People argue that we need to get the money flowing again, meaning we need to get the banks to lend. There are several problems with this.
First is, of course, a problem of income. Any purchase of any capital good made on credit is a final transaction where manufacturing is concerned. This is why so many car companies created financial arms: when a car is bought on credit, that's it; there's no more car bought until the note is retired somehow.
This means there's no purchasing with the money set aside to pay the note. So, if someone buys a car on credit, with payments of $300 per month plus full coverage insurance payments of $100 per month, that makes $400 a month they cannot spend on anything else.
When the debt load gets high enough, most people are spending most of their money servicing debt, and are unable to make new capital purchases. They still buy food and they still buy minor things, although the maximum price they can afford is lower, so either the quantity or the quality of the non-capital goods they buy suffers.
This puts capital goods producers out of work, ie, auto manufacturer workers. These workers now have an income of zero and are no longer able to service their debts let alone contribute to employment of others.
So, sooner or later, other sectors suffer. Makers of toys do badly. Makers of gadgets do badly. Netbook manufacturers do well at the expense of notebook and pc manufacturers. In other words, people spend less and less, causing there to be less and less to spend.
If, for instance, a person manages to get a job for less money, or is trying to live on one income when they used to live on two, they can reduce the price of the things they buy by, ie, buying generic or cooking their own meals. However, their debt payments remain fixed. As previously noted in the annals of the bureau, all activity is at the margin.
Now, if they pay, say, $1000 in debt and used to make, say, $2000 per month, they had $1000 to spend on their non-debt needs, such as food and toys. If their pay drops to $1500, a 25% decrease, their net income is now just $500. A 25% decrease in their income results in a 50% decrease in their negotiable income, leading to severe hardship. A 50% decrease in their income will lead to a 100% increase in their negotiable income, leading to bankruptcy, as their only chance of survival is to reduce their debt payments.
Now, to arc back onto the topic of this point, if we drive greater debt to the consumer, the end result will be a greater percentage of their income servicing debt and therefore less of their income being spent on non-debt items. Think about that for a second. People will buy fewer combs, fewer toys, less expensive food, fewer of anything that does not require debt to acquire. It is perhaps true that greater availability of credit will save the auto industry in the US, although it is just as likely that the available money will go to Japan or Korea or Germany. However, it is almost certain that it will reduce negotiable income.
Fortunately, most people sense this and are not interested in acquiring more debt. Now is a time of paying off debt, meaning increasing, over time, negotiable income. This is hard on the banks, as their revenue is related to the amount of debt people are willing to assume, and they have so much bad debt they are trying to acquire good debt so they can achieve positive cash flow.
So, creating new loans is good for banks. It also may help house builders and the auto industry, as alluded to above. It also allows venture capitalists to start business that may or may not be a waste of money.
However, sticking to the banks, banks that are making new loans at this point are making a high percentage of bad loans. This is because most of the people willing to assume more debt right now are not necessarily effective at managing their own money. Also, there is no reason to believe that the system has recovered enough to make that person's job secure enough to assume a high load of debt no matter how collateralized.
Since the problem with the economy is an overabundance of bad debt, with leverage ratios up around 30 to 1 before the collapse, making more loans is not really a good idea. However, banks have no other way to generate income, so must do so or fail.
A loan that defaults is an immediate loss to a bank. In other words, when someone borrows, say, $100,000 to buy a house, and makes payments of, say, $800 a month on his mortgage, the bank gets to apply a percentage of that, very low initially, to the principle and applies the rest to its bottom line, probably around $700 a month. However, if the loan defaults, the bank is now out the remainder of the principle, say, $70,000. I chose that number to simplify math, as it is clear that it is 100 times the income from the loan per month. So, on a cash flow basis, having a loan default is on the order of a hundred times greater than the income from the loss. This means that around 100 other loans that you have must pay on time in order for you to not lose money on a cash flow basis. Of course, on a net accounting basis, it isn't as bad, as that loan comes out of your reserve. However, if, as was common in banking, the reserve was not adequate to the defaults, the bank gets in trouble and the only way it has to increase its reserve is to write more loans to get more income.
