Amir Sufi talks about consumer debt in this podcast. He makes the point that an economy with a lot of consumer debt is fragile, which is a point I make in my essay on economics after the virus.
He makes interesting points about wealth inequality and consumer debt. He says that when the savings of rich people are channeled into loans for poor people, risk get transferred away from people who can bear it and toward people who are less able to bear it.
Hardly anyone remembers “petrodollar recycling,” which was oil-rich countries lending to underdeveloped countries in the 1970s. The IMF and other “experts” were very keen on it. It worked out poorly. See Latin American debt crisis.
In general, channeling savings from rich to poor in the form of loans is not a good idea.
Politicians encourage rich-to-poor loans until the loans fail. Then the same politicians denounce them as “predatory.”
It is a little sad that one of the few topics on which prominent libertarian public intellectuals are willing to take a firm stand against the progressives is one of the few rare cases where progressive instincts line up with the correct policy, even if their reasoning is based in antipathy towards those lenders they see as “predatory” and “exploitative”.
The words “predatory” or “payday” are not in the index to Rizzo and Whitman’s truly epic “Escaping Paternalism”, but this part on page 226 struck me as having an implication that runs counter to and cuts against their general argument:
So, many people have this built-in bias that is a heuristic and coping skill in that they use compartmentalized mental accounts to split up fungible assets to assist them with their efforts at self-regulation and in minimizing the time-inconsistency behaviors.
And we should understand the utility and function of these heuristics before we just call this kind of behavior impulsive and dumb and irrational.
The trouble is, the more we understand about what they are doing and why, the more we know for sure that while doing this stuff may result in the optimal outcome for an impulsive person in a situation where they face lots of temptation to be a spendthrift, they *still* come out worse off than in the paternalistic scenario where easy credit at high rates (coupled with harsh bankruptcy law) is simply unavailable to them altogether.
Usury laws used to be enforced in almost every state and are still technically on the books, but Marquette National Bank (1978) allowed the race to the (unlimited) bottom, which is why the return address on most of your credit card-related snail mail says “South Dakota”.
He’s not saying anything new. Ancient wisdom has been to avoid debt. Societies banned it or religions intensely discouraged it.
No rational person lends 20 dollars to the local tin cup guy.
“when the savings of rich people are channeled into loans for poor people”
This is the loanable funds fallacy. Banks are NOT financial intermediaries, as Professor Richard Werner points out:
“The bank of England discovered that money is created by banks and informs the world in its quarterly bulletin. 97% is created by banks not – as they described them as – other financial intermediaries, when they extend credit, when they do what is called lending. Which actually means that banks are not financial intermediaries because they do not lend money, they create money, they are not in the business of lending, they are in the business of money creation. One pound in net new bank lending is one pound addition to the money supply and purchasing power so the bank of England has come up with that so this financial intermediation story was simply wrong, banks are not intermediaries they are creators of the money supply and of course they allocate – because there is always more demand for money, they are on the supply side and actually they are not just reallocating existing money, they are creating new money, their decision therefore become pivotal in the economy because they can decide who gets money and for what purpose and that will reshape the economic landscape in no time.”
Also this from Frances Coppola who worked in banking for 17 years:
“As many of you know, I have spent much of the last seven years explaining to anyone who will listen that banks do not “lend out” deposits or reserves. Rather, they create both loan assets and matching deposit liabilities “from nothing” by means of double entry accounting entries. Creating money with a stroke of the pen (or a few taps on a computer keyboard) is what banks do.”
Not true.
When the Bank of England issues a loan it cheats and lets the borrower move up in front of the savings queue. This distorts the deposit to loan ratio and causes a currency risk to be assigned to government.
The deposit queue and the loan queue are naturally independent. The effect tying them together is to create regular recessions as the price of money gets distorted. This fallacy on the part of the of BoE and Francis is the very reason Arnold raised the objections. It creates a loop in the system, finance has to count up the distortions and recompute the real S/L ratio after equilibrium time around the loop. The time around the loop is the period between recessions.
This is one of the great scientific blunders of out time, lasting some 250 years and finally discovered around 2001. It is the thesis behind the ‘This time is different’ history book, the cause of periodic government defaults.
Forgive all undergraduate tuition-related federal student debt from two- and four-year public colleges and universities for borrowers who earn less than $125,000 per year.
default of $119.8 billion by 5.5 million borrowers. One can imagine it may be even more now. Pretty hard to imagine how the culture of the borrowing demand side is going to change when children continue to be indoctrinated in the dogma that not only is it wise and good to mortgage their futures to the credentials charlatans, but that such debt can be managed.
And what message is President-elect Biden (Just ask Paul Krugman) sending with his plan to forgive all undergraduate tuition-related federal student debt from two- and four-year public colleges and universities for borrowers who earn less than $125,000 per year?
Trump’s worst failing as president was not shutting down public subsidies to the credentials charlatans.
At the elementary school level, we have states like Illinois with insolvent retirement plans passing out fat pay raises to teachers unions while seeking federal bailouts. Great role model for average citizens. Teaching an important message: somebody else should pay your debts. Since teachers don’t want to teach, close the schools permanently. They are financially unsustainable and deliver low returns in learning outcomes. Politically the unions are powerful enough to stymie all reform initiatives. They would not be missed.The reality is that students are learning more now, just as they do during teachers strikes, than they do when caged in schools.
–“borrowers who earn less than $125,000 per year.”–
Wow, that’s a terrible threshold.
