freeing the country from the credit trap

I’m sure many of you have had your fill of new perspectives on the financial crisis and the conditions that led to it; I thought I had, too. But I find the piece “Infinite Debt” by Thomas Geoghegan to be absolutely essential reading. Harpers gates it’s content for subscribers only, but this video interview with Geoghegan does a great job of explaining his point of view. Go ahead and watch it. Really. Watch it. (I know, I’m demonstrating that I’m an unreconstructed lefty by linking to Democracy Now. Bear with me.)

Geoghegan identifies the beginning of the instability and bubble/bust cycle that has come to dominate American finance as being a product of the United States essentially abandoning usury law in the 1970s. As Geoghegan points out, usury law (laws that regulate the kind of interest rates lenders can charge to their lendees) have been around in almost every civilization that has had a currency, stretching back thousands of years. And he points to this current crisis as a demonstration of the basic wisdom of usury.

Geoghegan points out that, when banks can charge whatever they want for interest– 12%, 15%, 18% on credit cards, 200% on payday loans, etc.– capital will inevitably be invested in financial vehicles rather than in businesses based on manufacturing or providing services. A really fantastically profitable and efficient manufacturing concern might get an investor 5% or 6% return on his investment. But lenders, free from any constraints on the rates of interest they can charge, can claim to double or triple that return to investors. So capital flows away from businesses that actually provide products or services that people want to pay for and towards lending credit. As Geoghegan points out, GM and General Electric, two huge and once hugely profitable manufacturing concerns, both created banks to lend money, because that’s where the greatest profitability came from. And when companies are allowed to represent as assets money they are owed rather than money they have collected, with no reasonable accounting for the odds that the money lent is going to be repaid, the lenders have an enormous advantage in profitability over manufacturing companies– even if profitability is something of an empty term in these conditions.

The problem, though, is that this profit rests on the supposed value of the agreement of the people and companies who have been lent money to pay that money back and then some. And as more and more investor want to be involved in the credit lending business, as it shows the most impressive rates of return, there is more and more pressure on the lenders to lend to those who are unlikely to pay back the principle and interest. The subprime crisis couldn’t have happened if there weren’t so many investors trying to create profit (or the appearance of such) by getting people to agree to pay back more than they borrowed. The lenders went after subprime borrowers because they were looking for borrowers, period, and they had to start looking under rocks previously unturned in order to generate more interest, and more paper profits…. And in the short term, this limitless lending and interest looks like a spectacular deal for the country, as all the financials are reporting record profits. The problem comes when people start to look for, you know, the actual money and not just the promise of being paid back.

Worse still, as more and more capital was invested in credit lending, there was less money going into the real, productive economy of manufacturing and providing valuable services. This is a big problem in an era of hyperactive credit and lending, because the workers actual wage growth has stagnated, meaning they aren’t making the kind of money they would need (as a class) to pay back this enormous credit burden. If the real economy is humming along, and the buying and selling of actual goods and services is generating growth, then the workers (due to higher wages) would have the capacity to pay off higher interest rates, at least within reason. But in our economy, the loss of real wage growth meant that there was no capacity for these workers to pay off what they owed. Unfortunately, there wasn’t the possibility of a groundswell of populist support for changing the system, because the workers and middle class could get what they wanted to buy– because of all the credit out there! Banks and financials lent money, charged absurd interest rates, people borrowed the money and bought things they couldn’t have possibly afforded, the banks represented the money owed as assets, and everyone was happy, except for the people who were financially ruined by the lack of any meaningful limit on the ability to borrow and the crushing interest rates. But once people got a little worried, and wanted to see the actual capital involved– when spooked investors wanted actual liquid capital, rather than representations of capital in stock or the “asset” of being owed money– the system collapsed.

Clearly, this system is deeply flawed. But it’s very easy to see why it’s seductive for everyone involved. The banks show record profits, thanks to the fact that they can represent the value of what they are owed as assets, often regardless of the likelihood that those debts would be repaid. The investors were seeing huge returns on their money. The average consumer, provided he didn’t fall so far behind that he lost access to the great flow of cheap and easy credit, was able to buy and consume at previously unheard of levels. True, he was likely carrying a mountain of debt, but he had stuff, and if a lot of his net worth was tied up in a house that had its value artificially inflated, he didn’t feel particularly insecure. Besides, the stigma of being deeply in debt had almost vanished. Every was getting ahead, as long as we all agreed to believe in the value of agreements to pay back money. The problem is that many of these agreements were actually valueless, because the debtors had no genuine capability to repay the debts.

