CHAPTER ONE
WHEN PERSONAL DEBT WAS REALLY BUSINESS DEBT (2000 B.C.- A.D. 1920)
Academic histories of debt in America usually start in Italy, their introductory paragraphs awkwardly positioning the fourteenth-century Medici bankers as Citibankers in tunics. Popular histories, such as those scattered in newspaper articles, CEO speeches, or lenders' pamphlets, go even further into the past, like this account from one of the largest U.S. credit card companies: "Credit dates back as far as man's known existence. Clay tablets belonging to the year 2000 B.C. tell of credit transactions, and records indicate that ancient Romans bought homes and other durable goods on installment plans-just as men do today."1 Though it's true that people have always borrowed, the way in which we borrow in the United States today is unprecedented. Never before has personal debt been so central to how an economy works. Never before has borrowing to consume been such big business.
Big business, on the other hand, has always borrowed. Historians frequently date the beginning of the modern capitalist (as opposed to the medieval) era to when states and businesses began to incur large debts. Trade, war, and Christianity turned the disjointed polities of a peninsula into the continent of Europe. Beginning with long-distance IOUs for the Crusades in the medieval period, negotiable bills of exchange enabled long-distance trade. This trade slowly reignited the European economy, laying the foundation of modern capitalism. The Crusades against Islam all too quickly became wars within Christendom itself. Wars cost money. Starting in fifteenth-century Italy, European governments began to issue debt to pay for those wars, borrowing vast sums from their own subjects. The Bank of England, founded in 1694, enabled Britain to both fund its wars and create an easy way for the British to invest their money. These liquid, deep debt markets only encouraged other forms of nongovernmental borrowing, and national central banks underpinned European commercial banking. Merchants and industrialists could eventually borrow from commercial banks to invest in their capitalist endeavors. In the United States, central banks had a more checkered history. Though a national bank was founded in 1791, its first incarnation lasted only forty years, as Jacksonian populism triumphed over federalism. In the United States, commercial banking, absent a central bank, developed in a more piecemeal fashion at the state level. Commercial banking was no less successful in America than in Europe, however, and as in Europe banks enabled the sustained growth of the Industrial Revolution in the nineteenth century.
Though financiers, merchants, and industrialists could borrow without difficulty from banks-if they had a good reputation and a good business model-ordinary people could not. There was no personal lending from banks until the 1920s. Legal borrowing, since the Crusades, had always been for profitable investment or for government purposes (which, depending on how you look at it, may or may not be profitable). Personal debt of an everyday nature was not part of this system. Merchants borrowed to buy inventory to trade overseas. Industrialists borrowed to build rails. States borrowed to make war on one another. But you and I could not borrow two nickels for consumption, which, by its definition, cost rather than created money. Profits came from investing in production and trade, not consumption.
Legal borrowing, like business loans, turned on the idea of the productive investment. Investors and bankers gave money to ship captains and factory owners because they used that money to make more money. That is how investors and bankers knew they would get paid back. The whole enterprise of banking turned on this idea of assets producing profits. Loans to deadbeat brothers or aging widows might help the borrowers out of a jam but would not produce profits. It was just bad business-or so the conventional wisdom went.
Bankruptcy laws, today nearly always used for personal debt, were created to help small-business men take risks. Before bankruptcy laws, debts never went away, and before the mid-nineteenth century, a debtor could be thrown in jail. The infamous debtors' prisons were filled mostly with failed businessmen, not degenerate samplers of pleasure.2 Debt in the fifty years before and after the American Revolution served two wildly divergent purposes. As you might expect, loans could be for business, but equally common was debt as a substitute for currency. In most areas of the country, particularly rural areas, cash was scarce. Store owners needed to sell on account if they were to have customers. Every year the period when the crop came in saw a minor financial crisis, as cash flowed spasmodically through the economy to settle the yearlong accounts.
Small-time debtors could sometimes not meet their obligations, but even more than today, the failure to repay a loan was a moral failure- indeed, such a moral failure that it could send you to jail. Today, lending is an impersonal act. Every lender knows that there is a chance the debt will not be repaid and can either refuse the loan or increase the interest rate. In the eighteenth century, debt, especially on account, was a moral act of charity that happened to enable trade. Borrowing without repayment was seen as a moral failure akin to fraud. Duplicitous customers duped store owners. Despite the grip of debtors' prisons on our popular imagination, such prisons were rare in the United States. Save for a few debtors' prisons modeled on British examples, such as the Prune Street prison in Philadelphia or the New Gaol in New York City, most debtors would find themselves bedding down with murderers, rapists, and other reprobates-or, more accurately, sleeping in hallways and on stone floors with other criminals.