In a proper deflationary depression, banks simply fail. This means they run out of reserve and then auction off their assets. The government covers depositors up to $100,000. Many companies get in trouble covering their profligate spending with bonds, as the bond market would simply crater with the auctions of bank assets. Lots of very rich people would be rendered destitute.
However, this would be fair. These rich people desperately need to get some sort of comeuppance. They haven't learned their lesson. Worse, they claim to be able to manage risk, yet failed significantly to do so. Since the only reason a bank is supposed to be able to charge interest is related to the risk of making the loan in the first place, if they will not shoulder the consequences of taking the risk, they should not receive the interest.
It is like the insurance companies lobbying the feds to pay for 9/11. Insurance companies accept premiums for assuming risk. They're supposed to manage the risk and require premiums to cover the risk. If they then throw the risk onto the government, they no longer have a valid claim to accept premiums.
So, the problem was caused by banks making mistakes on a grand scale, cheered on by government that did not understand economics (there's a surprise) and this lead to a debt crash, which, in broad strokes, is simply that people now have so much debt that the maintenance payments eat up all their disposable income, leading to a reduction in purchasing, leading to a reduction in manufacturing, leading to a reduction in payment, which causes a vicious cycle that eventually results in a 'blow off' of bad debt, clearing the way for people to start spending again.
However, not only has the government not learned from the mistakes, but it is actively helping the banks to not learn from their mistakes. The leverage ratio is not as bad, but, given that much of the reserve these days is debt, banks are not in a positive position yet. That aside, they are starting to do the same sorts of risky things that led to this problem in the first place, emboldened by the fact that the government stands ready to make good any of their losses. This is called a 'moral hazard' by economists, although one analyst insists that a better term is 'ethical hazard', as it really isn't about morality, but about the risk generated by a misallocation of resources.
Since the government has made good the losses of banks that are 'too big to fail', those banks have a golden ticket to do whatever fool thing they dream up while their stock valuations soar. Since any losses will be made good, they can go ahead and do the whole gamut of foolish loans to groups with low repayment outlooks. Doing this increases their supposed income, so their stock looks ever more attractive, leading to increased stock valuation, leading to executives making more money.
However, none of this is good for the greater economy, as it locks lots of people into untenable debt situations, creates more economic activity with little hope of producing useful returns and in general misprices much of what happens.
For instance, if a venture capital firm can get cheap money, they can go out and take a risk on some startup that may or may not ever make money. There will be a lot of economic activity in that particular company before its inevitable failure, putting lots of people on the streets.
However, the bigger problem is that something has been produced that nobody wants enough to pay its real cost. This means that things we actually want cost more because there is less of it and the people who made the thing we don't want are competing for what we want with us. Yes, inflation in price of most of the things we want is the result, leading to lower effective income for everyone.
I've said it before and I'll keep hollering it until I can wail no more. Any activity, whatsoever, that produces anything people do not want, will be inherently inflationary in prices. The only way to have such activity, as a matter of fact, is to have inflation in the money supply so that people are paying for the things nobody wants enough to pay for out of money that nobody really ever had. Of course, the bankers & co. take their cut and live high on the hog, as it were, while the rest of us in the trenches repeatedly see our purchase power decrease.
Now, were the banks allowed to fail, we'd see everyone's debt load reduced, leading to greater available income, leading to greater actual spending, leading to greater demand, leading to greater employment, leading to greater available income, leading to greater spending, and so on. Also, a reduction in impediments to employment would really help, such as the destruction of the IRS, Medicare, Medicaid and anything else that requires documentation and paperwork to employ someone. Also, the minimum wage has to go. Basically, if an employer can employ someone for a low amount to start, the employer can grow more easily, leading to greater employment, which leads to greater spending, which leads to greater employment and so on.
This is what we need to foster, not the negative spiral of debt for the benefit of big bankers and their big lifestyles, but the spiral of increased purchase power for the benefit of the average Joe and Jill and their three kids. In order to accomplish this, we have to reduce regulation and impediments to employment and we have to establish a stable monetary policy, such as my favorite, free money (not free as in anyone can have some, but free as in you can use anything you like to trade or pay for anything you like).
