The Bear’s Lair: Neither a borrower nor a lender be

According to a Fed report this week, U.S. consumer credit increased $28 billion in November, the largest rise in 16 years, with credit card debt rising at annual rate of 13.3%. This is of course a sign of consumer confidence, another sign that President Trump’s administration has revolutionized the U.S. economic outlook. However, it is bad news in the long run; the U.S. consumer is already over-indebted, as is government as is business. We need to restructure capitalism so that people don’t binge on debt every time there is an economic uptick. To do that, we must reverse many of Maynard Keynes’ precepts.

The traditional view of borrowing money was expressed by Polonius in Shakespeare’s “Hamlet:”

Neither a borrower nor a lender be,
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.”

Polonius is often regarded as a pompous old fool by literary critics, and indeed is described as “tedious old fool” by Hamlet himself. However, the ineffective soliloquizing Hamlet, who ends up wiping out half the court by mistake, is one of the lowest-IQ Shakespeare heroes, so his view should not be taken as gospel. Polonius’ advice given above looks pretty good to me. Loans to friends always cause trouble and heartache. As for borrowing — and this is where Polonius is a much better economist than Keynes – it allows you the pleasures of consumption before you have earned it, slackening effort and often leading to a vicious cycle of increasing debt, financial difficulties and spiraling misery and despair.

Given that the appropriate attitude to debt was known more than 400 years ago, why are we still over-indulging in it? The debt glut is not just a problem of the ignorant masses. Governments borrow far more than they should, pushing up their countries’ debt ratios when there is no war, nor any other conceivable need to do so. Companies borrow far more than they should, even in some cases liquidating their book equity to buy back shares, surely one of the most short-sighted corporate actions in history.

Excess debt is not cost free. Whereas economies with little debt can endure periods of lower output and squeezed margins with little difficulty, in over-leveraged economies such periods inevitably cause credit crises. Companies that would survive perfectly well with a little trimming go bankrupt. Families who just need to reduce their outlays for a year or two find themselves in the street, with no home, no assets and no job. Governments that need to slim down find themselves unable to borrow, like Greece, and their people endure a decade of misery.

Part of the problem is that debt, like life insurance, is a product that is very heavily marketed. This is notoriously true of consumers, where anyone with a halfway decent credit rating gets 2-3 re-financing offers daily. Right at the start of their adult life, useless colleges and the Federal student loan system push students into an indebted position, even when they do not need to borrow money for college – my son’s college kept trying to force him to take out a modest college loan, even though I was paying his entire costs.

It is also true of corporate credit, where banks and bond houses prepare endless spreadsheets and presentations showing how companies can goose their earnings and their managements’ bonuses with just a little more leverage or other arcane financial products. It is also true of governments, where political consultants explain to both parties that, if they would only relax a bit further their tiresome emphasis on fiscal probity, more goodies can be promised to the electorate (and in the monetary area, that just one more year of low interest rates will ensure their re-election.)

Debt products are even marketed to banks, supposedly the principal salesmen in the financial arena. For proof, watch over the next few weeks as the major U.S. and foreign banks doing business in the U.S. take massive write-offs from their balance sheets because of the tax law change, even though that change has greatly (and in some respects, excessively) reduced banks’ and other corporations’ tax liabilities.

The explanation is simple: those write-offs are the result of past tax leasing deals, aggressively marketed to banks in past years by the Wall Street houses. Those deals relied for profitability on being able to write off vast amounts of tax at the then tax rate of 35% (plus state and local tax, in some cases.) The tax subsidy allowed the banks to lease capital goods at costs below those of ordinary debt financing. However, with the tax rate reduced suddenly from 35% to 21%, the excess deferred tax “assets” in the balance sheets must be written off. Essentially it turns out that all the “profitable” tax leasing deals done by the banks in recent years were in fact loss-making. Of course, substantial bonuses have been paid in the banks for the fictitious “earnings” the leasing deals produced and in the brokerages for the commissions made on selling them. But as always on Wall Street, profits may come and profits may go, but bonuses are forever.

Given the powerful forces embedding excess debt in our economic system, and the damage it does, it would seem worthwhile to reverse the strong economic and social forces that encourage it. At the government level, the tendency to Keynesian “stimulus” whenever the economy encounters a speed bump must be resisted – maybe with a balanced budget amendment, mandating a budget balance every year (in a downturn, the figures will be fudged, but it’s better than nothing.) More important, the Fed needs to be Volckerized so that real interest rates are kept high, in booms and recessions alike – 12% Federal Funds rates are good for you, they prevent over-investment and purge the rottenness out of the system.

Corporate bosses need to have their brains cleansed of the fatuous Efficient Market Hypothesis and associated theories that claim that the cost of a company’s capital is independent of its financing, so that since debt interest is tax-deductible, more debt is always beneficial. In an ideal world, returns on debt and equity would be treated the same for tax purposes, so that if debt interest is tax deductible, dividends would be also (while a substantial excise tax would be imposed on stock repurchases). That, plus higher interest rates, should alleviate the problem at the corporate level.

At the consumer level, the wise advice of Polonius should be taught in schools, but much more needs to be done. All government sponsored programs encouraging low-income and minority consumers to borrow should be reversed, so they are discouraged from taking out obligations they may be unable to repay. Programs such as the FHA “3% down” mortgages for low-income consumers should be abolished forthwith. While richer consumers can get themselves out of overborrowing trouble through austerity, poorer consumers cannot do so, and so should be discouraged from borrowing in the first place. The entire “subprime mortgage” fiasco did far more damage to low-income consumers than it helped.

Similarly, students should be discouraged from borrowing money to attend college. A first degree except in a STEM subject is very unlikely to repay their investment, unless they are of exceptional ability. The availability of courses and certifications over the internet at low cost has made a 4-year college degree unnecessary, except for getting jobs at employers obsessed with credentialism, of whom fortunately the number is declining. If colleges do not have the guaranteed flow of impressionable intellectual cannon-fodder at 18, they will be forced to lower their costs and improve the quality of their offerings.

As for credit cards, their mail offer, telephone and Internet offers should be prohibited. Consumers who want a credit card should be forced to apply through a financial institution, who will legally have to warn them of the pitfalls and ensure they can manage credit. Consumers who do not wish to do this may use debit cards, which offer convenience without the danger of running into debt.

Excess debt is undoubtedly going to push us into another painful recession within the next year or two. When it does, the policies applied to exit the recession should be the precise reverse of those followed in 2009-16. Debt must be discouraged and expensive at all levels, so that further speculative bubbles and credit crises are not created. The process will be painful, but at the end we will have the satisfaction and security of an economy designed by Polonius, not Keynes.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)