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The History of Debt in America - 1900-1949

The period of 1900-1949 was again one of turmoil and financial panics. This period included the Panic of 1907, World War I, the Great Depression (the second one), World War II and the rise of consumer credit.

The Panic of 1907
In the summer of 1907, the American economy was showing signs of weakness as a number of business and Wall Street brokerages went bankrupt. In October, the respected Knickerbocker Trust in New York City and the Westinghouse Electric Company both failed, touching off a series of events known as the Panic of 1907.

In the wake of the initial business collapses, stock market prices plummeted and depositors made a massive run on the nation’s banks. The U.S. Treasury pumped millions of dollars into weak banks in the hope of saving them, but the string of collapsed institutions lengthened.

J.P. Morgan summoned the leading bankers and financial experts to his home where, over the course of three weeks, they set up shop in his library. Together they labored to channel money from the strong institutions to the weaker ones in an effort to keep them afloat.

The joint effort of the government and the business leaders improved conditions markedly over the course of several weeks. Following the Panic of 1907 reformers convinced Congress that thorough bank reform was necessary to provide badly needed currency elasticity (a major issue in the Panic) and the general soundness of the banking system. With the passing of the Owen-Glass Federal Reserve Act of 1913, the Federal Reserve System was created.

Early Payday Loans
As busy as New York City’s pawnbrokers were during the early part of the twentieth century an estimated two-thirds of the total lending came from small-loan agencies. These companies loaned money either on the basis of a secured property, property the lender could hold onto, or on the assignment of future wages. These small loan agencies were often chain stores with one particular company run by D.H. Tolman operating offices in sixty-three cities.

Skirting usury laws by claiming they weren’t lenders but “salary buyers” wage assignment lenders like D.H. Tolman often charged interest rates as high as 1,000 percent. Borrowers filled out a lengthy application and signed complicated-looking promissory notes. Because the interest rates being charged were illegal the documents had no real legal standing but relying on the ignorance of the borrower they proved effective in reducing the number of those skipping out on their debts.

These lenders had a well-defined system of collection. Employees of companies that forbad them from taking out wage assignment loans were routinely approved because the threat of telling the employer proved to be an effective collection tool. For others the collection started with letters and phone calls. If necessary a personal visit from a “bawlerout” was prescribed. This entailed having a female collector publicly embarrassing the debtor in front of his co-workers or family by browbeating him for being a sorry deadbeat.

Peddling Debt
Although installment selling for the well-to-do had been in vogue for decades of the 1880s and 1890s the new century opened up the practice to working-class households. For recent immigrants this opportunity often came from peddlers who supplied household good on very easy terms. The peddlers, often immigrants themselves, were given lines of credit by established merchants. This allowed them to introduce hundreds of households to the American style of consumerism.

The successful merchant peddlers forced many retailers to switch from selling for cash or thirty-day credit terms to using installment payment plans. Quick to take advantage of these easy payment plans were a category of merchants known as Borax Houses. They sold shoddy, overpriced goods to low-income customers. They discovered that by hiding high interest rates under easy weekly payments selling on the installment plan led to large profits.

Cash is King but Credit is Convenient
Within the expanding credit market there was also an increasing number of cash buyers. As early as 1831 buyers were schooled in the advantage of purchasing with cash, as it “really gives you more money to purchase with” because merchants give substantial discounts for cash. In the later part of the century merchants such as Macy’s, Sears and Roebuck, J.C. Penny and Montgomery Wards championed the “cash and carry” cause. Sears in particular used its catalog to preach against “the evil of the credit system.”

But as more and more stores offered credit, more and more customers expected to use it. This led to a centralization of credit operations that included the issuing of metal identification charge plates by the 1920s. This precursor to the modern credit card allowed customers to buy furniture, pianos, phonographs, and sewing machines on installment terms. As the easy availability of credit led to ever increasing payments Americans began the modern paradox of loving credit while hating debt.

The Small Loan Movement
The founders of the small-loam movement were not trying to spread consumerism by giving easy credit, in fact the reverse was true. Early small-loan lenders were philanthropists who thought that by providing capital to workers they could cultivate the habit of good money management and take themselves to the next financial level. To their dismay instead of building a society of independent, thrifty, and hard-working businessmen they laid the ground work for a debt-ridden consumer culture.

