Posts tagged ‘interest rates’

## Restricting Credit to the Unsophisticated -- And Are You Really Any Better?

After years of arguing that expanded credit is critical for the poor, and attacking banks for "red-lining" poor and minority districts, the liberal-left of this country has reversed directions, and has decided that the poor can't handle credit.

No matter how much folks want to paint the recent mortgage problem as some sort of fraud perptrated on homeowners, the fact of the matter is that in large part, lenders lowered their income standards and a lot of those folks now can't pay.  While we have yet to see any specific legislation beyond bailouts, it is impossible for me to imagine any reaction-regulation that does not have the consequence (intended or not) of restricting credit to the poor.

But these restrictions are not limited to the housing market.  Many states, for example, are cracking down and even outright banning payday loan companies, often the last resort (legal) credit source before people turn to the loansharks.  First in Ohio (via Mises Blog)

If Ohio's 1,600 payday-lending stores want to continue operating past this fall, it
appears they will have to find something else to offer besides payday loans.

A hotly debated bill that effectively would spell the end of the short-term,
high-interest payday-lending industry in Ohio sailed through the Ohio Senate yesterday despite
pleas from lenders that their stores would close and 6,000 employees would be put out of work.

The Senate was unable to find a compromise that both satisfied payday lenders and
eliminated the debt trap that bill supporters said forced too many borrowers to take out new loans
to pay for old ones. So it did what the House did last month: dropped the hammer.

"I think everybody said there is just no way to redeem this product. It's
fundamentally flawed," Bill Faith, a leader of the Ohio Coalition for Responsible Lending, said of
the twoweek loans. The industry "drew a line in the sand, and the legislature kicked the line aside
and said we're done with this toxic product."

And perhaps soon in Arizona.  Yes, the interest rates are astonishing, though the dollars involved are seldom huge for the short life and small size of the loan.  And, as an extra added bonus, Tony Soprano does not send someone to break your legs if you don't pay (the Sopranos being the only alternative provider once payday loan companies are illegal).

So, for those of you oppose payday loans, you are welcome to comment below about what a bad idea they are.  However, I challenge folks to criticize payday loans without simultaneously implicitly expressing disdain for the intelligence of payday loan customers, or trumpeting your ability to make better decisions for payday loan customers than they can make for themselves.

However, for those who think they are ever so much smarter than payday loan customers, who are charged a lot of money for small liquidity boosts, consider this:  Let's say you take out $40 each week from an ATM to keep you liquid and that the ATM fee is$1.50.  You are therefore spending $1.50 or 3.75% for a one week liquidity boost of$40, which you must again refresh next week.  Annualized, you are effectively paying 195% to get liquid with your own money.  For this kind of vig, at least payday loan customers are getting the use of someone else's money.

## More on the Teens as the New Seventies

For a while, I have been worried that the next decade may well be a return to 1970's economics, with bipartisan commitment to large government, ever-expanding government micro-management of... everything, growth-destroying taxes, and consumer-unfriendly protection of dead US industries.

Now, Megan McArdle points to an article that hints that the stagflation of the 1970's may be back as well.

Inflation and sluggish growth haven't joined in that ugly brew called
stagflation since the 1970s. They may not be ready for a reunion, but
they are making simultaneous threats to the economy and battling one
might only encourage the other.

Among a batch of economic readings today, the Labor Department
reported that import prices jumped 1.7% last month. The data included
troubling signs that consumer products, many imported from China, have
caught the inflation bug. The signs pointing to slowing growth included
a sharp deterioration in consumers' mood, as measured by the
Reuters/University of Michigan Surveys of Consumers, and a worsening
outlook for manufacturers, revealed in the Federal Reserve Bank of New
York's Empire State Manufacturing survey for February. The government
also reported that U.S. industrial production only increased slightly
during January, as colder weather elevated utilities output and offset
sharp declines in the auto and housing sectors. If indeed inflation is
teaming up with slower growth, it means big headaches for policy
makers, in particular Ben Bernanke. The Federal Reserve chief in
congressional testimony yesterday suggested that he is willing to keep
lowering interest-rates if the economy stalls. But, naturally, he will
have less room to do so if those lower rates would accelerate inflation
to unacceptable levels.

