Countdown 3/2/10: Excerpt from Econned
Folks, the time has come when I must start shamelessly promoting my book, Econned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism, which is being released March 2, 2010.
I thought the extract below would give readers an idea of what the book is about, with one caveat. Econned goes into some detail about crisis mechanisms (as in why it got as bad as it did) and has unearthed a heretofore unexamined hedge fund trading strategy that turned the subprime mania into the detonator of the global debt bomb (and yes, we have the goods).
Enjoy!
In 1776, Adam Smith published The Wealth of Nations. In it, he argued that the uncoordinated actions of large numbers of individuals, each acting out of self-interest, sometimes produced, as if by “an invisible hand,” results that were beneficial to broader society. Smith also pointed out that self-interested actions frequently led to injustice or even ruin. He fiercely criticized both how employers colluded with each other to keep wages low, as well as the “savage injustice” that European mercantilist interests had “commit[ted] with impunity” in colonies in Asia and the Americas.
Smith’s ideas were cherry-picked and turned into a simplistic ideology that now dominates university economics departments. This theory proclaims that the “invisible hand” ensures that economic self-interest will always lead to the best outcomes imaginable. It follows that any restrictions on the profit-seeking activities of individuals and corporations interfere with this invisible hand, and therefore are “inefficient” and nonsensical.
According to this line of thinking, individuals have perfect knowledge both of what they want and of everything happening in the world at large, and so they pass their lives making intelligent decisions. Prices may change in ways that appear random, but this randomness follows predictable, unchanging rules and is never violently chaotic. It is therefore possible for corporations to use clever techniques and systems to reduce or even eliminate the risks associated with their business. The result is a stable, productive economy that represents the apex of civilization.
This heartwarming picture airbrushes out nearly all of the real business world. Yet uncritical allegiance to these precepts over the last thirty years has produced a world in which corporations, especially in finance, are far less restricted in their pursuit of profit. We show in this book how this lawless environment has led the financial services industry to pursue its own unenlightened
self-interest. The industry has become systematically predatory. Employees of industry firms have not confined their predation to outsiders; their efforts to loot their own firms nearly destroyed the industry and the entire global economy. Similarly destructive behavior by other players, often viewed through a distorted lens that saw all unconstrained commercial behavior as virtuous, added more
fuel to the conflagration.
Some economists have opposed this prevailing ideology; indeed, comparatively new lines of inquiry focus explicitly on how economic actors can fool themselves or others into making poor, even destructive, choices.
But when the economics profession has used the megaphone of its authority to dominate discussions with policymakers and the public, it has spoken with one voice, and the message has been the one described here. We therefore confine our criticism to these particularly influential ideas.
Theories that fly in the face of reality often need to excise inconvenient phenomena, and mainstream economics is no exception. Idealizing the rational aspects of business decisions means refusing to notice behavior that is predatory, destructive, criminal, or simply stupid. Believing that risk is manageable through mechanical systems has required not just unrealistic assumptions but also willful
blindness to clear signs of danger.
We offer here another point of view. This book lays bare both the actions leading to the credit crisis and the economic constructs that defended, facilitated, and even exacerbated this behavior. Our case makes clear that if our economic system is to harness the self-interest of individuals to achieve the general
good, it must be supervised within a democratic society and responsive to criticism by outside voices of those who are unafraid to think independently.
Since Obama seems hell bent on doing exactly the wrong thing at the wrong time, namely proposing a spending freeze while jobs are still being lost, as expounded on by Marshall Auerback , here is a little background as to why this is not good by John Carney of the Business Insider:
Most of the blogosphere has been skeptical of the rally in equities since the beginning, with ZeroHedge pointing out that the rise can be attributed, basically, to free money courtesy of the Federal Reserve, and aided and abetted by High Frequency Trading and the principal program trading of the usual suspects. Now, even for those who are not conspiracy minded, charts such as these speak volumes(pun intended).
