Credit wor­thies

How round trip­ping R100 left ev­ery­body sat­is­fied

Finweek English Edition - - Openers -

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 stephenm@fin­

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