## Not a Bailout?

I was watching CNBC over lunch and saw that Alan Greenspan has criticized the President's plan for freezing the interest rates on some adjustable rate loans.  He argued, and I agree, that it is bad to mess with contracts and markets, and bad to stand in the way of a real estate bubble that needs to correct.  He said that if the government feels sorry for certain mortgage holders, it should give them cash.

I am not too excited about giving away cash to people who made bad financing decisions, particularly since I have successfully weathered a couple of tough years in my business brought about in part by rising rates on our businesses adjustable rate loans.  However, I am very much a supporter of being as open and up-front as one can be in government taxing or spending.  For example, I prefer direct payments to farmers rather than price supports.  I prefer a carbon tax to CAFE-type mandates.  In both cases, while both alternatives probably cost the economy about the same in total, the cost-benefit tradeoff is more clear in the first alternative.  Which is why, predictably, politicians usually prefer the second alternative.

All of this pops into my head because apparently the President's reaction was that he preferred his plan to a "bailout."  Huh?  How is his plan any more or less a bailout, except that the exact costs are more hidden and who pays the costs are more obscure.  The only real difference is that Greenspan's approach is probably less likely to set bad precedents for the future or to make mortgages more expensive for the rest of us, which the President's plan almost certainly will.

## Happy Birthday Leonhard Euler

Yesterday was apparently the 300th birthday of Leonhard Euler, one of the greatest mathematicians of all time and perhaps the greatest that the average layman has never heard of.

Euler is responsible for so much that is still important to modern mathematics it is hard to pin down his greatest achievement, but most will point to his famous equation that was sort of the unified field theory of mathematics, describing a relationship between all five of math's most important numbers:

$e^{i \pi} + 1 = 0, \,\!$
I learned something the other day that might be interesting to you business and finance folks out there -- the constant "e" was first described by Jacob Bernoulli when he was studying compound interest rates.

Jacob Bernoulli discovered this constant by studying a question about compound interest.

