September 5, 2017

This is an excellent article by Doug Hoyes on the perils of payday loans and borrowing money from Cash Advance outlets, whether on the Main Street or found online.   Interestingly, toward the end of the article, Doug turns his attention to a problem that I have frequently blogged about “irresponsible top tier lending”.  Unfortunately he doesn’t delve very far into this topic, or perhaps the article was edited.

Nonetheless, let’s just think about how credit card companies operate.  They, and banks, are at bottom not terribly different than payday loan outlets.  There are many signs of recklessness and irresponsibility – after all, who in their right mind would lend $20,000 to an 82 two year old woman, living on a pension of $1,100 a month and set up a payment scheme that would allow her to pay the obligation back over a term of 128 years?  That’s right that wasn’t a typo, I said 128 years.

Credit card companies take advantage of every opportunity to encourage more indebtedness for example, unless prohibited by law, they will arbitrarily increase credit limits.  You get a “FREE toaster” just for applying.  Take out a loan for furniture and you get a credit card in the mail with your first statement, “welcoming you to the company” and encouraging you use the card with enticing advertisements.   

But, should a customer miss one payment their interest rate can increase by 10% or more.  These are the same tactics that were employed by Finance Companies in the 1980s and 1990s – if an account was delinquent they would “rewrite it” allowing a grace period for the missed payment(s) and setting a higher interest rate.

Why do they do this?  Blame it on GAAP (Generally Accepted Accounting Principles) – an account receivable is recorded on the company’s balance sheet as an “asset”.   A receivable that is delinquent is a “liability” that is recorded by adjusting the value of the assets.   A credit card company or a bank that has a lot of receivables is in a better position to borrow money from other lenders at rates that are more favourable than the rates at which they lend. 

As long as the lending and (GAAP) recording cycle can be maintained with fresh money coming in both from lenders (central banks) at reduced rates and borrowers (us, the consumers) at premium rates the scheme works.  So, in theory at least, having that little old lady owe a debt of $20,000 that is payable at an rate of 17% per annum over a term of 128 year allows the lender to record a receivable of $78,849 on their balance sheet.   

Now because the company has such a strong balance sheet it can issue dividends to shareholders and bonuses to executives.   And thanks to the magic of fractional reserve banking and the use of electronic banking the companies don’t even need any real money at all they just make accounting entries in accordance with GAAP.