#43 A “new foundation”

On June 17, 2009

Hello Everyone,

Before I begin, let me alert you to a new, very modest website I have created as a repository for the Obamagrams I have written since the primary campaign began in February 2007. There are 43 in all, so far. In future Obamagrams, I will from time-totime provide links back to them. The URL of the new site, which also includes my bio, is http://obamagrams.com.

As my long-time readers know, during the campaign I struggled to understand what was really happening, not just what the media was reporting. Now, I am trying to get my mind around what is really happening as our economy is being re-structured in fundamental ways. What is the Obama Administration trying to do and why?

I am starting to focus on two words, “new foundation,” that President Obama has been using for awhile now. They could be trivialized as a slogan or mistakenly likened to New Deal and New Frontier or Great Society and Ownership Society. But I think that President Obama is using them in lower case, more as an organizing construct than as a slogan. The idea is no less grand – just not grandiose, in keeping with his temperament.

It can be argued that the weak foundation that underlies our current economy was started to be laid over four decades ago. Since then, that foundation has been rocked by repeated bubbles or other shocks – oil and inflation, junk bonds and S&Ls, technology and dotcoms, housing, and financial “innovations.” Our current mess is not simply a product of sub-prime lending. And, it has been a long time in the making.

It seems as though Barack Obama was aware of the shaky foundation even before he started to campaign for the presidency and well before the “credit crisis” surfaced.

In Audacity of Hope, published in 2006, he wrote of the need to shore up that foundation. “Let’s start with those investments that can make America more competitive in the global economy: investments in education, science and technology, and energy independence.” And, he wrote at length about the need to fix our “broken” health care system.

Then, in his inaugural address in January, he said, “What is required of us now is a new era of responsibility.” He went on to use – in his characteristically understated way – those two words that may come to define his presidency. “And we will act, not only to create new jobs, but to lay a new foundation for growth.”

Most recently, in April, in his major speech at Georgetown University on America’s economic challenges and his comprehensive proposals to respond to them, President Obama said “We must lay a new foundation for growth and prosperity — a foundation that will move us from an era of borrow and spend to one where we save and invest…”

I urge you to read that important speech in its entirety if you want to better understand how the President is thinking. I wrote about it in an Obamagram in April, entitled “No Ordinary Time – Thinking Strategically.” The following link will take you to that section on the new website (see item 6a for the Obamagram and item 6b for the speech): http://obamagrams.com/group-5/no-ordinary-time-%e2%80%93-thinking-strategically/.

Then, last month, the President signed into law major new protections for credit card borrowers.

I think that that legislation and the President’s previous writings and speeches about our economic foundation are profoundly connected in ways that few have discussed directly. Credit cards were perhaps the cornerstones of the old foundation which led to the “era of
borrow and spend” that got out of hand.

Therefore, credit cards are both a culprit and a symbol. A symbol of the need for a new era of personal responsibility and a sounder foundation. Rethinking our individual use of and relationship to credit cards will be critical first steps in that rebuilding.

I have written before about America’s addiction to debt (see item 4, “Culture of Addiction and Impatience” at: http://obamagrams.com/group-5/culture-of-addiction-and-impatience/. I think the first step in getting off that wagon is to conceptually eliminate the word “credit” from “credit card.”

What we currently call credit cards were invented in the 1950s. Joe Nocera is a business columnist for the New York Times, as many of you know. His award-winning book, A Piece of the Action: How the Middle Class Joined the Money Class, was published 15 years ago, long before our current predicament. In it, he claims that the introduction of the credit card ushered in a new era of personal finance “when a simple, ordered, highly regulated world began to evolve… into an immensely complicated universe.”

Nocera writes about the democratization of the financial markets over the last four decades. The middle class, and even the working class, gained access to financial markets and new financial instruments – credit cards, mutual funds, cash management accounts, IRAs, 401ks, and exotic mortgages. “Democracy always comes at some price. Even financial democracy.”

Nocera goes on to say that there has been an “astonishing transformation of the financial habits of the middle class.” A broad set of new habits “have resulted from Americans having to take charge of their financial lives, (including) the way we borrow, the way we save, even the way we think about money.”