One simple example is an account that starts with $1.00 and pays 100% interest per year. If the interest is credited once, at the end of the year, the value is$2.00; but if the interest is computed and added
twice in the year, the $1 is multiplied by 1.5 twice, yielding$1.00Ã—1.52 = $2.25. Compounding quarterly yields$1.00Ã—1.254 = $2.4414"¦, and compounding monthly yields$1.00Ã—(1.0833"¦)12 = $2.613035"¦. Bernoulli noticed that this sequence approaches a limit for more and smaller compounding intervals. Compounding weekly yields$2.692597"¦,
while compounding daily yields $2.714567"¦, just two cents more. Using n as the number of compounding intervals, with interest of 1/n in each interval, the limit for large n is the number that came to be known as e; with continuous compounding, the account value will reach$2.7182818"¦. More generally, an account that starts at $1, and yields$(1+R) at simple interest, will yield $"‰eR with continuous compounding. In the 20th century, we have gotten in a mind set that math is this strange discipline that lives purely out in the theoretical either. But we forget that a lot of modern math was invented to solve real-world problems. Newton invented calculus (yeah, I know, I haven't forgotten Liebnitz) to solve planetary motion problems, and it turns out "e" was invented to work with interest rates. ## Why the Health Care Issue is Different I was sitting here today, and was trying to discern why the government-run health care issue made me more nervous than other government welfare programs. I get ticked off, for example, about the horrendous rates of return (think negative interest rates) paid out by Social Security on what are nominally our retirement account premiums. But I don't get nervous. Why? I think because unlike other welfare proposals that [just] cost us a ridiculous amount of money, the current plans for providing universal health care imply that my personal health care and health care options will get much worse. When government provided housing, my housing did not get worse. When government provided a ripoff retirement plan, my personal non-government retirement savings did not take a hit. In all these cases, we paid out tons of money to provide some terrible base-level services for the poor and the true-government-believers in the middle class, but my options did not get worse. However, in the case of health care, most proposals on the table will very likely result not only in much higher taxes, but also in my personal health care options getting worse. The government will not want to provide multiple levels of service, and can't afford anything beyond "crappy", so as a result we will all end up with crappy service (Insert Rush song "trees" here). A lot of crap is written about how great all these other socialized medicine services are, but thousands of people travel from other countries to have medical procedures in the states, and about zero travel the other way. More on the topic of closing coverage gaps at the price of making your own personal care worse here. More on why these gaps are not as large as advertised here. Update: Quick proof -- My chosen health plan is now illegal in Massachussetts ## Finally, Someone States the Obvious The media and many politicians have an inventive system that drives them to take the most pessimistic possible interpretation of every economic event (the media to sell papers, politicians to panic us into giving them more control of the economy). Chinese ownership of US debt securities is one such issue that everyone seems to be in a tizzy about. Thanks to Don Boudreaux for finally stating the obvious: In fact, foreign-government holdings of U.S. debt arguably make these governments "hostage to the economic decisions being made in Washington." The Fed, after all, could monetize this debt, inflating away its value. Or Uncle Sam could repudiate this debt, or unilaterally change its terms in ways unfavorable to holders. Or you and your colleagues could implement economically disastrous policies that drive up long-term interest rates and, hence, drive down the value of outstanding treasuries. Finally! All you have to do to understand this is reverse the situation. If the US government owned a hundred billion dollars of Venezuelan government bonds, would this really give us power over Hugo Chavez? Or would it, more likely, given him more power over us, at least in terms of circumscribing our actions? ## That Light May Be a Train "It would be difficult to characterize the position of home builders as other than in a hard landing," says Robert Toll, chief executive of luxury home builder Toll Brothers Inc., which reported yesterday that net income fell 19% in the third quarter ended July 31. (See related article.) In his 40 years as a home builder, Mr. Toll says, he has never seen a slump unfold like the current one. "I've never seen a downturn in housing without a downturn in employment or... some macroeconomic nasty condition that took housing down along with other elements of the economy," he says. "This time, you've got low unemployment, you've got job creation, you've got a stable stock market and relatively low interest rates."... In much of the country, property markets began cooling rapidly in the second half of last year. Home builders were still turning out houses at a rapid clip, and the surge of new and previously occupied homes on the market convinced buyers there was no need to hurry. Over the past year, the number of previously occupied homes listed for sale nationwide has risen nearly 40%. In some metropolitan areas, including Orlando and Phoenix, the supply has quadrupled. I never got that excited about the run-up in the price of my home, so I won't worry too much if it falls again. For the average homeowner, the paper-price run-up of housing prices doesn't really have much meaning unless they are considering moving soon to a lower-home-price area or they are going to retire and downsize. My house supposedly doubled in value in the last four years. We went out shopping for a home in the area, and you know what? All the other prices doubled too. I could trade my current house for about the same house I could trade it for four years ago. The only really beneficial effect was that the increase in home equity made for useful collateral in a business loan I took out. Of course, the home speculators may take a bath - there are several latecomers to the speculation / spec home business in my neighborhood who are holding houses that won't sell for the huge prices they are asking. I posted that this was coming over a year ago, using a model for contrarian investing I learned at the Harvard Business School: Do the opposite of what doctors and dentists are doing. ## Thanks, China! In yesterday's Wall Street Journal, Lawrence Lindsey wrote about the Chinese government's policy of not allowing the value of the yuan to rise against that of the dollar: America, however, benefits from this arrangement. The Chinese clearly undervalue their exchange rate. This means American consumers are able to buy goods at an artificially low price, making them winners. In order to maintain this arrangement, the People's Bank of China must buy excess dollars, and has accumulated nearly$1 trillion of reserves.
Since it has no domestic use for them, it turns around and lends them
back to America in our Treasury, corporate and housing loan markets.
This means that both Treasury borrowing costs and mortgage interest
rates are lower than they otherwise would be. American homeowners and
taxpayers are winners as a result.

