Friday, March 30, 2012

Where Our Debt Addicted Nation Is Heading ... Kablooey!?

Americans are heavily in debt. No secret there.

Too much debt tends to get us into trouble. No secret there either.

Our government is perhaps the biggest debt enabler of all. Therein may lie a small secret. If so, let's get it out in the open.

And to do that, let's review a few situations, starting with what is never a good idea--when government loans to the private sector.

Notable & Quotable quotes from economist Henry Hazlitt's 1946 book "Economics in One Lesson." My, how things have changed since then:

"There is a strange idea abroad, held by all monetary cranks, that credit is something a banker gives to a man. Credit, on the contrary, is something a man already has. He has it, perhaps, because he already has marketable assets of a greater cash value than the loan for which he is asking. Or he has it because his character and past record have earned it. He brings it into the bank with him. That is why the banker makes him the loan. The banker is not giving something for nothing. He feels assured of repayment. He is merely exchanging a more liquid form of asset or credit for a less liquid form. . . .

Now it is to A, let us say, who has credit, that the banker would make his loan. But the government goes into the lending business in a charitable frame of mind because, as we saw, it is worried about B. B cannot get a mortgage or other loans from private lenders because he does not have credit with them. He has no savings; he has no impressive record as a good farmer; he is perhaps at the moment on relief. Why not, say the advocates of government credit, make him a useful and productive member of society by lending him enough for a farm and a mule or tractor and setting him up in business?

Perhaps in an individual case it may work out all right. But it is obvious that in general the people selected by these government standards will be poorer risks than the people selected by private standards. More money will be lost by loans to them. . . . [T]he recipients of government credit will get their farms and tractors at the expense of what otherwise would have been the recipients of private credit."

Thus, Mr. Hazlitt made the point in 1946 that government lending to private businesses is inappropriate. Charitable concerns or other good intentions are not sufficient reasons for government to loan taxpayers money to private sector participants. Along those lines, Solyndra and other recent poor government "investments" come to mind.

But that's not the end of the story. Not by a long shot.

Since Hazlitt's unheeded warning of more than a half century ago, government has become the major lender to many individuals and households. Consumers, in other words.

If it's not a good idea for government to loan to businesses, and it isn't, it's an even worse idea for government to extend credit to individuals, including home buyers and students.

Meanwhile, government has now taken over the student loan business and pretty much the entire home mortgage portfolio as well. Not even business related.

These are simply loans to individual consumers which are granted or guaranteed by government.

Let's hear what another writer says about the debt dilemma in America today, much of which is now backstopped by government.

Debt, the American Way is a review of the book "Borrow: The American Way of Debt" by Louis Hyman. In it Hyman asserts that Americans have an addiction to debt:

"Americans are maxing out their credit cards again. . . . Consumers have been more willing to use credit cards for shopping . . . . Banks are lending, consumers are borrowing and China is busy making us more stuff.

Who knew getting out of an unprecedented debt crisis was this easy? Print trillions of dollars for the banks, give Wall Street speculators zero-interest loans, and run up the national debt clock to $15 trillion. . . . Whip out your credit card, if you've still got one, and enjoy it while it lasts.

{According to Hyman}, "We all know it's going to happen . . . . Interest rates have to go up, and when they do—Kablooey!" . . . .

{The book} . . . points out that while borrowing has been around for millennia, it was used to finance production, not consumption, for most of that time.

This thing we take for granted, buying houses, cars and electronic gizmos on credit, is a relatively recent development. It created the middle class we know today, but it's also destroying it. Consumer debt has crowded out business debt. {Lenders} can make more money issuing credit cards to consumers than . . . loaning money to businesses.

Indeed, the interest rates charged for many consumer loans used to be prosecuted as criminal offenses."

Discussion and Analysis

In 1946 Hazlitt's book persuasively argued that government should stay out of lending to businesses.

In a similar vein today, Hyman concludes that our economic woes won't end until government policy changes and government gets out of the lending business entirely.

Unlike the old days, government loans today are often to consumers who represent poor credit risks.

Government needs to get out of the way and allow private sector lenders to get on with loaning responsibly to private sector business borrowers and consumers as well.

And private sector lenders shouldn't be rewarded or kept from losing money when they make consumer loans to those who later prove unable to service those loans.

As for government, it should refrain from making any loans at all, since it has no business expertise, no skin in the game and merely passes on the effects of bad lending to unsuspecting taxpayers.

The central point is simple and straightforward. If borrowed capital is invested in businesses that will use it to create good jobs, then people will require less credit to buy the things they consume.

"Debt, the American Way" summarizes its position on consumer credit cards as follows:

"Our grandparents would have never imagined taking out a loan for a bite to eat. Anyone who charges a pizza and doesn't pay off the balance at the end of the month eats debt for dinner.

Americans do not need to eat like this. They need jobs. But the great allocators of capital known as Wall Street would rather keep flipping debt-backed securities. And the great drivers of the U.S. economy known as consumers are increasingly stuck with low-paying jobs and high-interest credit cards."

Summing Up

Our collective financial illiteracy and tendency to borrow excessively and irresponsibly is truly destructive. Too many individuals, households and government entities fail to understand the risks they're undertaking at the time of borrowing.

As a result, too many of us assume the responsibility to service debts we should have avoided but didn't, and only because we weren't sufficiently knowledgeable about matters relating to debt.

For that matter, as a nation we need to get a grip about community and state finances as well, along with our country's debt service obligations as a whole.

Meanwhile, politicians through government programs such as cash for clunkers and rebates for home buying and such continue to encourage imprudent borrowing by individual households and government, too.

We the People need to internalize that government can't bail us out of our poor financial decisions, even if the politicians say otherwise.

Most borrowing is best left to the producers and should be used only sparingly by consumers.

And that's the plain and simple truth.

Thanks. Bob.

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