I would like to point out one possible explanation for this phenomenon from a contentious source that I have quoted before. I maintian that Keynes is misunderstoond by many and that he is not the source of all wisdom, but, rather, someone who asked the right questions at the right time and pointed out many problems in the workings of the economy in periods of turmoil.
Unfortunately a serious fall in the marginal efficiency of capital also tends to affect adversely the propensity to consume. For it involves a severe decline in the market value of Stock Exchange equities. Now, on the class who take an active interest in their Stock Exchange investments, especially if they are employing borrowed funds, this naturally exerts a very depressing influence. These people are, perhaps, even more influenced in their readiness to spend by rises and falls in the value of their investments than by the state of their incomes. With a "stock-minded" public as in the United States to-day, a rising stock-market may be an almost essential condition of a satisfactory propensity to consume; and this circumstance, generally overlooked until lately, obviously serves to aggravate still further the depressing effect of a decline in the marginal efficiency of capital.
When once the recovery has been started, the manner in which it feeds on itself and cumulates is obvious. But during the downward phase, when both fixed capital and stocks of materials are for the time being redundant and working-capital is being reduced, the schedule of the marginal efficiency of capital may fall so low that it can scarcely be corrected, so as to secure a satisfactory rate of new investment, by any practicable reduction in the rate of interest. Thus with markets organised and influenced as they are at present, the market estimation of the marginal efficiency of capital may suffer such enormously wide fluctuations that it cannot be sufficiently offset by corresponding fluctuations in the rate of interest. Moreover, the corresponding movements in the stock-market may, as we have seen above, depress the propensity to consume just when it is most needed. In conditions of laissez-faire the avoidance of wide fluctuations in employment may, therefore, prove impossible without a far-reaching change in the psychology of investment markets such as there is no reason to expect. I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands.
The point of contention is, and has been, the last sentence, which raises the blood pressure of everyone involved, on both sides, like nothing else ever written about economics (save maybe Marx). I am not venturing out on a limb when I say that the powers that be have read this passage and drawn their own conclusions from it. Even Greenspan said :
The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen. Previously capital-strapped companies have been able to raise considerable debt and equity in recent months. Market fears of bank insolvency, particularly, have been assuaged
.
Juxtaposing these two quotes does not a proof of a government engineered market melt-up make, but one does have to wonder.
Robert Shiller is perhaps best known for his Case-Shiller home price index and for having correctly identified the previous bubble in financial markets in his 2000 book Irrational Exuberance . Shiller is concerned with risk and uncertainty in human affairs and has never been a proponent of the orthodoxy which either claims that bubbles do not exist(!) or that markets should be left to themselves since they instantly and efficiently incorporate all known information, something known as the Efficient Market Hypothesis . Barry Ritholz discusses the hubris of economics in a must read post, and over at Washington´s Blog another great post points out that economists had a incentive to be wrong.
Now Robert Shiller´s criticism of prevailing economic orthodoxy may not be as acid but it is nevertheless a damning indictment. Below is his lecture on Behavioral Finance and a very informative article on the decline (one would hope) of the Efficient Markets Theory and the rise of Behavioral Finance.
Steve Keen is one of the few economists who predicted the financial crisis and he is not at all impressed with the government response arguing that texboox economics failed to predict the crisis and are also not going to solve the problems we are facing. His outlook is less than rosy to say the least.
There is nothing like a crisis of momentous proportions to focus the mind. The intellectual edifice that was neo-classical economics came crumbling down last fall, something admitted by none other than the guru of efficient self-regulating markets himself, Alan Greenspan.
Now a well worn phrase has been that "no one could have seen this coming." Well, that is just not true; many did. And what set them apart from the cheering herd and its Panglossian view that all is for the best in this best of all worlds is that they did not drink from the neo-classical ideological kool-aid.
