American Credit: Exploring Its History and Predicting Its Future

Credit in the contemporary American culture has become a vital part of our everyday life because it makes the management of people’s finances easier and more accessible through the means of borrowing money and paying it later. When people use credit, they can satisfy their needs for today and pay for this satisfaction in the future. According to the US History Encyclopedia (2003), the two primary types of credit are “producer credit and consumer credit”. Olney (2003) explained that “producer credit is extended to businesses”, while consumer credit is the type most people use as it is the one “extended to individuals” and “can be extended long term or short term” wherein “long-term credit generally has a maturity of one year or more”. In this case, Kapoor et al. (2003) defined credit as “an arrangement to receive cash, goods, or services now and pay for them in the future”, while “consumer credit refers to the use of credit for personal needs (except a home mortgage) by individuals and families, in contrast to credit used for business purposes”.

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The emergence of credit is quite unclear as Olney (2003) believed that the demand for it can be traced back to the first settlers in America. Since the economy was agricultural and mercantile in nature, producer credit was extended directly by merchants and individuals. Olney (2003) also recounted that borrowers lived far away from lenders, which is why they need to plan everything the use of their borrowings and the terms vary depending on what the lenders would set upon them. Determining the “creditworthiness” of the borrower is also difficult because of the physical distance between them and the lack of centralization of all their financial activities. While credit was originally a privilege of the affluent, farmers came to use it extensively. No direct finance charges were imposed; instead, the cost of credit was added to the prices of goods.

When the Bank of North America opened its doors in Philadelphia in 1781, many banks followed suit and opened branches that, by 1810, there were 88 banks to serve people who seek credit. However, banks prioritized businesses first because they need it to finance their activities. In the 1840s, the industrial revolution paved the way for long-term credit because transportation firms and production factories have emerged to fuel the growth of the American economy. When 1865 came in, demand deposits or “checking accounts” have been introduced as these replaced the means of extending credit through the use of banknotes (Olney, 2003).

With the advent of the automobile in the early 1900s, installment credit, in which the debt is repaid in equal installments over a specified period, exploded on the American scene. The first type of credit card was also introduced by oil companies and department stores as these were made of paper and were called proprietary charge cards. Yet, it was not until 1950 that the real credit card emerged to serve the needs of the American public. The first credit card was the Diner’s Club that was promoted as the first “travel and entertainment” card (Sienkiewicz, 2001). By the late 1960s, many banks began issuing cards to their customers and merchants began accepting them as payment. These early cards required payment in full within a short period, usually less than 90 days. However, banks quickly recognized the revenue potential of simply extending the repayment time while continuing to charge interest. Soon after, banks, led by Bank of America, created associations to act as clearinghouses for credit card transactions. Some of these associations included BankAmericard, BankMark, and MasterCharge and were the forerunners of the current two associations, Visa and MasterCard.

With the evolution of American credit in the 20th century, all economists now recognize consumer credit as a major force in our economy. Any forecast or evaluation of the economy includes consumer spending trends and consumer credit as a sustaining force. To paraphrase an old political expression, as the consumer goes, so goes the U.S. economy. Sienkiewicz (2001) emphasized the impact of consumer credit that “in 1970, only 16 percent of households had a credit card” and when 1995 came “approximately 65 percent” of Americans “had at least one credit card”.

At present, Kapoor et al. (2003) deemed that the aging of the Baby Boom generation has added to the growth of consumer credit. This generation currently represents about 30 percent of the population but holds nearly 60 percent of the outstanding debt. The people in this age group have always been disproportionate users of credit since consumption is highest as families are formed and homes are purchased and furnished. Thus, while the extensive use of debt by this generation is nothing new, the fact that it has grown rapidly has added to overall debt use.

Looking into the advent of credit in American culture, we can now realize that consumer credit enables people to enjoy goods and services now—a car, a home, an education, help in emergencies—and pay for them through payment plans based on future income. Credit cards permit the purchase of goods even when funds are low. Customers with previously approved credit may receive other extras, such as advance notice of sales and the right to order by phone or to buy on approval. In addition, many shoppers believe it is easier to return merchandise they have purchased on account. Credit cards also provide shopping convenience and the efficiency of paying for several purchases with one monthly payment.

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Kapoor et al. (2003) informed that one-third of all credit card users generally pay off their balances in full each month. These cardholders are often known as “convenience users”. Others are borrowers; they carry balances beyond the grace period and pay finance charges. Credit is more than a substitute for cash. Many of the services it provides are taken for granted. Every time a person turns on the water tap, flick the light switch or telephone a friend, they are now using credit. It is safer to use credit since charge accounts and credit cards let people shop and travel without carrying a large amount of cash. The use of credit cards can provide up to a 50-day “float,” the time lag between when a person can make the purchase and when the lender deducts the balance from our checking account when the payment is due. This float, offered by many credit card issuers, includes a grace period of 20 to 25 days (Kapoor et al., 153). During the grace period, no finance charges are assessed on current purchases if the balance is paid in full each month within 25 days after billing. Finally, credit indicates stability. The fact that lenders consider a person a good risk usually means he or she is a responsible individual. However, if one does not repay debts on time, they will find that credit has many disadvantages because they can be sued by the bank or they will pay large interests that accumulate every time a person fails to pay on time.