It turns people earning $125,000+/yr into chumps… it also turns people who spent two years at community colleges and who worked full time to minimize their student loan burden into chumps.
I’d support forgiving/repaying all accrued interest expense for all federal student loans instead. The resourceful, successful and prudent aren’t really harmed by this. The guy who saw his $50,000 debt grow to $80,000 after making $10,000 in payments sees real relief, with his balance falling to $40,000, but the guy who paid off his $50,000 gets a check for whatever interest he ended up paying.
First of all, thanks to Arnold for posting the National Affairs article. I am sure I will review it over and over again over the next few years.
College debt is a classic example of trying to be generous without raising taxes.
It would not be difficult to calculate the increase in income taxes that could make public colleges free, and with a living-expense stipend to boot. We did this for the GI Bill and never missed a beat. Germany and Norway do it today with ease. Pell Grants could be $10,000 a year and available to anyone.
However that would be on-budget, and so would be vetoed by conservative legislators.
So the liberals said, “We cannot give people the money for college, but we can lend it to them.” At the same time, sleazy entrepreneurs opened for-profit diploma mills to harvest those loans, and to pay huge dividends and salaries to themselves.
I will respect any plan from Biden to forgive loans, but only if he does way with future loans by raising taxes.
All federal education support should be eliminated. The interest on existing or paid off loans should be forgiven/repaid, but not the principal balance.
A good first step would be to stop over-regulation mortgage lending so that it would be easier to substitute secured debt for unsecured debt. I frequently see the argument that people who want to shut down payday lending under-appreciate all the nuanced benefits of those loans and overstate a number of problems that are visible when those loans are made but aren’t really caused by the existence of those loans. Yet many proponents of that criticism refuse to apply the same reasoning to mortgages.
In the UK payday lenders are scrutinized for “irresponsible” lending. You can lose your license if the regulator decides that you are creating a hardship for borrowers. (Consumer Credit Act 2006.)
Back in 2014 Todd Zywicki wrote:
“In sum, none of the statistical methods of comparing consumer credit outstanding or changes in consumer credit outstanding produces a conclusion that recent experience is startling or obviously problematic. Furthermore, although economic studies including econometric studies of long-term growth of consumer credit have not been especially numerous over the years, there have been some serious studies in this area that go beyond just outlining the basic statistical trends as above. While most of these studies are rooted in the specific questions and issues of the times when they were written, serious analysts have reached similar conclusions concerning the generally benign nature of long term growth of consumer credit, regardless of the time period covered by their individual efforts.”
Has anything changed since then? Could 6 years of CFPB “protection” have moved the needle that much?
Zywicki is a really smart guy whose book on this topic seems diametrically opposed to Dr. Kling’s views expressed above.
I have no idea if there would be a sharp difference in opinions on the topic today but it is interesting when two highly respectable authorities seem to draw such different conclusions.
Banks create money. Central banks can create money too. In some way of thinking, the owners of commercial banks (shareholders) and other financial institutions do lend money to consumer credit-card holders, home and car buyers.
In an unusual case like a COVID-19 economy, or a recovery from the 2009 debacle, it probably makes more sense to risk “moral hazard” and print money and give it to people to spend. Why build up debts?
I prefer tax cuts and holidays to effect such a policy, such as a holiday on Social Security payroll taxes.
Is the Federal Reserve now printing money and financing government outlays? Does a Mobius strip have two sides?
BTW, the Bank of Indonesia is buying bonds directly from that nation’s Ministry of Finance, at zero percent interest. The BI has an inflation target of 2% to 4%, the outlook is they will miss the target on the low side.
China, Japan and Indonesia are examples where Western macroeconomic orthodoxy struggles. When theories are sacralized, they become theologies. That’s about where orthodix macroeconomics is now, in relation to monetary and fiscal policy.
Side note: There are about 120 million households in the US, and US defense-military spending is about $1.3 trillion (DoD, DHS, VA, black budget, pro-rated interest on national debt). So, that’s about $10,000 per household.
This year, the government is sending back a couple thousand dollars to each household of that income confiscated. Horrors!
Makes you think.
I’m sorry but this doesn’t make sense. When you take on a loan the risk goes to the holder of the note, not to the person with the loan. When a person takes savings, which are extremely low risk, and makes a loan with them they are increasing their own risk. This statement here
‘He says that when the savings of rich people are channeled into loans for poor people, risk get transferred away from people who can bear it and toward people who are less able to bear it.’
Is literally the opposite of the standard definition of ‘risk’.
Good point.
I think what they must be saying is there are 2 risks to the poor.
1. Because it can cause an economic shock leading to unemployment if too many loans fail at about the same time, like happened in 2008 and that’s a risk to the poor.
2. The poor risk bankruptcy due to the asset that they buy, typically a home, falling in value. This could be solved in 2 ways. A market that allows people to gain cash if there home value falls. Make mortgage loans only allow the lender to repossess the home on failure to pay. Sort of rent to own. the problem their is that the owner could damage the home but there could be work arounds for that.
Government should be careful to never encourage debt. Debt can be dangerous and I see only 2 benefits to it. 1. Allow better fast growing businesses to grow faster. 2. Move some consumption to earlier in life, like through a home mortgage or car loan. IMHO people over 37 should not have car loan and people over 50 should not have home mortgages.
You are correct about age limits for debt, but the American economy might not survive your new rules. Giving new mortgages, reverse mortgages, and/or home equity loans to persons over 50 was virtually a bulwark of our economy the last time I looked.