But, no preparations had been made for this “money revolution,” as Nocera calls it. The vast majority of we Americans are financially illiterate, or close to it. We are now confronted with a vast array of increasingly complicated financial products. Yet, most of us are unprepared to deal with them.

Credit cards were the precursors of bigger things to come. We weren’t prepared to handle the credit being sold in the guise of convenience. They were the first in a long line of new increasingly addictive means to acquire a dangerous debt habit. Much like the progression from pot to heroin.

The forerunner of the “credit card” was the “charge card”, issued in the early 1950s by Diners Club. It was the first card “that could be used in more than one establishment,” according to Nocera. “Its appeal was convenience rather than credit, which it did not offer. Customers were expected to pay their bills in full at the end of each month.”

“By the mid-1950s, there were at least a dozen attempts to create an all-purpose credit card.” It would offer the first open line of credit to the American consumer – where, unlike the simple charge card, the holder wasn’t expected to pay off the balance at the end of every month. Indeed, providing easy access to credit was its intended purpose as its name clearly indicates. Open lines of credit were previously available only to corporate borrowers. Now with its advent, “consumer credit was [starting to spill] out in every direction,” per Nocera.

In 1958, Bank of America made the first mass mailing of credit cards – 60,000 of them – to the citizens of Fresno, California. A new era had begun.

Of course, consumer credit was nothing new in America. Sears had been selling sewing machines and refrigerators on credit for generations. But, generally speaking, each such purchase was financed by a discrete loan, with fixed installments payable over a fixed period of time.

“Well into the 1950s and beyond, the [Great] Depression remained the nation’s dominant economic memory…” according to Nocera. “The ethos of thrift was one natural result of the Depression experience. So was an aversion to risk… [and] the [country had a] deep and abiding suspicion about the power of bankers.” Our collective memory, economic and otherwise, fades with the passing of time. But, it is currently being refreshed with a vengeance with regard to both risk and bankers.

In order to start breaking our bad debt habits, I think we should all stop thinking of credit cards as credit cards and begin thinking of them as convenience cards.

Big, long-lasting items (like houses and cars) can responsibly be financed with loans of appropriate size and finite duration which have been arranged for each such purchase. We all should under-spend (i.e., save) in order to manage our debt addiction. We should assiduously avoid using debt to buy expendable items — like vacations, flat screen TVs, iPhones, and dinners out.

This is the only way for our society to start to deal with its pervasive addiction to debt.

Here’s an irony — or a dirty little secret — in all of this. The 60% of Americans who borrow using their credit cards are subsidizing those of us who don’t.

I have only one convenience (credit) card. I never use its credit feature. I pay no fee to use it. I don’t even pay for the “float” I use. The float is the interest-free loan that those of us who carry no credit balances gets from the card issuer from the time of each purchase to the end of the monthly billing cycle. Those card holders who use them as credit cards – perpetually rolling over balances and paying usurious interest – actually subsidize my free float.

Here’s another little secret. I have read that about 80% of consumers don’t realize that, if you carry a debt balance, you not only don’t get float for free, but you immediately begin accruing interest for reach new purchase made.

Furthering the irony, Nocera notes that, “One of the great misconceptions people used to have about credit cards is that, by paying in full at the end of each month, they were acting as ‘good customers.’ But bankers never wanted them to pay in full; for a bank, that defeated the whole purpose of credit cards, which was to create debt. Bankers had a word for people [like me] who paid off their balances each month: freeloaders.”

There is another much larger irony in this entire discussion of our debt addiction. The government needs to borrow heavily now to provide a bridge to a sounder financial future for the country. Think of imbalanced budgets as a form of methadone to get us off of our heroin addiction.

David Brooks, as he frequently does, sums up our situation well, “We [have] moved from the Age of Leverage to the Great Unwinding. For about a generation, the U.S. surfed on a growing wave of debt… This rise in debt fueled a consumption binge… The leverage wave crashed last fall… And now attention turns to the task of the next decade: slowly unwinding the debt that built up over the past generation.”

Eschewing credit card debt is the best place to start in building a new foundation for the American economy.

Please, as always, pass it on.

Chuck

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