There’s a lot of consequences to our understanding of this situation. The first is, I think, another nail in the coffin in the notion that you can ever have a truly free market when you have a currency. When you have a currency, you’ll have lending, and when you have lending, you’ll have interest, and human nature being what it is, lenders will wring out as much interest as they can when they can, offsetting the balance of our economy. You’d like borrowers to be rational, and say “I’m not paying 18%, no way;” but people aren’t rational, a lot of the time, and they don’t make good decisions, and when people really need money they will make terribly impractical decisions in order to get it. So we need a strong regulatory apparatus to limit the size of interest rates and the degree to which banks are leveraged, in order to prevent the kind of situation we have now, where there is vastly more money owed than the people of the country have the capacity to repay. Adjustable rate mortgages and CDOs and all the other various shenanigans that helped get us here are symptoms of a larger disease of interest rates run amok and the flight of capital into financial investment and away from the real economy.

Secondly, the pro-globalization furor that has gripped our consciousness in recent decades bears a lot of blame. We have a very diverse set of opinions and ideas here on the Web and in our media, but there are certain ideas that are enforced in an exclusionary way. Being at all skeptical about globalization for too long has meant being excluded from the ranks of the “serious”. The idea that globalization is good for the United States, the world and its people is an attitude that people insist on with incredible zeal, and this insistence comes from conservatives and liberals, Democrats and Republicans. But the consequences of globalization for the United States have meant a hollowed out economy, where we produce very little of actual value, and where a huge amount of our growth comes from the accumulation of imaginary money. Unfortunately, the policies that could spur a return to the ancient and tested method of generating growth– making products people want to buy– have been derided by many of the pro-globo set as mere protectionism, nativism or simple naivete. We have to begin to push back against the rigorously enforced idea that globalization is some wonderful tonic that spreads money and stability around the globe. Some degree of globalization is necessary and welcome, but we cannot allow our dedication to a global economy to leave us with no domestic capacity to generate growth through the buying and selling of internally produce commodities. We’ve got to resist the Tom Friedmans.

Third, I think it’s time for those of us who are sympathetic to unionism to stop our long retreat and start fighting again, armed with the fact that unions increase wages for the middle class, and that what this country needs is a middle class which actually makes more money in real dollars, rather than getting what they want from going deeper and deeper into debt. Whatever else is true, union workers tend to get paid more, and those higher wages represent actual money that can actually be spent to stimulate the economy and spur growth, without the inevitable payback that an economy based on debt requires. It’s true that unions reduce the raw profitability of the factories and businesses that have been unionized; decent wages and benefits cost money that could otherwise be diverted to profit. But perhaps the owners and CEOs and boards could be made to see that they have a financial interest in the country having a middle class that is capable of significant wage growth, and not just the replacement of wage growth through the extension of more and more debt.

This all has the fringe benefit of refocusing our vision of the point of society, so that we look not at the growth of GDP or the total amount of wealth being moved around, but at how the majority of the people have their lives materially improved. I wish that those who cheerlead economic growth as the end-all, be-all of human existence would admit that this financial crisis has proved that paper growth does not in fact ensure the best for our people. It’s time to ask, what is the point of progress if it doesn’t lead to human abundance and happiness, and sustainable human abundance and happiness?

We have to move back to being a society that buys the things it can pay for and lives according to its means. Look, banks and lending are good things when they exist in a context of real growth through production. If a guy has a great idea for a widget, he should be able to borrow money from the bank to start his factory, so that he can hire workers to make a decent wage in sound working conditions, so that they can make the widgets, earn money to spend in the real economy, earn him profit and enable him to pay back the bank. All of that is to the good. But when we incentivize the extension of credit so far beyond the degree to which we invest in the making and marketing of tangible goods and services, we ensure growth without actual value, and it leaves us in the kind of untenable position we are now. If we’re going to rebuild our real economy, we need to firmly regulate the lending of money, we need to restigmatize the accumulation of too much debt, we need to have policies and laws that benefit our manufacturing sectors, and we need to stop apologizing for privileging institutions and movements that put real money into the hands of our workers.

