Why do people borrow? To hear law professor turned Senator Elizabeth Warren, it is because they are seduced by rapacious lenders and a consumerist culture into living beyond their means, buying big-screen televisions, new cars, and expensive vacations. And before you know it, you are under the thumb of the big banks—or, even worse, of the street corner payday lender.
But as we show in our new book, Consumer Credit and the American Economy, economists have long understood why consumers borrow. Although there are exceptions to any rule, for most it bears little resemblance to Senator Warren’s picture of hapless victims goaded into debt by rapacious credit card issuers. Instead, consumers borrow for essentially the same reasons that businesses borrow: for capital investments and to smooth disruptions in income and expenses. And paternalistic regulations that make credit more expensive and less available typically makes people poorer.
Consider something as mundane as a washing machine. A washing machine is no frivolous bauble; its value is in not having to schlep to the laundry mat every Saturday with a pocket full of quarters. While a washing machine costs much more on the front end to acquire, it generates a stream of benefits over years. In that sense, it is no different from a construction company that borrows money to purchase a backhoe to dig a ditch instead of hiring ten guys with shovels. Whether it is the financing of a car or a financing of a college education (increasing human capital), the bulk of consumer lending goes to acquisition of investment goods. In addition, like retailers that rely on bank loans to ride out quarterly fluctuations in sales and expenses, households use consumer credit to deal with unexpected expenses like a sick child, emergency car repair, or other financial disruption.