Tuesday, April 05, 2005

The Benevolence of Loan Sharks

For various reasons, I've ignored Elizabeth Warren's bankruptcy section of Talking Points Memo. For one thing, I guess I thought the bill in question had already passed or was unstoppable or something, and I'm generally not the type to worry about things that I can't do anything about. This might break your heart, but Doctor Biobrain is not the activist-type; with this blog being the most public stance I've ever taken on anything. But Josh alerted us to a recent post, and I was somewhat floored by this paragraph:

Start with a brief look at the data. Bankruptcy write offs represent about half of the total bad debt writes, which would suggest that they ranged from 1% in 1985 to 2.5% in 1992. Much larger is the cost of funds, which is the amount companies must pay to borrow the money they lend out. From 1980 to 1992, that cost fell from 13.4% to 3.5%, a stunning decrease in costs. What happened to the interest rates the companies charged? In the same time period, the average credit card interest rate rose from 17.3% to 17.8%. Move the clock forward a bit. When the cost of funds dropped nine times in 2001, instead of passing along the cost savings, the credit card companies pocketed a windfall of $10 billion in a single year. So much for the idea that the credit card companies are lined up to pass savings along to the customers.

Now am I wrong for thinking this is criminal? I don't mean legally criminal, of course. But maybe that's just because I don't write the laws (yet). But criminal in the sense that it's just plain wrong and relies upon a perversion of the market system. I'm a devout capitalist, but every system has its flaws; and capitalism is no exception. And one of those flaws becomes apparent any time a 600-lb gorilla works in the same marketplace as the 5-lb monkeys. Conservative-myth to the contrary, monopoly isn't just a boardgame and can too easily be effectively achieved by supposed competitors. For me, it is my strong belief in capitalism and the free-market system which forces me to protest such disparities. A little noted paradox of life is that the ultimate end of capitalism means the destruction of the free-market. (a concept I'll bring out more in the future) But for now, we can just note that the current trend of credit companies shows that they are far more at the ownership/power side of that equation, to the detriment of the free-market side.

Debt Puritans

One of the primary aspects of bankruptcy and the issue of debt is that the debtor or bankruptor is somehow immoral for taking on too much debt, and therefore deserves almost any punishment we can met out. And while most reasonable people don't use "immoralness" as the basis for punishment, many of those same people do seem to believe that the immorality of excessive debt is somehow different. That these people have "it" coming, and that we shouldn't let them off the hook for their wrong-doing. They made their bed, and now have to lie in it.

I'm not exactly sure what their problem is, but it seems to be some sort of puritanical vestige left over from times past; the same way that nutritionists are puritanical about "eating better and living right". That's a post I have yet to write, so you'll just have to wait. But I'll just say for now that I get the strong impression that nutritionists don't want there to be some magic pill that gets you fit and trim. They enjoy working out and eating right, and they'll be damned if anyone can get that for free. And I think that this type of puritanism is unhealthy and has led to many many wrong pronouncements from that field, which we are only now beginning to correct.

In their case, it's not that they want everyone to be healthy; they just want everyone to act like they do because they believe it's more moral. And it makes their own lifestyle seem better as they sit high on their perch and chastise fatties for being so unhealthy. After all, what's the fun of acting moral if all the immoral folks get to have immoral fun AND a healthy life? Deep down, people are cheap and just like to feel good about themselves; and they can invent any number of rationalizations to convince themselves that they can put down others without relinquishing the right to call themselves good people. Self-righteousness is its own reward; not virtue.

Similarly, I think the Debt Puritans are allowing their own indignation to override their better judgment; or even reality. Rather than a sensible debt approach, they want the immoral debtors to suffer gravely. And while I would never suggest that we remove all penalties from debt; I am suggesting that there is more to the Debt Puritans than the public motives they attest to.

Private Industries' Public Servants

And what really bothers me is that this is looked at by them as a one-way street: morally corrupt individuals ripping off these naive, benevolent companies which serve our greater needs. But is that the case? Of course not. They know what they're getting into. They have quicker access to our financial histories than we do. More than that, many of these lenders INTENTIONALLY make loans to people who can't afford it so they can make more money. That's the god damn reason they get to charge so much. If the borrower wasn't such a risk, then they couldn't make so much money.

In fact, the proper way to look at this is the same as stock market investors who choose risky ventures for the high profit potential, who then turn around and sue the company when the investment goes bust. The reason they were investing was the same reason it went bust. That's just how risk and profit works. If the stock wasn't risky, everyone would want it, the price would be skyhigh, and you couldn't make a lot of money off of it. Some people make a fortune, and most don't. It has to be that way; much the same way that lions who eat too many prey will eventually starve, until there aren't enough lions to eat all the prey. In the longterm, life is self-correcting and the markets are no different. Everyone wants the free lunch, but outside of pure corruption, it doesn't exist. And while some corrupt corporations do deserve to be sued, many do not. And that's how it is with these loan shark companies. They insist on lending to risky individuals, and then scream foul when the risk was just slightly more than they had anticipated. But they knew that going in. The guaranteed return could never have been so.

What's worse: it's not just that they lend to risky borrowers and happen to get screwed. It's that they WANT the borrower to have trouble paying it back. Bankruptcy or default are worse of course, but they don't want people paying everything back either. They want to lend to people who will pay late every few months, go over their limit, and give the company an excuse to increase the interest rates. That was the creditor's intent from the start. And once the cycle starts the debtor is denied the ability to switch their debt to a lower rate provider who naturally won't give loans to someone with high debts and bad history.

So it's not just that they lend money to risky borrowers, they clearly want the borrower to stay at risk. They want you teetering on the edge so that you can barely pay them back. They want you borrowing $800 and accumulating thousands more in interest and fees; a scenario that happens far too often. And often, it is their own high interest rates and fees which make the borrower unable to repay the loan. They purposefully design loan agreements to keep the debtor on the hook forever. And this newest bankruptcy bill was solely intended to deny debtors that one last resort option.

Who's Zoomin' Who?

And in that light, who's the immoral one? Someone who wrongly borrows more than they can repay, perhaps with the intent of defaulting? Or a company which intentionally loans out too much money with the intent that the borrower won't always be able to pay it back? That's a tough question. But it's a far different scenario than the one of the immoral borrower and the benevolent lender. Which is why it's entirely ignored by the debt puritans who have a lot more fun on their black & white highhorse.

In the end, credit companies are big boys and they know what they're doing. If they don't want people defaulting, they should have higher standards, lower rates, and lower profit expectations. They aren't performing a public service; they're in the business of making money. And while there is nothing honorable about declaring bankruptcy, there is nothing healthy about loan sharks either. If we want to stop the sharking, we need to make it easier to slip the noose; thus giving the companies less incentive for risky loans. Instead, Congress has only served to greatly tighten the noose; which is a complete disservice to their constituents. Excepting the sharks and the puritans, of course, who celebrate another victory.

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