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Since 2008 – Progress Through Politics

Don't Demonize Debt

Cross-posted at River Twice Research.

As Wall Street continues its slow-motion hari kari, tens of millions of people on the lower-end of the income spectrum are finding that their access to credit is becoming all but nonexistent. As banks set aside ever more cash to cover themselves against potential future losses, the credit spigot that flowed so promiscuously to riskier customers is now not flowing at all.

Even with the promising plan of the federal government to take the more toxic loans off of bank balance sheets and fold them into the so-called “bad bank,” loans to the lower-end of the income spectrum are likely to be hard to come by and inordinately expensive. That is a problem that none of the current plans address and it is real one.

Just because people making under $30,000 a year tend to be at higher risk of defaulting doesn’t mean that they should be denied access to vital credit. People at that income level represent as much as 40 percent of the country, according to census data, and while granting someone with that income a $300,000 mortgage is absurd, so is granting them zero credit or credit at rates that would make a loan shark blush.

The experience of Grameen Bank, founded by Noble prize winner Muhammad Yunus in Bangladesh and now operates one branch in Queens, New York. A pioneer in microfinance, Grameen lends mostly to women, and in small amounts, but has a repayment rate that any commercial bank would envy. By maintaining close community ties and an on-going relationship between borrowers and lenders, the bank never forgets that one of the best risk controls is making sure that those who lend money have some direct relationship with those who borrow.

The experience of Grameen should be a reminder that credit is a vital source of economic activity and growth, especially for the less affluent. Demonizing credit creation because of prior lax standards risks an excessive caution against further debt, and that is exactly the wrong path. Debt is a powerful tool that can help generate robust activity is used and created wisely, just as it can be immensely destructive if allowed to spin out of control.

Technology can be used to create better risk controls, just as it was used to fashion quantitative models that would have made Pollyanna look like a sourpuss. Robert Shiller, the Yale economist has some novel ideas about how to use derivatives as a risk-management tool for the individual home-owner (for more on Shiller, see my piece on him here: http://www.newsweek.com/id/181266 ). Not all will agree with his ideas, but financial innovation can be a tool for greater prosperity – after all, once upon a time a mortgage was a new and untested innovation, and on the whole has been of more societal benefit than not, current morass notwithstanding.

Debt can be good, bad or indifferent. Denying it to a wide swath of society that can and does use it constructively is as distorted as the profligate dispersion of debt that we have just witnessed, and it will make it that much harder for millions of people who are determined to improve their lot in life. Finding the right balance between too much and too little is never easy, but replacing one extreme with another is no solution.

For a look at additional blogs and other writings of mine, feel free to visit River Twice Research.


30 comments

  1. One person’s spending is another person’s earning.  When spending stops, earnings stops and the reverse cycle of economics kicks in – people/institutions with money stop spending it out of fear of the future, leading to reenforcement of the forecast that there will be less earning, and therefore less spending, therefore less lending and less spending and less earning…

    We’d all like to step back and “let the banks stew” out of frustration, but that way leads to disaster.  They’ve got to get back to the business of doing their business, and as you say that is offering credit.

  2. creamer

    and I agree that credit needs to be availible to all, it seems that the market was allowed to evolve uncontrolled into an unbeleivably destructive force. Talking of creating more finacial vehicles for speculators and gamblers to play with seems rash. I think developing new ways for the finacial elite to make more money without producing anything needs to be considered warily.

  3. fogiv

    This is a very informative diary; many thanks for posting it here.  Welcome to the Motley Moose.

    …one of the best risk controls is making sure that those who lend money have some direct relationship with those who borrow.

    Indeed.  Dad, if you’re lurking, the check’s in the mail.  :)

  4. All money is a form of debt – a promise to pay – a form of exchange around assumed value, so your diary is great and timely.

    I suppose the question is: why did the trust break down (between banks particularly over securitised debt) and where can it be re-established. Governments throughout the world are trying to shore up the banking system by taken over toxic debt, or guaranteeing loans, and yet the inter bank lending is still a trickle…

    Is the problem of trust a globalised ‘inter-bank’ failure, and how much power do individuals, and their spending plans, have over these institutions.

    Personally, I’m trying my very best to reflate the economy by maxing out my credit cards. I’m sure they’ll understand if I can’t pay…

  5. and welcome to the moose – i couldn’t agree more.  the grameen bank stands alone as a shining example the positive contribution to the markets can be profitable.

  6. Michelle

    By maintaining close community ties and an on-going relationship between borrowers and lenders, the bank never forgets that one of the best risk controls is making sure that those who lend money have some direct relationship with those who borrow.

