Fog Creek Software
Discussion Board




Can credit bring an economy to it's knees?

I live in a country in East Europe.

The problem is, about one year ago, the banks started offering credits for people.

Before, it was very hard to get credit. Now, it's very easy!

A lot of people are buying a lot of stuff kinds of stuff on credit - cars, apartments, TV sets, refrigerators, etc.

I would like to emphasize that this was a suddent change - from "no credit available" to "credit available to a lot of people".

Why am I upset, then? I was able to buy some stuff on credit, too.

The problem is - the economy seems to be falsely stimulated using this "borrow from the future" thing.

In a few years, many people will have large debts, and won't be able to take on new credit. They will also reduce their spending in order to be able to pay off the debts.

I am afraid that this will bring the economy of my country (which is pretty weak) to it's knees - that we shall have a recesion.

What is your opinion about this?

Has this kind of thing already happen in other countries?

What measures should I take to prosper in the coming economic bust?

Is there any web site about this kind of economic phenomenon (credit -> debt -> reduced spending -> economic bust)?

Thank you in advance for your replies!

Max
Tuesday, September 09, 2003

There's no such thing as a free meal. If you know - which you say you do - that credit is bad, then don't do it.

You can't protect other people from themselves.

Mickey Petersen
Tuesday, September 09, 2003

Move here.

The land of golden opportunities -- THE United States of America.

gg
Tuesday, September 09, 2003

CF Thailand, 1998 or so.

mb
Tuesday, September 09, 2003

BTW, the key phrase to look for is 'overextended credit'.

mb
Tuesday, September 09, 2003

"The private control of credit is the modern form of slavery."

-Upton Sinclair

Jeff MacDonald
Tuesday, September 09, 2003

You could pretend to believe that credit could improve the economy by allowing people to spend and stimulate the economy even when wages were tight, and then when the economy warms off, start paying off debt and the reduced spending will help level the economy.

Of course it is bogus, people spend their money in whatever way they feel like.  All you can hope is that when people can't make their debts anymore, the credit people feel the pain.

I wouldn't be surprised if a 12 year old can get a credit card in the US these days, and our economy hasn't collapsed. 

err,  much.

Keith Wright
Tuesday, September 09, 2003

You don’t have to worry that much. There is an entire theory on Credit Risk Management and since big Western banks own the most banks in Eastern Europe I expect they have their homework done. I suppose there will be many personal bankruptcies in the future but don’t forget the credits are the grease for the wheels of the economy.

19th floor
Tuesday, September 09, 2003

You are correct to be worried. Easy access to credit is a well-known trap, deliberately exploited by some banks and some types of "businessman" in the West.

They dish out the credit, which naive people suck up, and then start applying high interest rates. They know people will be stuck with a debt for a long time, and thus have to pay rent on it for a long time. It's real money for nothing stuff.

Even worse, some businesses deliberately trap people into giving their houses or their relative's houses as security for big loans, then foreclose as soon the lendee is late on a payment. The whole operation is aimed at grabbing valuable real estate. Disgusting but true.

JM
Tuesday, September 09, 2003

Two things which made the US strong:

1) No debtors prison. Easy bankruptcy means more risk taking. More failures but even more successes.

2) Estate tax. Splitting of a person's wealth at death prevents aristocracy, which eventually goes stale or destructive.

Mind you, in the past 5 years both of these have been seriously reduced at the behest of credit card companies and wealthy families. Does not bode well for the future of the US economy.

As for your east european economy, the banks may well have planned something (or maybe not). As someone else mentions here, the something may be reasonable credit for a strong economy, but it may also be something else like lifetime repayment (good medium term bank profit) or property acquisition. I hope you have good bankruptcy laws.

mb
Tuesday, September 09, 2003

In the 80's the UK began running a consumer credit economy on a scale that hadn't been considered before, because of liberalisation of personal consumer credit regulations.

The upshot was that within around 7 years that although inflation was barely affected we had interest rates of around 15%.  It took another 7 or so years (and a monetary crisis) for that to wind out of the economy.

