The Credit Collapse Opened the Door for Trump and Sanders

The pain of deleveraging is "a big part of the political story."

Photographer: John Taggart/Bloomberg

Americans lost so much in 2008 — jobs and homes, incomes and wealth — that the recession still dominates the public mood three elections later.

They lost something else too, something less talked-about on the campaign trail: a credit lifeline. For households before the crash, borrowing made good times better and hard times bearable. It held out the promise of a step up, even for the millions of working-class Americans whose wages had stalled. Paying down debt after 2008 had the exact opposite effect, amplifying the hurt and anger — and sapping the recovery.

“If you take the credit away, people are going to feel poor,” said Lucia Dunn, an economics professor at Ohio State University who led a study on household debt and the stress it caused.

Retrenchment came in two main varieties: by choice and by force. Some borrowers, seeing the devastation around them, scrounged up the cash to reduce debt. Others went bust and saw their homes go into foreclosure, or lost access to credit as banks clamped down.

In both cases, living standards took a hit. Between 2000 and 2007, borrowed money was adding about $330 billion a year to Americans’ purchasing power, according to the Federal Reserve Bank of New York. By 2009, households were diverting $150 billion to pay back debt — a swing of almost half a trillion dollars, even without counting the impact of lost jobs.

Enter Donald Trump and Bernie Sanders.

Both presidential candidates have rattled the political establishment, in large part by appealing to blue-collar — and highly indebted — Americans with an “I understand your anger” type of message. “Debt is a big part of the political story,” said Sherle Schwenninger, co-author of a study of household borrowing by New America, a policy institute in Washington. “The debt overhang, the debt struggles, the debt traps,” he said, all form part of the “narratives on both the Democratic and Republican side.”

Of course, when viewed from a different angle, the result of all this deleveraging is an American consumer in better financial shape.

Federal Reserve chief Janet Yellen highlighted this point two weeks ago, telling reporters in Washington that “household balance sheets are much improved.” As a share of the country’s economic output, consumer debt is down almost 20 percentage points from its 2008 peak, at 78 percent. And because interest rates have stayed low, Americans can afford to keep current. Debt-service costs as a share of disposable income are near historic lows.

That macro picture doesn’t tell the whole story, though.

Debt —and the ability to repay it — aren’t distributed equally. Especially after the subprime lending boom, the lower-income groups have the heaviest debt burden, according to New America’s study. That’s one reason deleveraging is weighing so much on the recovery. It takes cash away from the people most likely to spend it.

There’s “a day-to-day, week-to-week struggle of ‘How am I going to pay this bill or that bill?”’ Schwenninger said. And that fuels “a sense of desperation and anger.”

For many Americans, the end of the credit cycle was jarring. Lifestyles had been built around that extra cash, and people just hadn’t realized it could disappear, according to Diane Gray, a vice president at Navicore Solutions, a nonprofit financial counseling service in New Jersey. Those who sought help in the immediate aftermath of the crisis were “scared and distraught,” she said.

That desperation faded as the economy recovered, Gray said, and the profile of callers is now shifting: Housing debt is playing a smaller part, student loans a bigger one. She’s noticed another trend that may be more troubling, though. Before the crisis, customers would take out unsecured loans — typically more expensive than mortgages or auto financing — for perks such as vacations. Now, they’re often being used to cover basic living expenses.

Aileen Dooley, a 58-year-old school department head from Chantilly, Virginia, admits she was in the perks camp.

“We were going out for dinner three or four times a week,” she said. “Going to Nordstrom. We took family vacations, we used to go to Disney World once every two or three years. It was things as simple as that, you know? Getting dinner out, getting hair done and buying clothes. Stuff that now seems — well, it was — dangerous.”

Dooley’s balance sheet turned critical after her husband had to take a much lower-paying job in 2007. With credit-card debt peaking around $30,000, she turned to Navicore to help negotiate write-downs. It worked, though she said she still owes money on the loans that financed her daughters’ college education.

Student debt has been the fastest-growing component since the end of 2008, almost doubling to $1.23 trillion. Sanders, who has used his broad support among young voters to challenge Democratic front runner Hillary Clinton, is tapping into the anxiety that student loans create. He’s promising to make public college free, while Clinton has pledged debt relief for students.

Schwenninger said Sanders also won support with a broader argument: that one side of America’s credit equation — the borrowers — shouldered the whole burden while lenders “could rig the system and get bailed out.” He sees traction for that story among Republicans, too, where it has helped propel the outsider Trump to first-place status in the campaign.

The U.S. mortgage market has shrunk markedly since the bubble burst. Total home loans stood at $8.25 trillion at the end of last year, down from $9.29 trillion back in 2008. Americans have also trimmed their credit-card liabilities: Outstanding balances were $733 billion in the fourth quarter, compared with a 2008 high of $866 billion. Like student debt, auto loans are on the rise, and a growing share of them are going to subprime borrowers.

As borrowing rocketed to record highs before the crash, most policy makers and economists played down the risks.

Steve Keen was one of the few who didn’t. A professor at Kingston University in London, he warned of a brewing private-debt crisis as early as 2005. The problem for the U.S. economy now, he said, is that it’s unrealistic to expect much credit growth “in the aftermath of the biggest debt bubble in history. So a major source of demand is removed.”

Richard Koo, chief economist at Nomura Research, says the U.S. is going through something similar to the “balance-sheet recession” that hit Japan in the 1990s. After a credit boom-and-bust, Koo argues, it doesn’t matter how low interest rates go: Households and businesses want to repay debt, not spend or invest. So monetary policy can’t dig the economy out of its hole.

Policy makers wouldn’t want a repeat of the borrowing binge anyway. The question is: What fills the gap? Fiscal spending isn’t doing it. The government has scaled back its post-crisis stimulus; business investment is slowing; and wage increases during this recovery are only barely outpacing inflation.

Carol Oursler, 59, said she hasn’t had a raise in two years and still earns less than she earned in the sales position she lost in 2009. What’s more, the salary from her new job had to cover the cost of deleveraging: Oursler had run up almost $20,000 of credit-card debt after leaving her husband and moving to a home in Baltimore that she then had to fix up.

It took her five years to clear the balance. Looking back now on her debt odyssey, Oursler takes responsibility — “I regret that I used it for things I probably shouldn’t have; I did a lot of Christmas shopping a couple times” — but also wonders whether government officials and bankers should have done more to prevent the crisis.

“It was too easy for people to get into debt and get in way over their heads,” she said. “And that bothers me.”

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