    It may be risk control, but it seems to hint at something much larger to me, and that is shared responsibility.  The borrower and lender are responsible to each other, and by building that relationship, it becomes harder for either one to shirk their responsibility to the other.  Our economy and free market system have reduced the 40% of our work force making under $30,000 to economic tools and data, forgetting that the real impact of such sterility is a major factor in the reverse cycle that Chris mentions upthread.  Hoarding all the cash with the richest of society is going to lead us back into the dark ages.  Without lending out money to the backbone of our workforce and economy, then it’s all going to continue to crash to a halt.

    The irresponsible lending in the mortgage sector has more to do with Wall Street created financial derivatives that ran amok, unchecked by any government entity or oversight.  The IBs all made a ton of money pushing mortgage lenders to create more mortgages and HELOCs for their derivative trading shenanigans.  And the riskier the mortgages (i.e. lending to people who had slim chances of repayment), the higher the return reward for derivative traders when those risky mortgages were repaid.  High stakes gambling at its best, with our economy on the line. ALL of us are now paying the price for it.  But we can’t let the banks fail.  What we can do is provide more oversight, including forcing the terms of any bailout to mean lending to our lower to middle class, rather than hoarding the funds at the top.  Bottom up economics, I suppose, rather than the failure of trickle down.

  7. spacemanspiff

    This is class warfare at an early stage, between two classes of beings: natural, and artificial.  By endowing corporations with artificial personhood, we have created a new species that competes with natural born life for all ecological niches.  Corporations are morphing into anti-human predators.  It is they who suck our blood and push our faces in the dirt.

    Corporations are as aliens on the earth and we are engaged, whether we like it or not, in the War of the Worlds.  We need to kill them before they do it to us.  How?  By changing the laws, so that aggregated capital cannot be anonymous, so that artificial persons cannot own each other, by making shared wealth possible only in the form of human cooperatives.  Most of all we need to kill corporations by withdrawing all of their subsidies, because they cannot survive without government support.

    /end of slightly on (off) topic rant.

    Great essay and I hope you share a lot more with this community.

    I’m really psyched about having you post here.

    I love to learn.

    Excellent.

  8. creamer

     I read your “There still room to spend” article at your site. Very interestings. It’s nice to here some balance.

     You seem to have some knowledge of finances, I’d be curious to hear/read your views on the 2nd installment of the TARP funds.

  9. LotusBloom

    Link

    Bad

    As the Obama administration apparently prepares to launch Hankie Pankie II – buying troubled assets from banks at prices higher than they will fetch on the open market – it occurred to me that an updated version of an old Communist-era joke may be appropriate: under Bush, financial policy consisted of Wall Street types cutting sweet deals, at taxpayer expense, for Wall Street types. Under Obama, it’s precisely the reverse.

    Update: Maybe I was too cryptic. The original joke was, “Capitalism is the exploitation of man by man. Socialism is the reverse.”

  10. LotusBloom

    The complaint is against too much debt…debt that is out of proportion with the capacity for repayment, and debt that is frittered away.  

    Noone argues against taking on a limited debt in order to go to school; but what we have encouraged is taking on debt in order to buy a big screen TV, or an SUV.

    Now, all things being equal, I am not advocating that credit be denied to a wide swath of society.  But all things are not equal… there is simply not enough credit to make it available to a wide swath of society.  The reason for this is our own past history (using up our credit to buy SUVs and big screen TVs).

    In order to make credit available to everyone, someone else has to assume that debt…right now, there isn’t anyone willing to do that.  So the only option is to have the Fed print lots of money.

    And there is a very good reason why that (printing lots of money) is not a normal response to a recession… it is VERY VERY risky

  11. Kysen

    that it oft times makes me want to cry.

    I do not have a firm enough grasp of it to know what needs to be done..I just know that something does. Hopefully those more knowledgeable than I will succeed in implementing that which will best serve the best interests of our nation (and all her citizens).

    Welcome to Motley Moose!

    Photobucket

  12. Hollede

    I think that micro loans are an amazing path to help raise all ships. Why do republicans seem to worship downward mobility for pretty much anyone who is not a millionaire?

  13. GrassrootsOrganizer

    as they always have when bank credit is not available to them — from loan sharks and pawn brokers.  There will still be plenty of credit available to them, at eye-popping interest rates with rather ugly repayment conditions.  Of course those loans won’t be written for durable goods and property that stabilize their communities and stimulate the economy — those loans will be taken out to cover rent instead of the purchase of a home or a string of junkers versus a quality used car.  

    And the poor will always have a number of other funding sources available to them — military sign-on bonuses, crime, prostitution, the sale of the meager family heirlooms.  At any rate, it’s time for them to live within their “means” and overcome their addictions to wide-screen TVs, SUVs, prescription medications and new school shoes for the kids every September.  

    But not to worry, when it comes to true emergency funds there will be plenty of creative  entrepreneurs ready to rush in and fill the void left by the withdrawing of bank credit to low income families.  

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