EROC: Excessive Reliance on Credit

Wikipedia:

Financial institution debt levels and incentives

The Financial Crisis Inquiry Commission reported in January 2011 that: "From 1978 to 2007, the amount of debt held by the financial sector soared from $3 trillion to $36 trillion, more than doubling as a share of gross domestic product. The very nature of many Wall Street firms changed—from relatively staid private partnerships to publicly traded corporations taking greater and more diverse kinds of risks. By 2005, the 10 largest U.S. commercial banks held 55% of the industry’s assets, more than double the level held in 1990. On the eve of the crisis in 2006, financial sector profits constituted 27% of all corporate profits in the United States, up from 15% in 1980."

And that's after things went bad in 1974 because of excessive reliance on credit.


Speaking of EROC, following is a bit of history from Wikipedia's Mortgage-backed security article. I have put Wiki's words in chronological order, removed links, and used "..." a few times, but otherwise added or changed nothing:

After the Great Depression, as a part of the New Deal the federal government of the United States created the Federal Housing Administration (FHA) with the National Housing Act of 1934...

In 1938, the government also created the government-sponsored corporation Federal National Mortgage Association (FNMA), colloquially known as Fannie Mae...

In 1960 the government enacted the Real Estate Investment Trust Act of 1960 to allow the creation of the real estate investment trust (REIT) to encourage real estate investment.

In 1968 Fannie Mae was split into the current Fannie Mae and the Government National Mortgage Association (GNMA), colloquially known as Ginnie Mae...

Ginnie Mae guaranteed the first mortgage passthrough security of an approved lender in 1968.

In 1970, the federal government authorized Fannie Mae to purchase private mortgages, i.e. those not insured by the FHA, VA, or FmHA, and created the Federal Home Loan Mortgage Corporation (FHLMC), colloquially known as Freddie Mac, to perform a similar role...

In 1971 Freddie Mac issued its first mortgage passthrough, called a participation certificate, composed primarily of private mortgages.

In 1977 Bank of America issued the first private label passthrough...

In 1981 Fannie Mae issued its first mortgage passthrough, called a mortgage-backed security.

In 1983 Freddie Mac issued the first collateralized mortgage obligation.

...in 1984 the government passed the Secondary Mortgage Market Enhancement Act (SMMEA) to improve the marketability of such securities.

The Tax Reform Act of 1986 allowed the creation of the tax-free Real Estate Mortgage Investment Conduit (REMIC) special purpose vehicle for the express purpose of issuing passthroughs.

The Tax Reform Act significantly contributed to the savings and loan crisis of the 1980s that resulted in the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), which dramatically changed the savings and loan industry and its federal regulation, encouraging loan origination.

The above list includes two events in response to the Great Depression, one event in 1960. Everything else happened since 1968.

By 1968, the availability of credit was already problematic.

The 1960 event -- the REIT, "to encourage real estate investment" -- was a very early indicator that policymakers thought more credit use and availability was needed. Again, Wikipedia:

A real estate investment trust or REIT is a tax designation for a corporate entity investing in real estate. The purpose of this designation is to reduce or eliminate corporate income taxes. In return, REITs are required to distribute 90% of their taxable income into the hands of investors.

And again:

Real estate investment trusts (REITs), which began when the Real Estate Investment Trust Act became effective January 1, 1961, are available. REITs, like savings and loan associations, are committed to real estate lending and can and do serve the national real estate market...

It was a way to encourage the availability and use of credit. Why? Because Congress thought we needed to expand credit. Why? Because credit is good for growth. Why? Because that's what we think: Credit is good for growth.


After 1960, nothing until 1968. Then everything rolls in like thunder.

Why? Because available credit gets used up. And not having access to additional credit hinders growth. That's what we think: hinders growth.

Apparently, nobody ever thought about just paying off some existing debt as a way to free up credit and make it available for lending again. No. We prefer to roll debt over, keeping credit in use. And to invent new ways of expanding credit.

But it isn't preferences. It isn't us. It is policy. If there were tax incentives encouraging the accelerated repayment of debt, we would pay off debt faster and free up credit for re-use. But we don't have those policies. Instead, we have policies that encourage credit expansion.

When we use credit, we create debt. The debt we have today, public and private, is a direct result of policies that encourage credit use.