Should consumer credit be reined in?

[belinda]

.
On the day when UK banks are expected to anounce good profits, how about considering the future and NOT raking over the reasons for the recession?

"There is no means of avoiding a total collapse of a boom brought about by credit expansion.
The alternative is only whether the crisis should come sooner as a result of abandonment of further credit expansion, or later as a final catastrophe of the currency system involved"

My question is:

Should banks only lend money that they have already in hand instead of gambling on the ability of the borrower to repay from future wealth acquisition?

i partly take this proposal from:

http://www.bankofenglandact.co.uk/

put forward by

a group of economists, lawyers, engineers, former civil servants, university academics and business people who have realised that the root of the instability in the world economy, and huge burden of debt in every country, is due to the fundamental design of the banking system.

and, not knowing enough about economics to assess the proposal, i cheekily rely on the interest of posters in the question to read the background document.

Your views and knowledge will be appreciated.

.

[Krebby2001]

I'm a business prof, so I'll answer from that perspective. Anytime that your bills stack up to paying the minimum on your credit cards, along with paying your utility bills and other "mandatory" payments, you're in deep doo doo. It will take an eternity to pay off your credit cards, and you will pay an enormous price.

What is a "manageable" credit balance? At the basic level, when you have a surplus of funds left over from your pay-check, after all bills are paid. It's not rocket science. First, sock away as much as you can manage into retirement accounts. Take advantage of this, especially if your employer "kicks in" for whatever you contribute to retirement. An ideal is to maximize your matching fund potential. Yeah, it means that you'll be receiving less every month. But, you'll be confident in your knowledge that the money will be there for you when you retire. Six percent, that's all it takes. With matching funds, that will be twelve percent added to your retirement, in most cases.

In terms of savings accounts, you should have enough to tie you over for a year (most financial analysts will even suggest two years' worth of savings). Set aside five percent of your earnings to AUTOMATICALLY go into your savings account. Hold your nose and automatically deduct this amount from your earnings, and pretend that it's not there after that. If your debt obligations will not allow that, realize that this is a problem. Rationalize that by saying, "This is a temporary situation -- I'll get to the point where I can automatically deduct this amount in the future -- and make it happen. How do you make it happen? By taking a real objective look at where your money is going. Do you REALLY need to spend money on eating out to be happy?

If you maximize your retirement accounts, and then work A LITTLE BIT toward creating "rainy day" savings, you'll be OK. If you can't do this, it's not the end of the earth, it's something to work for.

Hold off on cashing in on your retirement accounts, as difficult as it might be, until you're at least 59 1/2. Otherwise, your withdrawal of retirement will be seriously affected.

Ultimately, the hardest realization for most folks is to realize that possessing the latest "Crackberry" is not what defines them. I have a cell phone that I purchased in 2006. It doesn't define me. I joke about the fact that I have to "crank the handle" on it and say, "Mabel, give me PA 90230." My Hickey Freeman suit is a better investment.

A new car? A new car loses more than 20 percent of its value as soon as you drive it out of the dealer's lot. I have 3 of them, the latest, a car that I purchased at $24,000, with an original MSP of $46,000. Less than 20,000 miles on it when I bought it. Where did the equity go? The loss in equity was sustained by the original buyer. His loss, my gain.

Be a smart shopper.

So, in answer to the question of whether consumer credit should be reigned in, my answer is, "No!" The ultimate responsibility of discerning whether one can "make good" on credit should reside in the consumer, not the regulator. Alas, when the consumer is too tied up with vanity and "keeping up with the Joneses," it's up to the creditors to decide. Our loss, not theirs.

[belinda]

So, in answer to the question of whether consumer credit should be reigned in, my answer is, "No!" The ultimate responsibility of discerning whether one can "make good" on credit should reside in the consumer, not the regulator. Alas, when the consumer is too tied up with vanity and "keeping up with the Joneses," it's up to the creditors to decide. Our loss, not theirs.

UK banks and building societies wrote off £10.9bn of loans to individuals in the
last 12 months to end Q2 2010. In Q2 2010 they wrote off £3.47bn (£2.14bn of that was
credit card debt). This amounts to a write-off of £38.06m a day.
Total UK personal debt at the end of July 2010 stood at £1,456bn. The twelve-month
growth remained at 0.8%. Individuals owe more than what the whole country
produces in a year.

Average household debt in the UK is ~ £8,628 (excluding mortgages). This figure
increases to £18,000 if the average is based on the number of households who actually
have some form of unsecured loan.

Source: Credit Action

http://www.creditaction.org.uk/assets/P ... r-2010.pdf

As i said, i am not an economist. But if a bank writes off that much debt, then a) someone somewhere is getting something for nothing (!) and b) those who do pay their bills are subsidising those who cannot repay, because the banks aren't going to "make a loss", are they?