Now with house price inflation we are having a similar but hidden consumer credit boom, if you can't sell your house (because there aren't enough buyers around), you remortgage it as we have historic low interest rates at the moment and spend some of the asset value on paying off the credit card bill and buying holidays and whatnot.

This is converting short term credit into very long term credit and fuelling the inflation of the assets which backs that debt, the bubble will burst at some point, its hard to see when though.

Simon Lucy
Tuesday, September 09, 2003

The US because of its size is more immune to swings in macro and micros economics.

There is a heavy debt boom over here as well - the consumer is fueling the economy. I have colleaques that buy an SUV on 60K salary per year. This is fine except they have over $15 000 or so on their credit cards. Add the home morgage, student loans, kids etc. Plus gas prices keep rising.

That is one major migrane.

Ram Dass
Tuesday, September 09, 2003

http://www.washingtonmonthly.com/features/2003/0305.kurlantzick.html

Jim S.
Tuesday, September 09, 2003

I read a book about that once.  A farmer lost his farm because he had mortgaged the farm and could not produce any income:

http://www.amazon.com/exec/obidos/ASIN/0140186409/qid=1063154148/sr=2-2/ref=sr_2_2/002-5290523-0687251

Jonathan
Tuesday, September 09, 2003

Welcome to the club. You should see the average american consumer debt. Living paycheck to paycheck and still borrowing.

Tom Vu
Tuesday, September 09, 2003

http://www.newstepsolutions.com/debt-statistics.htm

Tom Vu
Tuesday, September 09, 2003

Australia had a finance company that used to make lots of loans to young working class guys so they could buy trucks and become owner-drivers. They would get the guys' parents or grandparents to put up their houses as security.

All very palsy-walsy. Then the borrowers would hit a bad patch and whoompf, those b_stards would evict the grandmother and sell the house.

e
Tuesday, September 09, 2003

Stay out of credit. You will be in better shape than your neighbors. Buying things on credit is banking on your future that things will be good for you. Do yourself a favor and give the future you a break - save.

m
Tuesday, September 09, 2003

Credit cards do have certain advantages that other forms of payment do not, including limited liability upon theft and (when used responsibly) impressing credit bureaus when it's time to get a car loan or mortgage.

All you have to do is pretend that it is really a debit card, and only spend what you can pay in full at the end of the month.

Just remember that the interest rates on most credit cards would be considered usurious on almost any other loan.

Devil's Advocate
Wednesday, September 10, 2003

Things are starting to look pretty scary in the UK at the moment.

Consumer credit is at staggering heights. A lot of people owe over a year's salary, even before considering their mortgage. This doesn't seem sustainable in the medium to long term.

I have already paid off all of my credit cards and car loan and will do as much as I can to pay off my mortgage too.

This will (eventually) save me about £20,000 a year in interest payments and also mean I'm debt free.

Steve Jones (UK)
Wednesday, September 10, 2003

Does that country from Eastern Europe happen to be Romania? I am worried about this phenomenon too.

King K
Wednesday, September 10, 2003

I think that Gordon Brown, the British Chancellor, has it right with his golden rule: Credit should only be used to fund capital spending, not current spending.
http://www.timesonline.co.uk/article/0,,5-642682,00.html

Capital spending is basically spending that generates further income.
http://www.investorwords.com/cgi-bin/getword.cgi?694

This is how I personally apply the rule to personal finance.

If house prices are increasing, then getting a mortgage on a house obeys this rule.  The cost of the credit should be more than covered by the houses increase in value.

Credit to buy a car is OK if the car will give you an opportunity to increase your income.  Perhaps by making a better payed job available.
   
The same goes for spending on education.  If gaining a qualification increases your worth in the job market then this should cover the cost of the credit.
   
Of course, you have to consider risks.  Housing and Job markets collapse.  You need to consider this.
   