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28 thoughts on “freeing the country from the credit trap

  1. Excellent post. It dovetails nicely with a new article in the Atlantic by a former IMF economist. (Link here; hat tip to K. Drum.)

    As best I can tell, as long as finance is promising rates of return greater than the increase in GDP, we’re in an unsustainable situation of ever-increasing debt. A few people can beat the market, because their gains are offset by others’ losses. But the sector as a whole simply cannot outperform the economy as a whole.


  2. Sort of ponzi-like, no?

    Really great post, Freddie. I’ve long been of the opinion that usury laws need to be tightened up. Similarly, interest rate manipulation by the Federal Reserve can cause those at the top who get the money first to pay a lot less for it, and then by the time it reaches normal consumers with credit cards and payday loans the rates are much, much higher. It furthers disparity and devalues money.

    Have you read at all about Islamic finance which prohibits usury?


  3. It’s true that Islamic finance prohibits usury. It’s also true that Islamic restrictions on finance have helped keep economic growth in Moslem countries to rates far below that of population growth. See the archives at, particularly the posts by The Lounsbury, for the joy of actually having to deal with Islamic finance.
    Anyway, Freddie, it’s an interesting post indeed. My main quibble regards your points on globalization. Partly this is because I’m working in Prague for half the money my position pays in America but for a comparable and in some ways superior standard of living. There are a lot of small countries out here that, barring foreign direct investment, would be poor forever. I don’t think it’s a good idea to go blaming other countries’ comparative advantages for the problems of one’s own country, and I think that stacking the deck to eliminate another country’s comparative advantage too often only leads to stagnation in one’s own country and poverty in the other. See UK in the 70s or India under the Indian Way. I also think that “globalization” has by now so thoroughly escaped from Pandora’s Box that no gov’t really has the power to stuff it back in.
    At the same time, I think the Free Trade mantra of the developed countries is more than a bit hypocritical and amnesiac. No country supports free trade while it is developing its own industries. It’s only when its economy is a world-beater that suddenly “free trade” becomes a mantra. Note the 19th cent. “conversion” to free trade by formerly mercantilist Britain.
    Other than this quibble, which is more something I’d like to talk about with you over some pints than an actual disagreement, this is a most interesting point. Have you noted that the other major basket case of this crisis, the UK, also has no usury laws?


  4. I agree with most of this, but you lose me a bit in the paragraph on globalization. While I bow to no one in mocking the globalization-as-cure-all pollyannaism of Tom Friedman, I think you overstate things too far the other direction. You claim “…we produce very little of actual value”, but that seems drastically overstated. I’ll grant you the lack of value in the sort of Wall Street chicanery that got us into this mess, but the financial sector is only a small part of GDP. What other industries are valueless I wonder, and why?

    Then you finish up saying “we need to have policies and laws that benefit our manufacturing sectors”, which also makes me wonder why. What is the justification for privileging manufacturing over any other sector of the economy? Are people in health care, software, architecture, construction, media, etc, not doing “real work”, not producing real value? Why are the products of their labor any less important than manufactured goods? And what does it even mean to benefit the manufacturing sector anyway? We already are the world’s largest manufacturer, so how much more assistance do you want?

    Now it’s true that manufacturing jobs are down, and I think that’s what worries you. But the reasons for this are based in technology; I’m not sure what sort of government policy would make manufacturing work more labor-intensive, or why it would be a good idea. Of course, once upon a time people were incredibly worried that the number of agricultural jobs were going down dramatically, but this didn’t destroy the country. I may be off-base, but it seems to me you’re romanticizing manufacturing work a bit. I want there to be plenty of middle-class jobs too, but I hold no particular attachment to what sector of the economy they come from. Just as a New Yorker is just as much of a “real American” as a Hoosier such as myself, a nurse is just as much of a value-creating worker as someone on an assembly line.


