s,bankswerehemmedinbyusurylaws,whichcappedinterestrates.BeginningwithArkansasin1957,thestates, which since the 1920s had raised usury limits, began to lowerthemagain.In1970,aturningpointcamewhentheWisconsinSupremeCourtfoundthatthestate’susurylimitof12percentappliednotonlytocash loans but to retail credit as well.62 Historically, usury laws hadconstrainedonlycash lending,not installmentor revolvingcredit.Thisinterpretation, coupled with the increasingly strict usury laws, slowlyturnedthescrewonlenders’profits.InNewYork,forinstance,Citibankcouldlendmoneyatonlyhalftheinterestrate(10percent)thatMacy’scouldcharge. InMinnesota, in1973,MarquetteNationalBankchargeditsBankAmericardholdersamembership feebecause the legal lendingrateof12percent“doesn’t,”accordingtobankvicepresidentJackBell,“allowus tomake a satisfactory profit.”63Minnesota retailers, such asDayton’s department stores, stopped their revolving credit programs.

BankAmericardsuspendednewapplications.64With such low rates, it was hard tomakemoney if therewere anydefaults.Even just keeping trackofwhoowedwhat towhomcost toomuch. Higher-risk borrowers necessitated higher interest rates. Mostretailers could not stop lending for fear of choking off sales, but theycouldreverttoolderforms.Dayton’sinMinnesota,forinstance,shiftedits revolving credit customers back to installment credit.65 But banks,withouttheprofitsofsellingmerchandise,simplycouldnotlend.Fortheexpanding credit card market, interest rate regulation—controlled byindividualstates—determinedthechanceofeithersuccessorfailure.In1978,Citibankandeveryothercreditcardissuer’sluckchanged.Though the largest banks can seem to dictate the development offinance,smallbanks,suchasMarquetteNational,cansometimesmakeadifferenceaswell—particularlyinmattersofregulation.Inaseeminglyinsignificant case—now called the Marquette decision—the SupremeCourtunintentionallydismantledalltheusurylawsoftheUnitedStates.Whilethedecisionwasobviousandsimple,theconsequenceswerenot.AnenterprisingNebraskabankhadbeensolicitingcreditcardsinnearbyMinnesota. Minnesota, at the time, had lower interest rate caps thanNebraska.SincetheNebraskabankcouldchargeahigherinterestrate,itcould lend to riskier customers. Marquette had stopped issuing newcardssinceMinnesotahadcappedtheinterestrate.66Naturally,thegoodcitizensofMinnesota,andthebanksofMinnesotainparticular,werenothappyatseeingtheirlawsunderminedbyNebraska.TheSupremeCourt,in a unanimous decision, sided with Nebraska. Since residents ofMinnesota could legally go to Nebraska and borrowmoney there, theresidents of Minnesota should not be penalized, as Justice WilliamBrennanwrote,for“theconvenienceofmodernmail.”Without state sovereignty over interest rates, South Dakota andDelaware,statesnotknownfortheirfinancialservicesindustriesbutthatlackedinterestratecaps,quicklydrewtheattentionofthecoastalbanks.A bank in either could lend anywhere. Citibank, the indomitableNewYork bank, began to consider its options. Citigroup’s chairman,WalterWriston, after taking local movers and shakers pheasant hunting andpromisingmyopiclocalbankersnottocompetefortheiroh-so-profitableSouth Dakota clients, moved Citi’s credit card operations from LongIsland to South Dakota. Behind Citibank’s transition was the

technologically savvy young executive John Reed, who believed thatconsumer finance could be the future of the traditional commercialbank. From 1973 to 1984, he headed Citibank’s consumer financedivision,leadingCitibank’sthen-pioneeringinitiativetogivecreditcardsto customers who had no other relationship with the bank. Getting acredit cardhadnothing todowithbeingadepositor.Reedenvisionedconsumer finance as something unto itself. After Marquette, wheninterestratescould float freely inanationallycompetitivemarket, thispossibility became a reality as interest rates quickly rose. Real profits,aftermillionsofdollarsinlossesduringthe1970s,becameapossibilityforthecreditcardbusiness.With the change in the regulatory environment, banks could lendatwhatever rate they chose. Even if the state no longer restrained theirrates, themarket did.Mature competition betweenMasterCharge andBankAmericard,nowcalledVisa,keptmerchants’discounts low,whichkept the banks’ revenues down. Booming interest rates made fundingconsumercreditexpensive,whichkeptcostshigh.Onbothsides,profitswerethreatened.Evenasopportunitiesseemedtoblossominthecreditcard industry, bankers were apprehensive about the cards’ futureprofitability.67In1971,theheadofcreditofJ.C.PenneytoldBusinessWeekthat“thetelephone rings almost every day, with bankers trying to talk us intochangingourpolicy[ofnotallowingbankcards].Ouranswerisalwaysno,butadmittedlywe’reinabetterpositionthanmostretailerstoresistthe pressure.”68 Yet the underlying economy was changing, anddepartment store creditno longermade sense.Department store credithadflourishedintheprosperouspostwareconomy.Ithadbeeneasytolendwhenmostpeoplegotannualraisesandkepttheirjobs.The1970seconomyof risingunemploymentand stagnatingwagesmadedecidingtowhomtolendmorechallenging.Moreover,banksandstoreswantedopposite practices from their borrowers. Bankswanted interest, whichmeant slow repayment, and stores wanted more sales, which meantquick repayment.69 With budgets tightened, the banks and borrowers’interests were more aligned. With the rise of distributed credit,department stores lost one of their key competitive advantages overspecialtychainsanddiscountstores.

Creditcardsslowlydisplacedstorecreditinthe1970s.(IllustrationCredits6.1)

Departmentstoresresistedthebankcardseverystepoftheway.Inthemiddleofthedecade,one-fifthofthetoponehundreddepartmentstoreshad begun to accept the high-status American Express card, but moststorescontinuedtorefuseAmexaswellasVisaandMasterCharge.70Bythe end of the 1970s, however, many department stores began toreconsider their credit programs.While aminority of high-end stores,suchastheultraluxeNeimanMarcus,maintainedtheirprograms,otherstores began to accept bank cards. Young people, raised withdiscounters,focusedonfindingthebestpricesandhadlessstoreloyaltythantheirparents.71In the fall of 1979, despite being in a better position to resist, J. C.

Penney was the first national department store to take Visa orMasterCard, but others soon followed.72 The economics of credit hadchanged.Bankcardswereabletoprofitfrominterestpaidbyborrowers,not just a cut of the merchant’s revenue. Issuers were able to cutmerchant fees from 4 percent in 1975 to 2 percent in 1979, so

departmentstoresneededtoweighthecostofofferingtheirowncreditagainstthebankcards’lowerfees.73Equallyimportant,bothbanksandretailers realized thatbankscouldmoreeasilyshoulderbaddebts thanstorescould.74As the economy pushed and banks pulled consumers toward longer

repayment periods, department store cards predicated on quickrepaymentwerenolongerviable.Storescouldnolongeraffordtolend.By1979,FederatedDepartmentStoresadmittedthatitnolongermademoneyonitscards,butatthesametime,asitsheadofcreditsaid,“theyare our link to the customer.”75 By 1977, more than half of alldepartment store sales were on credit, and stores felt they had nooption.76 The VP of retail sales for American Express observed thatdepartmentstores“considertheirchargeaccountbasetobethelifebloodof their business.”77 So much effort and money had been invested inoffering credit over the years that it seemed unbelievable that thedepartmentstoresshouldgiveuptheirstorecards.Afterall,credithadacted as a barrier to entry for many of the stores and kept out thecompetition. If their customers could easily use BankAmericard, thestoreswouldonceagainneedtocompetemoreopenlyonprice—whichmore vitally threatened their bottom lines. EvenFederated,whichhad“vowed” never to allow bank cards, tested outside credit in itsMiamistores,forcingotherretailers,suchasDaytonHudson,to“lookcloser”attheircreditprograms.78Thesuccessfulexperiencesoftheircompetitors,morethananyargument,swayedbigretailerstoacceptbankcards.Liketheircustomers, retailershadentrenched ideasas tohowcredit shouldwork.79Storesthatacceptedbankcardsactuallygotnewbusiness.While credit card rates rose, so did interest rates throughout the

country.ShortlyaftertheMarquettedecision,in1979,PresidentJimmyCarterappointedPaulVolckerthechairmanoftheFederalReserveinaneffort to stamp out the inflation that afflicted the economy. Volckerraisedinterestratestoslowtheeconomyanddampeninflation.Hewassuccessfulbutintheprocesscausedtherecessionoftheearly1980s.Banks’highcostofborrowingdrovethefinalnailintothecoffinofthe

usurylaws.Evenstatesthatstillhadusurylawsonthebookscouldnotseriously expect the banks to borrow from the Federal Reserve at 20percentandthenlendthatmoneytoconsumersat6percent. Inplaceswhere bankswere restricted, loans ceased. Banks that lentmoney lost

money. InTexas, theusury limitswere flexiblypegged to thediscountrate,yetlendingstillgroundtoahalt.OneHoustonbanker,E.MichaelGatewood, told The Wall Street Journal that “loan demand is literallydead.” With high rates of inflation, rational consumers should haveborrowed,butthehighnumbersshockedpotentialborrowers.Gatewoodobserved, “there’sobviouslypsychological impactwhenyou talkabouthigh interest rates. The consumer is just not interested in going intodebt.Peopleareconcernedabouttheeconomy,anditgoesrightdownto their individual credit.”80 Even the grouphistoricallymost likely toborrow—newlyweds—was cutting back. A recent California bride,Marcie Leonard, canceled eleven credit cards and postponed buyingfurniture on installment because “prices are just too high and creditchargesareexorbitant.”81Ratherthanborrowingmore,peopleborrowedlessasinflationclimbed.Thehighinterestratespresentedcreditcardcompanieswithagolden

opportunity.Creditcardinterestrateshadrisenalongsideotherinterestrates, butwhen the recession ended in1983andall theother interestratesfell,creditcardsmaintainedtheirhigh—23percent—rates. Itwasthen, in1983,whenCitibank’sbetsof the1970spaidoffhandsomely.Rather than drop the interest rates and return to their traditionallyaffluentclientele,creditcardlendersbegantolendtoriskier—andmoreprofitable—borrowers.Thetimeofcreditcardsforeveryonehadarrived.For John Reed, the success of credit cards led to his success, as heassumedthechairmanshipofCitibankin1984.By then,MasterCharge andBankAmericardhad long sincedivorced

themselves from the banks that created them. As Master Charge, andespecially BankAmericard, consolidated their credit networks, memberbanksincreasinglyresentedsendingasliceoftheirprofitsofftoamuchlargercompetitor. InCalifornia, for instance,WellsFargodidnotwanttoissuecardswithitsrival’snameonit.82Beginningin1970,memberbanksslowlyboughtoutBankAmericardfromBankofAmerica.In1977,BankAmericard was renamed Visa.83 Master Charge’s name change toMasterCard followed in 1979. The credit networks had completelyseparatedfromthecapitalsources.While John Reed remade Citibank, another young executive named

JackWelchrodethenewcrediteconomytopower.In1977,Welchwasgiven the reins at GE Credit, the division that managed all those

revolvingcreditaccounts.With$11billioninassetsatthebeginningofthe1970s, thedivisionhada lotofpossibilitybutwasnotat thesexycenterofGE’smanufacturing,whichhadbeenbuildingearth-shatteringengines,infactthefirst-everjetengines,sinceWorldWarII.Withspaceshuttles and jets filling the skies and swelling thehearts of patriots, itwas hard to convince people that lightbulbs and credit cards couldpossibly compare. Taking the profits from selling lightbulbs andinvestingthemindebt,WelchbegantoshineatGeneralElectric.Threehundredfiftyretailersmaintainedprivate-labelcreditprogramsthroughGEin1979.84By1980,GECapitalhad$70billion inassets, including$9billionoverseas.When Jack Welch took the helm at GE in 1981, based to a large

degreeonhissuccessinconsumerfinance,hisvisionwasclear:“Financeis not an institution—it has to be the driving force behind makingGeneral Electric the most competitive enterprise on earth.” Olderdivisions,includingthelightingdivision,whichhehadmanagedduringhis rise to power, would be continued, but the profits would bereinvestedinfinancialproducts.Divisionsthatwerelosingprofitability,such as the one that made toasters and clocks, were sold. U.S.manufacturerscouldnotcompetewith low-costproducts fromAsia.Bythemid-1980s,70percentofnonautomotiveconsumergoodscamefromAsia,broughtacrossthePacificincontainerships.ThegeneralelectricalproductsthathadgivenGEitsnamewerenolongerevenmadebythecompany. The purpose of GE was to make money. Welch no doubtagreed with U.S. Steel president David Roderick’s assessment in 1979that “the duty of [U.S. Steel’s] management is to make money, notsteel.” Unfortunately, although making money is good for U.S. Steel,makingsteelcreatedmoregood-payingjobsforaveragefolks.Itishardtoconveythekindofgenerationalrevolutionthatthiskind

of financial thinking amounted to. U.S. Steel had beaten the Nazis.AmericanjetenginesintimidatedCommunists.Turningthegreatcentersof Americanmanufacturing into financial companies, which, as HenryFord would have been the first to assert, produced nothing, wasappallingtomanyCEOs,whopridedthemselvesonmakingsomething.Ina joint interview in 1996, Fortune magazine asked Jack Welch andRoberto Goizueta, then the CEO of Coca-Cola, about the rest of thedecade.ForWelchtheanswerwasclear:“Ithink,withoutquestion,that

financialservices,becauseoftheopportunitiesavailable,willbecomeanincreasingmixofourbusiness.Thatisabsolutelygoingtohappen.”TheCEOofCoca-Colademurred, surprised: “Iwouldnever findexcitementin the financial services. I dislike to produce something that I couldnevertouch.”ThoughGE’sprofitsgrew,itsmanufacturingin1995was10percentlessthanin1980,thecompanyhavingclosed43percentofitsfactories.In1980,theyearbeforeWelchtookcontrol,GEemployed285,000 people in the United States. In 1998, as the companyfinancialized, it employed only 165,000. ForWelch, and for successfulU.S.corporations,theriseinprofitsfromturningmanufacturingcapitalinto financial capital mattered more than all the good-paying factoryjobs—andhehadnochoice.CEOshavearesponsibilitytoshareholderstoproducemoreprofit.Adollarinvestedindebtmademoremoneythanadollarinvestedinafactory.Thebenefitwasclear.Forthecountryasawhole,however,therisingprofitabilityoffinancecameatadevastatingcost as the largestU.S. industrial corporations began to see finance astheroadtogrowth.Moremoney,itseemed,couldbemadebyfinancingpurchasesthanbymakinggoodstobesold.If the increase in borrowing only underlined Americans’ economic

troubles, for lenders, the borrowing boom of the 1980s provedimmensely profitable. Though John Reed’s consumer finance divisionhadlosttensofmillionsofdollarsinthe1970s,thehundredsofmillionsearned in the 1980s more than made up for the loss. The growth ofGeneralElectric’sfinancialdivisionsrevivedthestagnatingcompanyandledJackWelch tobecelebratedasoneof thecountry’sgreatestCEOs.Credit cards had become tremendously profitable, reorientingcommercial banks and manufacturing companies toward consumerfinanceasneverbefore.Banksofallsizespioneeredcreditinthe1960s,butbythe1980slarge

banks were again in control. Though any bank could tap into theMasterCard and Visa networks, only the largest issuers had theeconomies of scale to make it profitable. The largest card companiescould offer interest rates 4 percent lower than those of their smallercompetitors.85While small banks,with less than$25million in assets,averaged 203 loans per credit employee, banks with more than $500millionaveraged1,702loanspercreditemployee—eighttimesasmanyloans, substantially lowering labor costs.86 By the early1980s, the top

fiftyissuersowned70percentoftheoutstandingbalances.Citibank,GE,andotherlargefinancialinstitutionswerepoisedforsuccess.Creditcardshadcomealongwayinonlyadecade—from10percent

ofreceivablesin1968to35percentby1977.87Tokeepthisexpansiongoing would require more money to lend. Even as Reed and Welchremadetheindustry,thebasicstuffofcredit—capital—remainedscarceand expensive. In the 1980s, an old idea that had long remaineddormant—securitization—wouldbeappliedtothenewestformofcredit,flooding the Visa and MasterCard networks with money to lend. GE,Citibank,andother financecompaniescouldhelp theJosephMiragliasacrossthecountrybringgoodthingstolife—buthowlongthatgoodlifewouldlastwouldbeanotherquestion.Oncepeoplestartedusingcredit,itwas hard to stop.Miragliawas let off in 1959—the judge evidentlyconsideredhisactionstobeyouthfulindiscretions—but,likeeverythingelse having to do with postwar credit, the case portended things tocome.In1984,MiragliaperpetratedwhatTheNewYorkTimescalledthe“largest credit card counterfeiting ring ever encountered in the NewYorkmetropolitanarea.”88Hedidayearandahalfinfederalprison.Itremainsuncleartothisdaywhetherhiscreditratingsuffered.

CHAPTERSEVENIFONLYTHEGNOMESHADKNOWN

(1968–1986)

In a bizarre, yet telling, Freddie Mac advertisement in the AmericanBankers Association journal in 1984, the CFO of FreddieMac, LelandBrendsel,hishoundstoothcoatboundedbygardengnomes, claimed tocommune with “the gnomes of the secondary market, our omniscientassociates.”Accordingtotheadvertisement,thegnomeshadbroughtthedark secret of securitization—the collateralized mortgage obligation(CMO)—to Freddie Mac. Remember the participation certificates fromthe1920s andhow theyhad contributed to themortgage crisis of theGreatDepression?For forty years, suchbondshadbeen largely absentfrom the economy because of their inherent instability. Beginning in1968,forthemostnobleofmotives,theywerebroughtbackwithanewname—mortgage-backed securities—but the same old problems. Themortgage-backedsecurityand its successor, theCMO, transformedU.S.finance through the process called securitization, which, like theparticipation certificates of the 1920s, turned consumers’ debt intoinvestors’bonds.Though clearly the result of an advertiser pulling an all-nighter, the

gnomesreflectedthebasicallysupernaturalqualitiesoftheCMO,whichseemed to violate the laws of nature, turning ordinarymortgages thatwere difficult to resell into easily sold bonds. Even gnomes in EuropeandAsiawouldbuythem!TheCMOappearedtosolvealltheproblemsFreddieMacandFannieMaefaced.Newinvestorscouldbefoundforalltheselong-termmortgagesnowtransformedintoshort-termbonds.Withanewsupplyof investors,S&Lscould readily resell theirmortgages toFreddie and Fannie, which no longer had to worry about their debtceilings. Subterranean, beyond the light of auditors, the gnomish

mysteryofsecuritizationgrantedpossibilitiesinaccessibletothenaturalworld—or at least to traditional banking. Securitization offered awayoutoftheconstraintsofcapitalfacedbybanksinthe1980s,butthroughalightlesstunnelwhoseexitremaineduncertain.Congressresurrectedthemortgage-backedsecurityintheHousingActof1968 inorder to solve theurban crisis.After theurban riots of the1960s, policymakers desperately looked for new sources of capital toinvestinAmerica’sinnercities.Atthesametimeitcreatedaprogramtoinvestthosefundsinmortgagesforthepoor—theSection235program.Overseeing the connection between these two programs were FannieMae and Ginnie Mae. In the same housing bill, Congress privatizedFannie Mae and spun off Ginnie Mae (the Government NationalMortgageAssociation,GNMA).FannieMae’sbudgethadgrownovertheyears,ashaditsdebt,andprivatizingitwouldtakeallitsmortgagesoffthe federal balance sheet. Johnson had spun off Ginnie Mae to allowgovernmenta freehandwithpolicy.Becomingtwoinstitutions,FannieMae (keeping the name) would continue to facilitate the secondarymortgagemarketwhile thenewlymadeGinnieMaewouldhandle the“do-gooder” stuffby subsidizingmortgages to low-income families; thesubsidies—if not the mortgages themselves—would remain on thegovernment’s balance sheets. Moving mortgages off the governmentbooks allowed more money to be spent in the subsidization of low-income housing. Fannie Mae, however, would remain strictly off thebooks. Itsgoals,whichCongresshopedwerenot incompatible,weretopushformiddle-classhousingandamodicumofprofit.Together,GinnieMae, mortgage-backed securities, and Section 235 would redefine theU.S.mortgagesystem—anddeterminethefutureofAmericanfinance.