If the banks could only lend money they had in reserve, and took the loss on their profits, not in increasing costs of borrowing, would they not make "better" decisions about who they lent money to? And if they could only lend money they already had, and preserved deposited money, would there be a need for the government to step in if there was a "run on the bank"? Would it diminish the likelihood of a run on the bank?

i think the question i am really trying to find the answer to is - does the economy need a personal, unsecured credit system in order to work?

.

[Jo van]

UK banks and building societies wrote off £10.9bn of loans to individuals in the
last 12 months to end Q2 2010. In Q2 2010 they wrote off £3.47bn (£2.14bn of that was
credit card debt). This amounts to a write-off of £38.06m a day.
Total UK personal debt at the end of July 2010 stood at £1,456bn. The twelve-month
growth remained at 0.8%. Individuals owe more than what the whole country
produces in a year.

But if a bank writes off that much debt, then a) someone somewhere is getting something for nothing (!) and b) those who do pay their bills are subsidising those who cannot repay, because the banks aren't going to "make a loss", are they?

Speaking as someone who had a bank "write off" a "debt" for over £100K, which I had never recieved a penny of, I can imagine there would be others in similar situations.
The one that springs to mind immediately, is "Forced sales" and "repossessions".
I wonder what proportion of those write-offs, in a falling house-price market, are due to overvaluation of "assets", and "negative equity" situations....?

But I take your point, and have said similar things.

The bit I find amazing, is that you seldom hear mentioned, the "Quantitative Easing", where the BoE basically printed an extra £200 billion(?), and gave it to the banks for nothing.

[MahoganyRush]

Ive read that article and as usual it written by people who have no clue about money
what they are proposing is as silly as McDonalds restaurant serving Diet cola products

Should consumer credit be reined in?? absolutely not, the problem isn't the banks and the system, its the people borrowing money
is a major part of the problem.

Do you blame the alcohol for being people being alcoholics? The problem is the majority of the consumers are dependent on credit, no wealthy person in either countries UK or the North America ( including Canada) has a problem with credit, its the people who are credit dependent is the problem, its fine and dandy to blame the banks, but some people are hypocrites, they want to tear down the bank for their " lending criteria" but are the first in line to get the multiple credit cards and none of the banks are forcing you to shopping and spend spend spend by using credit.

Take a quick survey ,find 10 people who are whining about the financial state they are in, you will find a common denominator , the majority of them are credit dependent, the wealthy ones like I mentioned earlier isnt, as soon as i hear people say, oh my credit cards interest is too high, right there tells me, they carry a balance every month, and/or make unnecessary purchases

Its like the politicians who say " we should run the government like a corporation/business' that tells me they have no clue what they are doing? you cannot run a government like a corporation, a corporation or business sole purpose is to make money/profit, you shouldn't run the government that way, this is why we have all this unnecessary spending, high taxes etc.

Maybe if the average consumer takes a financing course instead sitting home watching American Idol ( im not sure if there is a British Idol) and understand money a bit more this would eliminate some of the problems in the financial sector.

[Krebby2001]

Ah, yeah, now I understand the question better -- thanks -- my mistake.

Yes, Consumer Credit should be reined in on the basis of better vetting of good borrowers from bad. In the U.S., the banks were driven by showing increases in their short term (quarterly) numbers rather than on longer term sustainability.

Case in point, the nefarious mortgage brokers and lending banks. They were dishing out money to buy $200,000 to folks on $20,000 salaries. In the case of NINJA loans, they were even lending to folks with no jobs. Reason? Lenders were not required to service the loans -- they took their commission and sold the loan papers to other institutions. Sub-prime loans were eventually bundled as CDOs (Collateralized Debt Obligations), labeled as AAA (good) securities and sold OTC (Over the Counter), out of scrutiny of the SEC. In the case of the credit card industry, instead of denying credit to customers, they stuck outrageous interest rates on the credit.

So, who's at fault here? I feel like it was both the consumer and the banking industry's fault. Those wanting to keep up with the joneses and banks too interested in generating short term profit and, in essence, knowing that a day of reckoning would come, but hoping that it would be later rather than sooner.

So, from the point of view of responsible customers -- they should not have to pay for the indiscretions of others. From the point of view of taxpayers who chucked over a $700 Billion Bailout -- better vetting of good from bad customers is certainly needed, but also needed is to more closely scrutinize and reign in, the nefarious practices of the Banking and Mortgage industry. This is not as difficult as it might sound, as much of the regulation is already there -- it's just that some have created loopholes (see Enron Loophole) and "work arounds" the regulation.

[MahoganyRush]

Krebby, I see where you're going and some of the things you said I dont agree, I take it you live in the US of A, and you bring up a good point on Credit default swaps and CDO's , but it boils down to the consumer, nobody put a gun to any of the consumer's head to sign up for any sub prime mortgages, most of these people gambled and they lost.

Who is the blame?? everyone is to blame, not certain mortgage brokers and lenders, President Clinton was the one who forced the issue about every American should own a house, without realizing that not every one should or is capable of owning a house. Country wide and all the other mortgages companies just jumped on board.

