We focus on the amount of consumer debt—mortgages, credit cards, student loans. We see that big number and collectively wonder how we are going to pay it back. The trouble is we are thinking about this entire situation backward. The question is not why consumers continue to borrow, but rather why those with money continue to lend.
The simplest answer is that creditors make more money lending than by putting their money somewhere else. Buying consumer debt, whether directly through a bank’s loan or indirectly through an asset-backed security, is an investment decision subject to the same balance of risk and return as any other. Consumer debt is just one investment choice among many. Perhaps, as Mike Konczal argues, helping indebted consumers would do some good, but the real issue, the reason for the ongoing financial crisis, is the lack of good opportunities to invest outside of consumer debt—specifically, in businesses. We haven’t developed policies that create better business uses for capital, uses that would create jobs.
We might have those policies if we hadn’t gotten it into our heads that markets are self-correcting. A hundred and fifty years of history show that government protection of private capital investment is essential to the formation of new industries. Railroads received land grants, and the aerospace, aluminum, and electronics sectors all benefited from private loans guaranteed by the federal government’s Defense Plant Corporation. (Mitt Romney has criticized President Obama for taking an analogous approach in the burgeoning green energy sector.) Thanks in part to these guarantees, industries that had languished in the 1930s became engines of postwar growth. The neoliberal obsession with free markets has blinded us to this historical reality.
In financial innovation, however—the area where one would most expect laissez faire to rule—the private and public sectors have continued to work together. While we have abandoned our real economy, our financial economy has enjoyed decades of government support. Fannie Mae was remade in the Housing Act of 1968, which privatized it and authorized it to issue mortgage-backed securities to connect the previously unrelated capital and housing markets. Regulators worked hand-in-glove with investment bankers to develop new debt instruments to back federally insured mortgages.
Two years later, during the emergence of so-called deregulation, Freddie Mac was founded to do the same with the rest of the mortgage market. Once again, federal guarantees enabled consumers to borrow from capital markets for the first time. Rarely has there been such a misnomer as deregulation: these markets were never outside of the purview of the state. Instead, deregulation meant they would be differently regulated for purposes other than helping the real economy grow.
Use asset-backed securities to create productive businesses, not unproductive homes.
Today, as we fret about consumers who haven’t learned their lesson and continue to borrow, let us remember that these seemingly profligate consumers are also hard-pressed workers whose wages have stagnated for 40 years. Indeed, inequality is part of the reason that there is so much money available to invest in this consumer debt. The money concentrated at the top, which was paid in wages during the postwar period, needs to be invested somewhere. Our regulatory policies have made it easier and safer to invest in consumer debt—through asset-backed securities—than in business debt.
Let’s use those asset-backed securities to connect investors with business, especially small and mid-sized businesses. At the moment there are no substantial markets for small-business debt—a problem that we know how to solve. These businesses can no longer borrow from banks, which, thanks to consumer debt securitization, have safer options than taking on the risks of small players. By pooling small-business loans together and selling them as bonds, we can distribute the risk for growing enterprises just as we have done for home mortgages.
The difference would be, of course, that these loans would create productive businesses, not unproductive houses. Like the riskiest consumers, the riskiest businesses—new restaurants, fashionable tech startups, etc.—shouldn’t be lent to. But there is a broad middle of stable companies that would like to borrow in order to grow. Today it is difficult for such unfashionable small companies to borrow. Selling equity to venture capitalists might be an option if you have a high-profile tech company but less likely if you make plumbing fixtures. And most small-business owners would prefer to borrow capital than sell equity. Forced to rely on retained earnings, these firms can’t grow to their full potential, stalling the economy.
We should have policies to encourage securitized investment in small businesses instead of in home mortgages. Unlike houses, those businesses can help us all.