Using the credit to buy disposable items, such as consumer goods, or to sustain an expensive lifestyle is bad.  The credit will have to be paid eventually, and if you haven't used to the money to generate more income the only way to pay it off is over a long period of time.

Ged Byrne
Wednesday, September 10, 2003

Ged,

>> Using the credit to buy disposable items, such as consumer goods, or to sustain an expensive lifestyle is bad.  The credit will have to be paid eventually, and if you haven't used to the money to generate more income the only way to pay it off is over a long period of time.  <<

I often use credit to buy disposable items such as consumer goods and holidays. Credit allows me to buy items that would otherwise make an unacceptable hit on my immediate cashflow. I have no problem with paying more over the longer term as long as it preserves my short-term cashflow.

<rant>
Credit doesn't bankrupt or enslave people. Greedy people making stupid credit decisions bankrupt or enslave themselves.
<rant/>

Mark
----
Author of "Comprehensive VB .NET Debugging"
http://www.apress.com/book/bookDisplay.html?bID=128

Mark Pearce
Wednesday, September 10, 2003

Mark,

I have to admit to doing the same myself.  I consider it a very different type of credit. 

I think the distinction is credit that puts you into significant debt.  If I borrow £500 for an item (perhaps by paying it off on my credit card) and pay it of over six months, but I have £6000 pounds in saving then that credit isn't actually putting me into debt.  I could pay it off if I needed to, but overall the service's convenience is worth paying for.

Would you 'go into debt' in order to pay for a Holiday?  I think its a bad idea.  I know of people who go into significant debt (over a quarter of their annual income) in order to fund Christmas.  I think these people are probably more stupid than greedy.

Ged Byrne
Wednesday, September 10, 2003

No bank in the world wants to foreclose when they loan you money on collateral.  What they want is their money back, plus the interest they charged you (which is their profit).  But they take collateral because otherwise people will rip them off by taking their money, spending it, and then say "whoops, I can't pay it back.  Sorry!"

Is easy credit good for your Eastern European country?  Unambiguously yes.  If for any given person, taking credit is not useful, they won't take the credit, and will be no worse off than before.  If it is useful, then they will, and be better off than when there was no credit available.  Some people are better off, and some people are the same.  That sounds like a net improvement to me.

Foolish Jordan
Wednesday, September 10, 2003

I think there is a lot of very sensible comment here, especially from the UK folks.

It is very worrying here in the UK, levels of debt are going through the roof. While interest rates stay low and house prices are stable or keep going up it's probably ok.

BUT house prices increases are slowing (falling in London) and it's only a matter of time until interest rates are raised. Even a small raise will hit house prices and, more imporantly, increase the cost of borrowing which could be nasty for many.

The comments are capital spending are spot on. If you're borrowing in a way such that you can get a greater return than what you're paying then go for it. Borrowing to live a certain lifestyle is just crazy and some people are going to get in a right mess in next x years.

Yanwoo
Wednesday, September 10, 2003

Jordan, if you look around, I am sure there are people in US or wherever you live for whom credit is very bad.

A large percentage of people are probably not financially responsable.

For example, somebody may borrow a hell of a lot of money using their credit card, and ignore that they have to pay this afterward.

But, when that afterward inevitably comes, they find themselves burried in huge debt, and having to cap their spending drastically in order to pay that debt.

Max
Wednesday, September 10, 2003

Jordan,

Is this what happened in America during the 20s?

Ged Byrne
Wednesday, September 10, 2003

Ged (re: credit card debt) -

I have always thought that savings, not credit, was intended to smooth out cash flow.

If we pull from your example of £500 paid over 6 months with considerably more than that in the borrowers savings acct.

Note that a typical savings acct. in the US earns about 1% interest, and a typical credit card charges about 18% interest, than at the end of 6 months (assuming equal payments every month), a borrower would be about £25 poorer than if he paid directly out of savings and used the subsequent months 'payments' to replenish his savings.

I don't know about prices in the UK, but the equivalent US$ (50) could easily cover, say, dinner and a movie for two. I know that given the choice, the latter is much more appealing to me.