First is, of course, a problem of income. Any purchase of any capital good made on credit is a final transaction where manufacturing is concerned. This is why so many car companies created financial arms: when a car is bought on credit, that's it; there's no more car bought until the note is retired somehow.
This means there's no purchasing with the money set aside to pay the note. So, if someone buys a car on credit, with payments of $300 per month plus full coverage insurance payments of $100 per month, that makes $400 a month they cannot spend on anything else.
When the debt load gets high enough, most people are spending most of their money servicing debt, and are unable to make new capital purchases. They still buy food and they still buy minor things, although the maximum price they can afford is lower, so either the quantity or the quality of the non-capital goods they buy suffers.
This puts capital goods producers out of work, ie, auto manufacturer workers. These workers now have an income of zero and are no longer able to service their debts let alone contribute to employment of others.
So, sooner or later, other sectors suffer. Makers of toys do badly. Makers of gadgets do badly. Netbook manufacturers do well at the expense of notebook and pc manufacturers. In other words, people spend less and less, causing there to be less and less to spend.
If, for instance, a person manages to get a job for less money, or is trying to live on one income when they used to live on two, they can reduce the price of the things they buy by, ie, buying generic or cooking their own meals. However, their debt payments remain fixed. As previously noted in the annals of the bureau, all activity is at the margin.
Now, if they pay, say, $1000 in debt and used to make, say, $2000 per month, they had $1000 to spend on their non-debt needs, such as food and toys. If their pay drops to $1500, a 25% decrease, their net income is now just $500. A 25% decrease in their income results in a 50% decrease in their negotiable income, leading to severe hardship. A 50% decrease in their income will lead to a 100% increase in their negotiable income, leading to bankruptcy, as their only chance of survival is to reduce their debt payments.
Now, to arc back onto the topic of this point, if we drive greater debt to the consumer, the end result will be a greater percentage of their income servicing debt and therefore less of their income being spent on non-debt items. Think about that for a second. People will buy fewer combs, fewer toys, less expensive food, fewer of anything that does not require debt to acquire. It is perhaps true that greater availability of credit will save the auto industry in the US, although it is just as likely that the available money will go to Japan or Korea or Germany. However, it is almost certain that it will reduce negotiable income.
Fortunately, most people sense this and are not interested in acquiring more debt. Now is a time of paying off debt, meaning increasing, over time, negotiable income. This is hard on the banks, as their revenue is related to the amount of debt people are willing to assume, and they have so much bad debt they are trying to acquire good debt so they can achieve positive cash flow.
So, creating new loans is good for banks. It also may help house builders and the auto industry, as alluded to above. It also allows venture capitalists to start business that may or may not be a waste of money.
However, sticking to the banks, banks that are making new loans at this point are making a high percentage of bad loans. This is because most of the people willing to assume more debt right now are not necessarily effective at managing their own money. Also, there is no reason to believe that the system has recovered enough to make that person's job secure enough to assume a high load of debt no matter how collateralized.
Since the problem with the economy is an overabundance of bad debt, with leverage ratios up around 30 to 1 before the collapse, making more loans is not really a good idea. However, banks have no other way to generate income, so must do so or fail.
A loan that defaults is an immediate loss to a bank. In other words, when someone borrows, say, $100,000 to buy a house, and makes payments of, say, $800 a month on his mortgage, the bank gets to apply a percentage of that, very low initially, to the principle and applies the rest to its bottom line, probably around $700 a month. However, if the loan defaults, the bank is now out the remainder of the principle, say, $70,000. I chose that number to simplify math, as it is clear that it is 100 times the income from the loan per month. So, on a cash flow basis, having a loan default is on the order of a hundred times greater than the income from the loss. This means that around 100 other loans that you have must pay on time in order for you to not lose money on a cash flow basis. Of course, on a net accounting basis, it isn't as bad, as that loan comes out of your reserve. However, if, as was common in banking, the reserve was not adequate to the defaults, the bank gets in trouble and the only way it has to increase its reserve is to write more loans to get more income.