Usury and Illegal Lending
Prohibition against usury, the practice of charging high interest rates, dates back to at least the fifth century A.D. It was prohibited because of moral principles as well as a defense for the easily taken advantage of borrower. In 1545 King Henry VIII broke with tradition and set interest rates at 10 percent. That decree stood until the 1800s when Parliament repealed all usury laws

In the United States usury laws continued in effect until the early twentieth century. But this didn’t stop the practice of small-loan lending from expanding rapidly, even if illegal.

From the 1870s on small-loan lenders began springing up around the country. In fact other than the Great Atlantic and Pacific Tea Company (the A&P), the largest chain stores in America were illegal lenders. Because of a desire to protect consumers from themselves legislators resisted changing the law. But that didn’t stop illegal lenders from stepping in to fill the demand.

Small-loan lenders generally came in two varieties; the first being run by philanthropists or responsible businessmen. Often charitable organizations were formed just to lend small amounts of money to workers. Responsible businessmen saw an opportunity to earn money while providing a much desired service. Even though their interest rates were illegal they kept them to a minimum and provided terms that could be met.

Then there were those who sought to capitalize on the ignorant or desperate. They charged what ever they could and often inserted terms that seemed to go on forever. These unscrupulous lenders were the origin of the term “loan sharks.”

The Fight for Legal Lending
The fight to change usury laws into a modern law that not only protected small borrowers but allowed lenders to earn a profit was led by Arthur Ham. Ham began his quest while working for the Russell Sage Foundation. There he undertook a comprehensive study into chattel lenders, lenders who made loans based upon securing property, usually furniture and other household goods. His study made no distinction between the “good” lenders and the loan sharks.

Ham undertook a two-pronged approach to the problem. He lobbied to have the illegal lenders put out of business while changing he laws to allow for regulated lending. His campaign against existing lenders netted the big fish, D.H. Tolman. Tolman, operator of a chain of offices, actually served a jail term of six months. This in addition to the lenders giving in to the obvious public campaign against them led the formation of the American Association of Small Loan Brokers, an organization that lobbied for legal reform.

Together with Ham the AASLB put together a compromise legislative package. By 1917 the proposal was introduced in several state legislatures. By 1932 twenty-five state had some version if the law on their books.

From Loan Sharks to Credit Counselors
As small lenders came out of dark back offices into modern high profile offices they attempted to redesign their business image. Holding onto the idea of the early lending philanthropists they claimed to teach the value of thrift and savings. They actually positioned themselves as the educators of finance for working-class people. The concept reached such lofty heights that lenders boasted that their education into the principle of household finance would allow the borrower to pay off his loan while establishing saving regimens that would keep him out of debt forever more.

This well-intentioned if not self-serving mantra did not always jive with the economics of the time. For as installment selling grew and workers longed for the new modern conveniences more and more borrowers went to small-loan companies, now called “personal finance” lenders, to consolidate installment payments into one loan.

So as the lending practice become legal and more socially acceptable it’s nature changed from helping the poor worker survive financial doom to helping more affluent worker manage their financial boom.

The Rise of Installment Selling
Installment selling first became popular with high priced farm equipment. The equipment allowed much greater productivity but the price made a cash purchase impossible. Because of the increased productivity the new machine promised family farmers readily agreed to purchase on installment terms. In the best case scenario the machine would virtually pay for itself. The installment plan not only helped build the business of Cyrus McCormick but also help I. M. Singer and Company bring the sewing machine into thousands of American homes.

Soon almost every type or consumer good could be purchased on the installment plan. While large ticket items like furniture, pianos, and sewing machines were among the most popular purchases items like curtains, dishes, and clothing were sold on installment plans too. Many merchants set up shop to sell exclusively on the installment plan. They came in a variety of classes. Some catered well-made goods to high-class buyers while others sold lower priced, often shoddy, merchandise to lower class customers.

Selling on the installment plan became so popular that business empires that were built on it still exist today. After attempting to sell high quality furniture for cash led to bankruptcy the owners of Spiegel made a decision to change course. They began to buy low-priced furniture added good mark-ups and sold it on the installment plan using high pressure sales tactics that stressed it was of a superior value. Sales were so brisk that in 1902 the company established a mail-order department that offered credit to customers nationwide.

