Haywood Jablommi wrote:
That is a good point. And now we are seeing the fallout of living beyond our means for so long. It is a totally unsustainable economic system that we have in America.
It is fashionable right now to decry the recent use of credit in the US right now, but lets not throw the baby out with the bath water. There IS a happy medium between living beyond one's means and living a completely pay as you go existence. Not ALL people who use credit use credit irresponsibly.
For example, I bought my house with a 20% down payment and a 30yr FIXED rate mortgage. I was able to do this because I only bought a house whose monthly payments I could AFFORD (roughly equivalent to what HAD been paying for rent). It would have been hard if not impossible for me to have made that purchase at that time if I couldn't have borrowed the bulk of the cost of the house. Since then I haven't been late on a single payment and have 75% equity in my house. Similarly, my current car was purchased with a dealer financed 1%APR 3yr loan. Again, I didn't purchase more car than the payments I could afford, never missed a payment and today the loan is paid in full. If I couldn't have borrowed, I would either have had to buy an even more modest car or used money that I had in investments that were returning much more than 1%/yr at the time.
In fact, whenever you can gain more benefit/return (adjusted for risk) from something than what it costs you to purchase/invest in it, it pays to make that purchase/investment. This is what is known as "leveraging". The problem in the US with many, but not ALL, people is NOT credit ITSELF but how they USED it.
1) Buying more than you can even afford to make payments on, or barely afford to make payments on (in which case any interruption or drop in income puts you at incredible risk.
2) Making payments barely affordable by borrowing on an adjustable rate loan and not really worrying about what happens when those initial low teaser rates balloon.
3) Relying on housing prices ALWAYS going up forever and ever, as the thing that could bail them out if it turned out they could no longer make their payments.
4) Borrowing for things that you don't really need or offer any real return or savings, e.g. power boats and other "toys", expensive vacations, etc. as opposed to necessities such as modest roof over your head, a sensible vehicle that you need to get to work, essential home appliances, etc.
5) Carrying balances on high interest credit cards because of making unessential purchases, rather than paying them off every month.
Durable goods like housing, cars, refrigerators, etc. have a useful life greater than just one financial period. Buying on credit enables the consumer to match his expenses with benefits of those purchases. It also enables merchants to sell items that they wouldn't otherwise be able to find many customers who could afford to pay the full price outright. Charging SOME level of interest is perfectly understandable for 3 reasons: 1) to cover expected inflation, 2) to cover risk of default by the borrower and 3) to cover a REASONABLE profit for the lending institution. Some merchants will even absorb all or part of the interest as one of their incentives to customers. That is no different really than offering any upfront discount to cash buyers. Some buyers are not particularly creditworthy, in which case a higher interest rates are justified to protect the lenders against losses from those borrowers who default.
So the basic concept and theory of benefits of consumer lending are still very sound. The PROBLEM is with how some (or many) people involved in consumer lending in the US went too far (okay, crazy). And that applies to BOTH the borrowers AND the foolish lenders who in many cases pushed credit on people that they knew, or should have known, shouldn't have gotten it. If you have a FICO score over 700, you SHOULD be getting a lot of CC offers in the mail, but the CC companies were pushing cards on people barely out of bankruptcy or with no credit history at all. And we all know about "liar loans" where both lender and borrowers were complicit in taking out loans that they did not really qualify for, no money down loans or even 110-20% home loans which did not consider the possible, or in fact inevitable, drop in overly inflated home prices. In most cases in the US, the problem was not that interest rates were too high or usurious, but that they weren't high ENOUGH. If they were made as high as they should have been for the least creditworthy or the already overextended, those who really couldn't afford what they were borrowing money for probably wouldn't have taken the loan or made the purchase and we wouldn't have seen as many defaults AND the lenders would have made enough on such loans to cover whatever defaults they still would have had. Instead, people who never should have gotten the loans that they did defaulted, the banks that made the loans (or wound up with them) got stuck with losses and now the banks are trying to recoup by sticking EVERYONE with higher rates and fees.
We're talking about an entirely DIFFERENT problem with the nature of loans to Ticos (and poor people in the US). The question is not one of interest rates being too low for the level of risk involved but whether they are too high. In the US, Rent-a-centers were an example that was already given. Pawn shops are another. Factoring is the high rate/fee alternative for credit poor businesses. And, of course, there is also the "underground banking system" aka loansharks. Because "legitmate" lending institutions usually won't lend to poor people (or those with bad credit) at the rates they're limited to, these other outlets mentioned above move in to fill the gap. Because these other outlets are not regulated in the same way that "legitmate" lending institutions are and their desperate customers have few other choices, they can take advantage and charge just about whatever they think their market segment is willing to pay. Whether their loss ratio really justifies those rates or not is, IMHO, highly questionable.
Similar factors probably drive lending in CR, but there are additional ones for countries like CR, particularly lack of transparency and lack of regulation. Banks aren't regulated like they are in the US. Bankruptcy laws are also different. Financial records both on the lender and borrower side are highly suspect, if they exist at all. And, because of much higher poverty rates and a much higher portion of the population living closer to the financial edge, more people who want to borrow are naturally also much higher credit risks based purely on income. Banks can't tell with any real degree of reliability how likely their credit applicants are to pay so they charge more to cover the higher uncertainty/risk.
Last comment, some gringos express astonishment that these types of interest charges exist in places like CR, but it is no surprise to me. It is actual pretty typical for 3rd world lending institutions. And these are just the rates being charged by the "legitimate" Tico banks. Factoring agencies and neighborhood loan sharks probably charge even more. This is why I always felt that it was at least possible that the Villalobos Brother's claims that their 40% rates of return were from factoring, rather than from a long term pyramid scheme and that it only collapsed because their accounts were frozen by greedy tico officials, the IRS (seeking unreported income of gringo expats) and the DEA (thinking it was drug money laundering).
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