General Motors and "Repaid" Debt

Monday, April 26, AD 2010

I usually don’t go in for thought experiments, but for once I’ll make an exception. Let’s pretend for a moment that I need $50,000 to maintain a struggling business, and you, being the wealthy and charitable individual you are, provide me with $50,000 in the following manner:

1) $30,000 in ownership (a share in future profits, if any)
2) $13,000 for emergency cash (to be repaid at no interest)
3) $7,000 in debt (at an interest rate 7% lower than I could get elsewhere for accepting a similar risk)

Not too many angel investors, venture capital funds, or private equity funds would sign up for such an arrangement, and that, dear reader, is why I am relying on your generosity. After one year, the business still has not made a profit. However, I have managed to “pay back” the initial $7,000 in debt in the following manner:

1) I borrowed an additional $10,000 from you for environmentally friendly investments.
2) I used some of the $13,000 in emergency spending cash to pay back the $7,000.

In other words, at the beginning of the year, you provided me with $50,000. I now owe you $53,000 (plus the emergency spending cash I used and the interest you’ve lost), with no real prospects for paying the money back. However, I am confidently assuring my customers and you(!), of all people, that I have “repaid my loan in full,” by which I mean the $7,000 in debt, not, of course, the $53,000 you provided that has not yet been returned. Change the thousands in the thought experiment to billions and the debtor to

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2 Responses to General Motors and "Repaid" Debt

On Certification Instead of Regulation

Thursday, January 7, AD 2010

What started as a “Ha, do you libertarians endorse this?” dare by Mike of Rortybomb has turned into a somewhat interesting discussion between him and Megan McArdle about to what extent it’s possible to protect people who are not good at understanding complex financial products (the elderly, or people who just aren’t good at understanding complicated service agreements) from being victimized by banks without in the process hurting the people you’re trying to help. This as the new credit card legislation is going into effect, trying to crack down on banks which raise interest rates quickly if you’re late paying, have hidden fees, or move due dates around (theoretically in an attempt to keep people from paying on time.)

Mike suggests that banks should be required to offer a “plain vanilla option” of products such as credit cards or checking accounts.

And that solution would be mandating financial services to provide Vanilla Option financial products. Boring, low-reward trap-fee products you’d probably have to pay a yearly fee for.

So much of our financial services are predicated on tricks and traps but also have a lot of benefits. You get free checking, but if you overdraft you lose more than you gained. Now with a vanilla option, you could pay more upfront to not take the risk of losing later. This is banking how it used to be, boring. And this is exactly the kind of product that people with weak cognition would want to have available. Someone approaching older age, but before getting there, could opt for the “extra boring” financial services package. People buy renter’s insurance; some might view a yearly-fee on their checking account or credit card as a “trap insurance.”

Megan doesn’t think the idea would be very successful:

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One Response to On Certification Instead of Regulation

  • The Thaler and Sunstein book Nudge made some similar recommendations regarding what you might call “plain vanilla” options for things like credit cards, mortgages, etc. In general they think that you could get around the problems noted by Ms. McArdle by making the plain vanilla the “default option” rather than just one option among many. The idea is that most people tend to stick with a default option whatever it is, and the few who don’t tend to be the ones who are more knowledgeable and capable of comparing the pros and cons of other options. I’m not sure how that would translate into things like health care, but it’s an interesting idea.

Lessons of the Financial Crisis

Wednesday, February 25, AD 2009

While I’m on the topic of narratives, Matthew Boudway at dotCommonweal has a post up entitled “They Cannot Fathom Their Failure”.* The post is based on a George Packer column, which basically makes the argument that conservatives “cannot fathom the failure of their philosophy” after the recent financial crisis, and that to deny they have been discredited is a form of self-delusion. This is a charge, I suppose, to be approached with trepidation; false consciousness is notoriously difficult to disprove. That said, it may be worthwhile to offer some thoughts in response. Here is an excerpt from the post:

…“[T]hey cannot fathom the failure of their philosophy.” Not “they will not fathom” it. They cannot. Sure, the response of many conservatives to the bailout and the stimulus package has been opportunistic and cynical. Many of them, though, simply cannot imagine what it would mean — what it now does mean — for the premises of their policy agenda, and indeed of their entire political philosophy, to have failed.  Not even the most spectacular failure can force anyone to learn a lesson he desperately wishes not to learn. Historical events are always complicated and contingent enough to admit of more than one interpretation, and the most plausible interpretation is often not the most attractive.

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7 Responses to Lessons of the Financial Crisis

  • 100% spot on, John Henry. Well said.

  • I have a feeling I will be repeating that Megal McArdle line until everyone is very tired of it, but it’s something always worth keeping in mind.

  • If the financial crisis somehow disproved conservative economic policies, then how does one explain the fact that the crisis is even worse in Europe and Japan than it is here?

  • Ah, but that’s only because the evil American conservatives victimized all the foreigners, right?

    😉

  • Well, one could reply that the financial crisis spread from the U.S., but as the links BA provided show, the leading economic indicators in other countries fell off prior to the U.S. crisis. And proponents of regulation and intervention in my view need to offer a compelling reason to believe that the political process is more effective at regulation than the financial markets. Granted, the track record of the latter has been less than stellar recently, but countries with higher levels of regulation generally have much lower economic growth and slower recoveries from economic downturns.

    At a minimum, if one is going to make the strong claim that a political or economic philosophy has been completely discredited, then one should provide evidence for the position.

  • Sarbanes-Oxley has had a chilling effect on risk-taking and investment, resulted in less firms going public

    Having done contract work for the past three years and doing work for the same company from time to time, I have seen two companies revert back to a private firm and a new one never going public. Sarbanes-Oxley was a major variable in their decisions to revert or remain private.

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