Our economy lives and dies on debt, and before I get into this financial crisis and the absurd hypocrisy of this bailout plan, let’s get back to basics.
Previously , I referred to Debt as Savings’ evil step child. The relationship comes from the fact that the money that banks lend out in the form of credit cards, car loans, and mortgages is in fact the money you have saved in the bank. Americans love this. It means we can buy crap that we can’t afford in the short term, and pay for it over time. The evil part comes from the risks involved in being heavily indebted, and this crisis has been a painful demonstration of that risk.
It has been estimated that the average American adult carries about $4,200 in credit card debt alone. But what’s so bad about that? I mean, we’ve got all this time to pay it back. The fundamental problem, though, is that we do not save. So when something bad happens – say an unexpected hospital visit or the loss of a job – we do not have the cash cushion to weather the storm. If Americans have an average of $700 in the bank at any given moment (I made that number up), it doesn’t take an investment banker to figure out how little time it will take to burn through that cash making your credit card payments. From there, bankruptcy is right around the corner.
But what does this have to do with the bailout?
More fingers are being pointed than you can count, but it is this simple idea that really underlies the whole crisis. Banks, it turns out, carry debt too. They borrow from each other to make investments and cover operations (to me, this is like transferring balances from one credit card to another). But they carry a hella lot of debt. Whereas on an individual level, Americans may carry $18 in debt for every $3 they have in the bank, some of these banks were carrying as much as $100 in debt for every $3 in the bank. I am sorry, but that is plain friggin’ dumb! So when their income streams unexpectedly slowed – when people started missing mortgage payments, for example – and their creditors kept knocking on their doors, you can see how a bank can vanish in an instant. Lesson: when you have debt, you gotta have savings.
It’s obviously deeper than that, but this was the fundamental root of the problem. People try to pin it on other things, and some of it makes me angry. One scapegoat has been the Community Reinvestment Act, which merely stopped banks from discriminating against people of color–a practice they got so comfortable with that they actually had maps outlining minority neighborhoods where they refused to lend. People claim it forced lending to people that couldn’t pay, but CRA was enacted over 30 years ago and can only be tied to 20% of the crappy mortgages. Fannie Mae and Freddie Mac are even older. Yet no banks were collapsing until a rules change in 2004 let them take on too much debt relative to their cash on hand.
What pisses me off the most though is that only a year after this rules change, Congress changed the bankruptcy code to make it harder for individuals that get in trouble by taking on too much debt to declare bankruptcy. Yet when banks took the same risk, but to an obscenely higher degree, Congress hauled ass to bail them out. This basically lets them declare bankruptcy, wipe out their bad debts, and immediately get back to borrowing. Individuals, on the other hand, get their credit handsomely screwed for at least 10 years. That’s just not right.
-MannyFresh
{ 2 comments… read them below or add one }
I feel you Manny. Its just bad all the way around. The thing that I have always found interesting is that young people are sort of thrown into the world of credit without a lifeboat. Meaning that we are told that we have to build our credit, which to a young person means, buy a bunch of stuff with your plastic, thus build credit. Then we bite off more than we can chew and fall by the waste side, looking like just a bunch of irresponsible folks.
Like you said, its not right! Saving is very important, but becomes impossible when all of your income goes to pay off debt.
Great post.
Most def Barb. The fact that young people don’t have a lifeboat is precisely why they are targeted by the credit card companies. They figure kids will charge things without understanding the consequences, and will usually get bailed out by mommy and daddy if they get in trouble. And thus our college campuses are flooded with credit card promoters.
You are right about it being hard to save when you gotta pay off debt. Getting out of debt is a lot harder than using it responsibly.
One of the things I am most passionate about is getting a financial curriculum into our schools, because we can’t be sending our children out into this crazy world uninformed like this. They gotta know before they get in trouble, because getting out is tough.
…but then again, the whole credit industry is about to change.