Hyman Minsky is about the last person asset managers would want to be mentioning in their letters to their clients (I cannot recall where I originally read this, or I would attribute credit). Minsky is perhaps best known for his Financial Instability Hypothesis which is being wonderfully articulated by Steve Keen at his debt deflation blog , along with the good folks over at the Center for Full Employment and Price Stability and many others.
Why the resurgence in interest in Minsky? Well, he explained and expanded ideas set forth by Keynes, who did not believe that markets were efficient and self-regulating. The price of an asset was not always the correct price.
From Keynes´s article in 1937:
Actually, however, we have, as a rule, only the vaguest idea of any but the most direct consequences of our acts. Sometimes we are not much concerned with their remoter consequences, even tho time and chance may make much of them. But sometimes we are intensely concerned with them, more so, occasionally, than with the immediate consequences.
Now of all human activities which are affected by this remoter preoccupation, it happens that one of the most important is economic in character, namely. Wealth. The whole object of the accumulation of Wealth is to produce results, or potential results, at a comparatively distant, and sometimes at an indefinitely distant, date. Thus the fact that our knowledge of the future is fluctuating, vague and uncertain, renders Wealth a peculiarly unsuitable subject for the methods of the classical economic theory. This theory might work very well in a world in which economic goods were necessarily consumed within a short interval of their being produced. But it requires, I suggest, considerable amendment if it is to be applied to a world in which the accumulation of wealth for an indefinitely postponed future is an important factor; and the greater the proportionate part played by such wealth-accumulation the more essential does such amendment become.
By "uncertain" knowledge, let me explain, I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty; nor is the prospect of a Victory bond being drawn. Or, again, the expectation of life is only slightly uncertain. Even the weather is only moderately uncertain. The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealthowners in the social system in 1970. About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know. Nevertheless, the necessity for action and for decision compels us as
practical men to do our best to overlook this awkward fact and to behave exactly as we should if we had behind us a good Benthamite calculation of a series of prospective advantages and disadvantages, each multiplied by its appropriate probability, waiting to he summed.
How do we manage in such circumstances to behave in a manner which saves our faces as rational, economic men? We have devised for the purpose a variety of techniques, of which much the most important are the three following:
(1) We assume that the present is a much more serviceable guide to the future than a candid examination of past experience would show it to have been hitherto. In other words we largely ignore the prospect of future changes about the actual character of which we know nothing.
(2) We assume that the existing state of opinion as expressed in prices and the character of existing output is based on a correct summing up of future prospects, so that we can accept it as such unless and until something new and relevant comes into the picture.
(3) Knowing that our own individual judgment is worthless, we endeavor to fall back on the judgment of the rest of the world which is perhaps better informed. That is, we endeavor to conform with the behavior of the majority or the average. The psychology of a society of individuals each of whom is endeavoring to copy the others leads to what we may strictly term a conventional judgment.
Now a practical theory of the future based on these three principles has certain marked characteristics. In particular, being based on so flimsy a foundation, it is subject to sudden and violent changes. The practice of calmness and immobility, of certainty and security, suddenly breaks down. New fears and hopes will, without warning, take charge of human conduct. The forces of disillusion may suddenly impose a new conventional basis of valuation. All these pretty, polite techniques, made for a well-panelled Board Room and a nicely regulated market, are liable to collapse. At all times the vague panic fears and equally vague and unreasoned hopes are not really lulled, and lie but a little way below the surface.
Perhaps the reader feels that this general, philosophical disquisition on the behavior of mankind is somewhat remote from the economic theory under discussion. But I think not. Tho this is how we behave in the market place, the theory we devise in the study of how we behave in the market place should not itself submit to market-place idols. I accuse the classical economic theory of being itself one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the
future.
I daresay that a classical economist would readily admit this. But, even so, I think he has overlooked the precise nature of the difference which his abstraction makes between theory and practice, and the character of the fallacies into which he is likely to be led.