  5. Really Good Article! Well Done! The fact that Judge Brennan’s decision was not over-turned by any subsequent Federal administration tends to suggest that over the last thirty years there has been a pretty good “capture” by the “Natural Economy” idea of Friedrich Hayek and Milton Friedman that interference by government in business dealings was a bad idea. Not convinced about the beefing up of unionism though as a long term thing. As a former union shop steward it was hard work keeping people’s interest in a permanent revolution of maintaining real wage levels. I much prefer the Distributivist approach as the long term answer to maintaining demand in the economy.


  6. Antiquated Tory:

    I can’t comment on the substance of this post (thought-provoking though it is) for conflict of interest reasons. But….you’re in Prague? My wife and I are visiting there for a few days in May – any advice on things to do, places to go that are away from the tourist traps? If you’d prefer, you can e-mail me:


  7. Linking up with Thomas Geoghegan’s interview is Simon Johnson’s article “The Quiet Coup” in the latest Atlantic Monthly May 2009.


  8. Excellent post, and it’s always nice to see Geoghegan get some more exposure. (All’s the greater pity that he didn’t win the 5th district seat.)

    He also discussed his Harper’s piece on Eight-Forty-Eight yesterday morning, though in a much shorter format than in the Democracy Now piece. (Which you can find: here if you say for some bizarre reason you can’t watch the DN piece.)


  9. I forwarded this post to a friend of mine in the business, and he answered:

    "I don't buy it. The returns people care about are returns on equity. If the financial sector grows, competing banks will lead to greater competition for lending business, leading margins to fall to the point where their return on equity is something closer to normal (the amount of equity large banks had on their books prior to the current huge losses was quite large in absolute terms – even if it was levered 30:1). Returns on assets in manufacturing may be 5 or 6%, but if the manufacturing company is levered 1:1 then the return on equity could be double that – matching up with banks.

    "Usury laws could be of benefit by reducing the ability to invest in overly risky ventures (where you need the planned return to be high in order to offset higher risks of default). Forced risk aversion would be good if banks were more easily swayed by the return than they were worried about the risk of default.

    "Also, note that the housing bubble explosion was when people stopped being able to afford to continue to pay loans where the introductory rate was something like 1 or 2%. No usury law is ever going to block that – that's overly cheap lending, not overly expensive lending."


  10. Dear Freddie:

    Thanks for such a generous summary of an important article.

    A couple of points that Geoghegan missed on what caused the anti-anti-usury movement of the 1970s onward:

    First, the inflation of the 1970s made the old anti-usury laws impractical. If interest rates were capped at, say, 9% and prices were expected to rise 10% over the next year, then nobody would lend. So, getting rid of the old interest rate cap laws was justified as simply a practical expedient for adapting to an era of high inflation. (Of course, they weren't put back in place when inflation came back down.)

    Second, opposition to usury was widely seen as anti-Semitic (e.g., Henry Ford's war on New York banks), so it became politically untenable after about 1967.


  11. i can just hear the 'free market' morons now:

    " it will lead to more black market behavior'
    translation: we have no respect for the law unless its convenient.

    "it is anti'freemarket'
    Translation: We get special privileges from the government and the quasi private fed, but any attempt to attach regulation to those priveldges is 'restricting the free market' in other words, we want federal money lent at a set below market rate, we want that ability to be limited to us, but we want to charge whatever interest rate we want.
    Why can't I, as a consumer, just borrow money from the fed directly, Why do I have ot got o a bank?


  12. Great article- I have long been against globalism, despite being educated globally.
    I have only met a few economists who "get" this.

    The other problem is the privileged position that real estate occupies in our lending/tax codes.
    Banks lend on assets, they are not venture capitalists. A failed widget compamy has very little value,
    and requires specialised knowledge to exploit. Real estate can be sold to anyone via a simple auction.
    This alone creates a bias toward real estate investing, as capital is more easily available for this type
    of investment.