However, another type of credit gained fame as many Americans wanted to have flexible terms using their properties. Working in a mechanism somewhat similar to credit cards, a home equity loan is based on the difference between the current market value of a home and the amount that someone still owes on his or her mortgage. With such a loan, a person may borrow up to $100,000 or more on their homes. Depending on the value of the home, they can borrow up to 85 percent of its appraised value, less the amount they still owe on their mortgage. The interest they pay on a home equity loan is tax-deductible, unlike interest on other types of loans (Kapoor et al., 155).

With these home equity loans, an unprecedented proliferation of a controversial type of mortgage called subprime mortgage came to predate unscrupulous borrowers. With people having low credit ratings, they cannot easily obtain regular loans this is why they opt to take the subprime mortgage, which is a home loan given to people with relatively low incomes and unwarranted credit records. To look attractive enough, lenders dress up subprime mortgages with lesser down payment requirements and low introductory interest rates. These are two features that make these loans tempting enough for those with meager incomes or bad credit because it minimizes the annoying barriers to homeownership. Little that they know, almost all subprime mortgages are adjustable-rate loans, which have initial low-interest rates that may shoot up after the introductory period. This is when interest rates were raised in 2007 the payments for this subprime become ridiculously higher than what they might seem at first glance.

A mortgage crisis cannot be stopped from happening because subprime loans were at 5.6% in 2001 when as the housing boom peaked, subprime loans accounted for 20% of the overall mortgage market, amounting to amounted to $600 billion (Eavis, 17 September 2007). This means that between 2000 and 2006 millions of Americans became homeowners courtesy of subprime mortgages. However, when higher interest rates kicked in borrowers were shocked to know this reality.

According to the foreclosure tracking company RealtyTrac Inc., there was a 42% increase in foreclosures in 2006 than a year earlier and 35% more in the first quarter of 2007 (Gibeaut,  2007).

Fears began to materialize in 2006 when, amid an accelerating decline in housing prices, delinquent loans with payments more than 60 days overdue shot up to a rate of 13%, compared with 8% the year before, and the rate of foreclosures quickly spiked to record levels. As a result, the nation’s top subprime mortgage lenders, whose income is principally derived from their customers’ interest payments, also began to suffer. New Century Financial, the second-largest subprime lender in the United States, has filed bankruptcy as their loans began defaulting and the housing market began to fall downwards spiral (Cho, 2007).

The impact of the ongoing subprime crisis did not just affect U.S. homeowners and lenders, but its effect triggered a slowdown in financial markets around the world. That is because a wide range of financial institutions, including investment banks and hedge funds, also sought to profit by investing in U.S. mortgages, through a variety of financial instruments. For example, banking giant Citigroup Inc., a heavy investor in the U.S. real estate market, joined the bandwagon of mortgage-related casualties when it announced a 60% earnings drop for the year’s third quarter (Rosenbush, 2 November 2007). The U.S. economy itself had revised projections for annual real GDP growth downward from 2.2% to 1.9% for 2007 and from 2.8% to 1.9% for 2008. This was because the ongoing difficulties in the mortgage market are expected to continue next year driving down residential construction and investment income (Country Insight, 2007). The recent bankruptcy of the Lehman Brothers is also believed to be part of the domino effect of the bad loans made.

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Upon the victory of Barack Obama as the new president, he is faced with a gargantuan task of heaving up the country’s economic status. What should be done is to settle all the mess made by the subprime mortgages and support a new economic program that will prevent the crisis from happening again. It is good that the Federal Reserve has already intervened heavily in money markets and cut its discount rate by 50 basis points. Indeed, with a good economic prospect from the lessons learned, there is still a silver lining in American consumer credit that it will weather all the difficulties it is facing today and Americans will be warier in making loans in the future.

Works Cited

  1. Cho, David. Huge mortgage lender files for bankruptcy, The Washington Post, 2007, p. A1.
  2. Country Insight. (2007). Short-term forecast of global real GDP growth. London: Euromonitor International.
  3. Eavis, Peter. Oh, the people you’ll blame! Financial crisis from subprime mortgage lending. Fortune 156.6 (2007): 118.
  4. Gibeaut, John. Mortgage fraud mess: growing numbers of homeowners are being dragged down by questionable loans. ABA Journal, 93 (2007): 50-57.
  5. Kapoor, Jack, Dlabay, Les R., Hughes, Robert J. “Introduction to Consumer Credit”, Personal Finance, 7th ed. NY: The McGraw-Hill Companies, 2003.
  6. Olney, Martha L. “CreditUS History Encyclopedia, 2003. Answers.com. Web.
  7. Rosenbush, Steve. Citi: That sinking feeling; The banking giant’s shares flounder after analysts downgrade the company, citing a lack of capital and exposure to shaky credit pools and subprime mortgages. Business Week Online.
  8. Sienkiewicz, Stan. “Credit Cards and Payment Efficiency”, Discussion Paper Federal Reserve Bank of Philadelphia,  2001.
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