Keynes, John Maynard (1937). `The General Theory of Employment`, Quarterly Journal of Economics, 51. cited in Shaw, G.K. (198. The Keynesian Heritage: Volume I. pp.11-13
Minsky identified three types of finance: hedge, speculative and Ponzi. Once the Ponzi stage is reached, debt is taken on in the belief that asset prices will continue to rise which will enable the debt to be serviced. Needless to say, once asset prices start to fall many will default. This is what we are seeing now. From Wray and Tymoigne :
Minsky created a famous taxonomy of financing profiles undertaken by investing firms: hedge (prospective income flows are expected to cover interest and principle with a safe margin); speculative (near-term income flows will cover only interest, although it is expected that finance costs will fall, that income flows will rise, or that assets can be sold at a higher price later—in which case revenues will be sufficient to cover principle); and Ponzi (near-term receipts are insufficient to cover interest payments so that debt increases because the Ponzi unit borrows to cover interest payments). Over the course of an expansion, financial stances evolve from largely hedge to include ever rising proportions of speculative and even Ponzi positions. Some Ponzi positions are undertaken voluntarily (due, for example, to expectations that debt can be refinanced at much more favorable terms or that large capital gains can be realized from asset price appreciation), some are fraudulent (a “pyramid” scheme is an example, in which a crook dupes everlarger numbers of suckers to provide the funds to pay the earliest participants), and some result from disappointment (revenues are lower than expected or finance costs rise unexpectedly). Attempts to raise leverage and to move to more speculative positions can be frustrated at least temporarily: if results turn out to be more favorable than expected, an investor attempting to engage in speculative finance could remain hedge because incomes realized are greater than were anticipated. This is because as aggregate investment rises, it has a multiplier impact on effective demand that can raise sales beyond what had been expected. Later, Minsky explicitly incorporated the Kaleckian result that in the truncated model, aggregate profits equal investment plus the government’s deficit.7 Thus, in an investment boom, profits would be increasing along with investment, helping to validate expectations and encouraging even more investment. This added strength to his proposition that the fundamental instability in the capitalist economy is upward—toward a speculative frenzy (as investment generates profits), which breeds more investment.
Here is an in depth look at the work and ideas of Hyman Mynsky.
Paul Willmott has an interesting blog post in which he said that he is hoping for one L of a recovery and I have to say I concur wholeheartedly. The economic prognosticators , after peering into their respective crystal balls or tea leaves, have seen the future and declared it a V , U , W, square root and other exotic shapes. Now almost all observers are in agreement that the dreaded L shape which plagued Japan is to be avoided like the pest. Not so Wilmott, the whiz of quantitative finance. He asks:
"Have you any experience of Japan in the 1990s? Well I have. And it didn't seem too bad to me. Were there hordes of people begging on the subway? Not that I recall. Was it dangerous roaming the streets for fear of being mugged? No, it seemed safe enough when I was there. Was there high unemployment and general desititution? No. More on this anon.
Japan in the 1990s was, as it still is, a safe, enjoyable place, with a very high standard of living, and at the cutting edge technology wise. Not the hell hole that economists like to paint. And so I really cannot imagine what Japan would be like now if they'd had a V-shaped recovery. They'd all be communicating by telepathy and travelling via matter transporter I guess.
To me the important point about the economy is not what letter of the alphabet best represents it, nor its percentage growth. After all, is it really necessary to grow at x percent per annum in order to maintain the feeling of status quo? Like the shark, which supposedly has to keep moving forward in order to stay alive. What sort of life is that? I believe what is most important is the well being of the people, and that's not the same as GDP. It is, however, closely linked to rate of employment. And that's where Japan does remarkably well. That's what governments should focus on, to L with growth!"
This flies in the face of the conventional economic wisdom which repeats the words growth and consumption in a manner resembling autism, someting duly noted by the post-autistic economics network .
