Finance

General Motors and "Repaid" Debt

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 →']);" class="more-link">Continue reading

On Certification Instead of Regulation

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: →']);" class="more-link">Continue reading

Lessons of the Financial Crisis

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.

→']);" class="more-link">Continue reading

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