Friday, September 23, 2011

Possible and Advisable Aren’t the Same When Borrowing.

That’s an argument that one can’t win.

“Possible verses advisable” is an important issue that far too many people choose to overlook. It was stated fairly succinctly in a posting on this blog on Monday, July 4, 2011: “Yes, one can rationally say ‘take your credit and shove it’.” (See: “Whose Future Is It?” for context.) The reasons why one can’t convince people are many. The postings that follow “Whose Future Is It?” summarized the discussion (fireworks) that resulted. They illustrate one reason it’s hard to change attitudes about borrowing. As soon as one recognizes that all borrowing involves two willing parties, one has to give up the blame game. That’s no fun.

The second reason is less amusing, but it’s very sad. Once one realizes that often refusing a credit offer makes sense, one has to accept responsibility for one’s action. Taking responsibility for one’s actions is also no fun. All sorts of issues have to be addressed. Some people carry it to the extreme: they actually start thinking one should consider whether one can pay back the loan. It’s sad, but there’s a darn good chance that whoever lent the money will want to be paid back. Thinking about paying back a loan takes all the fun out of borrowing: it’s a real “bummer.”

Humbug is not the reason for bringing up paying back loans, and as discussed in “Truth In Lending” and “Borrowing For Investment,” borrowing is often a very good idea. By contrast, putting off thinking about all aspects of a loan is never a good idea. However, many people confuse not having to pay back a loan until later with not having to think about paying it back until later. Once one includes repaying in one’s thinking about borrowing, the problem shifts from how much one can borrow to what can be done with the borrowed money that justifies the cost.

There does seem to be one group that thinks it has found a solution. They congregate in Washington, DC. Need I name names? Witness the new and improved “stimulus” (a.k.a. jobs program) discussion. Washington seems to think they can say, “We’ll borrow on your behalf, but you’re so stupid you can’t figure out you’ll have to pay it back.” Thus, they think they’ll get another chance to squander money on their pet projects. The problem with their logic is that back in the 1970’s and 80’s economist had to modify their thinking (and if they wanted to have a chance of getting realistic results from their models, also change their models). Economists know it as a shift from adaptive expectations to rational expectations. Basically, they had to recognize the reality that people are, in aggregate, NOT stupid. Unfortunately residents of a certain city can always find some pretend economist who will ignore developments in economics since the 1980’s and defend the “greater fool” thinking many policy recommendations require.

Every once in a while a Washington killjoy surfaces. Then one finds reports like these quotes from the September 8th, “Heard on the Street” column in the WALL STREET JOURNAL:
“The threshold for increased government borrowing and spending should be whether it adds to the productive potential of the economy. It is through improved competitiveness that the apparent paradox of an expansionary fiscal contraction is resolved, not, as commonly assumed, via confidence alone. New investments should be judged on whether returns are likely to exceed the cost of capital rather than simply the current low cost of borrowing, a measure that takes no account of risk and is therefore likely to lead to substantial long-term wealth destruction.”
“But no government should be under any illusion that boosting borrowing and spending can provide anything more than a short-term stimulus, and it comes with big risks.”
“Some argue that the low bond yields in some countries show markets are comfortable with debt profiles and are effectively an invitation to borrow more. This is a dangerous delusion that risks a repeat of the mistakes of the boom, when households, businesses and investors were lured by cheap rates into unaffordable mortgages, highly leveraged private-equity buyouts and crazy structured investment vehicles.”

As was pointed out in “Borrowing For Investment,” the cost of borrowing is not the interest cost. The cost is always and everywhere the opportunity cost. When the proper criteria are applied almost all stimulus programs fail to pass muster. They are shown to be the boondoggle that they are.

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