The really unfortunate people in this are the poor who have no savings, because the money they could save is going to the lending institution, and at higher rates (c. 24%). The credit card companies love these people.

Devil's Advocate
Wednesday, September 10, 2003

Read this article, "Alan Greenspan, please come home"

http://freedom.orlingrabbe.com/lfetimes/greenspan_home.htm

Jason Watts
Wednesday, September 10, 2003

"I don't know about prices in the UK, but the equivalent US$ (50) could easily cover, say, dinner and a movie for two."

Hmmm, that's roughly £30-£35 in sterling? 2 x movie tickets = £14, and if you didn't have any movie snacks (easily another £14) you might be able to find a low-end, all-you-can-eat buffet type restaurant that would provide two dinners and possibly a soft drink each for the £20 or so you have left.

Fernanda Stickpot
Wednesday, September 10, 2003

DA,

Unfortunately we humans aren't all that rational, which is where Jordan's argument falls down.

For myself, I'm not very good at saving.  So what I do is have a fixed amount leaving my account each month on payday, leaving me what I need to survive the month comfortably.

Those savings are sacred.  As soon as I start chipping at them they will all disappear.  I know this to be true because I know myself.  I've learnt the credit lesson the hard way.

So I use the Credit Card to aid cashflow.  It's a service I pay for, it is true, but I value the service highly enough so thats ok.

Ged Byrne
Wednesday, September 10, 2003

"...a typical credit card charges about 18% interest,"

Only if the person isu stupid  and doesn't shop around (or call the card company) or is a poor credit risk. The highest fixed rate card I have is 9% and I don't carry a balance on it, ever.

Calling the card issuer and talking to an account rep is the easiest way to reduce your rate - just point out that you've received info on cards with lower rates in the mail but would rather not change cards. Most reps can cut several % off your rate without getting further approvial.

Shopping around for the best rates is another method - you wouldn't take out a mortgage without comparing rates but a lot of people seem to do so for credit cards.

Bankrate.com has an excellent section on finding a better credit card at:
http://www.bankrate.com/brm/howdoi/howdoicc.asp?prodtype=cc

RocketJeff
Wednesday, September 10, 2003

Banks have made disastrous loan deciisons and will continue to do so for a simple reason. Banks need to lend money to stay in business. If a bank can't lend money it goes broke, bexause it's not earning anything ot pay its depositors.

So when there is a lot of money siwishing around the banks lend it out. Take the 1970's; western banks awash with petrodollars., so they decide to lend to Latin American governments - pretty safe governements and Latin America was the future; except of course that it the dictators in charge kept half the money in their private bank accounts, and after a few years the economies of the Latin American countries went belly up because they couldn't service the debt on loans a large proportion of which they had not received in the first place.

A few lbankruptcies and loan "renegotiations" later the banks had well and truly learned their lesson, and decided to avoid risky developing nations like the plague, so off they go to invest in nice safe European, Japanese and Western property. Surprise, surprise, surprise, they get the figures wrong, and there is a massive slump leaving the banks with foreclosure rights on loads of property they can't sell, and the UK, EU and Japan in a long recessio caused by negative equity.

so next time round manufacturing is safe, and all the money goes to the Asian tigers, whio roared and roared until the 1997 crash deflated them.

So back home, and back to the future in the form of the dot.com boom. After all if all the trusted creditors have let you down it makes sense to invest in something new you don't have the least idea about doesn't it!

All of this of course happened because banks, unlike us, do not have the alternative of putting the cash under the bed, or splurging it out on a holiday in Honolulu. They have to lend, like you have to breathe.

As to whether your economy will be hurt, it depends. Credit can vastly improve the human lot. The Bangladeshi economist, Mohammad Younus, sadi that the right to credit was a fundamental human right, and the success of his Grameen (village in Bengali) banking system in Bangladesh which lends unsecured money to villagers (normally women) to do such things as buy bamboo to make furnitiure for sale, or a mobile phone to rent out to other villagers, shows how far judicious use of credit can improve the human lot.

