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Loan rates are high because default rates are high. Take a look at auto lending. At the bottom you have like a 15% default rate (e.g. the worst subprime auto lo
by rsj_hn 6y ago
Loan rates are high because default rates are high. Take a look at auto lending. At the bottom you have like a 15% default rate (e.g. the worst subprime auto loans), for these you are going to get (say) a 20% interest rate.
Now it's true that as rates go up, so do default rates, so the same people who would only default at a rate of 10% of the time if the lending rate was 8% are going to default at 15% of the time at a lending rate of 20%. That's the cold, hard, mathematical truth of how risk works -- those who are already safe bets are lent to at very low rates, but those in a precarious position are lent to at higher rates. No amount of hand-wringing or preaching from soapboxes is going to change the math.
Now this can be a strong argument in favor of locking the poor out of credit markets. The argument goes: if they have a history of poor decision making or inability to maintain stable incomes, then we can protect them from making a poor decision about a loan by removing the possibility of getting a loan. I think this argument has a lot of force, but it also catches people who had bad credit due to sheer bad luck, and not poor decision making, and it makes life a bit harder for them. Another cold, hard truth - often to help a majority you have to hurt a minority.
So we try another tack -- make those with good credit subsidize those with bad credit by forcing everyone to pay the same interest rate for a car. That is basically a law against credit analysis. Don't take things like payment history or income into account, every loan is made at 10%. Here the problem is that there are wealthy people who obviously pose little risk, and they will be able to borrow from other markets at a lower rate, and will exit the auto lending market, thus driving default rates up and the average interest rate up and again the net result is shutting down the entire auto-lending market rather than just keeping out those with bad credit.
For this lending business to work, we need the best credit analysis possible, and attempts at making credit analysis less accurate create dead weight costs for everyone.
Really this is an object lesson in an old economic dictum: don't mess with prices to stabilize incomes. If you want to help the poor, give them money. Don't try to regulate the prices the poor pay for things.
- lifeisstillgood 6y agoI think I agree. I fully support using price mechanism as a signalling device, it works and has been shown to work for centuries. I suspect I am upset that debt has become the way people fill-in for low wages, lack of social support etc. And worse, in say the 1930s, debt was accessible to (some) poor via low cost housing loans (Savings and loans). This seems to have vanished as everyone is now a bank not a mutal. Plus, it is very clear that there is a lot of the lending market actively searching out poor credit risk in order to get them to sign up - they have a win win - the law is on their side to force repayment, or the credit risk makes huge efforts to repay. I don't want to adjust the price - but actively seeking out people who see debt as a simple fix ... knowing its going to hurt them. Yeah its a socially problematic activity. So as you say the solution seems to be - freeze the credit markets at some (arbitrary) level (of x % APR) and start ensuring there are decent wages and decent social safety nets. You can see why price-fixing is so attractive
- rsj_hn 6y ago> I suspect I am upset that debt has become the way people fill-in for low wages, lack of social support etc. Yeah, that's the flip-side of extending credit. It used to be that houses were a smaller multiple of the average salary because only short term (e.g. 3-5 year) loans were available. Of course homeownership rates were lower. Then banks began offering 30 year mortgages and homeownership increased but house prices rocketed up and it became common for working people to carry 30 years of massive debt. Then downpayment requirements were weakened from 20% to 10% to 3.5%. Now you even have interest only loans. So locking people out of certain credit markets, or banning certain lending instruments, certainly has an appeal. I wouldn't mind if the federal government stopped insuring home loans and student loans and we returned to 3-5 year loans for homes and maybe 1-2 year loans for autos. We should not be in the business of subsidizing all this household debt, and we should be discouraging it a bit.
- lifeisstillgood 6y agoInteresting - there is a series of lectures (ref to follow) on UK economy - they try to show the biggest component of house prices is land and the biggest contributor to land is people just bid up using mortgage funds. On the other hand why should leverage be freely available to "the rich". I am tempted to solve it on the demand side - I am willing to bet one major difference in money management is just daily awareness of total spend and wealth. Something like Mint for everyone might actually move the needle (it's kind of where the EU / UK open banking is headed)