Revolutions in Leveraging: Two-income Families, college loans, and credit cards

Speaking of incentives that lead to financial panics, Christopher Caldwell’s provocative piece on Elizabeth Warren in the latest Weekly Standard, reminded me of a creepy prediction I had mentioned to my wife about 25 years ago on the occasion of our next-door neighbors’ decision, shortly after the birth of their first child, that the new mom should immediately get a job and use her new earnings to enable the couple to keep up the mortgage payments on their new 4,000 sq ft McMansion and to allow Mom to have her own BMW to match her husband’s.

At the time, my wife was appalled, mainly by our neighbors’ determination that the expansion of their material accumulations represented a higher priority to them than providing the maternal care and nurturing that only a  stay-at-home Mom can provide to an infant.  I was appalled for another reason:  it dawned on me that our nation had now, in just a few years, created three distinct phenomena that collectively represented a massive new leveraging of the American way of life:

  • a huge expansion of the income of the American family (Mr. Caldwell’s point),
  • a dramatic expansion of the new industry of providing college loans, and
  • the  conversion of the old-fashioned “charge card” (American Express, Diners Club, Carte Blanche) into the new-fashioned “credit card” (MasterCard and Visacard).

It seemed to me that people like our McNeighbors, with their newly inflated family income, were likely to start bidding-up the prices of residential real estate (first premonitions of that bubble); that the price of attending Yale (or Haverford or Vanderbilt or even your local State University) was similarly likely to rise substantially because of the flood of new money that was becoming so readily available that anyone who wanted to go to any particular college could now “afford” to go; and that the new credit cards, by effectively putting an additional $5,000 or $25,000 into the hands of virtually every sentient adult in America, were also likely to cause large increases in the cost of lots of things.

Back in those days, though I was aware of and influenced by Milton Friedman and his many acolytes, I didn’t have the knowledge or inclination to put all of this together and realize that, without an exceptionally strong hand at the helm of the Fed (and a sympathetic Administration), the inevitable result of all of these major movements would be things like the Real Estate Bubble/Crash of the late 1980s, the Long Term Capital Management blowup of the late 90s, and finally the Mother of all American central-planning fiascos : the Fannie May Memorial real-estate bubble/crash and the attendant financial crisis that enabled the election and agenda of President Obama.

What really has me spooked is the possibility that, even if we were willing and able not only  to rationally restructure our tax system but to  formalize our de facto conversion of Social Security and Medicare from retirement systems (fully funded by sequestered, after-tax contributions of trusting workers) into  vastly reduced “entitlements” (thereby retroactively turning our past contributions into mere payments of additional income taxes),  we would still be in no position to move the country back into growth-mode because we would not yet have de-leveraged ourselves back into a position where animal spirits would be likely to re-appear.

For that, I suspect we would need to install and empower  a latter-day version of Paul Volker (version 2.0, per the Reagan years, as distinct from version 1.0 per the Carter years and version 3.0 per the sad caricature that Obama insisted on parading before the cameras).  I am not suggesting that the task is impossible, but that the  sine qua non of any solution to our current financial crisis is a strong and stable dollar, which might take us quite a while to achieve.

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