Dealing with debt: Sonoma County consumers take advantage of endless supply of money to borrow
It used to be hard for a consumer to get a loan and go into debt.
Old-timers may remember the complaint, “You can’t get a loan unless you don’t need one.” You had to prove to your local banker that you’d have plenty of money to repay a loan before your banker would give you one.
Now it seems like you can get a loan as long as you’re breathing.
“BAD CREDIT CAR LOANS, Submit in 60 Seconds!” CarsDirect.com advertises. “Bad Credit? We can help! No Credit? We can help! Good Credit? We can help! Past Bankruptcy? We can help!”
Last year, Sonoma County households had debt levels that were almost double those in much of middle America and 30% higher than California as a whole, according to the Federal Reserve. Notably, local borrowing for houses, cars, credit cards and other purposes still was half what it was at the time of the 2007 to 2009 downturn, led by a big drop in mortgage balances.
“It seems like people just sort of go along and don’t really sit down and look at their budget. One reason is because it’s so easy to get credit,” said Craig Burnett, a bankruptcy attorney in Santa Rosa since 1988. “My grandparents would put money in different folders to budget it out. But it’s a consumer-driven economy we have now. It’s a different generation.”
What drives such borrowing? Low interest rates at times are one key reason. Laws to encourage homeownership, like letting homeowners deduct on their income tax returns the interest they pay on their mortgage, are another.
But an important reason is this: Shadow banking.
In the old days, banks approved a loan and held onto it until you paid it off. That was called banking.
Now banks pool thousands of loans together and sell pieces of that loan pool to investors. That’s what economists and financial analysts often call “shadow banking.” Not that it’s somehow suspicious, but because so much of the transaction happens outside banks and is hard to see. Others, worried that “shadow” is a pejorative word, prefer to call it market-based or nonbank finance.
In shadow banking, investors get the monthly payments consumers make on loans, happy to know they will probably keep repaying.
And the investors can also make even more money on loans by using the pieces of those loan pools to trade on Wall Street.
For example, some of them use the pieces, called securities, as collateral to get billions of dollars of loans for themselves. It’s like they’re taking their securities to a pawnshop for a loan. Many of these are overnight loans that must be repaid the next day, and the investors use the loan money to make overnight bets on Wall Street.
Put another way, every day investors borrow about $500 billion on Wall Street using pieces of loan pools as collateral, according to the Federal Reserve, and then they can use that $500 billion to place quick, overnight bets on Wall Street.
That means your loan can make lots of fast money for these investors. So they need consumers to borrow lots of money.
Who are the investors? They are financial institutions with money, lots of it. Sometimes they get their money from consumers.
They include: hedge funds, megabanks, large businesses, mortgage lenders, investment banks, money market funds, mutual funds, pension plans, insurance companies, states, municipalities, university endowment funds, certain community banks and others.
Seeing this opportunity, thousands of companies that are not banks, cleverly called nonbanks, have become lenders so they, too, can make pools of loans and sell pieces to these investors.
These nonbanks include lenders like Quicken Loans, the second-largest home lender in Sonoma County; SoFi, which makes online personal loans and has an office in Healdsburg; and Ygrene, a Petaluma company that makes loans in California, Missouri and Florida for homes and commercial buildings to become more environmentally sustainable. All three have been both praised and criticized for their lending.
Shadow banking now accounts for about 80% of U.S. lending, up from 40% in 1980, with traditional banking doing the rest, according to the Federal Reserve and the Securities Industry and Financial Markets Association. Data for Sonoma County is not available, but the global nature of 21st century banking suggests the profile is similar locally.
One more point about shadow banking: It has created an endless supply of money for consumers to borrow.
Here’s how: When investors buy the pieces of a loan pool from banks or nonbanks, the banks and nonbanks use that money from the investors to make more loans to consumers. And then they use your new loans to make more loan pools and pieces, to sell to investors, to get more money, to make more loans to you, to make more loan pools and pieces, to sell to investors, and so on.