Thegnomesunderstoodthenewfinancialinstruments,evenifnooneelsedid.(IllustrationCredits7.1)

Asthepostwarprosperityofthe1960sslidintothestagnationofthe1970s,WallStreetacquiredarenewedprominence.FortwogenerationsaftertheGreatCrash,Americanshadlookedwithdisdainonfinanceingeneralandthestockmarketinparticular.Production,notfinance,hadmade the United States a superpower. American steel, in the form ofships, planes, andbullets, hadbeatenback theNazis. By the1980s, itwas finance, not production, that was making investors billions of

dollars. The creativity of bankers, however, was hamstrung by thosepeskyregulations thathadsafeguardedtheeconomysincebankershadlast been in control during the 1920s. Many of the “new” financialinstruments of the 1970s and ’80s—such as the mortgage-backedsecurity—had actually existed in the 1920s and earlier and then hadsubsequently been eliminated for their contributions to the GreatDepression.As thepostwar prosperity built onmanufacturing faded inthe1970s,givingwaytothestagflationofhighunemploymentandhighinflation, policy makers began to reconsider those regulations—particularlywhenthelocalbanksappearedtobeonthevergeoffoldingbecause of the rapid rise in interest rates. Mortgage-backed securitiesbecame an easy fix not just for poor borrowers but for lenders’portfolios.ThesolutionforthepoorestAmericansandthesolutiontofixAmerica’s bankswere one and the same: securitization. Like the “easyfix” of the Section 235 program, the “easy fix” for the banks—andespeciallysavingsandloanbanks—hadunexpectedconsequences.Since theGreatDepression,mortgagemarketshadenabled thegreat

stretch of theAmerican suburban sprawl. Replicating California acrossthecountry,oddlysnow-drenchedranchhousesdefinedprosperity.Butwhile the suburbs prospered, the cities fell apart. Mortgage capitalflowedouttothesuburbs,whereFHAandVAloanguaranteesmadetheloans risk-free and high-yielding. In cities, where FHA maps outlinedAfrican-Americanneighborhoodsinred,federalloanscouldnotbeeasilyhad.Red-linedneighborhoodswerecutofffromthecapitalthatflowedfreelyintherestofthecountry.Homerepairbecamedifficultforwantoffunds.Resellinghomesbecameevenharderasinstitutionalmortgageswere either expensive or impossible to get. The same system thatproducedtheprosperityofthepostwarsuburbalsoproducedthepenuryofthepostwarghetto.1In themid-1960s, the ghettos exploded. Race riots had traditionally

involvedwhiteworkers protesting integration, but themid-1960s gaveraceriotsanewcolor,visibleontelevisionsetsacrossthecountry.Thiscolor terrified white policy makers, who, living in Washington,witnessedfirsthandtheeffectsoftheriotsasthecityburnedin1968.Though the precipitating cause of the riots in Washington was the

assassination ofDr.Martin Luther King, Jr., the underlying frustrationgave rise to a very particular kind of riot. Rioters didn’tmarch to the

Capitolbuildingandburn itdown.Theydidn’tmarch toBethesdaandtorchmiddle-class,whitehomes. Instead, they lashedout at their owncommercial districts. This anger, you see, was born of a specificeconomythatexisted,by1968,onlyintheblackghetto.Intheghetto,theworldoftheFatManandtheSkinnyManstillheldsway. Debt networks that made credit cheap for white people in thesuburbs did not extend to the inner cities. There, credit was stillpersonal,expensive,andarbitrary.Homesellerstypicallyhadtofinancetheir buyers, who could not get mortgages at a bank. Corner grocerystores stillkept theiraccounts in thickbound-leatherbooksbehind thecounter.As appliance stores financed their own customers, installmentcredit and repossession, disappearing in the suburbs except for cars,remainedapartofdailylife.Interestrates,throughconcealedcostsandadd-oncharges,couldbetentimestheinterestratesofthesuburbs.Therepossessionofbarelyfunctioning,overpricedtelevisionsmeantnotonlythelossofthemoneypaidbutalsohumiliation—andsubsequentanger.Theantiquatedcreditsystemhelpedsetthestagefortheriots.When the riots broke out, according to TheWashington Post, riotersfocused their irenotondistant stores thatdenied them servicebutonthe localones thatprovided themwithservice—expensive,extortionistservice.Thoughwerememberthe imagesofrioters leavingstoreswithtelevisionsanddiapers,therealstorytookplaceinside.Beforetheriots,credit relations were inflammatory, and during the riots—before thelooters left with stereos—they burned the records of their installmentcontracts.Credit, then,wasdoublyat thecenterof theurbanriotsof themid-1960s: an absence of mortgage credit choked off housing, while anabundant, but exploitative, charge and installment credit systeminflamedtheangeroftherioters.Topolicymakers,theobvioussolutionwastoconnecttheinnercitytothelargernetworksofcapitalthathadmade the suburbs stable and prosperous for the past thirty years.Suburbanites had watched their home values grow for a generation.Rarelydoesapolicysolutionappealsobroadlyandappearsoobviouslycorrect. Investmentbankers,suchasGeorgeWhitneyof theInvestmentBankers Association of America, testified before Congress that “moneyalone isnotnecessarily thesolutionto thisproblem.Therehas tobeamechanism to transfer ownership to the people who are hopeful of

helpingthemselves.”2Alackofcommunityownership,observersontheleft and right believed, had led to the riots.Conservatives and liberalsalike wanted to extend ownership in the inner city, hoping it wouldstaveoffarepeatofthoseterrifyingevents.Findingcapitaltoinvestiseasiersaidthandone,however.Seeingthe

instability, big banks would not lend. Even inner-city banks, mindingtheir fiduciary responsibility, invested their depositors’ money insuburban mortgages. Modeling lending programs on the FHA loansystem,Congresscreatedaprogramtochannelcapitalintothecitiesandreduce the risk to the lender. To do this, Congress brought back themortgage-backedsecuritytofundanewlendingprogram:Section235.Owningahomewentbeyondinvestment,however.Thesenewhome

buyers, policy makers believed, would take a greater pride in theircommunities and themselves. Indeed this moral transformationunderpinnedthepoliticalappealoftheprogram.PresidentJohnsontoldCongressthatexpandinghomeownershipwould“increaseresponsibilityandstakeoutaman’splaceinhiscommunity.Amanwhoownsahomehassomethingtobeproudof,andgoodreasontoprotectandpreserveit.”3Thevery firstpageof theHUDSection235handbookdefinedtheprogram’s purpose as “to enable lower income families to becomeowners of homes and thereby experience the pride of possession thataccompanies homeownership.”4 The political agenda of fashioning acontented, responsible citizenry mattered as much as or more thanwealthformation.MortgageprofessionalsapplaudedtheSection235programasaway

to rebuild U.S. cities. Section 235 was government housing thatrespected free-market institutions, rather than substituting for them,asin government-owned public housing. The president of the MortgageBankersAssociationofAmerica (MBA),Everett Spelman,believed “thepositionthatthelegitimatefunctionofthefederalgovernmentistoaidprivate enterprise, not to replace it. The most recent and importantexampleof this[outlook] is the interestsubsidyprograms—theSection235 and 236 programs.”5 MBA’s director of public relations observedthat “billionsof dollarshavebeen spent onpublichousing.Butpublichousing never provided a complete answer to the problem of housingthe poor, and never gave anyone a stake in the capitalistic system.Section235does.”6Thebeliefinownershipwasnotapartisanvaluebut

an American one. One mortgage banker declared that Section 235“answered the [rioters’] cry, ‘Burn, baby, burn’ with ‘Build, baby,build!’”7Section235,inthisregard,wasonlyoneofseveralprogramsinitiated

in1968torestoretheflowofcapitaltolow-incomeurbanareas.Butofthoseprograms,Section235wasthemost important in that itwas thelargestandhadthelongest-runconsequences.Thefederalgovernment’sroleinhousingin1971,whenfederalprogramssubsidized30percentofhousingstarts,wasshockinglyhigherthanthe4.4percentsubsidizedin1961, and, according to Nixon administration officials, “much of theincrease in housing units… occur[ed] in section 235.”8 Government-sponsored mortgage debt accounted for 20 percent of the overallincrease in mortgage debt in 1971.9 While in operation, Section 235marshaled mortgage-backed securities to transform hundreds ofthousands of Americans from renters to owners. Section 235 createdsuchanupswing inhousing thatby1972, thepresidentofMBAcoulddeclare it the “principal system” for low-income housing.10 PoorAmericansacrossthecountryleftrentedquartersforwhattheybelievedwouldbeatruepieceoftheAmericandream.Thedream,likemanyoftheSection235houses,wasbuiltonashaky

foundation.Thehopeof thebuyersand thepolicymakerswasquicklyunderminedbytheproblemsthatgrippedtheSection235program.Tounderstand why Section 235 unraveled, one must understand how itworkedontheground.Nearlyeveryassumptionthatmiddle-classpolicymakershadaboutthebuyingandsellingofhousescrumbledundertheSection235program.Freedfromconventionalmarketpressures,absentadministrative oversight, and with considerable profit incentives, theappraisal, brokering, and building of houses under the Section 235program were unlike any that congressional policy makers hadencounteredwiththeirownhomepurchases.Theconventionalhousingmarket relied onwell-informed, competitivemarket actors buying andselling.IntheSection235program,thebuyer’sabilitytochooseamongwell-pricedhousesdidnotexistforavarietyofreasons,andinthatlackof choice, the reality of Section 235 came tomock the dreamof bothpolicymakersandhomebuyers.

MortgagecompaniesprovidedSection235loans…(IllustrationCredits7.2)

…thatFannieMaeandWallStreetinvestmentbanksresoldasbonds(IllustrationCredits7.3)

Section 235 promised nothing less than to rebalance the scales ofAmericaneconomicinequality.ThemechanismsofSection235appearedstraightforward.Section235loans allowed buyers with little or no savings to buy new and usedhomes.Theprogramprovidedbillionsofdollarsinfinancingformillionsof homes during its operation. Eighty percent of the funds wereearmarked for familiesatornear thepublichousing income limit.11Ahome buyer who qualified for the program would receive an interestsubsidyeverymonthsuchthatthegovernmentwouldpayalltheinterestabove1percent.Sliding-scaledownpayments,whichreachedaslowas$200—two weeks’ income for the median Section 235 buyer—wouldenableeventheverypoortoownahouse.12Ifaborrowerdefaulted,thegovernmentwouldpayoff thebalanceof the loan.Homebuyerscould

borrow up to $24,000 as long as FHA house inspectors declared theproperty to be in sound condition. After having bought a home, theirmonthly rent payments would become, instead, equity. Section 235would build wealth. FHA administrators such as Philip BrownsteinbelievedtheSection235program“[broke]downtheremainingbarriersto the fullest private participation in providing housing for thosewhoareeconomicallyunabletoobtainadecenthomeintheopenmarket.”13By definition, Section 235 lent to borrowers who could not get amortgage fromconventional lenders.Theprogram intentionally soughtouttheriskiestborrowers,whomBrownsteindescribedas“familieswhowould not now qualify for FHA mortgage insurance because of theircredithistories,orirregularincomepatterns.”14Section235buyershadno normal access to home financing. The program offered them theironlychanceforhomeownership.While policy makers assumed that market pressures would provide

accurate pricing and quality control—as it largely did formiddle-classhousing—the subsidies of the Section 235 program skated over thedifferences between the inner city and the suburbs. Themarket-basedmechanismsofthesuburbs,whichreliedonsavvypurchaserswithmanybuyingopportunities,didnotexistinthecity.Marketprices,moreover,could not exist without a market, and by setting properties apartinstitutionally and financially, the prices Section 235 buyers paid nolonger reflected the market but an arbitrary number determined by aFHAappraiser.ThoughtheFHAappraiser’smanualwouldhavelikedtodefinevalueas“thepricewhich typicalbuyerswouldbewarranted inpaying,”theSection235buyer,bydefinition,wasnottypical,andtherewerefrequentlynootherbuyers.15TheFHApricingmethod,relyingon“substitution” of “comparable” houses and elaborate punch card dataanalysis, could not provide accurate prices.16 Without good pricinginformation, Section 235 buyers—trusting the FHA’s reputation—paidwhattheappraisertoldthemto.FHAstaffappraisersmayhave lackedpricesbutmorethanmadeup

for it in a shocking surplus of preconceptions. Rather than beingexperiencedconstructionprofessionals,FHAappraisershadaneducationthat consisted of only nine months of intermittent “generalizedinstruction” and on-the-job training with other inspectors.17 Perhapsmoreimportant,fewwhiteappraiserswantedtospendtimeintheblack

innercity.Inspectorswererarelyfromtheneighborhoodsforwhichtheywereresponsible,andtheyloathedgoingthere.LocalFHAofficeshadtorotatetheSection235appraisalresponsibilitiesamongtheinspectorstokeep the staff happy.18 Such rotation necessarily led to less skillfulappraisal. Appraisers minimized the time spent in inner-cityneighborhoods and complained about having to go at all. Appraisers’workreflectedtheircontemptforthebuyers.Thoughsomedefectsmighthave been overlooked, it is impossible to understand an appraiseroverlookingtwofloorscoveredwithdogandhumanexcrement,asoneFHA-approvedhomeinPittsburghwas.19Appraisers who worked for the FHA had a dead-end job with little

opportunityforadvancementandlookedontheirjobsassteppingstonesto themore lucrative private sector.Appraisers interviewedby federalinvestigatorsspokecomfortablyofhavingreceivedbribes.Beyondgraft,however,wasthepervasive feeling,asoneappraiser felt, that theonly“goodjobs”wereintheprivatesectorwithmortgagecompaniesandrealestate firms.20Rather than“civil service,”anFHA jobwas“basicallyapatronage job” reinforcing local networks and connections. Appraiserssolidified those connections and furthered their careers by issuingpositive reports. Littlewonder, then, thatmany of themost egregiousSection235scandalsreliedonappraisers’turningablindeye.In the inner cities of Philadelphia, Washington, D.C., Detroit, and

elsewhere, houses were bought by speculators, given a superficialrefurbishment,andthenquicklyresoldatan inflatedprice throughtheSection 235 program. Urban homes were old, and the rehabilitationdone on many of them could only be described, as it was incongressionalinvestigations,as“cosmetic.”21Aninvestorwouldputinafew hundred dollars’ worth of work—painting over old wallpaper,perhaps—andreapimmediateresalereturnsofseveralthousanddollars.InPaterson,NewJersey,forexample,arealestatespeculatorinleaguewith an appraiser earned between $7,650 and $18,200 per houseflipping fifteenproperties. Inelevenof the fifteencases, thesameFHAstaffappraiser,wholaterlosthisjoboverthecontroversy,hadevaluatedthe property. Only a few months later, investigations found codeviolationsintenofthefifteenhouses,withseveralexceedingahundredviolations per home.22 Those fifteen properties constituted only one-quarter of all the Section 235 properties in Paterson that violated the

buildingcode,andtheywerenotaberrant.23Speculators’repairsaddedlittle value. The difference between the purchase price and the sellingprice was far more than the cost of repairs. Perhaps most important,saddling new home owners with massive and necessary repair bills,discovered only after settlement, all but guaranteed foreclosure. Abustedwaterheater,whoseinstallmentpurchasewouldadd$10or$20amonth,couldbreakafamily’srazor-thinbudget,asitdidinthecaseofoneWashington,D.C., family.24 Formanyhomeowners, themortgagewasatthelimitoftheirabilitytopay.ThefaultyappraisalprocessleftmanySection235buyersinprecariousfinancialcircumstances.ThoughCongress had intended the Section 235 program to function

within thenormalhousingmarket, inpractice, theagents constructingthe housing market—the brokers—fashioned a market different forSection 235 buyers than for normal buyers. Restricted by brokers to alimited pool of houses, lacking experience in home ownership, andpossessedof no alternatives, Section235buyerswere the antithesis ofsuburbanbuyers,savefortheirambitiontoownahome.BeforeSection235,accordingtocongressionalinvestigators,mostofthepeoplebuyingandselling in inner-cityneighborhoodshadbeen“primarily realestatespeculatorsoutforafastbuck.”25Builderstootookadvantageoftheprogram.Thefederallysubsidized

homesbought in suburbanEverett,Washington, towhichblackbuyershad access typified the situation home buyers faced under the Section235 program. In Washington State, the Section 235 program wastremendouslyprofitableand,accordingtohousingexperts,“ ‘carr[ied]’therealestatemarket,”accountingfor,insomecounties,asmuchas80percent of all home sales.26 Such volume came at the cost of homebuyers’equity. InSpokane,Washington,ahomebuyers’activistsurveyfoundthat90percentofSection235homeownersdidnotbelievetheirhousewasworthwhattheyhadpaidforit.27Thehouseshadelectrical(41 percent), plumbing (48 percent), wall (42 percent), furnace (36percent), and floor problems (37 percent), just to name a few.28 Builtwith thecheapestmaterials and slapdashmethods, thebuildings couldnotlastlong,muchlessthethirtyyearsofthemortgage.Thesiding,forinstance, couldbepushed inwithonly the slightest of pressure.29 Thehollow-corefrontdoorswereonlyaquarterofaninchthick.Inspectorsdescribed the springy floors, which, lacking crossbeams, were akin to

“trampolines.”Overflowvalvesdrainednot into thesewerbut into theceiling. Though perhaps adhering scholastically to the building code,theseconstructionstandardswereatrocious.Oneofthemainproblems,theHouseBankingandCurrencyCommitteeinvestigatorsfound,wasthetotalabsenceofcommunicationwithlocalcodeauthorities.Simpleactsofcommunicationwouldhaverightedmanyoftheprogram’swrongs.30Adherence to building codes, a matter taken for granted by policymakers,went overlooked in the Section 235 program,which operatedoutside the conventionalhousingmarketpressuresof the suburbs.Theshoddy construction prompted observers to wonder if the program,intendedtoendurbanslums,wasinsteadcreatingslumsanew.31Buildersdefendedtheiractions,however,byblamingthenewbuyers,

claiming that they had brought the slums with them. Many problemswithSection235buyers,particularly thehigh foreclosure rates,whichranashighas25percentinsomelocales,wereblamedonthenewhomeowners’“personalitiesandbackgrounds.”Theproblemofthecultureofpoverty,somewarned,wasmoredifficultthantheproblemoffinancing.RobertGray, the director of public relations for theMortgage BankersAssociationofAmerica,wrotethat“youcanlegislateagoodlow-incomehousing program but you cannot legislate the personalities andbackgroundofthepeoplewhooperateit,northepeoplewhomoveintothe homes.”32Homeowner knowledge, in the critics’ views,wasmaleknowledge born of growing up in owner-occupied housing. Blackrenters,inparticular,couldnotberesponsiblehomeowners.Thetropeforallthesediscussionswasthe“welfaremotherwithyoungchildren.”33Whilebankersandinspectorsblamed“thetypeofpeople”whobought

throughtheSection235program, theproblemsascribed to thecultureofpovertywereinfacttheproblemsofshoddyconstructionandoverlytrusting buyerswhobelieved the FHAappraisers. Builders’ claims thatthe problems with homes arose because “the homeowners [did] notmaintain their houses” were difficult to reconcile with the lack ofcrossbeams.34 Feeling betrayed by both the government and the realestateindustry,manySection235buyerssimplygaveup.InEverett,forinstance,nearlyhalfof theSection235homebuyers justwalkedawayfromtheirhouses.Thosewhoremainedwantedtoleavebut,accordingtoinvestigators,didnot“becauseofthefearthatitwoulddamagetheircredit.”35The twenty-seven families thatdiddefaulton theirmortgage

in that Everett subdivision left the governmentwithhouses that couldnotbesoldfortheamountowed.36Rip-offswerenotuniquetoEverett.Inallareas,opportunisticbrokers

took advantage of first-time home buyers. Poorer buyers, brokersbelieved, would be easier to deceive. Brokers, particularly, targetedthose living in public housing because, as a Denver broker remarked,“compared towhere they’re coming from, theywantwhatever I showthem.”37AsonePhiladelphiabrokerput it, theSection235buyersgotonly “the really crummy houses, the lemons.”38 In desperation, thebroker believed, “the 235 buyer will buy literally anything.”39 Manybrokers saw the Section 235 program as an opportunity to unloadunsellable properties.40 Only when the seller, as one St. Louis brokerinsisted,is“introublewithhishouse”wouldhesellthroughtheSection235 program. The program presented a tremendous opportunity fortappingavirginmarketofbuyers.InSt.Louis,abrokerprinted12,000postcards to mail to potential customers, who, for this broker, weremostlyblackandinpublichousing.41Agovernmentsurveyfoundthat,indeed, in St. Louis and Philadelphia, one-third of Section 235 buyerswereonpublicassistance,themajorityofthemreceivingAidtoFamilieswithDependentChildren,orAFDC.42While home buyers lost money on fraudulently priced housing,

speculatorsinurbanhousingcouldreapextraordinaryprofits,relyingonfriendly appraisals to qualify the housing for Section 235 financing.Investigations found similar stories across the country. Internal auditsconductedbyHUDshowedwidespreadoverpaymentbyconsumersandovervaluation byHUDofficials.43Overvalued houseswould eventuallycost thegovernmentmoremoney in subsidized interestandbetray thetrustoflow-incomehomebuyerssaddledwithmortgagesforhomesthatcould never be sold for the price they had paid. In nearly half of theauditedhousesboughtundertheSection235program,thevalueswere,accordingtotheinternalaudit,“toohigh.”44Frauddidn’tendwithlocalappraisersandbrokers.Though the Section235programwas created inWashington, itwas

funded onWall Street.While government-insuredmortgages had beentradedsincethe1930s,themortgageshadalwaysbeenboughtandsoldindividually. Mortgage-backed securities pooled those mortgagestogethersothatinvestorscouldhandlethemaslargebondissues,with

interestpaymentsandpremiumsbackedbyahouse’svalueratherthanacompany’sassets.Liketheparticipationcertificatesofthe1920sbutonafar grander scale, mortgage-backed securities made investing inmortgagedebteffortless.Managingindividualmortgageswastricky,butbuying bonds was straightforward. The original mortgage lender—the“originator”—kept trackof theborrower,and thebondholdercollectedthecash.ThesamekindofcompanythatsoldFHAloanswasstillinthemiddle—themortgagecompany.ThoughbrokerssoldtheSection235houses,the actualmortgages did not come from local banks. Few bankswereinvolvedintheprogram.NinetypercentofSection235loansoriginatedwithspecializedmortgagecompanies,whoseonlybusinesswaslendingmoney and then reselling themortgages.45 According to theMortgageBankers Association of America, Section 235 loans, in 1970,made upthree-fourths of all mortgage company business.46 Though investorsreceived the mortgage-backed security, the mortgage company wouldhandleallthecomplicateddetailsofactuallycollectingtheinterestandprincipal payments and then would pass them along to the investor,after collectinga service fee.47Crucially,between the investorand themortgagecompany stoodFannieMae,whichboughtandbundled two-thirdsofallSection235 loans.48Whilemortgagecompaniesassembledthe pools of mortgages for bundling, Fannie Mae backed andorchestrated the sales, lending its auraofgovernment insurance to theprocess.Fewprivatefinancialinstitutionswantedtobuythemortgagesdirectly,butwhentheywererepackagedasmortgage-backedsecurities,investorscouldbefound.Withmortgage-backedsecurities,theseproto–subprimeloanscouldfindinvestorsinnationalandinternationalcapitalmarkets. Making mortgage-backed securities work, however, requiredpoolsofhundredsofmortgages.ToreselltheirmortgagestoFannieMae,mortgagecompaniesneededtocreatehugevolumesofloans.In their zeal to bundle mortgages to meet the minimum pool sizesrequired for FannieMae bundling, somemortgage companies falsifiedcredit histories.49 In April 1973, HUD, at the request of the Senate,investigatedmortgagecompaniesthatlentpredominantlytolow-incomeborrowers. Auditing 1,309 mortgages issued by 250 mortgagecompanies, the investigators found a stunning record of fraud anddeceptionamongasubstantialportionofthemortgagees.Sixtymortgage