In the early nineteenth century, that clear moral vision of debt began to become murkier. As nineteenth-century students of economy read their Adam Smith and David Ricardo, a new rationalism took hold. Lenders ought to have known that some borrowers would default. Every loan was a business decision, not a personal trust. Risk, as every lender who cut off a credit line knew, had to be weighed. This new perspective did not supplant the moral view of debt, but it did temper it. For the economy to grow and for innovation to occur, risks had to be taken. For every business that succeeds, many more fail. We would not want to live in a society in which reasonable risk could not be taken, because that would be a society without growth. In 1800, the first U.S. bankruptcy law exemplified this perspective, as it absolved only large business debts. Practically as well, imprisonment hampered repayment, as the imprisoned could not work. Only loans to the wealthy, who owned assets worth selling, could be repaid if they were imprisoned. By 1833, federal law eliminated imprisonment for debt. Most states abolished their imprisonment laws around the same time, in the 1830s and 1840s.
Even though imprisonment was abolished, bankruptcy as an opportunity to wipe the slate clean persisted for only a moment. The Bankruptcy Act of 1800 was repealed a few years later. Another version came in 1841 and again was rolled back. Our modern bankruptcy laws date back only to 1898. Like the act of 1800, this law was intended to encourage risk taking in business investment and was never intended to shelter consumers.
The merchants and industrialists who used these bankruptcy acts, however, were the elite of the U.S. economy. Though the manufactured goods of cities were ubiquitous, the United States in the nineteenth century remained an agricultural, rural country. Not until 1920 would the census reckon that most Americans lived in cities, and that term, defined as places with more than five thousand inhabitants, was used quite loosely. In this agricultural world, American borrowing was farm borrowing.
In the mid-nineteenth century, farmers in the West lived and died by credit. The harvest came but once a year, but they needed goods-farm equipment, clothing, groceries-year-round. Independent farmers may have owned their land, but they still depended on the manufactured goods of eastern textile mills and ironworks. The connection between the farmers and factories were the general goods merchant of the nearest town. In Davenport, Iowa, that connection was John Burrows. Cash poor and crop rich, farmers could offer Burrows little but wheat, eggs, and hogs. Burrows wanted to be a grocer, but he ended up as a wheat market. Selling on credit to the farmers, at harvesttime Burrows took their farm goods in trade, selling them in far-flung locales north and south on the Mississippi. Burrows "felt that this country had to be settled up, and to accomplish this, some one must buy the farmers' surplus, or it would remain a wilderness."3
For a time Burrows was the only game in town and could charge high prices for his services. Few merchants possessed the capital to finance such a business. Running a business for farmers on credit meant that payment could come as little as once a year. After the harvest in the North, moreover, there was little time left to ship crops before snow blocked the land and ice locked the rivers. Burrows would always have to store a portion of his goods until spring. Every debt that went unrepaid until autumn and every bale that went unsold till spring was Burrows's money sitting idle. To run such a business required large amounts of capital. At the same time, a would-be merchant would need Burrows's skill and connections at selling in New Orleans and buying from Philadelphia. This merchant would also need to be able to convince these merchants to trust him-never an easy task. Burrows enjoyed his prosperity for twenty years, as the biggest big shot of Davenport, until the railroad arrived and changed everything.
With the railroad, in this case the Chicago and Rock Island Railroad, the barriers to competition that kept Burrows wealthy ended. With the coming of the railroad, Chicago was no longer a distant name but a quick trip of only eight hours. Rivers could freeze but railcars still ran. No longer did merchants need enough capital to finance inventory and customers for a year. Shipments could arrive from Chicago the next day. Hogs didn't need to be stored all winter; they could be shipped as quickly as they were bought. The merchants now didn't need to know wholesalers in New York, Philadelphia, and Boston, just in Chicago. The barriers of capital, skill, and relationships that kept competition out fell. New merchants opened everywhere in Davenport, "bewilder[ing]" Burrows. Losing money steadily, he finally closed his business in 1860, becoming one of the farmers he had previously gouged. By the end of the nineteenth century, at least where there were railroads, the credit of northern and western farmers, who owned their own land, fell in cost. Credit prices still existed but competition drove them steadily down.