However loans that are basically used to fuel the import of consumer goods from outside the country, as happened in the UK in 1987, are likely to cause a massive depression within a couple of years.

The basic rule of economics is that speed is bad; slowly, slowly catchee monkee, or as the Catalans put it "mica a mica s'omple la pica" ("bit by bit the beak gets filled"). Many Eastern Europeans are only too aware of this, as the voodoo economics of that was foisted on them by Bush senior and his advisors, completely destroyed the old trading patterns but put nothing in their place.  They forgot  that the general prosperity that capitalism had bought to the West had taken forty or fifty years of exploitation before any improvement in the average persons life was seen.

Stephen Jones
Wednesday, September 10, 2003

I am not an economist but I dont see that credit can bring an economy to it knees by itself, the banks are clever and experienced enough to work out what people can afford and balance their risks carefully enough so that they are safe, some borrowers will bankrupt and default but the effects are contained and dont cause any serious problems (except to the  borrowers anyway)

The problem would come when other problems happen, such as a recession, in which many of those who could just about afford their repayments begin to default, causing the bankruptcy rate to increase rapidly sending shockwaves through the rest of the economy, as banks are crippled under the load of bad debt. This happened in the UK in the early 90's when a lot of people found themselves unable to make mortgage payments, the banks foreclosed and ended up with lots of property they couldn't sell and very little real money, leading to little lending and so little investment and a longer deeper recesion then it might otherwise have been.

Basically, debt is like whipped cream, a little can be pleasurable, but to much and you drown.

bil
Wednesday, September 10, 2003

DA,

>> I have always thought that savings, not credit, was intended to smooth out cash flow. <<

I don't have any personal savings. For tax reasons, all my money stays in my limited company, and I only withdraw enough to cover my regular outgoings. The personal tax that I don't pay is considerably more than the extra money spent on servicing my personal debt.

However, your general point is true. If I had savings, and had a savings cushion over and above any emergency need, then I would usually use the savings rather than taking a loan.

Mark

Mark Pearce
Wednesday, September 10, 2003

Ged -

I have never been a terribly impulsive spender, so this may not be good advice for someone who is. However, one thing that has helped me to organize my finances is using separate accounts.

When I finally saved up about a 6 months expenses cushion that I wanted to keep sacrosanct, I called up my bank and moved that money into a certificate of deposit. Not only is it earning slightly more interest, but I'd have to think long and hard about dipping into it.

I'll probably do the same when I start saving for a mortgage down payment.

That way, my basic savings account can smooth out my cash flow, and my credit cards are paid in full every month.

Devil's Advocate
Wednesday, September 10, 2003

(somewhat off topic) Mark Pearce, by keeping all you money in your LLC, aren't you exposing yourself to more risk? The purpose of a LLC is limited liability, but you've considerably expanded your liability what would be normally be protected personal assets in a corporation. If your corp gets sued, you may lose those assets. So your trading lower taxes for greater risk, correct?

I'm just curious.

Damien Katz
Wednesday, September 10, 2003

DA,

Thanks for the advice.  I think it might help.

Ged Byrne
Wednesday, September 10, 2003

DA, Ged..

I have a similar setup, not quite 6 months saved, but....

The emergency funds are located in GMAC Demand Notes
http://www.gmacfs.com/notes/demand/main.htm

Decent return, $1000 min dep, write checks (min $250) against it....

apw
Wednesday, September 10, 2003

http://www.moneyfiles.org/

P Liang
Wednesday, September 10, 2003

"If your corp gets sued, you may lose those assets."

Yes, but if he gets personally sued, he could also lose those assets if they were in a personal account.

I would assume he has some kind of corporate liability insurance to protect the company's assets to a good extent.  And he is sensible enough not to do the things that make lawsuits likely.  90% of the time when a company gets sued *and loses*, it's not the McDonald's spilled coffee type of incident ... it's something the company knowingly did but decided to weigh the profits vs. the potential of being sued, or something some rogue employees did without the knowledge or approval of the higher-ups (which would not happen in a one-man shop).