companies,orone-quarterofthetotal,hadprovided“incorrectorfalsemortgage credit information.”50 Mortgage companies wouldintentionallyomit otherdebts, aswell as lawsuits, in an effort tohelppotentialSection235homebuyersqualifyforamortgage.Innearly10percent of cases, themortgage companies allowed the buyers to avoidpayingthedownpayment,eitherbypayinglessthanthefullyrequiredamount or allowing a third party to pay it. While skipping the downpayment misled investors and perhaps helped the borrowers, 33mortgage companies in 917 cases, or 70 percent of cases, charged“unearned, unallowable, or excessive fees.”51 Mortgage companieshelped borrowers get into the house they wanted but made sure thattheypaidforit.Lendingmoneyatarm’slengthwithoutreliablefederalstandards enabled too much capital to flow into this noble butmismanagedprogram.Theonlypeoplewhodidn’tknowwhatwasgoingon—at first—were the investors who bought the mortgage-backedsecuritiesandthegovernmentagenciesthatsubsidizedthemortgages.At every step of the home-buying process, Section 235 buyersencountered another appraiser, broker, builder, or banker seeking todefraudthem.DeceptionintheSection235programemergedfromtheexplosivemix of an opportunity for profit, an absence of institutionaloversight, and a lack ofmarket discipline—in a series of events eerilysimilartothethoseofthesubprimecrisisof2007–2009.Quicklyafteritstarted, horror stories surfaced in the press, and Congress began toinvestigate abuses. Even as Section 235 remademortgage finance, theprogramfellapart.TheDepartmentofHousingandUrbanDevelopment(HUD), at the behest of Congress, investigated its operations in 1970.Theresultingreportassertedthat,insteadofhelpingpoorAmericanstoacquire a stake in the economic system, “the federal funds in thisprogram are ultimately going to the speculators, the real estatesalesmen,andthemortgagecompanieswhofinancethespeculator”andnot into owners’ equity.52 Though the report described manyshortcomings in theprogram,because the investigationwas conductedinternally by HUD, which oversaw the program, many members ofCongress doubted the report’s veracity. So Congress released a secondindependentlyconducted,andevenmoredamning,reportonJanuary6,1971.53ThoughinitiallyHUDsecretaryGeorgeRomneydenouncedthereportas“inaccurate,misleadingandveryincomplete,”onlyeightdays

laterhesuspendedtheSection235program.54WiththissuspensionSection235effectivelyended.“Whotoblame?”wastheessentialquestionsurroundingtheSection235program.Wasitsfailure born of individual malfeasance or the very structure of theprogram? The goal of the program had been simple enough—tosubsidizemortgages—yetateveryturn,itseemed,thetacitassumptionsof policy makers had been undermined by unexpected speculators’incentivesorinstitutionalfailures.Whileacknowledgingthefraudcases,mortgagebankerssuchasEverettSpelmanassertedthat“theindividualswho have violated the law should be … prosecuted. However thedishonestbehavioroftheseindividualsdoesnotrepresentadefectintheconcept of these programs.”55 HUD secretary Romney, less forgivingperhaps,attributedthefailureoftheprogramtotheunderlyingnaivetéofCongress.Thefailureoftheprogramwasnot,heinsisted,duetotheadministrationoftheprogrambuttheprogram’sbasicgoalofprovidinghome ownership to the lowest-income families. Romney believed that“neithertheFHAnoranyoneelsehadanadequateunderstandingoftheproblems inherent in an effort to place low-income families in ahomeownership situation.”56 Lending to extremely-low-income homebuyers was inherently precarious, since, as Romney pointed out, “anytemporary loss of income or unusual expense amounts to a financialcatastrophe.” Putting such people at the mercy of the rigid mortgagesystem was foolish because “it makes no serious provision towardleniency.”Theuncertainfinanciallivesofthepoorweremetonlybythesteady, unyielding demands of the mortgage. Though the FHAencouraged lenders to give borrowers “greater forbearance,” if homeownersmissedmorethanthreemonthsofpaymentsandcouldnotpayback missed payments, the house would still be foreclosed on.57Subsidiescouldalterthecostsofmortgages,butnosubsidycouldalterthe practices of mortgages. Section 235 failed not only because ofopportunists but because home owners could not build equity in anovervaluedhouse,nomatterwhat the termsof themortgage.Whetherthat inflated value came from corrupt inspectors or easy-creditmortgages is, in the end, immaterial to those home buyers’ lives. Theprogram to help the inner city lasted only a few years, plagued, as itwas, by fraud and corruption. At the most basic level, policy makersavoidedtheunderlyingproblemofincomeinequalitybyfocusingonthe

apparenteasyfixofhousingcredit.Though Section 235 failed, themortgage-backed security succeeded.Fannie Mae continued to bundle mortgages into mortgage-backedsecurities and sell them to investors. FannieMae confused public andprivate like no other institution. Though it still acted in the “publicinterest” during market downturns, liberally buying mortgages andsupportingthehousingindustry,itdidnotdampenexpansions,pushinggrowtheveninthefaceofinflation.58Thoughostensiblyprivate,FannieMae remained subject to the Department of Housing and UrbanDevelopment, particularly through HUD’s control over Fannie’s debtceiling. During the Republican ’70s, HUD’s authority went unused.PrivatizedFannieMaepaidagood13percentreturntoitsshareholdersand remained bullish on the economy. Since Wall Street and notCongressprovidedFannieMaewith funds, itsobligationwas to “showperformance” to its stockholders—or so went the reasoning of itsmanagement.59DuringRepublicanadministrations,low-incomehousingwasputonthebackburner,evenasFannieMaegrewinimportance.By1977, ithadmoreassets thanallbut fiveU.S. corporations.Unlikeallother “private” companies, though, FannieMae could swap debt withthe Treasury to give it some liquidity. Despite all the talk of beingprivate,FannieMaeoperatedasanoff-the-booksgovernmententity—acreatureofaccountingmagic.Enter FreddieMac. FreddieMac, chartered in 1970,was exactly thesame as Fannie Mae except that it handled conventional mortgagesinsteadof federally insuredmortgages (FHA,VA,and the rest).Duringthe 1960s, conventional mortgages had displaced federally insuredmortgages as the predominant way home buyers borrowed, but therewasno secondarymarket for them,as therewas forFHAorVA loans.WhenCongresscreatedFreddieMactoresellconventionalmortgages,ittoo took on the mortgage-backed securities model, calling them“participation certificates” like the mortgage-backed securities of the1920s.Bythemid-1970s,mortgage-backedsecuritiessupplieduptohalfthevolumeofmortgagedebt.Duringthe1970s,FreddieMacfashioneda national secondary market in conventional loans that produced thesameeffectasFannieMae’s.For the middle class, conventional mortgages had become moreimportant than federally insured mortgages, and it was here that the

stagflationofthe1970sreallyhithome.AstheAmericaneconomyslidintodouble-digitinflationinthemid-1970s,interestratesbegantoclimbtocovertherisingcostoflendingmoney.Lenderswithalargefixed-ratemortgage portfolio, like savings and loan banks (S&Ls), also known as“thrifts,” which took in short-term deposits and lent out long-termmortgages, were hammered by the rise in interest rates. The thriftbusinessinthepostwarerawasnearlyasstraightforwardastheoldjokethat bankers followed the 363 rule: pay depositors 3 percent, lend toborrowersat6percent,andbeonthelinksby3p.m.Unfortunately,therapid rise in interest rates in the late 1970s complicated that enviablejob. InMichigan, for instance,oneof the largestmortgage lenderswasStandardSavings&LoanAssociation.Foundedinthenineteenthcenturyas theWorkman’sSavingandLoanAssociation, ithadprosperedalongwithnearbyDetroitformostofthetwentiethcentury.Likemanyotherbanks, it lent low during the prosperity—and felt the sting as interestrates rose. By 1981, on average, it had to pay 11.4 percent to itsdepositorswhileonlygetting10percentfromitsmortgages—losing1.4percent! Ithadn’t lostmoneysince1893,yetnow itwasbleedingdry.The resolution of this defect would bring about the savings and loancrisisof the1980sand solidify securitizationas the true foundationofAmericanborrowing.According to the president of FreddieMac, Kenneth Thygerson, the

S&Ls’shareofnewmortgagesfellfrom60percentin1976to42percentin1982.60Withoutaccesstocheapcapitaltolend,S&Lswerecollapsing,and FreddieMacwas the onlyway to save them. Thygerson saw thisrestructuringofthemortgageindustryasa“dramatictransitionsimilarto theone that followed theGreatDepression.” In1982, like somanyS&Ls, Standard sold $1 billion of itsmortgages to FreddieMac. Usingthatcash,itcouldlendmortgagesatthecurrentmarketratesandraisethat10percent.Thevicepresidentofmortgagesdescribedthemortgagesaleasbeing“takenoutofthedarkness.”61In the late 1970s, some enterprising banks tried to get in on

securitization.BankofAmericaonceagain led thepack in innovation,offering the first private-issue conventionalmortgage-backed securitiesin 1977, but was quickly followed byWashingtonMutual (WaMu) aswell as an assortment of S&Ls.62 Salomon Brothers, the venerableinvestmentbankthathadassistedFannieandGinnieinlaunchingtheir

mortgage-backed securities, sold BofA’s securities as well.63 By 1980,individual investors could buymortgage-backed securities just like thebig institutional investors did. Itwasharder for individuals, of course,sincethelowestdenominationofbondwas$25,000,justliketheGinnieandFanniebondissues,butsomeinvestmentbanksprovided“oddlots”of bonds for those who wanted them. By this point, large banks hadcaughtontotheappealofmortgage-backedsecuritiesandwereissuingthem against their own holdings. BofA’s bonds didn’t have a federalguaranteebutdidhaveprivateinsuranceagainstdefault.Theinsurancewasessentialtoreassureinvestorsagainstforeclosureorarapidcollapsein values. Lee Kendall, the president of Mortgage Guaranty InsuranceCorporation, which insuredmost of the bond issues, told Fortune that“the insurance was devised to cover 1933 conditions.”64 Even if theinsurance companies somehow folded—inconceivable!—the mortgagesthat filledBofA’s poolswere “backedby ahome that isworth at least25%morethanthevalueofthemortgage.”65Despitethoseassurances,buyersdemandedahigheryieldthanonthemortgage-backedsecuritiesof Ginnie, Freddie, and Fannie. Private mortgage-backed securitieslackedafederalguaranteeand, liketheparticipationcertificatesof the1920s,couldn’tberesold.66OnlyGinnieMae,FannieMae,andFreddieMacbondsenjoyedastrongsecondarymarket.Thevalueofmovingthatdebtoff thebalance sheets,however,mademortgage-backed securitiesanattractiveoptionforthelargestbanks.ButtheS&Lscouldnotsurviveforlongevenwiththehigher-interest

mortgages in theirportfolio.Evenat11percent, savings flowedoutofthebanksas itbecamecheaper thaneverbefore to invest in the stockmarketthroughmutualfunds.Withthebullmarketofthe1980sfirmlyunderway,evensmall-timersfanciedthemselvesbig-shotinvestors.FacingthecollapseofS&Ls—thebanksmostdependentonfixed-rate

mortgages—across the country, Congress passed the DepositoryInstitutionsDeregulationandMonetaryControlAct (DIDMCA)and theGarn–St.GermainDepositoryInstitutionsActof1982inordertoexpandthrifts’accesstodepositsandexpandthekindsoffinancialproductstheycouldoffer.DIDMCArepealedmortgageinterestrateceilings,nomatterwhatstatelawsaid.67The1982actfollowedupbyallowingallbankstowrite adjustable-rate mortgages.68 The changes brought S&Ls into themorevolatileeconomyofthe1980s,butitalsomadeiteasierforS&Ls

to resell their mortgages to Freddie Mac. Pundits called this“deregulation,”but itdidnot removegovernment from themarkets; itjustchangedthenatureoftherelationship.One way to handle the crisis was to make the interest rate on

mortgages adjustable. Adjustable-ratemortgages had been available inEurope for a long time, but in the United States—because of thewidespread FHA system—mostmortgageswere fixed-rate.Many banksintheearly1980sofferedARMs—andevenincludedlower-cost“teaser”rates tomake the first fewyears easieron theborrower.69Despite thelures,mostborrowerswantedthestabilityofafixed-ratemortgage.Eveninthehigh-interest-rateeraoftheearly1980s,overallonly11percentof mortgages were adjustable.70 For thrifts, however, ARMs peakedquickly.71By1984,ARMsmadeup68percentofallS&Lmortgages,butasinterestratesfellthroughthe1980s,borrowersreturnedtofixed-ratemortgages.DeregulationallowedS&Lstoventure intothisnewkindoflendingandtochargehigherinterestrates—bothofwhichallowedthemto survive—but it was the securitization of fixed-rate mortgages thatmattered in the long term, allowing lenders to grapple with theirexisting portfolios and continue to lend when interest rates fell.Securitization,morethanARMs,shelteredtheU.S.mortgagesystem.After1980,thenewregulationsallowedthriftsnotonlytobuybutto

sell in vast numbers to FreddieMac. Selling offmortgages to Freddie,however, meant taking a loss. Even with deregulation, thrifts lost $5billion in 1981.72 Better to cut the losses than go under. S&Ls soldbillionsofdollars’worthofmortgagestoFreddieMac,whichpromptlyissuedbondsagainst them.Thederegulationcausedamassivesurge inthe mortgage-backed bond market, but S&Ls’ desire to sell exceededFreddie’sabilitytoresell.Sinceitsinception,FannieMaehadresoldmortgagesbutalwayshada

largeinventoryofunsoldmortgagesthatweresaidtobe“warehoused.”DavidMaxwell,appointedpresidentofFannieMaein1981,pushedforwaystoreducethewarehousingofmortgages.Reducingthatinventorybecamehisnumberonegoal.73Anymortgagesthatwerenotturnedintomortgage-backedsecurities—andthereweremany—encumberedFannieMaewiththesameproblemsastheS&Lshad.In1981,FannieMaehad$56 billion of such mortgages with an average yield of 9.5 percent,while borrowing cost 17 percent!74 In the first six months of 1981,

FannieMaelost$146million—afarcryfrom1976,whenithadearned$126.8million.75Atthesametime,S&LsincreasinglyreliedonFreddieMac to stabilize their balance sheets.More than half of Freddie’s loangrowth during the early tomid-1980s came from swapping debt withS&Ls.76 S&Ls issuedmortgages and then swapped them for mortgage-backed securities from Freddie Mac. S&Ls could reduce their riskthroughdiversification, but they still incurred a substantial risk that ifinterest rates shifted, they could lose lots of money—quickly.Fundamentally, thrifts’ long-term lending and short-term borrowingwere incompatible in thevolatileeconomyof the1970sand ‘80s.Newwaystoselloffmortgagesneededtobefound.Congress changed the federal law limiting oldmortgages to only 20

percent of Fannie Mae’s and Freddie Mac’s portfolios, but that wouldonlybea short-termfix.With the limits removed, theagenciesbought$8billioninS&Lmortgages,butsomethingelseneededtobefoundtogivethemtheliquiditythattheS&Lsneeded.Financiers may not have built the jet, but with deregulation under

way they certainly couldbuildnew financial instruments. Like the jet,theCMOwastheproductofpublic-privatecollaboration.InJune1983,FreddieMac,inassociationwiththeinvestmentbankSalomonBrothersandthecommercialbankFirstBankofBoston, issuedagenuinelynewfinancial instrument: the collateralized mortgage obligation (CMO).Whilethemortgage-backedsecurityanditsantecedent,theparticipationcertificatehadpaidallinvestorsinthesameway,theCMOmanagedtocreatemany different kinds of securities out of onemortgage throughthe“tranche.”

Securitizationturnedrealhousesintoabstractcashflowswithhigheryieldsthangovernmentbonds.(IllustrationCredits7.4)

In1984, JohnandPriscillaMyers found theirdreamhouse—a split-levelranchonawoodedhillsideoutsideLancaster,Pennsylvania.Inthedistance,duckscouldbeheardsquawkinganddeercouldbeseenintheevenings at the edge of the forest. A prudent middle-class guy whomarketed gasoline for a living, John Myers wanted a fixed-ratemortgage.Sotheywenttotheirlocalsavingsandloantogeta$47,000mortgage tobuythehouse.Yetwithall the interest ratevolatility, thebankcouldnotholdon toa fixed-ratemortgage.Whatcould thebankdo?

Tranchesweretrulyamagicalsolutiontothisproblem,abletoturnasimple thirty-year mortgage into short-, medium-, and long-terminvestments—allwith a range of risks and returns.While amortgage-backed security produced a long-term bond thatmimicked its origins,theCMOcleverlyturnedalong-termmortgageintoarangeofbonds—from the extremely short term to the long term. Through high-speedcomputers, investment banks could divide the interest and principalpayments on a mortgage into a series of securities, each called a“tranche,” thatwould receive different amounts everymonth. Each ofthedifferenttranchesreceivedadifferentshareofthepaybackfromthemortgages.Short-termbondsreceiveda lower interest ratebuta fasterrepayment,while long-termbondsreceivedahigher interestratebutaslower repayment. Shorter-term securities received their repaymentsmorequickly,withalowerinterestrateandlowerrisk,thanthelonger-termsecurities,whichshoulderedagreaterdefaultriskandreceived,asrecompense, a higher interest rate. Bewildered? Even to contemporarybankers,thesystemwasmysterious.Onlythegnomesreallyunderstood,butinpracticewhatitmeantwasthatbankscouldkeepwritingthirty-yearmortgages and use one-year bonds to fund them.Magic?Maybe.Butitmeantthatallthosewarehousedmortgagescouldbesoldoff.TheliquidityproblemofFannie,Freddie,andGinnie—aswellasalltheS&Lsin the country—could be resolved. Americans wanted fixed-ratemortgages because they fit neatly into a budget, and with the CMOfinancialinstitutionscouldprovidethemwithoutincurringtheriskthatinterestrateswouldfluctuateunexpectedly.ThemagicofCMOswasthatthemismatch of long-term lending and short-termborrowing could besolved.A CMO enabled the Myerses to buy their house. John may have

borrowedthemoneyatthelocalS&L,buthismortgagewassoldoffandrepackagedasaCMO.ThepossibleownerofhisCMOcouldevenhavebeentheMiddleEasternoiltycoonwhosegasolinehemarketed.Hesenthis$514paymenteverymonthtotheS&L—whichremainedtheservicerof the loan—buthedidn’tknowwhoactuallyheowedmoneyto—andhedidn’tcare:“aslongasPriscillaandIwereabletogetthemoneyforthe house…wewere happy.” By 1985, two-thirds of newmortgageswere funded by mortgage-backed securities and CMOs.77 LelandBrendsel, perhapsheeding the gnomes’ advice, pushed aggressively for

internationalinvestmentinCMOs,issuing,in1985,aCMOintendedforinternationalinvestorsthathehopedwouldbe“pavingthewayfortheexpansion of mortgage-related securities market around the world.”78SalomonBrothersmanaged the international issueof thebonds just aseasilyasitmanagedFreddieMac’sdomesticbondissues.“Mortgage money will never again be unavailable,” announced

Richard Pratt, the head of mortgages at Merrill Lynch.79 The CMOtappedintoawholenewcategoryof investor.ThoughFannieMaehaddreamed of new investors for mortgage-backed securities since the1960s,inreality,mostbuyershadbeenS&Ls.DespitetheplansofGinnieMae,pension fundsprovided less than1percentofallmortgage fundsby the early 1980s. Thrifts had, from Freddie Mac’s first mortgage-backed security issue in 1971, been Freddie’s primary buyers—purchasing,untilthelate1970s,95percentofallbondissues.Onlywiththe CMO did pension funds finally start buying mortgage-backedsecurities in the volumes that Freddie, Fannie, andGinnie had hoped.Andiftherewasmoneytomove,therewereprofitstobemade.Asearlyas 1983, just as theCMOwas taking off, SalomonBrothers earned 40percent of its net income—roughly $200 million—from mortgageactivity.Mortgagesforall,asPrattsaid,definitelycameat“aprice.”Asold-fashioned savings and loan banks struggled to make profits onmortgage lending, CMOs guaranteed the flow of capital into theconventionalmortgagemarket.Thefloodofmoneyfrompensionfunds—over $1 trillion by 1985—and other nontraditional investors intomortgage-backed securities gave buyers like theMyerses the ability toownahome.80As interest rates fell,Americans returned to the fixed-ratemortgages

that promised predictability. Though lenders would have preferredARMs—which gave them stability—competition from other lendersforced everyone to offer fixed-rate mortgages.81 And CMOs providedbanks with the predictability that whole mortgages could not. Wholemortgages,withoutdiversification,wereseenasmuchmorerisky.Creditmodelsof1988estimatedthatwholemortgageloansweretwiceasriskyas securitized mortgage loans.82 Banks that resold their mortgagestended to resell all of them. For instance, in 1986, in the suburbs ofChicago,thelittleLyonsSavings&LoanAssociationofHinsdale,Illinois,offeredthirty-yearmortgagesat9percent.Inthepostwarperiod,Lyons

wouldhavelentthemoneyandheldthenoteuntileverypennywaspaidback. In 1986, however, every single mortgage that Lyons made wasresoldtoinvestors.Injustfivemonths,Lyonssold$550millionworthofmortgages.ThechiefexecutiveofLyonsbelievedthatthelowerinterestrateswerebutarespitebeforethereturn.Bankersmighthaveremainedconservative—in avoiding risk—but their pessimistic outlook pushedthemintoavant-gardebanking.CMOs spread through the economy,drawing in institutions thathad

not traditionally been mortgage lenders. The boundary of retail,manufacturing, and finance—already fuzzy with consumer credit—continuedtoblur.KmartandJ.C.PenneyallowedS&Lstoopenshopintheir stores.Sears,Roebuck setup itsownmortgage lendingoperation(SearsMortgageSecuritiesCorporation),echoingthetrendofbecomingafinancecompany.Bythe1980s,Searsowneddiverseinterests inrealestate (Coldwell Banker), investment banking (Dean Witter), andinsurance(Allstate).83Buildingonitswidespreadstorecard,Searsevenlaunchedanationalcreditcard—Discover—asarivaltoMasterCardandVisa in1986. In storesacross thecountry, theSears creditdepartmentbecame the Sears financial center, offering mortgages, insurance, andrealestateservices,aswellascreditcards.84Nottobeoutdone,GMACbought the mortgage operations of two regional banks in 1986, tobecome the second largest mortgage lender in the United States,believingthatitspurposewastomakepossiblethe“twoaspectsoftheAmericandream—thestrongdesiretoownacarandtoownone’sownhome.”85 Even GE, through its General Electric Credit Corporation,offered mortgage-backed securities.86 Building on their earlierexperiences with finance in the 1960s, many businesses shifted theirfocustowherethemoneywasinthe1980s.Withsecuritization,Americanborrowershadcheapaccesstoinvestors

around the world. Oil money from the Middle East financed housingdevelopmentsintheMidwest.GlobalfinanceandU.S.financealignedtoproduce a new global economy of debt. Securitization did not resultfrom “deregulation,” despite what politicians and pundits might havesaid. Regulations may have changed to promote a certain kind offinancial system, but at no point did the state abandon themarket toitself. It was the interplay of public and private—Freddie Mac, S&Ls,