    But why do we allow interest on real estate loans to be deductible? And why do we allow maintenance expenses
    to be deductible? The purpose of maintenance is to stop the depreciation of a property. We allow maintenance
    expenses to be written off, whose sole purpose is to stop depreciation from occuring, as well as allow (phantom)
    depreciation to offset income!(And every real estate investor believes his property will appreciate,
    or he would rent, rather than buy, if given a choice. We know depreciation (in the tax code) was designed for
    manufacturing assets (assets used in manufacturing- the true basis of wealth)
    that really do depreciate- it is a tax dodge to apply it to real estate- a legal tax dodge, but a dodge.
    This creates enormous tax advantages which favor real estate investors.

    In a "fair" economy, the number of people who are "rich" would be distributed
    fairly evenly across the various ways of getting rich- manufacturing, real estate investing, lending, etc.
    The disproportionate number of real estate billionaires show that the game is "unfair". This is because our tax
    codes allow and encourage real estate as a tax dodge. The wealthy had it set up this way to get around the tax laws.

    This creates an asset class- real estate- which attracts an inordinate amount of investment capital,
    without adding much in the way of "real" (as opposed to paper) wealth.This starves the rest of the
    economy of investment capital, which means that they have to show much higher returns, and we're back
    to your usury argument.


  13. IMHO, this article is pretty much nonsense. Your thesis rests on a supposed crowding out effect whereby finance took the productive captial of the country at the expense of manufacturing. That thesis is unequivocally incorrect. Until last year there was so much captial available that the threshold to get debt or equity financing was lower than at any point over the last century. A good idea in manufacturing or finance could get find debt or equity financing more readily than at any point in our history.


  14. Why do you think unionism is the answer? Most manufacturing jobs left this country because its cheaper to pay Chinese labourers a fraction of US union scale wages. GM and Chrysler are going into bankruptcy because they overpaid and overpromised to the UAW for years. What a great idea, more the same for the rest of the US manufacturers!

    Innovation drives profit. New ideas for new products create profit. Innovation in manufacturing techniques drive profit. IDEAS drive profit. Picket lines and union demands do not. If you want prosperity for the middle class, then invest in education and lower the barriers of entry for new businesses. You won't get jobs/wage growth because you are good at marching in a picket line.


  15. Innovation drives profit. New ideas for new products create profit. Innovation in manufacturing techniques drive profit. IDEAS drive profit. Picket lines and union demands do not. If you want prosperity for the middle class, then invest in education and lower the barriers of entry for new businesses. You won't get jobs/wage growth because you are good at marching in a picket line.

    I'd say that the claim that "Ideas drive profit" is a good summation of the thinking that drove us to this crisis. What drives profit is the production and marketing of valuable goods and services that produces real growth. What destroyed our economy is more and more clever ideas about how to say "I'll pay you back later."


    • I'm sorry, I beg to differ. The source of real wealth is innovation. Maunfacturing or financial makes little difference. Wall st. and investors lost trillions on bad debt. Amazing but true, markets self regulate.


  16. Mr. Whig:: manufacturing has been left of fend for itself AND be forced into relationships with destructive unions by the government. On the other hand WALL STREET , courtesy of the government got acess to special interest rates, 'free money', exclusive licenesens and of course, bail out after bailout every time they became too big to fail. Before I hear another wall street type advocate free markets FOR US, I'd like to see you guys practice it a little yourselves.


  17. …and I would add, the only 'victors' of free trade are those countries which practiced stealth or overt restriction – like China – and yet every time they complain about any measure to protect our industry, the WJS et all prints their complaints verbatim as if they were legitimate.


  18. ""Ideas drive profit" is a good summation of the thinking that drove us to this crisis. What drives profit is the production and marketing of valuable goods and services that produces real growth"
    What! haven't you heard of the 'creative class' and " whole new mind" it's a whole new paradigm, the old rules don't apply!


  19. Wall St. has been dismantled. Govt ife support is bad for the country and bad for the street. The proper course would be an orderly unwind of firms deemed too large to fail and regulations that prohibit firms from growing too large to threaten the economy going forward. The option to fail must be implicit to avoid moral hazard. Our system has failed.


    • Quite right. The recent questioning of the role of the dollar by the Chinese premier was prompted solely by the fear that in inflating it's money supply
      at double digit rates, the U.S. is effectiviely repudiating it's debt. If 10 year
      Treasuries bought today by China buy only 1/2 the goods in 2019 that they
      buy today, China and all other creditors of the U.S. are losers.


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