The Feds applying the pressure on Fannie Mae, and Freddie mac to buy loans from certain financial institution, and shareholders forcing institution to increase the bottom line so that their shares in those institution will increase??

Obama can shout from the mountain all he wants, he can limit the salaries of executives on Wall Street that took the bail out money, ( which I thought was a stupid plan in the first place) he can add all the regulations he wants, but until he regulates the Rating agencies, get the hedge funds managers/companies out of the stock market, all he has done is put a band aid on a shark bite.

This is why Im glad the Canadian Government had these rules in places, none of our banks set up any special purpose entities or sold off loans to secondary markets,( not included MBS) We didnt have a subprime mortgage crises and only one of our 5 big banks was involved in Credit Default Swaps, CDO's but it was only a small percentage.

[Krebby2001]

Mohogany,
Yep, I'm based in the Southwest, USA.

Actually I think we're in general agreement, except in the area of regulatory reform My take is that you can't truly separate the "Jones" mentality on the basis of customer/private sector. The "Jones" mentality is very prevalent in the private sector as well. I'll not mention Barnie Madoff

Here's a pattern that I see operating in various sectors of industry: Limited scope projects adopted by the private sector and then exponentially grown for short term profits. Three examples:

Government "privatized" the handling of handling certain insurance claims (I believe that it was in the area of disability claims). One proviso was that they would be paid more on the basis of "claims rejected." Well, you can imagine what happened. When the court system finally put a stop to it all, because an immense number of rejected claims were, in fact, legitimate, numerous citizens had been seriously hurt.

Government "privatized" the giving out of cell phones to the needy. This sounds like an exorbitent give-away, but it's actually cheaper to do this than it is to send fire rescue/EMT/police equipment out after the problem has gotten serious. The private sector was charged with identifying and servicing the dispersion process. Well, again, you can imagine what happened. Cell phones were being given away like plastic bags at Wal Mart -- the more cell phones went out, the more $$ for the company.

Freddie and Fannie, again, started out as a limited scope project -- to help those in blighted neighborhoods and in agriculture. As history reveals, when the project was grown by allowing more participation on the part of the private sector -- out come the NINJA loans, CDOs, CDSs, etc. Make money quick, load the subprime loans off on someone else, keep the commissions.

Of course, it takes two to tango. Who were these folks who flocked to buy houses that they could not afford, trips to Disney Land on credit cards, folks on $20,000 income dishing out for $20,000 weddings (and often winding up divorced a few years later). So, there is certainly enough blame to go around for both consumers, the private sector, AND government. For example, the Enron loophole was championed by Mr. And Mrs. Cheney (who worked at one of the regulatory agencies). It placed CDOs outside of the regulatory scope of the SEC, by housing it in the OTC market, where this is light regulation. And, who was it that allowed CDS to operate outside of the insurance industry, and its regulations? Basically, because it was not so regulated, no reserves were mandatory, in the case that the CDOs went downhill. Insurance companies are required to have expected "pay-out" reserves. Not so for CDSs.

Reform need not be expensive or time consuming. As you point out, other countries have already done much of the work to plug up regulatory/bad behavior holes. The US need not reinvent the wheel. Had we had some of those in place, the BP fiasco might have been avoided, or at least the damage would have been minimized. Had we had those regulations in place -- again, damage avoided or minimized.

I don't like my 30 something percent in taxes being used to make up for folks who got in a hole by being irresponsible (any more than you do). Some of this, as I've stated before, can be avoided by more effective vtting of the credit-worthy. Recent history reflects that the private sector was, however, being incentivized to do the opposite.

[MahoganyRush]

Krebby, I agree with the vetting of "responsible consumers" but with the left wing whining about " rights" blah blah blah
I will tell you a story, Back In I would say 1999 or maybe 2000, im not sure, Our banks had a program for Doctors, engineers and certain white collar professions that graduated from what ever university they attended, it was a 100% percent financing, all they had to do was come up with the closing cost, the criteria being, they had to have a 700 FICO score, and earn or potentially earn over $60K per annum, well the politicians ( the NDP in particular) a bunch of socialist thought, that wasn't fair, that it should be open to anyone that earned over 60K, and hence the beginning of the 100% financing for any one who earns over 60K

Skip ahead to 2008, after the market crash, the biggest default the banks in Canada had was the 100% financing, and they end up scrapping that program after april 19, 2010
And as you said it earlier, certain mortgage brokers and lenders was the cause, but they are not the only ones to blame, we learned up here, and now we have a better Vetting system.

Maybe thats whats need down in the US of A.

[cyst & deceased]

I don't like my 30 something percent in taxes being used to make up for folks who got in a hole by being irresponsible (any more than you do). Some of this, as I've stated before, can be avoided by more effective vtting of the credit-worthy. Recent history reflects that the private sector was, however, being incentivized to do the opposite.

Krebbster, don't forget to add sales tax, property tax, and excise taxes to that figure. Ha!