mortgage-backed securities—that made these new sources of capitalpossible.Thenewestsourceofcapital,however,provedtobeanoldone.S&Ls

battledforsavers’deposits,butthatmoney,bythe1970sand’80s,wasgoing increasingly to pensions, IRAs, and 401(k)s. A huge fraction ofCMObondholderswere not plutocrats butworking stiffs. In 1981, theLabor Department expanded the limits on mortgage investments bypension funds. In the first offering of S&Lmortgage-backed securities,FannieMae sold 43 percent of the bonds to pension funds.87 Pensionswantedlong-terminvestmentstomatchtheirlong-termneeds.Forunionorpublic-sectorpensions, supportinghousingalsomeantgoodPRwiththe membership.88 The losses of the thrifts were the gains of theinvestors,whocouldbuybondswithaneffective15percentyield,whichwasbetterthanthatofAAAcorporatebondsthenpaying14percent.89The 1 percent difference, coupled with the implicit governmentguarantee,drovethedemandformortgage-backedsecuritiesthroughtheroof.S&Lscouldgetthecapitaltheyneededfromsmall-timesavers—butonlythroughthebondmarkets.To competewithother investments, S&Lshad to either sell off their

mortgagesor,inthecaseofthemanyhucksters,engageinsuchabsurdlyriskylendingthattheybecamemoreLasVegasthanWallStreet,whicheventuallyledtotheS&Lcrisis.ThenarrativeoftheS&LcrisisthatmostAmericanswholivedthroughitrememberisoneofoutrageousfraudbybankmanagers.Itcrushedmanysmalldepositors’savings.ThoughIwasa child in Baltimore in the 1980s, I can still clearly remember seeingfamilyfriendslinedupintheparkinglotoutsidetheOldCourtSavingsand Loan—one of themost notorious examples of bankmanagers runamok.Despitethesensationalexplanations,thelargerstoryofthecrisisisoftenignored.S&Ls,intendedtoberesuscitatedbyderegulation,wereinfactdeadonarrival.Ironically,thegovernmentonceagainturnedtosecuritization to resolve the fallout from all the S&L failures. TheResolution Trust Corporation, chartered by the government in 1989,securitizeddefunctS&Lassets.Aspartof thenewfinancial regulationsof the Financial InstitutionsReform,Recovery andEnforcementAct of1989,FreddieMacandFannieMaetookoverevenmoreofthemortgagefunctionsofS&Ls,relyingonsecuritizationtofundtheirenterprises.Nearly a quarter of U.S. S&Ls had failed in the early 1980s, when

interest rates rose, but the whole system no longer existed aftersecuritization. The survivors had struggled to remain viable byembracing securitization.90 In the process, however, they no longermaintained their importance as sources of capital. When Americanssavedat thrifts, itmade sense tohave thriftshold themortgage loans.But as American savings found their way into pensions and mutualfunds, theS&L’s rolebecamemore like thatof amortgage company—simply originating and reselling loans. CMOsmay have saved S&Ls asbusinesses,buttheyalsomadethemintoglorifiedmortgagecompanies.If S&Ls bought mortgages, they were just like any other anonymousbondholder—nothing special. The real S&L crisis was not a fewderegulatedhuckstersbutthecompleteshiftofAmericans’savingsfrombankstomarkets.Mortgage and finance companies could just as easily originatemortgages—andmanydid.In1984,thesameSalomonBrothersthathadpackagedmortgages forS&Lsandcommercialbanks sold$100millionin mortgage-backed securities from American Southwest FinanceCompany. The same secondarymortgagemarket that saved S&Ls alsokilled them—at least as they were traditionally run. The S&L crisisshowed,ultimately, thatS&Lsmightno longerbeneeded.Globalbondmarketscouldfill theroleof theoldneighborhoodbanker. Ina titanicshift in the organization of American capitalism, banks had becomeserviceproviders,notcapitalproviders.Policymakershadhopedthatthemortgage-backedsecuritywouldbeaneasyfixforinequality,spreadingthepostwarprosperitytoeveryone.Insteadthatloftyambitionhadproducedavalue-neutraltechnologythatenabled investment not just in low-incomehousing but in any kind ofconsumer debt. As profits in other parts of the economy receded, theprofits of this kind of lending exploded. Capital flooded into U.S.consumerdebt.Investorsfoundthatitwasaseasytobuyunproductiveconsumer debt as to putmoney into productive businesses. Instead ofcars,theUnitedStatesnowmanufactureddebt.Whenmortgagesbecame securities, thenumberofpossible investorsgrew. Rather than just producing mortgages for their own banks,bankers producedmortgages for themarket as if debtwere a productlikeanyother.Itwasthesameastheshiftinfarmingfromsubsistencecroptocashcrop.Producingforoneselfandproducingfor themarket,

even if it is still the same corn, results in a very different mentality.Knowingthatmortgagescouldberesoldintothecapitalmarketsmeantthatbankers lookedforwaystoexpandtheir lendingthatwouldneverhavebeenpossibleiftheyhadbeenlimitedtotheirowncapital.IntheeraoftheCMO,thesmartbankcouldbeliketheSkinnyMan,itsvaultnearlyempty,withapileof IOUs inanearbybasket.Though in1883this meant bankruptcy, in 1983 it would mean prosperity. Unlike theSkinny Man, however, none of the money at risk was the bank’s.Investors, who believed in the safety of bonds, and borrowers, whotrusted thatnoonewouldoverlend to them, incurredall the risk.Thedifferencethiswouldmakewouldbecomeclearinthenexttwodecades.

CHAPTEREIGHTTHEHOUSEOFCREDITCARDS

(1986–2008)

Goodparentsinstill intheirchildrenanappreciationoftheimportanceof thrift. Piggy banks, stuffed with grandparents’ largesse, abound inkids’ pink and blue bedrooms. Dutifully, grandchildren deposit dollarsfor “college funds,” even though, as the parents painfully know, theirpittancescouldnotevenbuythefirstsemester’sbooks.Thepurposeofthe saving, though, is not as important as the act of saving. Habitsinculcatedwhileyoungcansteeradultsthroughalifetimeofresponsibledecisions. Yet while piggy banks continued for children in the latetwentiethcentury,theactualwayAmericanssaved,bothknowinglyandunknowingly,bore littlerelationshipwiththeporcineceramicatopthedresser. It was this “investing,” which displaced “saving,” that led somanychildrentogrowuptobedebtors.Asthepostwarperiodended,Americanssavedlessinbanks—piggyor

otherwise—than they had before. Beginning in the mid-1960s,Americansrediscoveredthepoweroffinancialassets.Thoughbondshadalwaysbeenpopular,stocks,followingthecrashof1929,haddevelopedabadreputation.Timeandprofithealallwounds,andbythemid-1960sanewgenerationwasbeginningtorediscoverthebenefitsofequity.Inthe 1970s and 1980s—after Congress revised the tax law—Americanworkers could use newly invented IRAs and 401(k)s to shelter theirtaxable income for retirement. Unlike the postwar generation, whichrelied on the defined-benefits plans of large corporations, theseemployees had to manage their own financial lives. As never before,workers invested those savings in stocks, readingMoney, Fortune, andotherpopsuccessprimerstofigureoutwheretoputtheirnesteggs. Itworked.

Withmoresavings invested in financialassets suchas stocks than insavingsaccounts,Americansactuallygrewtheirwealthtwiceasmuchinthe 1990s as in the 1960s. Though they borrowedmore, the value oftheir assets grew even faster. Though lambasted for their lack oftraditional savings, the financially savvyAmericansof the1990scouldlook at their capital gains and know that theyhadmuchmorewealththantheirparentsdidbecausetheyhadtrustedthemarket.Theydidn’thavetosavebecausenowtheyinvested.Americans couldbe forgiven for thinkingof theirhomesasbeing inthesamecategoryasstocks.Theywatchedtheirretirementaccountsandhousevaluesgrow,butthoughstockpricesrose,inflationerodedthem.By 1983, stock prices had barely recovered to their pre-1973 crashheight,and,afteradjustingforinflation,theyactuallyhadn’t.Forhomeowners, the late 1970s were a tremendous boon. Most home ownersmadeabucketofcashduringthe1970sfromtherapidinflation.Homeowners who borrowed in the late 1960s with low interest rates hadenjoyed a decade or more of inflation. Inflation might be bad forcreditors, but it is great for debtors. Nominally, the house bought for$25,000in1970wouldbeworth$75,000in1985,butthehomeownerwould stillonlybepaying themortgageon$25,000.The$50,000 justsatthere.Though the rising price of houses made for a good “investment,”houseswerenotinvestmentsintheclassicmeaningoftheword.Moneyinvested in stockswasput intoabusiness thatproducedvalue.Moneyinvested in a house produced nothing. A house was not a farm orfactory,justanoversizedconsumergood.Thepricemighthavegoneup,butsocouldthepriceofsnowglobes.Mortgageswere,however,agoodway to save; they created a structuredway to put aside a little bit ofprincipaleverymonth.Intheboomofthe1980s,investmentacquiredanewshine,andsotoodidthe“equity”inhouses.Unlike the debt repayment of the postwar period, which relied onrisingincome,debtrepaymentofthe1990sreliedonrisingassetprices.With rising house prices, home owners could borrow against theirhouses and repay their debts, even if their incomes did not rise.Everyone’shouse,andtheU.S.economy,becameahouseofcreditcards.Thetroublewithassetsisthattousetheirvaluetheyhavetobesold.For stocks, this doesn’t present much of a problem, but for houses it

does,sinceunlikestocks,weliveinthem.Shouldhomeownershavetoselltheirhousestousethehouses’risingvalue?Inkeepingwiththenewinvestment ideas,mortgage bankers of the late 1970s and early 1980sdidnotthinkso.Increasinglypromotingopen-endedhomeequitylines,banksallowedhomeownerstoborrow,inarevolvingfashion,fromtheequityintheirhomes.The$50,000lyingfallowcouldbespentwithoutmoving. Intheearly1980s,mosthomeownersusedtheirhomeequitylinesliketraditionalhomeimprovementloans—tofixtheroof,tobuildanaddition,andsoon. In1984,asPresidentRonaldReaganbeganhissecond term in office, this traditional use of home equity began tochange.UnintentionallyReagansetthewheelsintomotiontotransformourhousesfromhomesintoATMs.Thistransformationbegan,unexpectedlyenough,onatelevisionshowin 1954. In the mid-1950s, Ronald Reagan was a popular, ifundistinguished, actor, except perhaps for the die-hard fans of KnuteRockne—AllAmerican.Thoughnotabox-officeleaderonthescreen,hewasaleaderbehindthescenes,havingbeenelectedthepresidentoftheScreenActorsGuild(SAG)inthe1940s.Inthe1950s,however,GeneralElectric hired him to tour its factories as a morale booster for itsemployees.Astelevisiontookoff,GeneralElectric,asoneofthelargestAmerican corporations, turned again toReagan tohostGeneral ElectricTheater,whichhedidfrom1954to1962.AsanemployeeofGE,Reagantouredthecountry,espousingGE’spointofview,whichwas,needlesstosay,moreantiunionthanSAG’s.Explaininghistransformationfromtheleader of one of the most liberal unions in the 1940s to the face ofconservatism in the1980s,he said, “Ibegan to talkmoreandmoreofhow government had expanded and was infringing on liberties andinterferingwithprivateenterprise.…ItfinallygrewtothepointthatonedayIcamehomefromaspeakingtourandsaidtoNancy,‘IgooutthereandmakethesespeecheswhichIbelieve—theyaremyownspeeches—andtheneveryfouryearsIfindmyselfcampaigningforthepeoplewhoaredoingthethingsthatIamspeakingagainst.’AndIsaid,‘Iamonthewrongside.’”1Morethanjustpolitics,partofbeingonthewrongsidewasReagan’sownexperiencewithhiswallet.Duringhisheydayinthe1950s,thetopmarginaltaxrate,whichhewasin,was91percent.Foreachadditionalmovie he made in a year, he took home only 9 percent of what he

earned.WhenReagantookpowerin1981,hisideasofpoliticsandtaxescamewith him, formed, in a large part, by his experiences atGeneralElectric.Whenhisexperienceswereconfirmedbysupply-sideeconomictheory,in1984,hetoldtheTreasuryDepartmenttoputtogetheraplanof tax reform to give high earners, including hard-pressedmovie starslikehimself,moretake-homepay.With a broad mandate from the president to fix the tax code, the

wonksattheTreasuryDepartmentsettowork.2Overthenexttwoyears,politicians and policy makers battled behind closed doors and overmartini lunches overwhat should stay and go in the tax code. At thecenterofthedebatesweretaxratesandtaxdeductions.BeginningwithPresident John F. Kennedy’s investment tax credit in 1963, tax creditsand deductions for private industry had blossomed in the tax code,leaving the middle class, which lacked either the capital or thewherewithal to take advantage of such tax shelters, furious. Theeconomics wonks in the Treasury Department cared less about voteranger thanmarketdistortions.Themortgage interestdeduction causedhousing to be cheaper to buy. Because housing was cheaper than themarket rate, the free marketers argued, Americans bought too manyhouses. Why should homes, as one possible form of investment, beencouraged?Peoplecouldjustrent.Infact,all formsofinterestshouldnolongerbedeductible.Consumers,afterall,werenotbusinesses.Though Reagan favored tax reform, eliminating the mortgage

deduction was nonetheless unthinkable. The reasoned economicargument mattered little to Reagan, who knew that eliminating thedeductionwouldleadtoarevoltbyhome-owningAmericans,aswellastherealestateindustry.Whilethewonksdebated,ReagangaveaspeechinMay 1984 to the National Association of Realtors, reassuring themthat“incasethere’sstillanydoubt,Iwantyoutoknowwewillpreservethe part of the American Dream which the home-mortgage-interestdeduction symbolizes.”3 Mortgage debt had long been thought of as“good” debt, which was why it was protected during the tax reform.Since the 1930s, when the FHA had made good housing a nationalproject, Americans had been encouraged to take out long-termmortgagesandbuyahouse.Owingamortgagewasnotjustafinancialchoice, itwas a sign of adulthood and the imprimatur ofmiddle-classsuccess.Whileamortgagesignifiedmaturity,creditcardssignifiedfun.

In themiddleof thedebates stooda few sacredcows: lower tax rates,steadygovernmentrevenues,andthehomemortgageinterestdeduction.Whilethedeductionformortgageinteresthadbeentabled,however,allthe other distortionary deductions, such as the interest on cars, creditcards,andallotherconsumerpurchases,werestillupfordebate.TheAmericanDreamofhomeownershipprovedtobeoneofthemostresilientobstaclestoReagan’sconservativeagenda.Thoughinprinciplehewasopposedto“biggovernment,”allhisattemptstoreininFannieMae,FreddieMac,andGinnieMaeprovedimpossible.Inthemid-1980s,alltheagenciesreachedtheirdebtlimits,ridingthewaveofaresurgenthousing market. Reagan’s administration—what Fannie Mae presidentDavid Maxwell called a “cadre of zealots”—moved to use this as anopportunity to push for totally private alternatives.4 In 1984, ReagansignedtheSecondaryMortgageMarketEnhancementAct,whichallowedprivate banks and S&Ls to poolmortgages and issuemortgage-backedsecurities with the same ease as Freddie and Fannie in an attempt todisplace the centrality of theMaes andMacs to the economy.5 Privatemortgage-backedsecurityissues,bycorporationssuchasGE,hadtotaledonly$2billionin1983,comparedto$70billionbyFreddie,Fannie,andGinnie.Reagan’spolicyoverrodethestatelawspreventingpensionfundsfrombuyingprivatemortgage-backed securities. The actwas part of abroadagendabytheReaganadministrationtomaketheU.S.mortgagemarkettrulyprivate.Illustrating the gap between “promarket” ideology and businessreality, nearly all groups associated with the housing industry—mortgage brokers, bankers, bond traders, builders, and so on—pushedbackagainstthereform.AneditorialinUnitedStatesBankerclaimedthatReagan’s call to “repeal [Fannie’s, Freddie’s, andGinnieMae’s] ties tothe Federal government in order to compete freely and equally withtheir private sector competitors” displayed a naiveté about theeconomy.6Therewasnoprivatealternative.Thoughbuyersandsellersforstockswereeasilyfound,mortgages—alwaysmorecomplicated—hada serious coordination problem. Even the relatively liquid GinnieMaemortgage-backed securities found both a buyer and a seller only 60percent of the time.7On a baddayon theNYSE, amere2percent ofstock tradeswouldgounmatched.TheMaes andMacworkedbecausethey could buy, hold, and resell mortgages—something that never

happenedonastockexchange.Thesecondarymarketwasamarket inname only. In practice, Fannie and friends were just traders. Privateintermediariescouldnottakeoverthisroleandwouldalmostcertainlylockupthesystem.Inthis,asinthetaxreform,Reaganbenttopoliticalandbusinesspressure,authorizingaraiseinthedebtceilingoftheMaesandMacin1986,evenashecontinuedtopursuehistaxreform.When theTaxReformAct of 1986was finally passed, themortgage

interestdeductionremained,butallotherconsumerinterestdeductionswereeliminated.Evenatthetime,policywonkswonderedwhatwouldhappen now that mortgage debt was so different from other forms ofdebt. Without the consumer interest deductions, economists reasoned,Americanswould borrow less, since debtwould now costmore. Theirreasoning certainly made sense. Despite their profound respect foreconomists’reasoning,however,Americansoptedtoborrowevenmore.Behind the scenes, in thehallsofWashingtonand thebanksofNew

York, houses and credit cards—through securitization—became evermore interchangeable.Andunlike the credit cardsof the1960s, creditcards could now be used everywhere. The new availability of creditallowedmoreAmericanstoborrowthaneverbefore,butinthevolatileeconomy of the 1980s, such access came at a high cost. Bankruptciesrose as more financially precarious people borrowed on their cards,budgeting their payments to the limits of their incomes, trusting thatcredit card companieswould not extend credit beyond their ability torepayit.Thoughborrowinglikethishadworkedinthepostwarperiod,inthe1980sitdidnot.Suddeninterruptionsinincomefromjoblossorillnessledtocatastrophe.Whileinstallmentdebtdefaultendedwiththerepossession,creditcarddefaultcouldhauntborrowersforyearsunlesstheborrowersdeclaredbankruptcy.Still,borroweroptimismaboundedeven in the direst circumstances. A Harvard University study ofbankruptcies in the 1980s found that most debtors, even when facedwiththehardtruththattheywouldneverbeabletorepaytheirdebts,struggledontoattemptrepayment,unwillingtoconcedethattheyhadbecome bankrupt. Most people who lost their jobs in the 1980s,especiallythewhite-collarworkerswhohadthegreateraccesstocreditcards,neveragainfoundjobsthatpaidsowellbutcontinuedtoborrowontheircardswhileunemployed,optimisticthattheiroldsalarieswouldreturn. The financial reality trumped the moral obligation to repay.

Inevitably, reality overtook even the most optimistic of borrowers,leading to an explosion of bankruptcies. By the late 1980s, the creditcardwent froma signofaffluence toa symbolofdegeneration.Whiletalking heads on television panicked about waning morality, thefinancial structures of profit that had given credit cards to all thosebankruptsmushroomed.Contrary topopulardenunciations, thegrowthofcreditcarddebt in

the1980scontinuedtobeamongtheuppermiddleclass.Stretchingouttheirpayments,affluentconsumerscausedoutstandingcreditcarddebttoskyrocketinthe1980s.Onlythemostprudentworking-classandpoorfamilies, with perfect credit scores, could even get credit cards—andthentheypaidthemback.Therewerepotentialworking-classandpoorconsumers who, no doubt, could have shown those yuppies how tomismanage some plastic, but they could not get cards. In the early1990s, the pattern of profligate rich and virtuous poor borrowersabruptlyended,andlow-incomeborrowersbegantobeasirresponsibleashigh-incomeones.8How could this have happened? People don’twake up onemorning

and suddenly stop paying their bills.Maybe they do if they lose theirjobs,butthechange,thoughithappenedduringarecession,didsoevenfor those who were employed. What changed in 1991 was not thebehavior of existing low-income borrowers but the behavior of riskierborrowers,who,forthefirsttime,hadaccesstocreditcards.Borrowers,not borrower behavior, changed. In 1970, only one-sixth of U.S.householdshadbank-issued revolving credit cards,while in1998 two-thirds of households did. People hadn’t changed; the people who hadcredit cards had. Around 1991, new credit card companies began toaggressivelylendtothosewho,throughoutthe1980s,hadbeendeniedcredit. The percentage of households with credit cards rose from 35percent in 1980 to 65 percent in 1991.9 These new borrowers werepoorer and riskier than any before, but credit card companies had, sothey believed, figured out a way to handle all the risk. They alsobelievedtheyhadfoundanearlyendlesssourceofcapital.Thoughthecredit departments of department stores of the 1950s and ’60s hadcollapsed under their scarcity of capital, credit card and mortgagecompanies of the 1970s and ’80s faced no such obstacle because of afinancialinnovationthatunderpinnedthisdebtexpansion.Securitization

had come to the credit card and, through its ability to repackage risk,facilitatedthisnewgroupofhigh-riskborrowers.After John and PriscillaMyersmoved into their split-level in 1984,theymight havewatched a shopping channel on their newly installedcable television. Relatively new, the shopping channels of the 1980sofferedretailinthelivingroom.TheSears,Roebuckcataloghadofferedthe same thing since the nineteenth century, but not with such livelyhosts. Buying the goods on shopping channels, like any other form ofretail,requiredcredit.In1984,oneoftheshoppingchannelsapproachedtheOhio-basedBancOneaboutofferingitscustomerscreditcards.BancOne had long ridden thewave of credit innovation. Its largestsubsidiary,CityNationalBank&Trust,wasn’tevenamongthetop150bankswhenitbecamethesecondbank—afterBankofAmerica—toofferBankAmericardin1966.Overthe1960sand’70s,CityNationalbecameone of the leading credit card processors, offering its services to otherbanks,creditunions,andeven financecompanies.By1977, ithandled33milliontransactionsannually—90percentofwhichwereonbehalfofotherbanks.10Itsactualbankingassetsremainedsmall,butitbecameahotbedof financial innovation,alwaysat theedgeofnewtechnologiessuchaspoint-of-salemachines,ATMS,andelectronicbanking.For years Banc One had offered credit cards to traditional upper-middle-class borrowers. The profits of their credit cards in the early1980semboldenedlenderslikeBancOnetopushintonewmarketssuchas television shopping. Banc One agreed to the deal, expecting thechannel’scustomerstohaveahighbutmanageabledefaultrateof5to6percent.11BancOneevenexpectedthedefaultrates,atfirst,tobemuchhigher, before the portfolio was “seasoned” and the good risks weresortedoutfromthebad.When,afterafewmonths,thedefaultrateheldsteadyat11percent,executivesbegantoworry.With$2billioninvestedin thedeal,executivesatBancOneneeded to findaway to resell thisdebt.Twobilliondollars,withsuchhighdefaultrates,wastoomuchtolose!Nootherbiginstitutionallenderwouldwanttobuytheportfolioofdebtsasitwastoorisky.Whattodo?In the immediate postwar period, such a situationwould have beenimpossibletoresolve.Withouttheabilitytosellallofthedebtsatoncetoathirdparty,therewasnowayoutbuttowriteoffthedebt—andfireall theexecutives involved.But luckily forBancOne, thecollateralized