Credit flowed more freely not only at stores but on the land as well. The opening of the West to rail also opened it to mortgages. Whereas before the Civil War western lands had generally been free and clear, by the late nineteenth century independent farmers relied on mortgages. Even with the railroad, mortgage credit was cheaper than store credit, enabling farmers to invest in and expand their cultivation. The newer lands took greater advantage of eastern credit. In the Dakotas, even before statehood, 75 percent of the farms were mortgaged, but farmers turned that investment into a rapid expansion of production. From just 1880 to 1885, Dakota wheat production increased from 3 million to 40 million bushels-or the equivalent of the combined production of Illinois and Indiana, both of which had been farmed for decades. At the same time, "mortgage indebtedness," as the Michigan commissioner on labor wrote in 1888, "operates as a mammoth sponge, constantly and unceasingly absorbing the labor of others."4 Hard work by western farmers became hard cash only for eastern bankers, fostering a widespread resentment of mortgages.
While production grew, however, the mortgages made sense for farmer and banker alike. Easy eastern money bid up land values, anticipating continued future growth in wheat production. After all, God wasn't making any more land. In fact, eastern investors demanded such a quantity of western mortgages that companies sent solicitors west, traveling from farm to farm, offering money to hard-strapped farmers, who happily took it. Some improved their lands, investing in new drainage tiles that did, in many parts of the West, double and triple production by artificially drying overly wet soil. Many other farmers took a different course, having grown weary of the hard life, and with their local knowledge and eastern capital speculated in land or even stocks. Mortgages sometimes exceeded the value of the land, as the demand for mortgages to invest in so exceeded supply. Nonetheless, mortgage repayments went smoothly once crop production rose, as did crop prices, as American wheat could be sold in the growing eastern cities and around the world.
In the East, western farm mortgages became fashionable investments. Like an earlier generation's investment in western railroad bonds, eastern investors of the 1880s poured money into western mortgages. Insurance companies as well as individuals bought into the western mortgage boom. To satisfy all the investors, New York financiers began to repackage western mortgages into that quintessentially eastern investment vehicle: the bond. "Bond houses" bought mortgages from brokers, called "mortgage bankers," and in turn issued bonds. Investors' capital paid for the mortgages, and the bond houses issued payments to the bondholders as if they owned a railroad corporation's debt. As much as possible, these mortgage bonds were modeled on the language and payments of railroad bonds. Slowly, beginning after 1900, the mortgage bankers began to bring their western financial schemes to the eastern cities, offering mortgage bonds to back commercial and residential real estate. Their national organization, the Farm Mortgage Bankers Association of America, spread the mortgage bond across the United States.
In the South, King Cotton continued to rule as it had before the Civil War, but instead of slavery, sharecropping now organized cotton production. Sharecropping is remembered as a particularly grueling economic arrangement, but what is less well known is the incredible credit system that underpinned it and cotton-producing slavery before it. In sharecropping, a farmer contracted with a plantation owner for a section of land. In exchange, the landowner had the right to a share of the crop. Because of southern laws, called crop lien laws, the first claim on the crop went to the landowner. This legal right meant that the farmer had to repay the landowner before any other creditor. With the vagaries of crop production, much less crop prices, lending to farmers was a very risky business-unless you were the plantation owner, who had the first right to the crop. But where could a planter get enough money to finance not only crop production but the personal lives of his tenants and croppers?5
Even by 1860, the entire cotton South had only about a hundred banks- less than the total number of banks in Massachusetts alone! Southern agriculture was financed through coastal middlemen called factors. At the beginning of each season, the planter would write to his factor, in a place such as Savannah or New Orleans, to request cash as well as crop seed, goods, and all the miscellany that a remote cotton planter would need to get through the year. Cash could be used at nearby merchants, such as a Montgomery store that advertised "Wholesale and Retail Dealers in Dry Goods, Clothing, Groceries, Hardware, Boots, Shoes, Hats, Caps, Bonnets, Cutlery, Flowers, Combs, etc., etc., etc.,"6 The factor would look at the request and in turn request a loan from a banker in New York. The banker would in turn borrow from a banker in Great Britain. Capital could flow halfway around the world, from Europe to north Georgia. After the Civil War, this system survived largely intact, despite the end of slavery. Only the last step changed. Instead of providing for his slaves, the plantation owner simply loaned money to his sharecroppers through his farm's "commissary."