T. Norman
Thursday, September 11, 2003

Maybe the impending economic meltdown will be so huge that those of us foolish enough to not have taken huge amounts of debt to fund pleasurable pursuits will have missed a golden opportunity.

Imagine 40% of the middle class population not able to fund their debt levels, will these people end up on the street? In the gutter? Probably not, huge amounts of write-offs by the banks is a more likely scenario, leaving those poor, well travelled, well healed, debt ridden fat cats who have just enjoyed the best 10 years of their lives free to get on with a fresh beginning.

While the more prudent complain about how unfair it all is.

Realist
Thursday, September 11, 2003

---"it's not the McDonald's spilled coffee type of incident ... it's something the company knowingly did but decided to weigh the profits vs. the potential of being sued"-----

But in the spilled coffee incident that was precisely what MacDonald's was doing. They were balancing the costs of damges for people serioulsy burnt by the coffee, compared to the losses they would suffer if it wasn't so hot. That was the reason for the punitive damages.

Stephen Jones
Thursday, September 11, 2003

Realist,

Thats an interesting scenario.  Has such a thing ever happened, historically?

Ged Byrne
Thursday, September 11, 2003

Ged,
        How many people actually got thrown out of thieir homes after the 1988 crash? There were plenty who just handed in the keys, and the bulding societies or banks were frantically trying to dissuade them and threateing to sue for the difference, which of course they didn't.

      My brothet has written of vast amounts of credit card debt (I on the other hand have never had a credit card and have bought everytihing cash for the last twenty-five years). On one occasion he went to his best mate, who was a solicitor, and told him he was going to have to declare himself bankrupt. The solictori's comment was "F....., you can't declare yourself bankrupt. You don't have enough money!"

      On another occasion he bought a second hand Triumph TR7. The condition of the car was misrepresented to him, and so he informed the credit company through his solicitor that he was holding up payment until the matter was solved, and either the car's deficiencies were fixed or the loan was renegotiated. This never happened (probably because the loan was so small that the finance company couldn't be bothered to treat it specially), and so my brother witheld all payments on the car for about three years until he sold it.

          About six years later, a little worried still about the outstanding debt, he asked his solicitor friend about the state of negotiations. The original finance company had gone bankrupt and passed the loan on to another company, which in its turn had offloeaded it to another company, which itself was in the hands of the receivers. My brother never had to make more than the initial first month's payment on the car (it was a no depositi loan).

Stephen Jones
Thursday, September 11, 2003

"How many people actually got thrown out of thieir homes after the 1988 crash? There were plenty who just handed in the keys"

You can hand in the keys, but that doesn't absolve you from repaying the mortgage, as many of them were surprised to discover.

Fernanda Stickpot
Thursday, September 11, 2003

Damien,

As T Norman states, I have liability insurance for my company and its (currently 6) employees to cover professional negligence and several other work-related issues.

To be frank, the UK is not nearly as litigious as the US. But as I intend to launch a new product in the US soon, I'll need to investigate the associated US corporate structure and the financial implications.

Mark

Mark Pearce
Thursday, September 11, 2003

---"Americans have kidney stones bigger than the British Isles."---

They tried, but I doubt if even 0.5% ever paid anytihing.

Stephen Jones
Thursday, September 11, 2003

---"You can hand in the keys, but that doesn't absolve you from repaying the mortgage, as many of them were surprised to discover. "---


They tried, biut I doubt if even 0.5% paid anything.


(Whoops, wrong quote in the message above! this was the right one)

Stephen Jones
Thursday, September 11, 2003

>"The private control of credit is the modern form of >slavery."
>-Upton Sinclair

+

>The Bangladeshi economist, Mohammad Younus, sadi that >the right to credit was a fundamental human right,

=

Knowledge Maker
Thursday, September 11, 2003

*  Recent Topics

*  Fog Creek Home