mortgageobligation(CMO)providedanalternativemodel.Pressedforasolution,theinnovative,smartguysatBancOnehadanidea:whynotjusttreatcreditcardslikeamortgage?Mortgagescouldbeparceledoffandsoldasasecurity,sowhynotcreditcarddebt?Creditcardincomewasfarmoreirregular,butwithenoughfinancialwizardry,something could be worked out. Banc One would retain the servicingincome of the cards, but the investors would receive the interestpayments—andbestuckwiththebilliftoomanyborrowersdefaulted.Twoyearslater,in1986,BancOneissuedthefirstcreditcard–backedsecurity, selling $50 million of the portfolio to investors. Anunexpectedly risky situation pushed it to find a solution, leading to afinancial innovation. The credit card–backed security was a marvel!Withoutitsowncapitalatrisk,BancOneandmanyotherlendersbegantorealizethattheirbusinesscoulddivorcetheriskinessoftheborrowerfrom their own profits. Unconstrained by their own available capital,credit card companies could rapidly expand their lending and sell thedebtassecurities.Theriskinessofborrowersnolongermatteredaslongasthesecuritycouldbeproperlytranched.Turningmortgages intoCMOsoffered amodel for financiers to turnanyassetintoanarrayofsecurities.WallStreetinnovationaccelerated,inaugurating an era of financial wizardry unseen since the 1920s. Asbefore,financiersbelievedthattheirinventionscouldnotfailandevenconsidered their magic an applied science, naming it “financialengineering.”TheCMOactedasaprototypeforotherkindsofconsumerdebt,notjustcreditcardsandmortgages.Bankers’faithinsecuritizationcannot be overstated. Securitization, by the late 1990s, embraced evermore exotic assets—tobacco company settlements!DavidBowie recordsales!—enablingborrowingwithoutriskingthecapitalof thosedirectlyinvolved.12 Securitization offered a nearly magical way for banks toevade the constraints of deposits, capital ratios, and the spirit ofgovernmentregulations.Securitizationenabledanunprecedentedriseinborrowing,madepossiblebythenewpoolsofinvestorcapital.Securitization could turn any loan into a bond. The slogan “If it’sgradable,it’stradable”—popularinthemid-1980s—meantthatanythingthatcouldbemadetolooklikeabond,thatis,givenaratingandmadeto produce regular coupon payments, could be resold.13 By the late1980s, that was true. As with mortgage-backed securities, the first

investors were large institutions. First Boston Corporation and GMACsecuritized auto loans in 1985, and it was only a short time beforeanything could become a bond.14 This more general category ofsecuritiesbecamecalled“asset-backedsecurities,”orABSs.Securitizingdebtallowedfinancialinstitutionstomovedebtsofftheirbooksandthusnothavetoholdreservesagainstthem,allowingafargreateramountofcredit tobeextended.15Financial institutionscould lendfarmorethanthey owned.Once lenders’ need for capitalwas reduced, interest ratescouldbelowered,allowingloanstobemadetoawider—andriskier—groupofborrowersthaneverbefore.In1986,asset-backedsecuritiesseemedlikeamagicalfix-all,lowering

costs and risks, at least for the lenders, while helping people buy thethingstheymostwanted.Importantobservers,suchasJamesConnolly,the managing director of the investment bank Salomon Brothers,believedthatsecuritizationreducedtheoverallriskintheU.S.mortgagesystem:“Whatwe’velearnedfromthemortgagemarketisthatyoucanreducedefaultriskstillfurtherbycarefullyunderwritingpoolsofloansthataregeographicallydispersed.”InConnolly’sview,“itwouldtakeamajor economic upheaval for most people to default on their homemortgages, and they’re not likely to be more cavalier about theirautomobiles.” Though the United States was one country, it was inrealitycomposedofmanysemiautonomouseconomies.Texas,NewYork,California,andFlorida—allstateswithdifferenteconomicbases—wouldallhave toentera recessionat thesametime for thesecurities to fail.Bankers knew that such a situation would be unlikely. Oil, finance,computers,andorangescouldn’talltankatonce.Couldthey?Innormalsituations,“thefewdefaultscanbeprotectedbyinsurance.”Everythingfailingatoncewouldbe inconceivable.16Moreover, thenewcomputermodels gave Connolly and other investment bankers confidence thatthey could predict defaults more accurately than would have beenpossibleagenerationearlier,allowingthemtofurtherreducetheirriskandextendmoreloans.Therewasnoneedfortheold-fashionedmarginofsafety.But therewas a need for investment bankers. Though itwould take

only1,000mortgagestocreatea$100millionassetpool,thesamesizepoolwouldrequire20,000autoloansor100,000creditcards.17Puttingtheelaboratedeals together requiredWall Street.Computersmade the

deals possible by rapidly classifying loans—by location, credit rating,interest rate, and size—for assembly into pools. I-bankers had a lot ofworkaheadofthem.Securitization rapidly overtook the credit card industry. In 1990, 1

percent of U.S. credit card balanceswere securitized. The demand forsecurities outstripped the supply. Investor demand, rather than lendersupply, began to drive the market. Lenders began to search for morepeople to lend to. The safest borrowers already had loans, so thesesearches ended with riskier borrowers. Say’s Law of “supply creatingdemand,” long discounted by Keynesians, seemed to be enjoying arenaissance. By 1996, 45 percent were securitized.18 Seventy-sevenpercentoftheriseincreditcarddebtfrom1990to1996wasfundedbycreditcard–backedsecurities.Americanschargedthreetimesasmuchin1998asin1988.Thefastest-growingcreditcardcompaniesinthe1990shadnodepositorsatall.Investors,notbankers,lentAmericansthecreditfortheirdailylives.Thefastest-growingcardissuersinthe1990swerenotbanksbutpure

credit card companies that acted like mortgage originators. Thesecompanies, such as First USA, Advanta Corporation, and Capital One,lent littlecapitalof theirown.Likemortgagecompanies, theyactedasmiddlemen between borrowers and investors, servicing payments andtakingacut.Likemortgagecompanies,theyreliedonsecuritizationfortheir capital. Since card companies lent to the riskiest customers, theirportfolioshada substantialdefault risk,butwithenough tranchesandinsurance,evenariskycorporatebondcouldbecomeAAA,appropriateforpensionfundinvestors.In1994,Advantasecuredallofits$2billionincreditcardbalances.19Bythelate1990s,morecreditcarddebtwassecuritizedthanownedbybanks.20Investors embraced the bonds.With AAA ratings and a better yield

thanTreasurybonds,creditcarddebtwasano-brainer.Thenewflowofcapitalproducedoddbedfellows.WhileunionsstruggledtokeepjobsintheUnitedStatesandmanyAmericanbusinessesfoundithardtogetabankloan,unionsandbusinessescouldagreeononething:creditcardsforeveryone.Inthemid-1990s,theBankofNewYorkpitchedmembersof theAFL-CIOa special card.Offered throughUnionPrivilege,whichnegotiateddiscountsforunionmembers,thecardfeaturedtheprofitablelackofagraceperiodbuthadarelativelylowinterestrateofprimeplus

5percent(13.25percentin1996).21In1996,for$575million,BankofNew York sold the union credit card debt—with $3.4 billion inreceivables—tothesubprimelenderHouseholdInternational,adealthatelevatedHouseholdtotheseventhlargestcreditcardissuerintheU.S.22Thoughthe2.2millionunionistswhoheldthecardmayhavefounditdifficult to organize for better wages, they could at least be sure ofgettingagoldcardwith“freecar-rental insurance,roadsideemergencyauto service, a retail purchase-protection plan, and extended productwarranties”thatprotectedthemasconsumersinawaythatReagan-eraunions could not protect them as workers.23 And of course, all thosehard-wonunionpensionfundsearnedagoodreturnbyinvestingintheirown members’ debt. Credit cards offered by the AFL-CIO brought anironicringtotheslogan“membershiphasitsprivileges.”Securitization made it easy for not only Americans but overseas

investors to invest in consumer debt. In 1989, Citicorp issued its firstcreditcardsecuritizationforforeigninvestors,the“Euroissue.”24Withinayear,alltheotherbigcreditcardissuersfollowedsuit.WiththeirAAAratings and relatively high yields, the bondswere in high demand forforeigninvestors.InMay1990,Citicorpissueditsfirst“globalissue”of$1billionofcreditcard–backedsecurities.25Theotherbiglenders,suchasFirstChicagoandHousehold,alsoissuedglobalissues—$1billionand$800million,respectively—overthesummerof1990.26Inthefirstninemonths of 1990, $8.4 billion in U.S. credit card receivables, or 21percent,wereissuedabroad.27Thoughtheprofitabilityofadollarinvestedincreditcarddebtfellin

theearly1990s,consumerdebtinvestmentsremainedtwiceasprofitableas banks’ business investments.28 The falling profits centered on twoseemingly incompatible facts: increased default and increasedrepayment.Borrower default increased simply because card companies lent to

riskier people. New borrowers needed to be found to meet investordemandand sustain growth.Unlike traditional banks, pure credit cardcompanieshadnootherbusiness,andwithsomanyissuerscompeting,all the reliable cardholders had long been tapped out. The 1991recessionbroughtariseincharge-offsfrom3.5percentto5.5percentinjusttwoyears.29ToaMoody’ssenioranalyst,therisingcharge-offswerenot at all surprising, since “issuers have gone to riskier and riskier

accounts,tryingtoexpandthemarket.”30Butcreditcardcompanieshadanewway to handle the riskier loans—and evenmakemoney off thebaddebt.Inanunexpectedway,theS&Lcrisisenabledcreditcardcompaniesto

lend to riskier borrowers.When the Resolution Trust Corporation soldoffthenonperformingloansofdefunctS&Ls,inanefforttoreclaimsomeofthelostcapitalfromthatdebacle,itcreatedatasteforbaddebtandcompanies that could process it. Credit card charge-offs, for instance,alongwithallthosebadS&Lloans,couldbedumpedintothismarket.31Forinstance,thenumberonecompanyinthebusinessin1993,Tulsa’sCommercial Financial Services (CFS), began in 1990 by buying $1million of bad S&L debts for 0.76 cents on the dollar, or $7,600. Ineighteen months, the company collected 3.5 cents on the dollar, or$35,000.Thatwasnot a lot ofmoney, but the rate of returnwas stillveryhighifitcouldbereproducedatalargerscale.CFSquicklyfocusedonbadcreditcarddebt.Accordingto industryspecialists,$1billion inbad credit card debt was securitized and sold in 1992.32 In 1992,Citicorp,thoughnotafailingS&L,sold$367millioninbaddebt.Buyersbelieved that 20 percent returnswere realistic. Buying the debts for 4centsonthedollar,evenmeagercollectionscouldyieldhighreturns.Bad debt securitization became good business. CFS led the way.

Standard&Poor’sgaveitsbondissuesanArating.CFS’scorebusinesswasbuyingbaddebtfromthetoptwenty-fivecardissuersandcollectingit.33In1997,thecompanyreportedprofitsof$190millionon$1billioninrevenue.34Withtwelvesecuritizationstotaling$1.46billionby1998,CFShad turnedbaddebt into investable securities.35 It securitized thebad debt for the same reason that credit card issuers securitized gooddebt: the loanswentoff thebooks.WilliamBartmann, thepresidentofCFS,explainedthatsecuritizationwas“averyeffectivetoolforbusinessplanningpurposes[since] it literally freesupall themoney tobuy thenext group of loans.”36 Securitization took bad debts off an issuer’sbooksjustaseffortlesslyasittookoffgoodones.By the late 1990s, for every fourteen dollars lent, one dollar was

uncollectable.37Likeanyotherformofsecuritization,usingtranches,thebondscouldbegivenagoodratingbysequesteringthehighestdefaultratesintohigh-risk,high-returntranches.Withsuchaneasywaytoselloffbaddebts,defaultswereno longer sobad.With thatcushion,even

riskier loanscouldbemade.Ofcourse,amongtheseriskier loanswereactualpeople,who—asthelenderskneweveniftheborrowersdidnot—wouldnot be able to pay backwhat they owed.Defaultwas expectedandplannedfor.Yet despite this increase in defaults, there was an increase in

repayments. Repayments would seem to indicate that debtors wereactually able to borrow even more than they already had. But therepayments came from an unexpected source: home equity loans.Investors,ofcourse,didn’tcarewherethemoneycamefromaslongasitcame.As long ashomeowners could continue toborrowagainst theirhouses,creditcard–backedsecuritieslookedlikegoodinvestments.Withrisingrepayments,lendersbelievedthattheyhadactuallyunderestimatedtheriskofdefault,whichfurtherencouragedtheirlooselending.This borrowing now increasingly took place through houses. Home

equityloansbegantobeusedinaverydifferentwaynowthatintereston money borrowed from a house was deductible, while credit cardinterestwasnot.By1991,onlymortgageinterestwasdeductible.Inthe1990s,homeequityloanuseexplodedasdebtorsshuffledtheir

loansfromcardstohouses.Homeequityloanswereaseemingwin-win.Homeownerslovedbeingabletotap“their”equitywhilestilllivingintheirhouses,andbanks lovedtomakehomeequity loans.Unlike theirfixed-ratemortgages,fewbankssecuritizedtheirhomeequityloans.Theyields on home equity loans—with their secured liens on houses andtheirhigher interest rates—were toogood.38Manyof thehomeequityloans, unlike normal mortgages, were variable-rate, and even if theyweren’t, theyweregenerallyof a short enoughduration to cause littleinterest rate risk to the bank. Borrowers and lenders both rode risinghousepricestoprosperity.Borrowing against a house, on some level, required less financial

reasoning than comparing two credit card offers. Comparing interestratesrequiredmathtocalculatethecostsandgainsofswitching.Homeowners already “owned” the equity. It was the owners’ to spend.Borrowingagainstahousewasrootedasmuchinideasofownershipasin such a financial calculation. The feeling of ownership allowed thechoicetobeeasier,andnonnumeric,thanthechoicebetweentwocreditcards.Homeequityloanswereaneasysell.Debt consolidation did not become the leading use of home equity

loans until 1991,when the tax deduction on other forms of debtwasfully eliminated. By the mid-1990s, 40 percent of home equity loanswere for debt consolidation, nearly twice the percentage of the nextmostfrequentuse,homeimprovement.While78percentofconsumers,ina1996survey,citedthetaxsavingofhomeequityloansasthereasontheywerebetterthanotherformsofdebt,theuseofhomeequityloanstoconsolidatedebtdidnothappenovernight.39Indeed,theimpetusforits necessity was the explosion of credit card debt made possible bysecuritization.Inthelate1990s,ashousingpricescontinuedtorise,lendersinventedsubprime mortgages. Demand for mortgage-backed securities hadcontinued to rise, andwith subprimemortgages investors couldgetaneven higher return. Combining lenders who risked nothing withborrowerswhobelievedtherewasnorisk,mortgagecapital,backedbysecurities,floodedtheU.S.housingmarket.Subprimelendingplayedoutalmost exactly the same as the Section 235 program had twenty-fiveyearsearlier.Hopefulhomeownerswithlittlefinancialexperiencereliedonthejudgmentofexperts,whoquicklypackagedmortgagesforresale.Intheaftermathofthecollapseofthemarketfortechnologystocksin2000, Alan Greenspan, the Fed chief who had presided over theeconomy since 1987, kept cutting the prime interest rate. PresidentGeorgeW.BushandGreenspanbothfearedarecessionasthebubbleintech stocksburst.Witha lowcostofborrowing,businessescouldkeepgrowing and the economy could keep adding jobs and growth. Theinterest rate became so low as to be, after adjusting for inflation,negative.ThislowinterestratehadeffectsthatneitherAlannorGeorgefullyanticipated.Inthepreviousthirtyyears,astheglobaleconomyhadfinallymovedpast the destruction ofWorldWar II, the capitalists of the world hadgotten rich on a level unseen since the Gilded Age. Not since theinventionoftherailroadshadthebourgeoisiebeensosuccessful.Globaltrade,whether on the Internet or on container ships, had created vastwealth. This wealth, for both individuals and nations, needed to beinvested. After the tech stock collapse at the turn of the millennium,fearful investors sought safety. ButwithU.S. interest rates so low, thetraditionally safe investment, theU.S.Treasurybond, earnedameagerreturn.Thebigglobalinvestorslookedforanalternativetoequitiesthat

offeredbothsafetyandagoodreturn.The mortgage-backed security, issued by government-sponsoredenterprises such as Fannie Mae, presented an ideal alternative. WithAAA ratings from Standard & Poor’s and other credit-rating agencies,mortgage-backedsecuritiesappearedtobeassafeasTreasurybondsbutwithabetterreturn.Realestatepriceshadbeengoingmoreor lessupforageneration.Whatcouldgowrong?Formostinvestorsinmortgage-backedsecurities,thesafetyoftheinvestmentmatteredmost.Yet,aswehavealllearnedinthepastfewyears,thesesecuritieswerenot nearly as safe as the credit-rating agencies made them out to be.Much of the discussion surrounding the current financial crisis hasfocusedonitasafailureofcapitalism.Thereisapervasivesensethatafewwrongdoerstrickedusand,indoingso,underminedcapitalism.Thecrisis, however, resulted not asmuch fromhucksters as from the verysuccess of capitalism. The question we need to answer is why thehuckstershadsomuchmoneytomisuse.The money for all this investment came from the global success ofcapitalismover the past thirty years. Capitalismworkeddoingwhat itdoesbest:creatingprofitsfortheownersofcapital.Therisinginequalityof theU.S. economy, coupledwith the saving economiesofChina andthe Middle East, concentrated a vast store of savings at the top,desperate for investment. Investing in stockswas oneoption, but afterthe tech stock collapse, investors looked for a safer alternative thatwouldstillearnadecentreturn.Thefloodofcapitalintothemortgage-backedsecuritiesmarketscreatedaglutofmoneythatneededtobeputsomewhere.To invest this capital,mortgagecompaniesneeded toproduce loans.The hard part was not gettingmoney to lend—which had historicallybeenthechallenge—butfindingborrowerswhowerewillingtoborrow.Lending standards, already historically lax, became almost comical.Buyerscouldgetamortgagewithnoincomeandnoassets.Paperworkwas scant. Mortgage companies pushed lending on more marginalborrowers, who, never having owned before and having watchedhousing prices rise as long as they could remember, took the firstopportunity to join theranksofAmericanhomeowners.With incomesstagnant,theappreciationofahouse’svalueseemedtheonlywaytogetrich.Theseemingpossibilityofgettingsomethingfornothingalsodrew

in the nonmarginal, who also saw the cheap money as their path towealth.Evenifyoucouldn’tgetajob,youcouldgetleverage.By2005,mostborrowers intendedtoresell theproperty theyboughtataprofit.American housing became the province of subprime and speculativeborrowers, not the stable market all the investors envisioned. For themortgagecompanies,borrowers’defaultsdidnotmatter.Thelosswouldbetheproblemnotoftheoriginallenderbutsomeinvestorinadistantcountry.Or an insurer. Unlike the participation certificates of the 1920s,mortgage-backed securities, by the 1990s, had their risks carefullybalanced by insurance policies—or so they thought. Such “creditenhancements” enabled even the riskiest of securities to acquire thevaunted AAA bond rating, making them safe bets for even the mostconservative investors. For traditional insurance companies, theinsurancepoliciesseemedtobeaneasysourceofrevenue.Themarketwasgrowing,unlikethatforlifeinsurance,andtherateofforeclosureswaspredictable,givenacertainrisklevel.Reflectingtheexpectedprofitsofthisnewkindofinsurance,in1998,AmericanInsuranceGroup(AIG),a traditional insurance company dating back to 1919, made a $2.7billion bid for a Miami insurer that specialized in securitizations.StymiedbythelargerbidofitscompetitorCendant,AIGbeganitsownsecuritization insurance operation. Big insurance companies like AIGlookedtosecuritizationasalucrativegrowthfield,pouringmoneyandtalent into it. The insurance policies gave even risky mortgages theappearanceofsafety.Aslongastheinsurancecompaniesguaranteedthebonds,therewasnothingtolose.The credit-rating agencies occupied a bizarre position in this wholesystem. The major rating agencies—Standard & Poor’s, Moody’s, andFitch—competed with one another for the business of rating theircustomers. Inevitablysuchanarrangementwascompromised. If judgeswerepaidmorebydefendantsif theywereacquitted, innocencewouldbe found a shocking percentage of the time. All the credit-ratingagencieshadastrongincentivetohelptheirclientsgetgoodratings.Yetthe ratings were treated as objective facts. Regulators used them toevaluate the investment decisions of pension fund managers. Privateinvestors simply plugged them into their computer models. EveryonebelievedthattherisksassociatedwithAAA,AA,andBBBsecuritieswere

