How round tripping R100 left everybody satisfied
THIS IS A TALE that those who relate it say explains the turmoil and carnage in world markets all flowing from excessive credit extension by, primarily, banks in the United States to, mainly, homebuyers who couldn’t afford to take on the debt. Your ageing correspondent doesn’t share this view but it’s a tale worth telling and any responses to it would be most welcome.
It goes like this: A travelling salesman arrives at a modest boarding house and requests a room for the night. “That will be R100,” says the lady owner. Our salesman hands over the R100 in cash, saying he’ll be leaving early and would prefer to settle the bill in advance.
His R100 is accepted and he retires to the bar.
Our landlady summons her son. “Jannie,” she instructs him, “take this R100 down to the baker. We owe him R100 and this will clear it up.”
Jannie obliges his mother, duly delivering the R100 to the baker. This worthy then dispatches his worker to the butcher, where he has an outstanding bill with instructions to give the R100 to the butcher and settle his account.
The butcher dispatches his assistant to the local garage to deliver the R100, which he owes them for petrol. The garage owner then strolls over to the boarding house and pays the R100 – which was outstanding on his bar bill – to the landlady.
Then the salesman appears from the bar to advise the landlady that he’s been called away urgently and therefore will not be spending the night and could he please be refunded his R100. The landlady obliges and the salesman leaves town with his R100 in his pocket.
Now one recalls the multiplier effect from Economics 101 but here we have R100 circulating and then disappearing but leaving several debts satisfied. What am I missing? HEADACHES AND HANGOVERS ANYWAY, CREDIT CAN, as we all know, be as addictive as alcohol, drugs or tobacco. And it’s been the case for a long time that the modern economic miracle in the United States has been kept spinning through the accumulation by millions of people of billions upon billions of debt.
Americans were encouraged to assume debt by generous tax allowances – including, for example, the deduction of the interest on a mortgage, which defies the concept of deductions only against income-producing activities.
Further, starting in 1992 under Bill Clinton, Freddie Mac and Fannie Mae, the great state controlled mortgage lenders, were instructed to lend to the poor, particularly those in minorities. Thus institutions were urged – and in some ways coerced by government – into lending to people who wouldn’t normally qualify for a loan.
Be all that as it may, there can be no getting away from the fact that greed and reckless speculation with other peoples’ money by obscenely rewarded financial services executives were key to the whole mess. And some of them have paid for it, although they’re not yet quite starving.
The great Mittal family of India, owners of ArcelorMittal (formerly Iscor) in South Africa, have seen their wealth decline by US$17bn. Other casualties, including those with now worthless stock option plans, include James E Cayne, former CEO of Bear Stearns, whose assets fell from $1,06bn to $61,2m, and Maurice R Greenberg, former CEO of AIG, who now has to get by on $49,6m against the $1,25bn he was worth in January last year.
Now debt has its role to play. A concept of debt has been around many thousands of years. An American scholar, Michael Hudson, writing on the antiquity of debt and interest, quotes from German writer Fritz Heichelheim’s Ancient Economic History, from the Paleolithic Age to the Migrations of the Germanic, Slavic and Arabic Nations, written in 1930 and revised in 1958: “Linking early ‘food money’ to the origins of productive credit, he speculates (1958:54f) that around 5000 BC ‘Dates, olives, figs, nuts, or seeds of grain were probably lent out… to serfs, poorer farmers and dependants to be sown and planted, and naturally an increased portion of the harvest had to be returned in kind.”
Naturally! In addition to fruits and seeds ‘animals could be borrowed too for a fixed time limit, the loan being repaid according to a fixed percentage from the young animals born subsequently’.
Usury, as interest on debt was originally known – and prohibited in the great religions – but which now means excessive levels of interest, is mentioned in Exodus 22:25: “If thou lend money to any of my people that is poor by thee, thou shalt not be to him as a usurer, neither shalt thou lay upon him usury.”
What’s essential in the matter of either lending or borrowing money is to assess affordability. That’s the essence, which appears to have been lost, of sound banking practice. Banks have a duty not to lend to those who can’t afford it.
For example, the debt service ratio of households in the US is now at an all-time high of 14,5% compared to 10,5% in 1980. In other words, 14,5% of total household income goes to service a mortgage. To return to a household debt service ratio of 1980 total US household mortgage debt will have to retreat by more than 31%. Even worse, the US household’s financial obligation rate – that includes insurance, rates, taxes and interest – is now at 19% compared to 16% in 1980.
We have been on a credit binge. There will be a headache and a hangover and it will be painful. But man learns only through failure and hardship, not through success.
STEPHEN MULHOLLAND firstname.lastname@example.org