Once again I find myself compelled to climb my heavily used soap box (which I of course got for free).

I just read this piece on CNBC which describes a blogging chain reaction following the Federal Reserves decision to spend $200 billion of the tax payers money to make it easier to extend consumer loans, student loans, and car loans. The thinking goes that without this stimulus, the economy would collapse. That’s right, it’s just what we need to cure the credit hangover, more beer!

And so how can this not be a good idea? Because removing the symptoms while exacerbating the disease is not a cure, stupid!

The problem is that a consumer credit driven economy is fundamentally a broken concept. Credit implies borrowing money and borrowing money implies investing it. All investments need to have a positive rate of return, that is, an increased productivity that exceeds the cost. The problem with consumer debt is that it does not directly result in increased productivity. Indeed, buying that sexy car or that 5 bedroom house does not make you more productive. They are, therefore, not investments. Many student loans are not invested properly either. Some are, but many are not e.g. $100,000 for a BA in English that leads to a $25,000 salary certainly is not. Without easy access to student loans, wannabe students would be forced to acknowledge what they are paying and what they get in return. Perhaps then, educations would not be so prohibitively expensive (what exactly are you paying for when you are handing over $40,000/semester, that you couldn’t get with a public library card and an internet connection?). In addition, students would not show up for class as if they could not care less (they don’t because paying back the loan does not happen until far into the future).

Indirectly, however, you could think of such loans as investments in the aggregate or maybe more accurately, it helps other people’s investments. Consumers borrowing money leads to actual investors using their capital to build the things that consumers use.

I find it funny that we, more credit conservative bloggers, get accused of being puritanic and paternalistic. I also find it funny that you can’t hit a personal finance blogger without being mainly focused on debt (unless, you hit me 😛 ): either getting out of debt or handling it “responsibly”, respectively.

Let’s deal with the paternalistic part first. I would say that a majority of people in debt are incapable of analyzing debt. Yes, they may go to a lender and the lender will present them with various options such as “how long do you want your chain to be?”, “how heavy do you want your ball to be?”, and “how much time do you want to serve?” Most people have no clue and lack the mathematical acumen to solve for a time series of cash flows and so they say “Sure, 30 years with a $500,000 principal and a 25% load, sounds good to me. I’ll just sign here on the dotted line (I don’t want to ask questions and look stupid)”.

I think most people have been “institutionalized” to the point of not choosing deliberately. They do not know why they are going to college (To get an degree is not an answer). They do not know why they are are buying a house, a car or charging on credit. They just do it. From that perspective, credit is a bad idea just like giving a gun to a 5 year old is a bad idea.

So is it a good idea. It depends on how cynical you are. In fact, if more people were investors rather than consumers or if more people where savers rather than in debt, the interest rate would be much lower and thus I would not have been able to stop working for money so soon. So yeah, thank you for that. But seriously though, it’s not really in your best interest, and I will tell you that. I will, however, also take advantage of the situation at the same time.

Second, there’s the puritanical part. I must admit that I feel a slight bit of schadenfreude towards the people who were living it up last year clearly beyond their means while bragging about how their net worth were going up although it was clear to me that most of that net worth was sitting in their very much leveraged houses. Yeah, so they struggle now, but they reap as they sow. In the end, it balances out. If I’m puritanical, it means that I don’t get to live it up while the going is good, but it also means I don’t get to struggle when the tide goes out.

At the end of the day, there is indeed nothing intrinsically bad about personal consumer debt, but couldn’t one say the same thing about personal hand grenades; they do not intrinsically kill anyone.

Originally posted 2008-12-02 18:00:54.