accurate. The same AAA rating given to the United States could begiven,throughinsuranceandsecuritization,tonearlyanygroupofhomeloans.Havingsteadilyrisensince1991,housingpricesbegantoriserapidlyin the late 1990s. Bolstered by the low interest rates intended tostimulate the economy after the technology bubble collapse of 2000,Americans dived in headfirst. For most people, particularly of modestmeans,mortgagesweretheonlykindofleveragetheywereabletoget.Securitization provided endless capital, and investors requiredoriginators to produce more mortgages in which to invest. Thetraditional20percentdownpaymentwasnolongerneeded.Americansonthemakecouldborrowlargesumsofmoneyatalowcostandwatchashousepricesrose.Perhapsencouragedbyalate-nightinfomercial,an“entrepreneur” would take out a $417,000 loan (the maximum for aconformingloan)tobuyahousewithonly5percentdown,or$20,850.If the price of that house rose 10 percent in a year—a number thathappened in many markets and in every house flipper’s head—theflipperwouldresellthehouseandwouldmake$41,700,doublingtheiroriginalmoney.Withleverage,evensmallincreasesinassetpricescouldproduce tremendous increases in returns. Watching those with housesgetrichandbragaboutit,thosewithouthousesboughtin,borrowingtotheverylimitsoftheirbudgets.Nearly extinct since the Great Depression, interest-only balloonmortgages reappeared amid this speculative frenzy. Whereas anamortizedmortgagepaiddowntheprincipaleverymonthasa formofsavings,inaballoonmortgagenoprincipalwasrepaid.Foraspeculator,whoexpectedtoflipahouseandcashouttheincreaseinassetprice,itwas the idealway toborrow.Moreexpensivehousescouldbebought,andleveragecouldbemaximized.With a surging supply of mortgage capital, houses became almostridiculously easy to acquire. A mortgage could be had withoutdocumentation, even if the borrower had a bad credit rating and noincome.Lenders,atthesametime,hadnoneoftheirmoneyontheline.Withnorestraintonthedemandforhousing,pricesexploded.Inshort,the U.S. housingmarket became a speculative bubble. In that bubble,fueledbyeasy credit, howpeopleborrowedmatteredasmuchashowmuchtheyborrowed.Theadjustable-ratemortgage,usedbymosthome

buyersby thepeakof thehousingbubble,made that speculationbothpossible and inevitable. Mortgage lenders happily accommodated anykindofbudget,lendingthemoneyandthenresellingthemortgagetobepackagedasasecurity.Unlikethetraditionalthirty-yearfixedmortgage,most newmortgages of the 2000swere adjustable—not because homeownerswantedARMsbutbecausesomuchofthemarketwasmadeupofspeculators.Bythe2000s,asbankssoughtoutnewcustomers,theadjustable-rate

mortgage was promoted again, but now in a climate of speculationrather than inflation. The introductory rates that had existed in the1980s became more important than the “adjustment” feature. Withintroductoryteaserrates,theinterestrateonaloanwouldautomaticallyincreaseafterayearortwo.Ifhomebuyersboughttothelimitoftheirresources,theyhadonlyafewyearstoeitherresellthepropertyorearnmoremoney.Theshortperiodtoresellthehouseortoearnmoremoneymade these teaser-rate ARMs more like the balloon mortgages of the1920s than like fixed-rate mortgages. Only speculators and optimistscouldsuccessfullycarryoutthescheme.Butashousingpricesrose,thelowerinterestratesofARMsappealedtomoreAmericans,whocouldnotafford the houses that they wanted with the higher-priced fixed-ratemortgages. Adjustable-ratemortgages allowed home owners to borrowto the very limits of their income.The structureof the adjustable ratemortgage, intended to shield lenders from interest rate risk, onlyexposedthemtoanother,worsepossibility.Whowerethespeculators?Theywerefromagenerationthathadfew

other ways to make money. If asset prices were going up, incomesweren’t.Thougheverybody couldnowget credit cards andmortgages,Americans’ income inequalitywas rising,making fewer people able topay back what they borrowed. The Internet economy of the 1990saccelerated thegrowingwealth and income inequalityof the1980s.A1996studybyStandard&Poor’sfoundthatoverthepasttenyears,20percentofworkershadbeenlaidoff,andthough90percenthadfoundjobs,40percentofthenewjobspaidless.40Everyyeargoodjobswereharder and harder to find, particularly for those without a collegeeducation.Buyingandsellingahouserequiredverylittleeducationand,with the securitizedmortgages, very little capital. The combination ofthe stagnating labor market and the go-go housing market was

combustible.Formost people themadness of speculative bubbles is obvious only

afterward. How to tell, in advance, if the rising price of an asset is abubble? The easiest test is profits. Asset prices rise in a competitivemarketbecause theassetsgeneratemoremoney. Ifacompanydoublesitsprofits, itcandoubleitsdividend.Astockholderwhoreceivestwicetheincomefromastockcanexpecttoseethestockdoubleinvalue.Thestockmarketweighsmore factors than dividend yield, but as a roughyardstick, it still works—at least in the long run. Prices can’t rise 10percent forever without a 10 percent rise in profits. In a speculativebubble,pricesrisewithoutariseinprofits.In the run-up to the crisis, careful observers could have noticed an

inconsistencybetweenhousingpricesandAmericans’wages.Pricesrose15percentayear,presumablyfromincreaseddemandforhousing.YetAmericans’incomesdidnotrise15percentayear.Averageincomes,infact, totally stagnated. Perhaps the increasing housing prices resultedfrompopulationpressures?Thoughthepopulationdidgrow, itdidnotgrow15percentayear.Suchalargepopulationshiftcouldbepossiblelocally, as factories opened or closed, as generations rediscovered citylifeorabandoned it,or someother factor,but in thehousingboomofthe 2000s, prices rose nearly everywhere,which demographics cannotexplain. The rising housing prices did not result from either risingincomesorrisingdemographicsbut fromspeculationmadepossiblebylowinterestrates,pureandsimple.Another observation could have been made at the micro-economic

level. If youeverhavehad thepleasureof takingEconomics101,youhave studiedhowsupplyanddemanddeterminemarkets.AdamSmithfirst came up with them in Wealth of Nations, but you would haveprobably learned them from the Nobel Prize–winning economist PaulSamuelsoninhiseconomicstextbook,aptlynamedEconomics,whichhefirstpublishedin1948andwhichcontinuedtobeused—albeitthroughmany editions—until the early twenty-first century. You would havelearned that if prices go up, consumer demand will go down. Thisfeedback between price and demand creates stable markets. In thecoincidence of interest where the price offered by the buyer and thepriceaskedbythesellerintersects,themarketisinequilibrium.Ineveryeconomicsclassroomin theworld, thisequilibriumjustifies themarket

economy. Markets where demand falls as price goes up are self-regulating. It is the oppositemotions of price and demand that createreliablemarkets.ThetroublewithspeculationisthatitflipsthedynamicduoofSmith

andSamuelsonontheirheads.Probablyasyoureadthelastparagraph,youwondered,“Whatifdemandroseaspricewentup?”Suchaquestionis straightforward since it reverses one part of the assumption. Yet inevery version of Economics this thought experiment is soundlydenounced. Economists call these fantasies Giffen goods, after the guywho first asked this question.Aprofessor inEcon101will take abouttwentysecondstodismisstheexistenceofGiffengoods.Impossible!Whywould anyone want something more when the price goes up? Giffengoods undermine the self-regulation of the market. Rather than anegativerelationshipbetweendemandandprice,asinanormalmarket,there would be a positive relationship. As price went up, so woulddemand.Insuchaworld,thebeautifullyself-regulatingmarketwouldrageout

ofcontrol.Theefficientmarkethypothesiswouldfailandpriceswouldbemeaningless,fuelednotbyrealdemandbutbytherisingpriceitself.Thoughthismightnotholdtrue formost things, itdefinitelydescribesspeculative goods. Whether tulips in seventeenth-century Holland orhousing in twenty-first century America, speculative goods are Giffengoods.Andthereisnoequilibrium.Themarketcannotself-regulate.Inmost speculative bubbles, the participants choose to be involved.

Investors in Dutch tulips or tech stocks knew what they were gettinginto, and, in the end,onlyother tulipowners and tech stock investorsgot burned. Speculation in housing, however, affected not just aspecialized niche but the two-thirds of Americans who owned homes.Thoughmosthomebuyersin2005intentionallybetthathousingpriceswouldcontinuetorise,mostofthosewhohadboughthomesin2004or1994or1984hadnotbeenspeculating.Forthem,thespeculationtookholdoftheirmostimportantassetandplayedhavocwiththeirlives.Until2007,housepricesandstockpricesroseinconcert.Debtflowed

freelyfrommortgage-backedsecuritiesintohomes,inflatingprices,andthenhomeequityloansturnedtheinflatedpricesintoawaytoborrowmoreoncreditcards.Americansaddeduptheirdebtsandassetsandstillcameoutahead.Thedebtmatteredlittlebecausenomatterhowmuchit

cost(whichwaslittle,withinterestratessolow),theassetscontinuedtoriseinprice.InvestorswithacavernousappetiteforAAAbondsboughtasmuchdebtas lenderscouldproduce.As longasbothhousingpricesandstockpricesrose,asitseemedtheywouldforever,everythingwouldbefine.Securitizationmayhave transferred interest rate risk from lenders to

investors, but it could not eliminate the greatest source of risk: wageinstability. Since the beginning of the twentieth century, lending hadrelied on the steady incomes of industrial workers. As the postwarprosperity finally ended in the 1980s, older patterns of uncertaintyreappeared.Itwasobvioustolendersthatthegreatestriskinaloanwasaborrower’spossiblejobloss.Professionalslikedoctorsandlawyershadthe lowest risk,while entrepreneurs had the highest risk, even if theyearned the samemoney.41 The important thingwasn’t income but thestability of that income. Small-business owners might have lived verydifferent lives from unskilled laborers, but according to mortgageinsurers, they had the same risk. As Americans’ working lives becamemorevolatile,sotoodidtheircredit lives.Securitizationcouldprovidemore capital, but it could not address the fundamental source ofinstabilityinthecreditsystem.Sowhileindividualslookedovertheir401(k)statementsapprovingly

andheard fromtheneighborshowhousepricesweregoingup,on thetelevisionandinthenewspaperstheykepthearingthatotherpeopledidnot save at all. The numbers that economists generated bore littlerelationship to theactualways inwhichpeople saved,and though thepeopleknewit,themediadidnot.Wheneveryoneisaninvestor,saving,itwasthought,nolongermattered.Aslongasdebtkeptflowing,therewouldnotbeaproblem.Inthefallof2006,theimpossiblehappened.Housingpricesbeganto

fall. As credit-rating agencies began to reassess the safety of the AAAmortgage-backedsecurities,insurancecompanieshadtoponyupgreaterquantitiesofcollateraltoguaranteetheinsurancepoliciesonthebonds.Theglobalcreditmarketrestedonasimpleassumption:housingpriceswouldalwaysgoup.Foreclosureswouldberandomlydistributed,asthestatisticalmodelsassumed.Yetasthosemodels,andthecompaniesthathad created them, began to fail, a shudder ran through the corpus ofglobal capitalism. The insurance giant AIG, which had hoped for so

muchprofitin1998,watchedasitsentirebusiness—bothtraditionalandnew—went down, supported only by theU.S. government. The arcaneoperations of the credit markets spilled out into the larger economy,bringing about the greatest economic downturn since the GreatDepression. The financial crisis began in subprime mortgages, but itquickly spread throughout the economy, as complex financialinstruments betrayed both their inventors and their investors, just astheyhadin1929.Theglobalresaleofdebthadenabledborrowingonascaleunimaginabletotheworldof1929,buttheconsequenceswerealltoofamiliar.

CONCLUSIONTURNINGTHEMAGICOF

BORROWINGINTOTHEREALITYOFPROSPERITY

In 1821, a “Northern Farmer” wrote an impassioned defense of theborrower,callingfortheendofimprisonmentfordebt:“Almostendlessare thewaysbywhichmenbecomepoor.Does itnotoftenarise fromcauseswhichforesightcannotprovidefor,norcareprevent?…Forallamanhasisunderthedominionoffortune.”1Forceslargerthanourselvesareoftenofmoreconsequencethanourownactions.“Thefairtrader,”NorthernFarmercontinued,“whenheembarkshisallonboardaship,knowsnotthatheshallreachhisdestinedportinsafety.Thesearages,and in a moment his goods are gone. Is he a man of fortitude andintegrity?Evenifallthiscanbesaidofhim,itgiveshimnopoweroverelements, and to this providential event he is bound to submit withsilence.”2Today,wearenotasmuchatthemercyofthewatersasatthemercy of capital flows. The difference between them is that we cancontrolcapital.Thoughstanding in silent submissionmighthavemadesenseintheageofmercantilism,inourpresentageofsecuritizationwemustspeakloudlyanddemandchangeinordertoshapeourfate.Whenwe demand change, however, it must be considered in light of howthingshaveactuallyoperatedinthepast.Peoplehaveborrowedandlenttooneanothersincetheinventionof

money, but how Americans borrowed in the twentieth century wasentirelynovel.Formostofhistory,personaldebtwaspersonal.Itexistedbetween twopeoplewhokneweachother.With thebeginningsof theresale of debt, from installment credit andmortgages in the 1920s, anew, impersonal relationshipdeveloped.Debtcouldbe traded likeanyother commodity. Character, perhaps the most personal description

imaginable, became abstracted into a credit score. Buying and sellingdebt became a specialist’s task. The debt itself remained tied to theoriginal purchase of cars, televisions, or houses. In the 1970s, thisspecialized network of resold debt was transformed again withsecuritization,whichmadedebtlooklikeanyotherformofsecurity.Abond backed by credit card debt or mortgage debt could not be toldapart from any other corporate bond. Consumer debt had becomeinterchangeable. Easy to invest in, the supply of money for consumercreditreachedunprecedentedlevels.Thetechnical,proximatecausesofthe financialcrisisareperhaps less important than the long-termshiftsin thedebt economy thatmade thempossible. Easy access to credit isneitheragoodthingnorabadthing;itdependsoncontext.Creditisjustone part of American capitalism. On the one hand, in the context ofrisingincomesandstablejobs,borrowingenabledpostwarAmericanstorealize their material dreams—years before they could have saved upenoughmoneytodoso.Gettingwhatyouwantnow,withoutsavingforit,shouldmattertoall-too-mortalconsumers.Iwouldnotwanttowaituntil Iwas sixty years old to havemy first dishwasher.One the otherhand, encumbering oneself with debt when income is uncertain orstagnantcanmakeborrowinglessanopportunitythanashackle.AsthevolatilityofAmericancapitalismreturnedinthe1970s,consumersreliedmoreonthemselvesthaneverbefore.Thereturnofeconomicinequality,all too familiar before World War II, had collided brutally with easyborrowing made possible through resellable debt. Hemmed in by lowwagesAmericanslookedforleverageintheonlyplacethattheycould—throughhomemortgages.Eventhosewhodidnotspeculateenjoyedtherisinghomeprices,cashingoutallthatexcesshomevaluethroughhomeequityloansandusingthemoneytopayofftheircreditcards.By the summerof2009,punditsandpolicymakersclaimed that theworstofthecrisiswasover.TheNationalBureauofEconomicResearch,whichdetermineswhenrecessionsbeginandend,announcedthatsinceGDP growth had returned, the crisis was over. The stock market hadregained a lot of lost ground. Unemployment growth had slowed.Housingprices,inmanymarkets,wereactuallyincreasing.Superficially,AIGandtherestofthesecuritizationinstitutionswerefunctioningagain.Thehundredsofbillionsofdollarsshotintotheeconomytopropupkeyfinancialinstitutionsappearedtohaveworked.

Yet today the underlying financial practices that enabled the crisisremain unfixed. Financial institutions and instruments are largelyunchanged.Credit-ratingagenciescontinuetooperateunregulated,theirAAA ratings as uncertain as they were before the crash. Mortgagelenders,thoughcurrentlyunderscrutiny,haveonlytowaitforthenextopportunitytoenablespeculation.Adjustable-ratemortgagesandteaserrates still lure people to budget themselves into bankruptcy.Securitizationallowsloanstooccurwithoutlendersputtinganyoftheirowncapitalatrisk.ButthesefinancialpracticesareonlytheechooftherealprobleminAmerica.Thestructuralconnectionbetweeneconomicinequalityandthecrisisremainsignored.Thedangerousinvestmentchoicesthatprecipitatedthecrisis are but a symptom of this underlying cause. Income stagnationcontinues,pushingAmericanstowardgreaterborrowingandlesssaving.Manyofthosewholosttheirjobsinthecrisisremainunemployedbutgouncounted since they have run out of benefits and haven’t looked forwork in the last two weeks (which is how the government measuresunemployment). Even those who have found work have often had toaccept lower wages. The media celebration of McDonald’s NationalHiringDayinearly2011speakstohowfarwehavedriftedfromFord’sfive-dollarday.Evenforthosewithjobs,incomeinterruptionsremainasdangerousas ever, asunemployment times lengthen.Sincehealth careinsuranceistiedtoemployment,illnessandjoblosscancontinuetobeadouble whammy. Compared to Europe, the limited welfare state haspushedAmericanstoborrowtobridgeunemploymentandpayforhealthcare.Evenforthosewithjobs,healthcareinsuranceremainsexpensiveand,forthemillionsofuninsuredorunderinsured,remainsakeycauseofbankruptcy.Thoughotherindustrialnationsallowtheircorporationstofocusonprofitability,weforceourbusinessestoactasmini–welfarestates, inefficiently tasking them with what should be a nationalconcern.Meanwhile, as those at the bottom hang on, profits continue toconcentrateatthetop.Withoutagoodalternative,capitalcontinuestobeinvestedinconsumerdebt.Itismoreimportanttoaskwhytherewasso much money to invest in mortgage-backed securities than to askabouttheparticularsofhowthoseinvestmentswentawry.Don’taskjustwhy Americans borrowed; ask why our financial institutions lent! To

avoidthiscalamity,wemustnotpretendthatbysendingsometraderstoprisonwe have rectified the economy. The crisiswas caused not by afew individualsbutby the structures inwhich those individuals acted.Mortgagebankerslenttopeoplewhocouldnotpaybackthemoney,butitdidn’tmatterbecauseinvestors,notbankers,wouldbeleftholdingthebag.Wemust askwhy these individualsmade the choices theymadeand why those choices had such power over our lives. Changing thestructureof lending,whiledifficult, is far easier than changinghumannature.Thefragilerecoverywenowenjoywillwiltagainassoonasinterest

rates rise. We are only in the eye of the storm. Though the Fed haspromisedtokeeptheprimeinterestratenearzero, inthe longrunthegovernment must raise the interest rate, and when it does the trueweaknessofoureconomywillberevealed.Atonce,theadjustable-ratemortgages still extant will suddenly go up. Credit card rates, nowadjustable as well, will rise. Minimummonthly payments will add tohigher mortgage payments, pushing people beyond the limits of theirfragile budgets. Americans will default at rates that will make thecurrentcrisislooklikeafoothilltotheRockies.The solution to all these complex problems is surprisingly simple:

investment. Investors, entrepreneurs, and corporations all lackproductive places in which to put their money. Productivity andprofitabilityarenotalignedbecausefinancialinstrumentsmakeiteasierto invest in consumer debt than in business debt. Consumers borrowbecause it is cheap and easy to borrow, but lenders give themmoneybecause it is profitable. Investors,without new companies inwhich toinvest,putmoneyintomortgage-backedsecurities,inflatingthehousingmarket.ForGeneralElectricandCitigroup,itismoreprofitabletolendmoneyoncreditcardsthantogiveloanstosmallbusinessesorevenbigbusinesses.Capital that inanother timewouldhavebeenput intonewenterprises, creating jobs and raising incomes, instead goes intoconsumer credit. This has happened not because capitalism has failedbut because it has been so successful. Global capitalism has been soprofitable that there is now an overabundance of capital in theworldandtoofewplacesinwhichtoputit.Asworkers,Americanshaveseenthat efficient capital operate with cheaper and fewer workers, cuttingincomes. As consumers, Americans have access to cheap capital to

borrow.Consumercreditisnecessaryformoderncapitalismtofunction,but the excessof capital allowed to format thevery top is starting toinhibit the growth of the economy. High tax rates, like those we hadduringthepostwarprosperity,putmoneyinthehandsofconsumersandthe government to spend. Since the Reagan administration, those taxrates have been falling. The justification of our low tax rates today isthatthewealthywillinvesttheirsavingsandgrowtheeconomy.Insteadthat wealth has been invested in speculation, destroying capital andhamperinggrowth.Ifthatcapitalwereinvestedinbusinessesandnotinconsumerdebt,thelowtaxratescouldbejustified.Consumerborrowinghascrowdedoutbusinessborrowing.Thekeyquestionis,then,howcanweenablegoodinvestmentwhilekeepingtaxrateslow?AsintheGreatDepression,thegovernmenthasthecapacityandtheresponsibility to create new opportunities for investment, while notspending themoneydirectly.Thegovernment can’t replace capitalism,but it can guide it. Waiting and hoping that financiers will sortthemselves out is the most dangerous form of delusion. New Dealregulation set limits on financial innovation—eliminating participationcertificates and balloon mortgages—and with limited opportunity forfinancial profits, American capitalists turned to producing the bestproductsand theservices in theworld.Financewasmade to serve therealeconomy,nottheotherwayaround.Theprosperityofthepostwarperiod,builtondebt,restedultimatelyonstrongregulationsabouthowtousecapitaltofundthatdebt.Borrowingmustplayanimportantpartin the economy, but it must be an ancillary part. When it is moreprofitabletobuildanelectriccarthantoinvestinacreditcard,wewillknow that this crisis is over. Helping create new investmentopportunities, as the federalgovernmentdidwith the formationof theaerospace and electronics industries, is the best way to divert capitalawayfromspeculatorsandintothehandsofentrepreneurs.Thoughbothare necessary, a carrot moves capital far better than a stick. Now asthen, we must pull together and make capitalism work for us, as anation. And today we have an opportunity to force finance to againsupportproduction.ThoughthenewConsumerFinanceProtectionBureauisagoodidea,we shouldbewaryof regulation that says “no” rather than“yes.”Thehistory of U.S. finance shows that the carrot has always been more

successfulthanthestickinaligningtheinterestsofcapitalwiththoseofsociety. The FHA, for instance, was successful because it channeledprivatecapitalintohousingatatimewhenmanypeoplelivedinhovels.ThoughwemightdebatetheneedforFHAloanstoday,theyweremostcertainlyneededinthe1930s.Asimilarlogicmustbeemployedtoday.Today we need jobs, not houses. We need to unleash our country’sentrepreneurialspirit.Regulationintendedtofixthefinancialcrisisthatlooksonlyat theborrowerandnot at the lendermisses thepoint.Wemustaskwhyinvestorsprefertoputtheirmoneyintoconsumerdebtinthe firstplace.Thetroublewithsecuritizationwasn’t thebonds, itwasthe mortgages. Creating a demand for mortgage-backed securitiespushedbrokerstoscourthelandfornewhomebuyers.Weneedawayto push brokers to scour the land for business opportunities and thengive them away tomeasure the opportunities against one another. Itbecame easier to lend mortgage money than make business loans.Securitization needs to be a mechanism that encourages money to beinvested in productive businesses, not consumer debt. Houses produceno value. Securitization is potentially themost powerful financial toolinventedinthetwentiethcentury,andwehavebeenusingittochannelourcapitalintosupersizedshoes,notshoefactories.Thesolutiontothecrisis must address the intertwined problems of securitization, creditrating,andbusiness investment.Tosaveoureconomy, itmustbecomeeasierforinvestorstolendtosmallbusiness.Economicgrowthissmallbusinessgrowth.We need to create two federal agencies. The first—let’s call it the