In a proper deflationary depression, banks simply fail. This means they run out of reserve and then auction off their assets. The government covers depositors up to $100,000. Many companies get in trouble covering their profligate spending with bonds, as the bond market would simply crater with the auctions of bank assets. Lots of very rich people would be rendered destitute.
However, this would be fair. These rich people desperately need to get some sort of comeuppance. They haven't learned their lesson. Worse, they claim to be able to manage risk, yet failed significantly to do so. Since the only reason a bank is supposed to be able to charge interest is related to the risk of making the loan in the first place, if they will not shoulder the consequences of taking the risk, they should not receive the interest.
It is like the insurance companies lobbying the feds to pay for 9/11. Insurance companies accept premiums for assuming risk. They're supposed to manage the risk and require premiums to cover the risk. If they then throw the risk onto the government, they no longer have a valid claim to accept premiums.
So, the problem was caused by banks making mistakes on a grand scale, cheered on by government that did not understand economics (there's a surprise) and this lead to a debt crash, which, in broad strokes, is simply that people now have so much debt that the maintenance payments eat up all their disposable income, leading to a reduction in purchasing, leading to a reduction in manufacturing, leading to a reduction in payment, which causes a vicious cycle that eventually results in a 'blow off' of bad debt, clearing the way for people to start spending again.
However, not only has the government not learned from the mistakes, but it is actively helping the banks to not learn from their mistakes. The leverage ratio is not as bad, but, given that much of the reserve these days is debt, banks are not in a positive position yet. That aside, they are starting to do the same sorts of risky things that led to this problem in the first place, emboldened by the fact that the government stands ready to make good any of their losses. This is called a 'moral hazard' by economists, although one analyst insists that a better term is 'ethical hazard', as it really isn't about morality, but about the risk generated by a misallocation of resources.
Since the government has made good the losses of banks that are 'too big to fail', those banks have a golden ticket to do whatever fool thing they dream up while their stock valuations soar. Since any losses will be made good, they can go ahead and do the whole gamut of foolish loans to groups with low repayment outlooks. Doing this increases their supposed income, so their stock looks ever more attractive, leading to increased stock valuation, leading to executives making more money.
However, none of this is good for the greater economy, as it locks lots of people into untenable debt situations, creates more economic activity with little hope of producing useful returns and in general misprices much of what happens.
For instance, if a venture capital firm can get cheap money, they can go out and take a risk on some startup that may or may not ever make money. There will be a lot of economic activity in that particular company before its inevitable failure, putting lots of people on the streets.
However, the bigger problem is that something has been produced that nobody wants enough to pay its real cost. This means that things we actually want cost more because there is less of it and the people who made the thing we don't want are competing for what we want with us. Yes, inflation in price of most of the things we want is the result, leading to lower effective income for everyone.
I've said it before and I'll keep hollering it until I can wail no more. Any activity, whatsoever, that produces anything people do not want, will be inherently inflationary in prices. The only way to have such activity, as a matter of fact, is to have inflation in the money supply so that people are paying for the things nobody wants enough to pay for out of money that nobody really ever had. Of course, the bankers & co. take their cut and live high on the hog, as it were, while the rest of us in the trenches repeatedly see our purchase power decrease.
Now, were the banks allowed to fail, we'd see everyone's debt load reduced, leading to greater available income, leading to greater actual spending, leading to greater demand, leading to greater employment, leading to greater available income, leading to greater spending, and so on. Also, a reduction in impediments to employment would really help, such as the destruction of the IRS, Medicare, Medicaid and anything else that requires documentation and paperwork to employ someone. Also, the minimum wage has to go. Basically, if an employer can employ someone for a low amount to start, the employer can grow more easily, leading to greater employment, which leads to greater spending, which leads to greater employment and so on.
This is what we need to foster, not the negative spiral of debt for the benefit of big bankers and their big lifestyles, but the spiral of increased purchase power for the benefit of the average Joe and Jill and their three kids. In order to accomplish this, we have to reduce regulation and impediments to employment and we have to establish a stable monetary policy, such as my favorite, free money (not free as in anyone can have some, but free as in you can use anything you like to trade or pay for anything you like).