Soon the catalogue department became the most successful part of the business. Even though the Spiegel catalogue had prices 5-25 % percent higher than the Sears & Roebuck catalogue their installment terms prevailed over Sears’ cash only policy. Still the stigma over installment buying continued. It was fed not only by class prejudice but by gender stereotypes. Large items purchased on credit, homes and farm equipment, were the decision of men but as more women took control of household expenses smaller purchases on credit were seen as a sign of financial weakness. But this was about to change.

In the 1920s the installment plan become common place and had become acceptable to the point that the social stigma had all but disappeared. The leader of the installment plan, now known as “Acceptance” or “Finance Plan” was the automobile. In 1924 three of four cars were purchased that way.

Automobiles on Time Payments
Early automobile purchases on the installment plan were not a result of car manufacturers or dealer. They were the result of wealthy car owners wanting to replace their old car with a newer model. In 1909 even the cost of a used car was well beyond what most people could afford so individuals began advertising their used car for sale with a down payment and the balance on payments.

It wasn’t until 1916 that the new automobiles were offered for sale on time. But even then financing wasn’t offered by the manufacturers and dealers but a third-party company that saw a business opportunity. Feeling threatened manufactures applied heavy pressure to have the financing ads discontinued.

Two weeks after the first installment plan ad ran a Ford Motor Company employee proposed that they set up a separate company to offer financing for consumers as well as dealers who had to pay cash for their cars. But Henry Ford, being steadfastly against most aspects of financial capitalism, squashed the idea.

Three years later the executives at General Motors saw the idea as a way to compete against the lower price Model T. By offering financing they were able to sell the higher priced more powerful Chevrolet and Oldsmobile to average car buyers. The 1919 formation of the General Motors Acceptance Corporation helped tripper the decline of Ford Motors throughout the 1920s.

Ford tired to merge his concept of Victorian money management with the installment plan by offering potential customers the opportunity to open up a savings account. This account would earn interest and be in the name of the consumer. Once the purchase price of the new Ford car was saved up the transaction was made and the consumer drove off in his new car. This simple plan fit Henry Ford’s model of the financial world but it increasingly seemed antiquated to those accustomed to buying on time.

The installment plan, although costlier than paying cash, had one big advantage. When saving to buy a house one still needed to pay rent and when saving to buy a car one still had to pay for other transportation costs. When buying the home or car on a payment plan you got immediate use of it had could stop the other payments. Your cash flow actually improved. This fact led to the failure of the Ford savings plan.

By 1926 2 of every 3 cars sold in America was bought on credit. By the end of the 1920s phrases like “Buy Now, Pay Later!” and “Take Advantage of Our Easy Payment Plan!” were standard phrases in the American vocabulary.

With the unveiling of the Model A in 1927 Ford announced the formation of the Universal Credit Corporation, its version of GMAC. But it came to late to help regain its market leadership.

Financing Other Consumer Durables
The tide towards financing was overwhelming those who held onto the cash-and-carry policy. Even those who had preached so fervently against it, like Sears and Roebuck and Montgomery Wards had to give in. Some merchants of smaller priced goods continued the moral campaign against financing. Often because consumer would buy higher priced durable goods and then cut back on consumables to make the payments. But in the end virtually everything, even candy and nuts could be purchased on time.

Self-Enforced Budgeting
For all of the fears that preachers of Victorian money management voiced about credit purchasing, the most common was the decline of morality and financial control that was sure to ensue. And their argument seemed to make sense. For those who over did it the demons of debt took control of their lives. But for those who maintained level-headedness the payment plan forced financial management on them that they could often not enforce on themselves. For those who hadn’t been able to save the necessity to make payments and to avoid collectors and repossession provided all the incentive needed to budget, save, and work harder when needed. Victorian principles, it seems, came in through the backdoor of consumer financing but took a prominent place in the modern household.

The Acceptance of Consumer Debt
In 1927 The Economics of Installment Selling was published. In it the author, E.R.A. Seligman introduced the concept of “pay as you use” as an alternative to “buy now, pay later.” This happened because you were actually simultaneously paying for and using the item. Seligman opened of the idea of “wise borrowing, foolish borrowing.” His view differed greatly from the Victorian era’s thinking in terms of borrowing to produce profit and borrowing to produce immediate comfort. In his view the production of comfort, in essence bringing happiness to one’s life, was just as valuable as the production of profit. In this sense the distinction of good and bad as defined by how the credit was used was erased. The real distinction was made in the borrower’s ability to pay the bill.