The Chinese are holding on to a Trillion dollars in US currency, with the main effect of subsidizing lower prices and interest rates for US consumers.  What a deal!  (I took a more tongue-in-cheek approach to the same issue here)  I know most commentators instead want to focus on the threat of China suddenly dumping those dollars, disrupting US markets.  People need to understand that the cost of doing the latter is enormous for China, not only in lost value of their dollar-denominated assets but in lost exports as the value of the Yuan would spike.  To test the hypothesis of holding dollars as a strategic weapon, would you feel more secure in the US if the government held a trillion dollars of yuan?  Why?  I would in fact feel more vulnerable to China, dependent on the health of their economy.  I personally am a big believer that Chinese investments in the US are great, and will act as a stabilizing influence in the future.

By the way, while the above refers the Chinese government holdings of US financial assets, Cafe Hayek also points to an article by John Makin of the AEI who observes that the trade deficit is a misnomer, as the US is providing services that are not counted, specifically wealth-protection services:

In summary, Makin argues that one of the reasons foreigners sell so
many goods and services to Americans and then consistently refrain from
buying an equivalent amount (in value terms) of goods and services from
Americans is that foreigners have a high demand for "wealth-storage"
services supplied by dollar-denominated assets.

The fact that global savers accommodate U.S.
consumers by keeping U.S. interest rates lower than they otherwise
would be and the dollar stronger than it otherwise would be is simply a
manifestation of America's comparative advantage at supplying wealth
storage facilities.

In
other words, there's no real imbalance.  If the services supplied by
"wealth-storage facilities" were counted in international commercial
accounts as "services," then the U.S. current-account would not be in
deficit.

I have written before about why we should not fear the trade deficit with China, and why the word "deficit" is itself a misnomer, here and here.

## Rates are Too High -- So Lets Limit Competition

Apparently, some of our local politicians in the Phoenix area are upset about payday loan companies.  According the an AP report in the AZ Republic:

The stores cater to customers who live paycheck to paycheck who need
quick access to a few hundred dollars for rent, car repairs or just to
make ends meet. Banks traditionally don't make those type of small,
short-term loans.

So these stores provide loans to people no one else will touch.  And customers use their services of their own free will.  So what is the problem?  Well, not surprisingly, the rates on these loans are high, and the default terms tend to be drastic.  "Activists" think that people are making the wrong decision using these services, and, to be fair, I would certainly advise anyone who asked to try to find another alternative.  But what do my preferences matter?  Its easy for me to say in my middle-upper class hubris that such services don't make sense, but I have a steady job and ready access to bank loans.  In a free society, both I and those activists are free to convince people to not use these services, but its wrong to artificially limit people's choices out of some elitist sense that we can make decisions for other people better than they can for themselves.

Besides, lets think about the alternative.  These folks are not going to get bank loans -- in fact many customers may be illegal aliens who are, post 9/11, effectively barred from the banking system.  The only other alternative before these payday loan companies were loan sharks, whose interest is even higher and whose penalty for non-payment even more dire. This reminds me of the people who decry Nike "sweatshop" jobs in poor countries.  "Activists" similarly decry these jobs as if the alternative is \$25 an hour office work, when in fact the alternative is actually grinding subsistence agricultural work for half the pay.  You may not like the payday loan companies, but they are replacing a much worse system.

Arizona now has more than 600 payday loan stores - with 165 in the [Phoenix suburb] Mesa area alone - and some residents are upset about it.

"People are sick of it in west Mesa," said Dave Richins, a neighborhood
activist and executive director of the West Mesa Community Development
Corporation.

Richins and other critics claim the stores exploit customers with high interest rates.

[Phoenix suburb] Peoria blocks the shops from opening within 1,000 feet of a competing
store. Phoenix and Tucson are looking to that city's restrictions as a
model for new rules in their communities, with action possible by early
next year.

Gee, I bet that will help keep rates down -- make sure there are no competitors nearby!  Lets make sure it is as hard as possible to compare rates, particularly since the customer base is one that can't afford the gas, or doesn't even have a car, to drive all over town shopping.  I wonder why no one is suggesting the same thing for gas stations to keep gas prices down, lol.