BureauofBusinessSecurity—willevaluatebusinessesthesamewaythattheFHAcreatedstandardsforhouses.Thesecondwillbeaninstitutionto coordinate the secondary market for the securitization of businessloans—let’s call that one Bobby Mac. Houses are all unique, as arebusinesses,butunlikeforhouses,wealreadyhaveacommonvocabulary—accounting—todescribefirms.EverydayWallStreetanalystsevaluatethefuturerisksandreturnsofbusinessesintheevaluationofstocksandbonds.Thebureauwouldsimplydothesame.Thebureauwouldcreatestandards to evaluate a business as the FHA created standards toevaluatehousing.Suchstandardswouldsolvetwoproblems.Theywouldenableamoretransparentevaluationofthosecompanies’creditratings,which were one of the core problems of the crisis. It would, more

importantly, enable business investment to be carried out throughsecuritization.Whatcanbegradedcanbetraded!Nodoubttherewouldbeobjectionstoafederalprograminvestigating

all businesses. As with FHA loans, businesses could opt not toparticipate.Largefirmswithsufficientborrowingpower,suchasGeneralElectric, would probably opt out. Businesses that refused to beinvestigatedwould simply not be able to securitize their debt throughBobbyMac.Andtherewouldbebusinesses,likehouses,thatwouldnotbeabletosecuritizetheirdebt.Notallbusinesseswillbeabletobepartofthesystem.Butformostbusinessowners,likemosthomeowners,thecapitalwillmakeitpossiblefortheirdreamstocometrue.I suspect that the prospect of cheap borrowing would be quite a

powerful carrot to make American business more transparent. On thestick side, potential investors would begin to demand that businessesprovidetheinformation.Securitizationwouldbemostimportantforallsmall and midsize companies, where the real growth potential in theeconomy resides. Many businesses fail, as many mortgages areforeclosed, but through risk management and federal standards, thebondscouldhandlethatpossibility.Withgoodinformation,ratingthosecompanies would be more accurate and transparent. Unlike privatecredit-rating agencies, thebureau’s futurewouldnotdependongivingbusinesses a good review. With a diversified portfolio of businessinvestments, risks for investors would go down. Business investmentwouldn’tbetheprovinceofafewmillionairesandtheirprivateequity;it couldbedonebyaverageJoeswith theirpension funds.Howmuchbetter would the world be if workers’ pension funds were invested inactivitiesthatproducedjobsinsteadofMcMansions?Regulationdoesn’tneed to tell firmswhat todo,but itdoesneed to

providethetransparencyforinvestorstoactwiselyandtohelpmarketsmaketechnologicaltransitionswhenthereisagreatdealofchange.U.S.housingmarkets continue to requireFannieandFreddieandGinnie toclear their secondarymarkets. Public institutions, such as BobbyMac,wouldmakeprivatesolutionspossible.Privateenterprisecannotcreateasecondarymarket forsecuritizedbusiness loansanymorethanitcouldcreate a secondarymarket for housingmortgages. Government cannotdictatetheeconomy,butbusinesscannotfunctionwithoutitsstructures.Ifwearetopreventthiscrisisfromgettingworse,weneedtoaddressits

fundamental causes. A Bureau of Business Security would accomplishthisgoal,puttingtheUnitedStatesonapathtogrowthandprosperity.ABureauofBusinessSecuritywouldbootstrapus toa levelofprosperitythat isas incomprehensible todayas thepostwarprosperitywas to theDepression.Gooddebt andbaddebthavenothing todowith thedebt itself butwhatrolethatdebtplaysinoureconomy.Commonsenseoftenfailsuswhenitcomestodebtbecausewethinkofitinmoralterms.Budgetingand borrowing with “good” forms of debt, such as mortgages andstudent loans, we judge ourselves—and others—for their “bad” use ofcreditcards.Seeingthewaysinwhichdebthastransformedusgivesusa sense of how themeaning of debt depends on its historical context.And everyone involved in debt, whether of the personal, business, orgovernment variety—which is to say every citizen of this country—isresponsiblefortheconversationastohowwewillstructuredebtwithinoursociety,howwecanencourageittoserveasabeneficentgenieinabottle,which itundoubtedlyhasbeen,asopposedtoanevilPandora’sbox, which it just as surely has been as well. Debt, along with everyotheraspectofcapitalism,issomethingthatwehavecreatedandhavethecapacitytomaster.

NOTES

INTRODUCTION:EVERYTHINGOLDISNEWAGAIN

1.WilliamH.Whyte, “Budgetism:Opiateof theMiddleClass,”Fortune,May1956,133.

CHAPTERONE:WHENPERSONALDEBTWASREALLYBUSINESSDEBT(2000B.C.–A.D.1920)

1. Household Finance Corporation, It’s Your Credit Manage It Wisely(Chicago:privatelyprinted,1970),7.

2.BruceMann,RepublicofDebtors(Cambridge:HarvardUniversityPress,2002),chapter3.

3.WilliamCronon,Nature’sMetropolis (NewYork:W.W.Norton,1992),319.

4. Fifth Annual Report of the Bureau of Labor and Industrial Statistics(Lansing,Mich.:1888),391.

5.HaroldWoodman,KingCottonandHisRetainers(Columbia:UniversityofSouthCarolinaPress,1968),282–286.

6.Ibid.,81.7. Pete Daniel, The Shadow of Slavery (Chicago: University of IllinoisPress,1990).

8. Asian immigration had been severely restricted since the passage oftheChineseExclusionAct.Africanimmigrationwasnonexistent.

9. “SecretaryMissing,$40,000Gone,Too,”TheNewYorkTimes,March16,1928,39.

10.FederalTradeCommission,ReportoftheFederalTradeCommissiononHouse Furnishings Industries, vol. 1, January 17, 1923 (Washington,D.C.:GPO,1923),16.

11. Louise Conant, “The Borax House,” American Mercury, June 1929,169.

12.LegalAidSociety,Fifty-fourthAnnualReportofthePresident,TreasurerandAttorneyoftheLegalAidSocietyfortheYear1929,AnnualReport1929,47.Inballoonmortgages,buyerspaidonlytheinterestonthemortgage with the intent of paying off the principal in its entiretywhenthedebtcamedue,whichinpracticehappenedinfrequently.

13. “LoanSharkTellsBusinessTricks; FoiledbyBureau,”ChicagoDailyTribune,February9,1912,1.

14. William Shepherd, “They Turn Your Promise into Cash,” Collier’s,February19,1927,8.

15. Lendol Calder, Financing the American Dream (Princeton, N.J.:PrincetonUniversityPress,1999),120.

16.Ibid.,121.17.Ibid.,130.18. Archie Chadbourne, “Debt Is the Only Adventure a PoorMan CanCountOn,”AmericanMagazine104,December1927,45.

19.Calder,FinancingtheAmericanDream,130.20. Joseph Budnowitz, “Pawnbroking: A Treatise on the History,Regulation,LegalDecisionsandaComparisonwithOtherSmallLoanAgencies”(lawthesis,ColumbiaUniversity,1931),folder“Levine:TheLaw of Pawnbroking, box 1, Russell Sage Foundation Papers,Manuscript Division, Library of Congress, Washington, D.C., 38(hereafterRSF).

21. Reginald Smith, The Facts About the Small Loan Business and theScientific Rate of Fair Charges (New York: Legal Reform Bureau toEliminatetheLoanSharkEvil,1922),folder“InterestGeneral,”box1,RSF.

22.“SmallLoansPutat$2,600,000,000,”TheNewYorkTimes,April27,1930,44.

23. Martha Olney, “Avoiding Default: The Role of Credit in theConsumption Collapse of 1930,”TheQuarterly Journal of Economics,February1999,322.

CHAPTERTWO:EVERYBODYPAIDCASHFORTHEMODELT(1908–1929)

1. William Shepherd, “They Turn Your Promise into Cash,” Collier’s,February19,1927,52.

2.DavidHounshell,FromtheAmericanSystemtoMassProduction,1800–1932(Baltimore:JohnsHopkinsUniversityPress,1984),218.

3. Quoted in Douglas Brinkley,Wheels for the World: Henry Ford, HisCompanyandaCentury of Progress, 1903–2003 (NewYork:Penguin,2004),153.

4. Quoted in Allan Bogue, “The LandMortgage Company in the EarlyPlainsStates,”AgriculturalHistory,January1951,24.

5. Henry Ford,My Life and Work (New York: Garden City Publishing,1922),40.

6.GeneralMotorsCorporation,AnnualReport,1922,6.7.Ford,MyLifeandWork,103.8. This argument is derived from Lawrence Glickman, A Living Wage:AmericanWorkers and the Making of Consumer Society (Ithaca, N.Y.:CornellUniversityPress,1999).

9. Alfred Chandler, Strategy and Structure: Chapters in the History of theIndustrialEnterprise(Cambridge:MITPress,1962),114–130.

10.GeneralMotorsCorporation,AnnualReport,1924,9.11.GeneralMotorsAcceptanceCorporation,AnnualReport,1927,1.12.GeneralMotorsCorporation,AnnualReport,1926,9.13.Ibid.,22.14.Ibid.,15.15. National Automobile Chamber of Commerce, “AutomobileManufacturing Conducted Almost Entirely on Its Own Capital,”December 15, 1925, Historical Collections, Baker Library, HarvardBusiness School, Allston, Mass. (hereafter BAK), 2. Capitalcalculationsbyauthor.

16.Shepherd,“TheyTurn,”52.

17.Hounshell,FromtheAmericanSystem,276.18.FordWeeklyPurchasePlan,Advertisement,LosAngelesTimes,April8,1923.

19. “The Jewish Bloc in Mr. Ford’s Presidential Path,” Literary Digest,August25,1923,49.

20. H. G. Andrews, “Henry Ford—Wall Street’s Shock-Absorber,” TheNation,January24,1923,93.

21.“HenryFord’sApologytotheJews,”Outlook,July20,1927,372.22.GeneralMotorsCorporation,AnnualReport,1929,20.23.Toaddinsulttoinjury,aseriesofcourtdecisionsbannedtheformalaffiliationofFordandChryslerwithanyfinancecompany.GMfoughtthe decisions and managed to hold on to GMAC, as the lone carmanufacturerwithacaptive financecompany,until the1950s.PaulBanner, “Competition, Credit Policies, and the Captive FinanceCompany,”TheQuarterlyJournalofEconomics,May1958,258.

24. J. George Frederick, “Dollar-Down Serfdom,” The Independent,September11,1926,299.

25. James Couzens, “Should We Stop Instalment Buying?,” Forum andCentury,May1927,655.

26.WilliamPost,Character,theBasicRockFoundationoftheFourBigC’sintheExtensionofCredit([Philadelphia]:1920).

27.“CreditandCharacter,”SaturdayEveningPost,July28,1928,1.28.C.ReinoldNoyes,“FinancingProsperityonNextYear’sIncome,”YaleReview,January1927,227.

29.Ibid.,242.

CHAPTERTHREE:FANNIEMAECANSAVEAMERICA(1924–1939)

1. Julius Gregory, “What Is Home Without a Mortgage?,” House &Garden,December,1931,68.

2. Oliver McKee, “Helping Our Home Owners,” National Republic,September1932,1.

3.W.C.Clark,“TheConstructionIndustry:Outlookfor1930,”ReviewofEconomicsandStatistics,February1930,23–29.

4.“RisingResidences,”Time,November25,1935.5.Ibid.6.William Stoddard, “Investing in Homes,”The Outlook, July 8, 1925,374.

7.Herrick&Bennettadvertisement,Scribner’s,October1918,65.8.“IssueofMortgageParticipatingCertificatesbyMemberBanks,”June15,1946,“MrHammondtoFederalReserveBoard,” folder430.1–2,Issue& Sale ofMortgageParticipatingCertificates by StateMemberBanks, box 2006: 430.1–2 1925–1946 to 430.1–17 1937, RG 82,NationalArchives,CollegePark,Md.(hereafterNARA).

9.“IssueofMortgageParticipatingCertificatesbyMemberBanks,”June15,1946,“NorbetttoBoothe,March16,1938,”folder430.1–2,Issue&SaleofMortgageParticipatingCertificatesbyStateMemberBanks,box2006:430.1–21925–1946to430.1–171937,RG82,NARA.

10.“IssueofMortgageParticipatingCertificatesbyMemberBanks,”June15,1946,“MrHammondtoFederalReserveBoard.”

11.Ibid.,2.12.Ibid.,7.13.FarmMortgageBankersAssociationofAmerica,SpecialBulletin,no.97,Science, IndustryandBusinessLibrary,NewYorkPublicLibrary(hereafterSpecialBulletin).

14.H.ThomasJohnson,“PostwarOptimismandRuralFinancialCrisisofthe 1920s,” Explorations in Economic History, Winter 1973–74, 173–192.

15. Lee Alston, “Farm Foreclosures in the United States During theInterwarPeriod,”JournalofEconomicHistory,December1983,891.

16.Ibid.,888.17.Ibid.,894.18.SpecialBulletin,no.99,2.19.SpecialBulletin,no.101,2.20.SpecialBulletin,no.102.21. “Denies Inflation inBuildingHere,”TheNewYorkTimes,December22,1925.

22.SpecialBulletin,no.105,2.23.Ibid.24.NugentDodds,“TheMortgageRacket,”Collier’s,September5,1931,16.

25. “Getting Away from the Short-Term Mortgage,” Literary Digest,September16,1933,37.

26. “Sins of the Mortgage Bonds Are Visited on the Building Field,”BusinessWeek,October19,1930,11.

27. Hammond, Division of Bank Operations to Federal Reserve Board,“Mortgages,etc.SoldbyMemberBanks,”folder430.1–2,Issue&Saleof Mortgage Participating Certificates by State Member Banks, box2006:430.1–21925–1946to430.1–171937,RG82,NARA,2.

28. Only 16 percent of banks offered mortgage bonds, but in thecollapsingsample30percentofferedsuchbonds;thustheyhadtwicetherate.

29. Hammond, Division of Bank Operations to Federal Reserve Board,“Mortgages,etc.SoldbyMemberBanks,”3.

30.HerbertHoover, “Address to theWhiteHouseConferenceonHomeBuilding and Home Ownership,” December 2, 1931, in John T.Woolley and Gerhard Peters, The American Presidency Project[online].SantaBarbara,Calif.http://www.presidency.ucsb.edu/ws/?pid=22927.

31. Eleanor Roosevelt, “I Answer Two Questions,” Women’s HomeCompanion,December,1933,24.

32. Josephine Lawrence, If I Have Four Apples (New York: FrederickStokes,1935),75;nowforgotten,IfIHaveFourAppleswasaNewYorkTimes best-selling novel for most of 1936 and a Book-of-the-MonthClubselection.TheNewYorkTimes,February2,1936,December29,1935.

33.Lawrence,IfIHaveFourApples,73.34.Ibid.,17.35.Ibid.,44.36. See Michael Bernstein, The Great Depression: Delayed Recovery andEconomic Change in America, 1929–1939 (Cambridge, England:Cambridge University Press, 1989), for what I think is the bestexplanationofthecrashandtherecovery.Alsosee“ReviewsTheoriesonSlumpRemedies,”TheNewYorkTimes,September4,1932.

37.“EconomicAbusesBlamedforCrisis,”TheNewYorkTimes,December4,1932.

38.Ibid.39. “Text of the Address by Ogden. L. Mills,” The New York Times,January26,1932.

40.MaxNahm,“DebtandDepression,”CreditandFinancialManagement,September1935,12.

41. Rolf Nugent, “Installment Selling Proves Itself as GoodMerchandising,”Printers’Ink,May1932,folder“1927–1934General,”box166,RSF.

42.“InstallmentCreditHeldSuccessful,”TheNewYorkTimes,August1,1930.

43.“DefendsTimePaymentSales,”TheWallStreetJournal,May1,1931.44. Milan Ayres, “Rapid Amortization Produces Stable InstallmentCredits,” Bankers Monthly, January 1932, folder “1927–1934General,”box166,RSF.

45.“Dr.KleinDefendsInstallmentSales,”TheNewYorkTimes,May18,1931.

46.EconomicReportofthePresident1969(Washington,D.C.:GPO,1969),228; Federal Reserve, Twenty-fifth Annual Report of the Board of

GovernorsoftheFederalReserveSystemCoveringOperationsfortheYear1938(Washington,D.C.:GPO,1939),23.

47.Lawrence,IfIHaveFourApples,104.48.Ibid.,4.49.“Industry:BigPush,”Time,August28,1933.50. FDR to James Moffett, folder Correspondence Between StateGovernors and Pres. Franklin D. Roosevelt Concerning FHALegislation 1934–1935, box 1 A1, entry 11, RG 3, Records of theFederalHousingAdministration,NARA.

51.“Housing:Trouble;NoTrouble,”Time,December3,1934.52.“Milestones,Feb.8,1937,”Time,February8,1937.53.“HousingTrouble;NoTrouble.”54.“Business:FancyMortgages,”Time,September30,1935.55. “Sees ‘RentDole’ in PublicHousing,”TheNewYorkTimes,October28,1934.

56. Walter Schmidt, “Complete Recovery of Building Industry,”ArchitecturalRecord,November1934,317.

57.“ThePresidency:BigKitty,”Time,April22,1935.58. Federal Housing Administration, First Annual Report (Washington,D.C.:GPO,1935),18.

59. SeeThomasSugrue,TheOrigins of theUrbanCrisis (Princeton,N.J.:Princeton University Press, 1996) for more on the history of racialsegregationandmortgages.

60.“People,May2,1938,”Time,May2,1938.

CHAPTERFOUR:HOWILEARNEDTOSTOPWORRYINGANDLOVETHEDEBT(1945–1960)

1. Lynn Spigel,Welcome to the Dreamhouse (Durham: Duke UniversityPress,2001),49–50.

2. JohnGribbon, “ANewApproach toCredit,”CreditManagementYearBook,1961–1962 (NewYork:NationalRetailDryGoodsAssociation,1961),10.

3.ThecorrectLatinisactuallyinlocomariti.4. “Prize Answers to Question Whether Husbands or Wives Are MoreExtravagant,”TheWashingtonPost,February14,1915,E3.

5.“WhatIfYouDon’tPayYourBills?”ChangingTimes,November1953,20.

6.“BeatingtheHighPriceofCoffee,”ChangingTimes,July1954,15.7.FrederickWalter,TheRetailChargeAccount(NewYork:RonaldPress,1922),41.

8. Bloomingdale’s advertisement, The New York Times, November 28,1947,18.

9.Bloomingdale’sadvertisement,TheNewYorkTimes,December2,1946,7.

10.RobertWallace,“PleaseRemit,”Life,December21,1953,42.11.“ChristmasatMacy’s,”Life,December13,1948,91.12.A&Sadvertisement,TheNewYorkTimes,November15,1954,9.13.Wallace,“PleaseRemit,”51.14.“DinerClubStuntUpsEateries’Take,”Billboard,August5,1950,40.

CHAPTERFIVE:DISCOUNTEDGOODSANDDISTRIBUTEDCREDIT(1959–1970)

1.LauraRowley,OnTarget (Hoboken,N.J.: JohnWiley&Sons,2003),117.

2. Carl Ryant, “The South and the Movement Against Chain Stores,”JournalofSouthernHistory,May1973,207–222.

3.“RetailTrade:BlowAgainstPrice-Fixing,”Time,June4,1951.4. Solomon Sherman, “Whither Fair Trade Laws? An Appraisal of theUnited States Supreme Court Position in the Light of Lilly v.Schwegmann,” American University Law Review, December 1953, 22–26.

5.Quoted inDavidRachman, “What LiesAhead for theDiscounters?,”Discount Operators National Show, Modern Retailer’s SeminarProceedings, 1961; Malcolm McNair, “The American DepartmentStore, 1920–1960: A Performance Analysis Based on the HarvardReports,” Bureau of Business Research Bulletin no. 166, HarvardUniversity(1963):BAK,25.

6. “Are Fair Trade Laws Obsolete?” Kiplinger’s Personal Finance, June1974,36.

7.GeraldFord,“StatementontheConsumerGoodsPricingActof1975,”December 12, 1975, American Presidency Project,www.presidency.ucsb.edu/ws/index.php?pid=5432.

8.PerryMeyers,ProfileofaNewMarketPlace:APilotStudyofDiscountStoreCustomers,August1961,appendix,“MostFrequentlyMentionedAdvantagesandDisadvantagesofDiscountStores.”

9.Rachman,“WhatLiesAheadfortheDiscounters?,”40.10.Meyers,Profile,i–iii.11.Ibid.,iii.12. Brecker, Discount Operators National Show, Modern Retailer’sSeminarProceedings,1961,130.

13.Ibid.,161.

14.“TheGEMStory:PartOne,”DiscountMerchandiser,January1962,15.15. “Target’s New Thrust and What It Takes,” Discount Merchandiser,April1969,59.

16.Meyers,Profile,iv.17.“LifeStudy,”DiscountMerchandiser,June1962,64.18.Meyers,Profile,appendix.19.Ibid.,vi.20. “The True Look of the Discount Industry: 1961,” DiscountMerchandiser,July1962,27.

21.“MiracleatKresge’s,”DiscountMerchandiser,December1964,39.22. “Sales of the Top 52 Companies,” Discount Merchandiser, January1968,28-TL.Targetwasranked21st,SchwegmannBros.35th,Caldor37th,andWal-Martwasstillnowheretobefound.

23. Goodman, Discount Operators National Show, Modern Retailer’sSeminarProceedings,1961,135.

24.Only5percentofstoreswereinshoppingcentersin1967.“The$100MillionClub,”DiscountMerchandiser,January1968,36-TL.

25.Meyers,Profile,10.Percentagesreconstructedfromdataintable2.26. The Gap, 10-K, 1977, F-2. Accounts receivable made up only 2percentofcurrentassets.

27.Ibid.,2.28.Ibid.,3.29.Ibid.,18.30.TheGap,AnnualReport,1977,4.31.LouisNevaer,Into—andOutof—TheGap:ACautionaryAccountofanAmericanRetailer(Westport,Conn.:QuorumBooks,2001),19.

32.Ibid.,21.33.Ibid.,37.34. “Caldor: Sales Are Good Close to Home,” Discount Merchandiser,October1963,36.