The Depression of 1921 and 1922
The Depression of 1921 and 1922 was short and relatively painless, not so the next one.

The Stock Market Crash of 1929
The 1920's were a time of unbelievable prosperity. The stock market was going through the roof and there seemed to be no end n sight. Ironically the widespread prosperity led to an attitude of contentment. The desire for consumer durables (expensive items refrigerators, radios, and automobiles) went down as Americans became satisfied with what they had. This in turn affected the companies and workers that produced these items and the economy began slowing.

A large amount of investing in the 1920's was done margin. Investors borrowed money from their brokers to buy stocks. This worked well as long as stocks were going up. Bank lent brokers money, brokers lent their customers money and everyone profited.

But with the crash of 1929 stocks lost value, and the profit chain reversed. Companies lost value, stock prices dropped, investors, brokers and banks alike all lost money, lots of it, overnight. On just one day, October 29, frantic traders sold off 16,400,000 shares of stock. At year's end, the government determined that investors in the market had lost some $40 billion. Of course the economy weakened and unemployment skyrocketed. The Great Depression had begun.

The Great Depression – 1929-1942
By the start of the 1930s 4,340,000 Americans were unemployed. Soon more than 32,000 businesses bankruptcies occurred and at least 5,000 banks failed. This led the unemployment ranks to swell to more than 8 million.

Because of the Stock Market crash millions of citizens suddenly had no savings. With factories and shops closing it was a desperate time for families. Starvation stalked the land and to add to the misery a great drought ruined numerous farms, forcing mass migration. This caused local governments to face great difficulty collecting taxes and to paying for ongoing services.

When Congress passed the Hawley-Smoot Tariff Act in 1930 every major trading nation protested against the law and many immediately retaliated by raising their tariffs. The impacts on international trade were catastrophic. This and other effects caused international trade to grind nearly to a standstill; the depression spread worldwide.

In spite of widespread hardship, President Hoover maintained that federal relief was not necessary. Farm prices dropped to record lows and bitter farmers tried to ward off forecloses with pitchforks.

Eventually the Hoover administration launched a road, public building, and airport construction program. More significantly they administration established the Reconstruction Finance Corporation (RFC) with $2 billion to shore up overwhelmed banks, railroads, factories, and farmers. This action signified, for the first time, the U.S. government's willingness to assume responsibility for rescuing the economy by overt intervention in business affairs. Nevertheless, the Depression persisted throughout the nation.

The Federal Government as Lender
The New Deal solidified the Federal Government as a major lender by supporting consumers with several kinds of credit. One type provided funding to business that in turn lent money to consumers. In 1932 the Federal Home Loan Bank system was opened for business. Designed to function for mortgage lenders as the Federal Reserve did for commercial lenders, it lent money to building and loan associations so that they could lend it to home buyers.

The most active of the New Deal governmental programs was made possible by the Home Owner’s Refinancing Act of 1933.Through the establishment of the Home Owners’ Loan Corporation (HOLC) money was lend to families in danger of losing their homes to foreclosure. By 1936 the HOLC suspended operations but by that time one out of ten mortgages in the country was assisted by a HOLC loan. It had also firmly established the long-term (twenty year) self-amortizing loan. It replaced the previous standard five-year loan with its semi-annual interest payments and lump-sum principle payment.

Also in 1934 the National Housing Act established the Federal Housing Authority (FHA). The FHA was established to do two things: to create jobs in the very depressed housing industry and to repair, modernize, and replace the existing stock of homes in order to bring them up to the standard of the times. It was a complete success with new construction starts going from 93,000 in 1933 to 530,000 in 1940. It also established a new norm for the home mortgage. Requiring a down-payment of 10% and a careful credit check the new FHA backed loans extended the mortgage to twenty-five and thirty year terms.

