Credit: A Vicious Spiral
How 720 became the new 680? article in the Washington Post drew the following reaction from Tom:
Credit: A Vicious Spiral
by Tom aka Rusty Rustbelt
Somehow over the years I became known as a bit of an expert in personal financial planning, I suppose the tax background plus getting dragged into senior financial planning (via my involvement in nursing homes and eldercare) and business client planning. I was also pretty good at assembling professional teams and keeping the right focus.
While I do not really practice any personal financial planning (except at the coffee shop pro bono) I do keep informed and I do troll my network for updates, and lecture now and again.
The Great Recession is hammering credit scores, for all of the obvious reasons. At the same time lenders, have been whipped for lending too easily, are raising standards and looking for higher credit scores.
So we get into a spiral of lower credit scores, higher credit standards, less lending, more credit problems, lower credit scores, etc. etc.
And if the economy does not come around soon, we may require a generation to get totally out of the cycle.
There will likely be more subprime credit available, at higher rates. Some retailers (such as auto makers) will use their own credit subsidiaries to lower rates and keep traffic coming. All in all, it is going to prolong the mess and prolong the misery.
The big reset, the “new normal” is upon us.
Considering that the problems we’re having are largely the result of too much credit, too easily available, I fail to regard this as a bad thing.
The problem is the US government extending credit to those with NO credit scores … the banks.
credit itself is the new normal. when i was young, middle class families lived on what the breadwinner earned and tried to pay off the mortgage as soon as possible…
Punchline to bad old joke: “It’s that wet-dry, wet-dry that kills ya.”
We have relied for a very long time on credit to spur growth. One of the things we have learned is that “financial innovation” means the capacity to pay off debt becomes disconnected from the capacity to borrow. The situation that Rusty describes, in which the capacity to pay off debt is still disconnected from the ability to borrow, but in the other direction, means that the economic adjustment that is being driven by the credit adjustment is particularly harsh.
It is not all that clear to me whether economic growth must be constrained if credit is constrained to a reasonable level, but what is clear is that the adjustment from a lot of credit to much less credit will kill ya.
This is only my own little pet theory, but I believe that there is problem at the center of our economic dynamics and that it is caused by a flaw in the theory of Marginal Utility. By example, a thug who knows how to launder money, a lowly person who for example abducts children and sells them as sex-slaves, theoretically, he makes a greater contribution to the economy than all of those citizens who earn less money than this thug.
It is this way of measuring ‘contributions’ that has enabled financiers and corporate executives to be compensated hundreds, and even sometimes thousands of times, more than other citizens who are in many cases making more integral contributions to society. We can live without financiers for instance but not without food producers. But these nonsensical inequities are only symptoms of a deeper illness.
It is how Marginal Utility theory distorts the dynamics of growth that is the central flaw. This gets complicated and so maybe it is best to begin with a comparison of two basic types of economies, a service-based, and a production based. Using my hyperbolic ‘thug’… a simple way to start is to say that a service-based economy relies more on this type of contributor than a production-based economy does, whether what the thug does to earn his income is illegal, or legal, has no relevance here, if ‘financier’ were not so difficult to spell it would serve just as well. The relevance here is in the fact that production-based economies derive more growth from that which is extracted from nature as commodities and etc. Conversely, a service-based economy relies more on growth from human capital. But as the advanced economies have become more dependent on human capital the assumptions inherent in Marginal Utility theory allowed external cost factors to be ignored.
Using another simplification, a worker finds a gold nugget worth 1G. The economy expands by 1G.
A thug steals jewelry worth the same amount from a foreign tourist. The economy expands by 1G.
But these types of growth are entirely different because one came from something that did not previously exist, in economic terms, and the other came at the expense of some other economy. Naturally, there are potentially negative externalities in the extraction of gold, but these are possible to eliminate or at least minimize and over the past several decades there has been some progress accordingly. But the external costs inherent in our thug’s way of expanding the economy are misleading and expansionary on yet another level:
Thug gets caught but jewelry is not recovered and he is broke. The investigation and court case cost 1G.
Thug gets sentenced to 1 year and prison cost is another 1G.
So, the true cost to economy A here should be 2Gs minus the 1G that was a loss to economy B, and minus the value of the gold nougat (1G), which of course = 0. But, in GDP terms, economy A grew by $2Gs and economy B contracted by $1G.
So, within the confines of this little equation the Cops, Judges, Prison Guards and others were compensated with growth value that is essentially a transfer from the productive side of the economy to the service-based side. ?
As economies increasingly rely on service-based economic activity, the pace of growth can only be maintained by an increase of two factors. The first is by increasing that which comes from outside of the economy at the expense of another economy, (it should come as no surprise that Marginal Utility theory was developed during the Colonialist Period). Secondly, increasing growth must come from an increase in lending. But it is important to make the distinction that literally, growth actually only comes from residual interest on loans, not the principle of the loans, principle is of […]
One problem is that if you have a job and good credit for years or decades, one spell of unemployment could destroy it. Then when reemployed, the bad credit rating hangs on.
So even those who did not indulge in too much credit may be hammered for 7 years or more. Hard to see how that could be healthy.
“…families lived on what the breadwinner earned…”
In the olden days, yes. These days, the median wage (not household, but individual) is roughly $30k per year before taxes. An olden family with mom and kids being supported by one worker at or below today’s median wage would officially be living at or near the poverty line.
Currently, half of all US workers make less than necessary to put a family into the middle class by any reasonable measure, so both adults go out into the workplace and do what they can. Living like we did in the good old days of the 50s and 60s is no longer an option for most citizens.
surreptitiously my point; in the 50s & 60s a one income working class family could be middle class without credit, pay off the mortgage and save for the kid’s education…but slowly the vast middle class has been pushed to where two incomes plus credit are required just to stay above poverty level…
the 80s marked the rise of the two-income family…that’s what reagan meant when he said he’d “put america back to work”
Um, nope. Not the way it works. Standard economic measurement centers around GDP, with emphasis on the “P”. Product. New homes involve construction, while selling used homes just involves a service, and the only credit in GDP is for the services. The asset that’s transfered is not counted toward GDP.
Economic crime generally involves the transfer of something of value, not its creation. So we do not get an extra exploitable human or an extra ounce of gold because of crime. And that’s just the first slice, the one that classical economists should find unexceptionable. There is also the notion of externalities. Crime causes changes in behavior aimed at minimizing risk, rather than at increasing enjoyment. If we credit emotional loss, and I won’t even get into the kidnapping issue here, then the finding that people tend to value gain vs loss at about 1-to-3 means the gain to the receiving party from a theft reduces net welfare by about twice the value of the item stolen.
So no, marginal analysis does not support the notion that crime adds to GDP, or economic or social welfare.
Change the Law. Reverse Marquette National Bank versus First of Omaha Service Corp. and allow state Usury Laws. Change the paradigm where it is not so easy to make $billions in capital appreciation.