35.“109LeadingDiscounters,”DiscountMerchandiser,July1963,30–31.

36. “Credit Is Nice but It Can Cost You,” Discount Merchandiser, July1965,44–45.

37.BernardKorn, “AllAboutCreditPlans,”DiscountMerchandiser,May1962,58.

38. “Not Everyone’s Pushing Own Cards,” Chain Store Age Executive,January1977,26.

39.Exceptgrocerystores.“ShareofMajorRetailSalesbyTypeofStore,”DiscountMerchandiser,June1966,63.

40. “Why Big Stores Are Taking Outside Credit Cards,” BusinessWeek,September3,1979,134.

41.SRAC,AnnualReport,1967.42.“TakeOvertheCountry,”BusinessWeek,August4,1975,53.43.“LinksinaChain,”TheWallStreetJournal,March8,1977,1.44. Ibid., 1. Kmart also leased its properties, rather than buy themoutright,sinceitsscarcecapitalwasbetterputintomerchandisethanland.

45.“S.S.Kresge’sChairmanTalksonDiscounting,”DiscountMerchandiser,January1968,107.

CHAPTERSIX:BRINGINGGOODTHINGSTOLIFE(1970–1985)

1.“BankintheBillfold,”TheWallStreetJournal,December1,1965,1.2. JosephMiraglia, “My $10,000 Credit Card Binge,” Life, October 26,1959,53.

3.“HighFinance:FunontheCard,”Time,October19,1959.4. Joseph Plummer, “Life Style Patterns and Commercial Bank CreditCardUsage,”JournalofMarketing,April1971,37.

5. Subcommittee on Financial Institutions, Committee on Banking andCurrency,Senate,BankCredit-CardandCheck-CreditPlans,90thCong.,2ndSess.,October9–10,1968,277.

6.“BankintheBillfold.”7.BankCredit-CardandCheck-CreditPlans,273.8.Ibid.,266.9.MatthewsandSlocum,74.10. Calculation by author based on Bank Credit-Card and Check-CreditPlans,quotedinWeistart,“ConsumerProtection,”footnote28.

11.“BankintheBillfold.”12.Ibid.13.Ibid.14.BankCredit-CardandCheck-CreditPlans,325.15.Ibid.,66.16. “Bank of America Plans Nationwide Licensing of Its Credit Cards,”TheWallStreetJournal,May25,1966,7.

17.Ibid.18. John Weistart, “Consumer Protection in the Credit Card Industry:Federal Legislative Controls,” Michigan Law Review, August 1972,1479.

19.“Chicago’sCreditCardCrisis,”BusinessWeek,July15,1967,35.20. Harold Taylor, “The Chicago Bank Credit Card Fiasco,” Banking,Winter1968,52.

21.“Chicago’sCreditCardCrisis.”22.Taylor,“TheChicagoBankCreditCardFiasco,”50.23.BankCredit-CardandCheck-CreditPlans,64.24.Ibid.,19.25.BankCredit-CardandCheck-CreditPlans,290.26. PaulO’Neil, “A LittleGift fromYour Friendly Banker,”Life,March27,1970.

27.“HowaLouisvilleBank,HardlyaGiant,HasBecomeHugeinCreditCardField,”TheWallStreetJournal,September6,1972,5.

28.Taylor,“TheChicagoBankCreditCardFiasco,”50.29.“DoYouReallyBenefitfromBankCredit-CardPlans?,”BetterHomesandGardens,November,1967,6.

30.“BuyNow,PayNever,”TheWallStreetJournal,November18,1970,1.

31. Irwin Ross, “The Credit Card’s Painful Coming-of-Age,” Fortune,October1971,111.

32.“DebateoverMagneticTapeCreditCardFueledbyContestonHowtoDefraudIt,”TheWallStreetJournal,April13,1973,7.

33.BankCredit-CardandCheck-CreditPlans,31.34.Ibid.,44.35.Ibid.,64.36.DanielCowans,“PresentBankruptcyActDefective,”quoted inBankCredit-CardandCheck-CreditPlans,53.

37.BankCredit-CardandCheck-CreditPlans,65.38. H. Lee Matthews and John Slocum, “Social Class and CommercialBankCreditCardUsage,”JournalofMarketing,January1969,73.

39.Ibid.,76.40. “Californians Charging Away,” The Wall Street Journal, March 15,1968,32.

41.Ibid.42.“BanksTrustJoinsBankAmericardPlan,WillIssueCardsin’69,”The

WallStreetJournal,November4,1968.43.BankCredit-CardandCheck-CreditPlans,284.44.Ibid.,260.45.TheFederalReservemadeasimilarargumentinits1968studyofthenascent credit card industry. See Bank Credit-Card and Check-CreditPlans, reprinted in House Subcommittee on Special Small BusinessProblems, The Impact of Credit Cards on Small Business, June 8–10,1970,247–350.

46.BankCredit-CardandCheck-CreditPlans,277.47.Ibid.,12.48.Ibid.,295.49.Ibid.,284–285.50. “Can Stores TrumpBankCredit Cards?,”BusinessWeek, January 30,1971,63.

51.“CaliforniansChargingAway.”52.“BankintheBillfold,”1.53.BankCredit-CardandCheck-CreditPlans,15.54.Ibid.,24.55.HouseSubcommitteeonSpecialSmallBusinessProblems,TheImpactofCreditCardsonSmallBusiness,1.

56. Patrick Kildoyle, “Bank Credit Card and Check Credit Plans in theSecondDistrict,”FederalReserveMonthlyReview,January1969,12.

57.O’Neil,“ALittleGift.”58.LetterstotheEditor,Life,April17,1970,28A.59.“CanStoresTrumpBankCreditCards?,”121.60. “Atlanta’s First National Sees Depressed 1st Half,” The Wall StreetJournal,June1,1970,8.

61. “CiticorpPosts19.4%Rise inNet for2ndQuarter,”TheWall StreetJournal,July13,1971,5.

62.“ClashoverCredit,”TheWallStreetJournal,March4,1971,1.63.“MinneapolisBanktoGiveItsCard-HoldersaCharge,”TheWallStreet

Journal,February23,1973,18.64.“Chain,BankAmericardinMinnesotaStopRevolvingCredit,FightingUsuryRuling,”TheWallStreetJournal,April30,1971,4.

65.Ibid.66.Ross,“TheCreditCard’sPainfulComing-of-Age.”67.ThomasWilliams, “Asking theRightQuestionsAboutBankCards—You Have Done a Great Job… Just Don’t Give It Away,” Banking,September1978,84.

68.“CanStoresTrumpBankCreditCards?”69. “Why Big Stores Are TakingOutside Credit Cards.” This pointwasmadebyInterbank(MasterCharge)’sKneelandMoore,marketingVP.

70. “More Stores Using Bank Cards,” Chain Store Age Executive withShoppingCenterAge,January1977,25.

71. “Bank Card Holdouts Fading Under Pressure,” Chain Store AgeExecutivewithShoppingCenterAge,February1979,36.

72.“WhyBigStoresAreTakingOutsideCreditCards,”132.73.“BankCardHoldoutsFadingUnderPressure,”41.74.Ibid.,33.75.“WhyBigStoresAreTakingOutsideCreditCards,”134.76. “The Big Push for Credit,” Chain Store Age Executive with ShoppingCenterAge,January1977,23.

77.“MoreStoresUsingBankCards,”25.78.“BankCardHoldoutsFadingUnderPressure,”36.79. “Department Stores Begin Adopting Bank Cards,” Banking, August1976,62.

80.“FearofBuying,”TheWallStreetJournal,December16,1980.81.Ibid.82.“WhenBanksStartCarryingTwoCards,”BusinessWeek,November22,1976,64.

83. “Bank Americard to Get a NewName: Visa,”The New York Times,September11,1976,41.

84. “Bank Card Holdouts Fading Under Pressure,” Chain Store AgeExecutive,February1979,41.

85.“ToughFutureforSmallCardPlans,”136.86.“Variable-RateLoansRise,”ABABankingJournal,October1984,154.87.“MoreStoresUsingBankCards,”26.88.“TheAgeofPlastic’sFirstCardShark,”NewYorkMagazine,January14,1991,32.

CHAPTERSEVEN:IFONLYTHEGNOMESHADKNOWN(1968–1986)

1. Thomas Sugrue, The Origins of the Urban Crisis (Princeton, N.J.:PrincetonUniversityPress,1996).

2.SenateCommitteeonBankingandCurrency,Financial InstitutionsandtheUrbanCrisis,90thCong.,2ndSess.,September20andOctober1–4,1969,177.

3.Ibid.,20.4. Department of Housing and Urban Development,Homeownership forLower IncomeFamilies (Section235):AHUDHandbook,October1968(Washington,D.C.:GPO,1968),foreword.

5.EverettSpelman,“Federalization&Housing:AtPointofNoReturn?,”MortgageBanker,June1971,57.

6. Robert Gray, “Good Counseling: The Answer in Successful 235Housing,”MortgageBanker,August1971,14.

7.Ibid.8.Spelman,“Federalization&Housing,”54;EugeneCowen,“TheNixonProgramforHousing,”MortgageBanker,July1971,10.

9.Spelman,“Federalization&Housing,”56.10.PhilipJackson,“TheCommitmentIsMassive,butSoIstheProblem,”MortgageBanker,June1972,6.

11.Toqualify,afamilycouldearnnomorethan135percentofthelocalpublic housing income limit, which was based on local economicconditionsandfamilysize.Afamilyoffourcouldearnupto$5,805inRedBay,Alabama,$6,615inPaterson,NewJersey,and$7,695inBoston, Massachusetts, for example. Department of Housing andUrban Development,Regular Income Limits for Sections 235 and 236Housing (Based on 135 Percent of Public Housing Admission Limits)(Washington,D.C.:GPO,1969).

12.DepartmentofHousingandUrbanDevelopment,1970HUDStatisticalYearbook(Washington,D.C.:GPO,1970),234.

13. Philip Brownstein, “The 1968 Housing Bill,”Mortgage Banker, May

1968,20.14.Ibid.,21.15.HouseCommitteeonBankingandCurrency,InvestigationandHearingofAbuses in Federal Low-andModerate-IncomeHousingPrograms, 91stCong.,2ndSess.,December1970(hereafterInvestigationandHearing),5.

16. Department of Housing and Urban Development, Guide for theRecording of Single Family Homes Sales for Use as Appraisal Data(Washington,D.C.:GPO,1968),foreword,1–3.

17.InvestigationandHearing,108.18.Ibid.,113.19.Ibid.,170.20.Ibid.,108.21.InvestigationandHearing,8.22.Ibid.,108.23.HouseCommitteeonBankingandCurrency, InterimReport onHUDInvestigation of Low-and Moderate-Income Housing Programs, 92ndCong., 1st Sess., March 31, 1971 (hereafter Interim Report), 113;“JerseyScreenedforF.H.A.Abuses,”TheNewYorkTimes,January8,1971,29.

24.InterimReport,107.25.Ibid.,6.26.InterimReport,103;InvestigationandHearing,103.27.InterimReport,48.28.Ibid.,49.29.InvestigationandHearing,133.30.Ibid.,188.31.Thestaffreport foundthat“theconstructionisofsuchpoorqualityandthecostsoquestionablethattheprojectscanbestbedescribedas‘instantslums.’”InterimReport,105.

32.Gray,“GoodCounseling,”6,12.33.InterimReport,105.

34.InvestigationandHearing,,133.35. Investigation and Hearing, 31. Twenty-seven of fifty-seven homeownersabandonedtheirhouses.

36.Ibid.,34.37.UnitedStatesCommissiononCivilRights,HomeOwnershipforLowerIncomeFamilies:AReportontheRacialandEthnicImpactoftheSection235 Program (Washington, D.C.: GPO, 1971) (hereafter HomeOwnership),46.

38.Ibid.,45.39.Ibid.40.Ibid.,8.41.Ibid.42.Ibid.,69.43. Department of Housing and Urban Development, Office of Audit,“AuditReviewofSection235SingleFamilyHousing,”December10,1971 (Washington,D.C.: GPO, 1971), Vertical Files collection, LoebLibrary,HarvardUniversity,4–5,10.

44. Ibid., 18. The audit surveyed 609 houses, of which 260 wereovervalued.

45.HomeOwnership,59.46.Ibid.47.Ibid.48.JohnSparkman,“OutlookforHousingLegislationin1971,”MortgageBanker,July1971,22.

49.JohnMonagan,“PictureofFailure,”MortgageBanker,July1972,18.50. JohnWetmore, “FHA Operation Now Vital to SecondaryMortgageMarket,”MortgageBanker,December1973,61.

51.Ibid.52.InvestigationandHearing,188.53.Thereportwaswidelydiscussed,making,forinstance,thefrontpageofTheNewYorkTimes(“U.S.ReportFindsFraudinHousing,”January6,1971,1).

54. InterimReport, 2; “Romney, in Shift, FreezesDisputedHomeAid toPoor,”TheNewYorkTimes,January15,1971,1.

55.Spelman,“Federalization&Housing,”57.56.InvestigationandHearing,237.57.Ibid.,239.58.“TheFeudingoverWhoRunsFannieMae,”BusinessWeek,September12,1977,74.

59.“DoesFannieMaePlayConflictingRoles?,”BusinessWeek,December13,1976,34.

60. Kenneth Thygerson, “Housing and Freddie Mac,”American Banker,February25,1983,13.

61.EricBerg,“TradingHomeLoansLikeBondsDrawsBillions,”TheNewYorkTimes,January22,1984,F1.

62. “Mortgage Pools Have Splashy Yields,” Fortune, October 23, 1978,139.

63.“ThePrivateSectorApesGinnieMae,”BusinessWeek,July25,1977,110.

64.“MortgagePoolsHaveSplashyYields,”140.65.“ThePrivateSectorApesGinnieMae,”112.66. “How to Get a Piece of the Action,” BusinessWeek, November 10,1980,148.

67.TitleV,StateUsuryLaws,PartA,MortgageUsuryLaws,DepositoryInstitutionsDeregulationandMonetaryControlActof1980.

68. “The Garn–St Germain Act of 1982 and Mortgage Lending; TwoProvisions Affecting Adjustable Rates and Due-on-Sale EnforcementWillBearWatching,”AmericanBanker,May16,1983,21.

69. “Today’s Mortgage Market Has Primary Flexibility and SecondaryDepth,”ABABankingJournal,April1983,118.

70. Rosemary Rinder, “How Real Is ARM ‘Repayment Shock’?” ABABankingJournal,April1983,47.

71.EricBerg, “Fixed-RateMortgagesHeldThreat toLenders,”TheNewYorkTimes,March10,1986.

72.“HowtheThriftsCanUnloadOldMortgages,”BusinessWeek,January18,1982,29.

73.“SavingFannie,”Forbes,October26,1981,54.74.Ibid.75.“TheFeudingoverWhoRunsFannieMae,”BusinessWeek,September12,1977,15.

76. “Freddie Mac and Fannie Mae Changing Their Role,” NationalMortgageNews,September22,1986,22A.

77.“SecuritisingtheAmericanDream,”TheEconomist,June14,1986,78.78. “Freddie Mac Announces Sale of Mortgages,” Business Wire,November15,1985.

79.“RiseofNationalMortgageMarket,”TheNewYorkTimes,January22,1984.

80.“ConsultantsSayManagementofRiskIsKeytoMortgageIndustry,”NationalMortgageNews,August12,1985,15.

81.Berg,“Fixed-RateMortgagesHeldThreattoLenders.”82. Sanford Rose, “Random Thoughts,” American Banker, November 8,1988,1.

83. “Secondary Mortgage Market Takes the Lead: But Some Doubt ItsPotential to End theHousing Credit Gap,”American Banker, August24,1983,1.

84. “TheSecondaryMortgageMarket:Having ItAll IsKey toSuccess,”AmericanBanker,December14,1983,4.

85.“SecuritisingtheAmericanDream,”78.86.“TheSecondaryMortgageMarket:HavingItAllIsKeytoSuccess.”87.“HowtheThriftsCanUnloadOldMortgages,”29.88.“S&LsHaveaNewWaytoRaiseMoney,”BusinessWeek,September8,1975,58.

89.“HowtheThriftsCanUnloadOldMortgages,”29.90.Berg,“Fixed-RateMortgagesHeldThreattoLenders.”

CHAPTEREIGHT:THEHOUSEOFCREDITCARDS(1986–2008)

1.WilliamRothschild,TheSecrettoGE’sSuccess(NewYork:McGraw-Hill,2007),116.

2. Jeffrey Birnbaum and Alan Murray, Showdown at Gucci Gulch (NewYork:RandomHouse,1987),chapter1.

3.Ibid.,57.4.JaneNelson,“IdentityCrisisatFannieMae?,”U.S.Banker,July1985,16.

5. “President Signs Measure Boosting Private Secondary MortgageMarket,”BondBuyer,October8,1984.

6.“TaxingHousing,”UnitedStatesBanker,April,1986,4.7. “Popularity and Paper Crunch Hobble Ginnie Mae,” The New YorkTimes,April14,1986.

8. Peter Yoo, “Charging Up a Mountain of Debt: Accounting for theGrowthofCreditCardDebt,”FederalReserveBankofSt.LouisReview,March–April1997,4.

9.A. Charlene Sullivan, “Do StateRateCapsMake Sense?”Credit CardManagement,March1992,21.

10. “City National Makes Electronic Banking Work,” BusinessWeek,February27,1978,76.

11.AuthorinterviewwithMarkStickle,April9,2009.12.“TheGrapevine,”Asset-BackedAlert,June26,2000;“ProductFocus:BowieBonds,”OperationsManagement,March24,1997.Owingtohisgreatness,DavidBowie’sbondscarriedaAAArating.

13.“SecuritisingtheAmericanDream,”TheEconomist,June14,1986,78.14. “Trend Toward Selling Off Assets as Securities Seen Growing,”AssociatedPress,March22,1986.

15.Ibid.16.“SuccessofMBSIssuesCouldLeadtoManyAssetPackages,”NationalMortgageNews,February10,1986,13.

17.Ibid.18.LindaPunch, “TheLegacyofCardBonds.”CreditCardManagement,May1998,36.

19. Kevin Higgins “The Comeback in Card Bonds,” Credit CardManagement,March1995,61.

20.LindaPunch,“TheLegacyofCardBonds.”21.“WithItsAFL-CIOCardGone,BankofNewYorkLooksforaNiche,”CreditCardNews,July1,1996.

22. “The Union Plus Card Gets Promoted to Gold Status,” Credit CardNews,September15,1997;“ADesiretoShedDebt,”CreditCardNews,February1,1997;“WithItsAFL-CIOCardGone.”

23. “The Union Plus Card Gets Promoted to Gold Status” and“Household’sLaborsBearsFruitatRival’sExpense,”CreditCardNews,March1,1996.

24. John Stewart, “Chicago Credit Card Issuers EnterWorldwide BondMarket,”Crain’s,November19,1990,40.

25.Ibid.26.Ibid.27.Ibid.28.DavidRosenbaum,“HighCreditCardRates:ALuxuriousNecessity?,”TheNewYorkTimes,November24,1991.

29. Peter Lucas, “Card Marketers Know the Score,” Credit CardManagement,September1992,76.

30. John Stewart, “Goodbye, Fat City,”Credit CardManagement,March1992,70.

31. Kevin Higgins, “The Seller’s Market for Bad Debt,” Credit CardManagement,January1993,20.

32.LindaPunch,“ASoberingYear,”CreditCardManagement,June1992,52.

33. “ANewTwist onCardBonds,”Credit CardManagement, September1996,38.

34.JaneAdler,“TheBoominBad-DebtBonds,”CreditCardManagement,

February1998,73.35.Ibid.36.“ANewUse forBadDebt:BackingUpCardSecurities,”CreditCardNews,July1,1996.

37.Adler,“TheBoominBad-DebtBonds.”38. “Who’s Afraid of the Secondary Market?,” ABA Banking Journal,August1984,50.

39. Linda Punch, “The Home-Equity Threat,” Credit Card Management,September1,1998,112.

40. “SomeBadNewsonCreditQuality fromStandard&Poor’s,”CreditCardNews,November15,1996.

41.“EvaluatingtheRiskofaMortgageBorrower:ConventionalRulesNotAlwaysAppropriate,”AmericanBanker,October15,1984.

CONCLUSION:TURNINGTHEMAGICOFBORROWINGINTOTHEREALITYOFPROSPERITY

1. “On Imprisonment for Debt, by a Northern Farmer,” The Debtor’sJournal,February24,1921,90.

2.Ibid.

ACKNOWLEDGMENTS

Writingabookisalwaysagroupeffort,evenifonlyoneperson’snameendsuponthejacket.ThisbookwouldnothavehappenedwithoutthedoggedencouragementofmyfriendMatthewPearl,whopushedmetothink about a broader audience for my research. Eric Lupfer is thegreatestagentayounghistoriancouldhave,andIamfortunatetohavemethimsoearlyinmycareer.JeffAlexander,myeditor,pushedmetoaskthelargestpossiblequestionsintheclearestpossibleway.Countlessfriendsandfamilymembersdiscussedthebookalongtheway.Aspecialfewenduredtheroughdraftsandgavemeclosereads:RachelHyman,PattyKuzbida,GregKuzbida,KelleyKreitz,BrianPellinen,BillRankin,Raphaelle Steinzig, Tara Smith, Weston Smith, and Ginger Myhaver.Borrowisasmuchtheirbookasmine.Inallthings,KatherineHoweisawondertobehold.Hergenerosityof

mind isevident in thisbook’s language,andhergenerosityofheart inhersupportfromthebook’sconceptionthroughitscompletion.I dedicate this book to my mother, Patty Kuzbida, whose steadfast

encouragementmadethis,andeverythingelse inmylife,possible.Shehasbeena truerolemodel forcreativity,curiosity,andcommitment—everythingamothershouldbe.

ILLUSTRATIONCREDITS

itr.1©Bettmann/CORBIS(c.1860)1.1Collier’s(1931)1.2Collier’s(1926)3.1NationalArchives(1937)

3.2Collier’s(1931)4.1Macy’sadvertisement(1951)4.2ChangingTimes(1951)4.3Bloomingdale’sadvertisement(1946)4.4ProfessorRobertHancock,CollegeofCommerce,UniversityofIllinois(1953)5.1UnitedStatesPatentOffice(1917)6.1Cartoon(1979)

7.1FreddieMacadvertisement(1984)7.2AssociatedMortgageCompanies,Inc.,advertisement(1969)7.3NationalArchives(1970)7.4BusinessWeek(1980)