Another type of government lending involved direct lending. The very first consumer credit program operated by the Government was the Electric Home and Farm Authority (EHFA) incorporated in 1933 as a subsidiary of the Tennessee Valley Authority (TVA). In an effort to promote the use of electricity the EHFA bought refrigerators and other appliances and made them available through local utility companies. The program, aimed at households that had been using washboards and iceboxes, helped bring increased demand for electricity to the Tennessee Valley. It also marked the first time the federal government was in direct competition with private lenders.

The New Deal’s Farm Credit Administration (FCA) was another program that involved the federal government in private lending. It started in 1933 and through twelve regional banks lent money to farmers. Unlike previous lending programs that helped farmers buy farm equipment this program focused on the purchase of consumer goods, automobiles, refrigerators, and the like.

The Federal Insurance Deposit Corporation (FDIC) also played a significant role in cementing the role of consumer credit into everyday life. By insuring depositors money it freed commercial banks from policies that prevented them from extensive lending. Until that time commercial banks had primarily lent money, on a short-term basis to businesses. This was considered both safe and morally acceptable.

There were a few notable exceptions. In 1920 a bank in Bridgeport, Connecticut, advertised small loans to individuals; four years later a Jersey City bank opened the first small-loan department in a commercial bank. But it wasn’t until 1939 that commercial banks surpassed small-loan companies in the total amount or personal cash loans extended. The following year commercial banks also became the largest lenders of consumer installment credit surpassing installment financing companies.

Also on that note there was the Federal Credit Union Act of 1934, It established credit unions as co-operative banks that lent members money at lower interest rates than institutions. Within a year of its passage over one hundred credit unions per month were opening.

The Chandler Act 1938
The Chandler Act of 1938 amended the bankruptcy law and created a menu of options for both individual and corporate debtors. In addition to traditional liquidation individual debtors could seek an arrangement with their creditors through Chapter 10 of the Act or they could attempt to obtain an extension through Chapter 12.

Corporations could seek arrangements on their unsecured debts through Chapter 11 or reorganization of both secured and unsecured debts through Chapter 10. However, because Chapter 10 required Securities and Exchange Commission review for all publicly traded firms with more than $250,000 in liabilities corporations tended to prefer Chapter 11.

With the enactment of the Chandler Act of 1938 American bankruptcy law had obtained its central features. Both individuals and businesses could declare bankruptcy. Both voluntary and involuntary petitions were allowed. Individual debtors could choose liquidation and a discharge, or some type of readjustment of their debts. By choosing Chapter 8 debtors retained possession of property, mainly residences, and offered creditors a three to five year payment plan during which a stay prevented lenders from enforcing liens. By 1939 involuntary bankruptcy became rare, never rising above 2,000 a year.

The End of the Great Depression
At the start of the 1940s the United States had not fully put its economic woes behind it. The 1940 census counted 11.1 percent of U.S. heads of household as unemployed and a deep latent productive capacity existed within American industry.

That changed soon after Japan attacked Pearl Harbor in December 1941. The nation swiftly changed gears from a peacetime to wartime footing that mobilized the populace and numerous industrial sectors. In 1942 the President called for unheard-of production goals. Soon labor unions, farmers, miners, factory workers and virtually every industry focused on the war effort. Massive unemployment became a thing of the past and the Great Depression was swallowed up in the effort to win World War II.

As great of a financial challenge as the Great Depression was, only a small number of consumer loans defaulted. But it did help popularize the use debt consolidation loans

For the period 1934-1937, the National Bureau of Economic Research estimated that approximately 50 percent of personal finance company loans were used to refinance miscellaneous existing debts.

Consumer credit actually declined during the Depression. Many paid off loans and simply declined to take out others until times got better.

Prosperity grew steadily thanks to the governmental spending that was necessary to win World War II. Americans enjoyed an economy that allowed workers to own homes, cars, and televisions. The fact that consumer credit didn’t lead to a total collapse of the economic system during the Great Depression, as some had feared, and with commercial banks, the Federal Government, and even Macy’s offering credit, America was primed for the next financial innovation. They soon embraced the invention of Frank McNamara, the credit card.

Who was in Debt?
Walt Disney's company Laugh-O-Gram Corp filed bankruptcy in 1923.

Paramount Studios filed bankruptcy in 1932.

William Fox, co-founder of 20th Century Fox Film Corporation, filed bankruptcy in 1936.

>>Next Page 1950 - 1999


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