Why on Earth Did We Mortgage Our Future?

Bradley Doucet
Issue CXCIX - July 5, 2009
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“Neither a borrower, nor a lender be,” Polonius cautions his son Laertes in Act I of Shakespeare’s Hamlet. “For loan oft loses both itself and friend,” he explains, “And borrowing dulls the edge of husbandry.” Does Shakespeare mean for us to understand that no one should ever lend or borrow money? Surely, this is too timid by half, but the ongoing financial crisis does demonstrate that the business of credit and debt is a risky one. Many people borrowed more than they could repay, and many lent too carelessly.

Overall savings rates have plummeted, too. The savings rate in America, for instance, has hovered in the 0-3 percent range for over a decade. As the recession deepens and American icon General Motors files for bankruptcy restructuring this week, it is worth reflecting again upon how we got to this point. Why, exactly, did so many of us throw caution to the wind in recent years?

Lending 101

Lending money to friends is indeed a touchy matter. In wanting to help a friend, one may have a tendency to underestimate the risk involved. And if the friend fails to repay the loan on time, or at all, the friendship may very well suffer or come to an end.

But this is no argument against lending in general. The fact that a borrower may default is a risk, but if the level of risk is properly assessed—taking into account such factors as past behavior and the presence or not of adequate collateral—it can be reflected in the interest rate charged and adequately guarded against. Lending one’s money then becomes a way of earning money on one’s savings. By delaying some of one’s current consumption, one can have more to spend later.

And there are excellent reasons for lending one’s money. Other people can have great ideas, products, or market opportunities, but lack the capital to realize their plans. Still others may simply be at different points in their lives, where borrowing is a good idea for them (see below), while lending suits your circumstances. Prudent lending is therefore not only perfectly legitimate, but in fact it’s absolutely essential to making the most of one’s savings.

Imprudent lending is what one should be cautioned against, and it is imprudent lending that has been so dramatically revealed in the current crisis. Banks lent money to unreliable home buyers based on the unrealistic assumption that home prices would keep on rising. But they never have kept on rising without end, and they never will. Lending with no real collateral to people who can’t pay is a formula for bankruptcy. Of course, banks had encouragement from on high—the Community Reinvestment Act, the Fed’s loose monetary policy—and when the housing bubble burst, their assumption that governments would bail them out proved all-too-realistic. The ultimate cost of this bailout remains to be seen, but at the very least, it will have involved a huge transfer of wealth from the prudent to the imprudent.

Borrowing 101

What about the other half of the equation? If lending can be good or bad depending on whether one is appropriately cautious, much the same can be said about borrowing. It is true that taking on debt for the purposes of current consumption might “dull the edge of husbandry,” which is to say, it might allow one to be less careful in managing one’s resources. Still, if one properly anticipates that one will have greater earning power in the future, based on greater skill and experience at one’s job, say, one might borrow somewhat for current consumption when young in order to even out one’s lifetime consumption patterns. In one’s prime earning years, one would then pay off that debt and accumulate savings, which could then once again be drawn down in retirement.

In fact, borrowing for consumption can be seen as saving with a fee. If it would take you 5 years to save enough money to buy a car, for instance, you might choose instead to take out a loan to buy it now. The interest you pay is a fee for enjoying the car while you save for it. There is nothing inherently wrong with this arrangement, as long as you can afford it.

Borrowing in order to invest is, of course, also to be encouraged if done wisely. Borrowing to invest in an education is prudent if it will lead to a higher-paying job and a more satisfying life. A startup loan for a small business can be a great idea if you have the skills and dedication to see it through successfully. Taking out a mortgage in order to buy a house is fine as long as the terms of the mortgage are realistic.

Again, it is imprudence that should be cautioned against, and imprudent borrowing is the flipside of every instance of imprudent lending. Market-distorting government and central bank policies must shoulder a large part of the blame, and so must lenders who gave credit to those who could not afford it, but so, too, must borrowers who took on those mortgages and credit card debts they could not afford. There is more than enough irresponsibility to go around.

The International Character Deficit

Economic growth, and hence material progress, depends on that proportion of production that is saved and invested rather than consumed. It can be invested directly by the person who saved it, or it can be lent out and invested by someone else. We in the developed world have been saving very little in recent years, while the Chinese, who earn far less than us on average, have nonetheless been saving a lot—between 30 and 40 percent of their disposable income in recent decades. This is one of the principal reasons why China as a whole has repeatedly posted double-digit economic growth rates, and why the Chinese have been able to take advantage of their newfound economic freedom to climb out of poverty by the hundreds of millions.

Many of us in the West, on the other hand, have to some extent been living quite literally on borrowed time. There are signs that we are waking up—the American savings rate hit 5.7% this past April—although it has taken the worst recession in decades for us to do so. Why have we been saving so little and borrowing so recklessly? Low interest rates are a disincentive to save, it is true, but there is more to it than that. We not only have budget deficits and trade deficits—we in the developed world increasingly have a character deficit.

The standup comedian Louis C.K. is on to something when he suggests that maybe we need this recession to shake us out of our complacency. In a bit he did on Conan O’Brien’s show this past February, which has gone viral on YouTube under the title, “Everything is amazing, nobody is happy,” the comic bemoans how spoiled we have become. Poking fun at someone complaining about a delay on a commercial flight, he quips,

"Oh, really? What happened next? Did you fly through the air, incredibly, like a bird? Did you partake in the miracle of human flight, you non-contributing zero? You’re flying! It’s amazing! Everybody on every plane should just constantly be going, ‘Oh my God! Wow!’ You’re flying. You’re sitting in a chair… in the sky!"

The deeper point is that not only do we no longer appreciate the wonders of modernity; we are well on our way to forgetting the kinds of attitudes that made modernity possible. Leading up to the 20th century, the general increase in future orientation and concomitant accumulation of capital was one of the pillars upon which modern civilization was erected. But we in the pampered West are no longer as ready as we once were to delay gratification.

The rise of the welfare state is both a cause and a consequence of this attitudinal shift: entitlements and the entitlement mentality reinforce one another. What we need to break this vicious cycle is a principled commitment to take responsibility for our own lives, to plan for our own futures, the way people in our grandparents’ generation did. “This above all: to thine own self be true,” Polonius goes on to tell his son. “And it must follow, as the night the day, Thou canst not then be false to any man.” Both lenders and borrowers could use a little more of this kind of integrity, and with a little more integrity, we will all see our way clear of the mess we’ve gotten ourselves into.

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