"Our enormously productive economy demands that we make consumption our way of life, that we convert the buying and use of goods into rituals, that we seek our spiritual satisfactions, our ego satisfactions, in consumption. The measure of social status, of social acceptance, of prestige, is now to be found in our consumptive patterns. The very meaning and significance of our lives today expressed in consumptive terms. The greater the pressures upon the individual to conform to safe and accepted social standards, the more does he tend to express his aspirations and his individuality in terms of what he wears, drives, eats- his home, his car, his pattern of food serving, his hobbies.
These commodities and services must be offered to the consumer with a special urgency. We require not only “forced draft” consumption, but “expensive” consumption as well. We need things consumed, burned up, worn out, replaced, and discarded at an ever increasing pace. We need to have people eat, drink, dress, ride, live, with ever more complicated and, therefore, constantly more expensive consumption."
I would prefer instead to turn to Keynes:
"The full employment policy by means of investment is only one particular application of an intellectual theorem. You can produce the result as well by consuming more or working less. Personally I regard the investment policy as first aid… Less work is the ultimate solution.”
Much more on this topic can be found here at econospeak.
This has been posted again and again by the good folks at econospeak and I will do my part to try to disseminate the "memo."
THE LONG-TERM PROBLEM OF FULL EMPLOYMENT
J.M. Keynes (May 1943):
1. It seems to be agreed today that the maintenance of a satisfactory level of employment depends on keeping total expenditure (consumption plus investment) at the optimum figure, namely that which generates a volume of incomes corresponding to what is earned by all sections of the community when employment is at the desired level.
2. At any given level and distribution of incomes the social habits and opportunities of the community, influenced (as it may be) by the form and weight of taxation and other deliberate policies and propaganda, lead them to spend a certain proportion of these incomes and to save the balance.
3. The problem of maintaining full employment is, therefore, the problem of ensuring that the scale of investment should be equal to the savings which may be expected to emerge under the above various influences when employment, and therefore incomes, are at the desired level. Let us call this the indicated level of savings.
4. After the war there are likely to ensure [sic] three phases-
(i) when the inducement to invest is likely to lead, if unchecked, to a volume of investment greater than the indicated level of savings in the absence of rationing and other controls;
(ii) when the urgently necessary investment is no longer greater than the indicated level of savings in conditions of freedom, but it still capable of being adjusted to the indicated level by deliberately encouraging or expediting less urgent, but nevertheless useful, investment;
(iii) when investment demand is so far saturated that it cannot be brought up to the indicated level of savings without embarking upon wasteful and unnecessary enterprises.
5. It is impossible to predict with any pretence to accuracy what the indicated level of savings after the war is likely to be in the absence of rationing. We have no experience of a community such as ours in the conditions assumed, with incomes and employment steadily at or near the optimum level over a period and with the distribution of incomes such as it is likely to be after the war. It is, however, safe to say that in the earliest years investment urgently necessary will be in excess of the indicated level of savings. To be a little more precise the former (at the present level of prices) is likely to exceed £m1000 in these years and the indicated level of savings to fall short of this.
6. In the first phase, therefore, equilibrium will have to be brought about by limiting on the one hand the volume of investment by suitable controls, and on the other hand the volume of consumption by rationing and the like. Otherwise a tendency to inflation will set in. It will probably be desirable to allow consumption priority over investment except to the extent that the latter is exceptionally urgent, and, therefore, to ease off rationing and other restrictions on consumption before easing off controls and licences for investment. It will be a ticklish business to maintain the two sets of controls at precisely the right tension and will require a sensitive touch and the method of trial and error operating through small changes.
7. Perhaps this first phase might last five years,-but it is anybody's guess. Sooner or later it should be possible to abandon both types of control entirely (apart from controls on foreign lending). We then enter the second phase, which is the main point of emphasis in the paper of the Economic Section. If two-thirds or three-quarters of total investment is carried out or can be influenced by public or semi-public bodies, a long-term programme of a stable character should be capable of reducing the potential range of fluctuation to much narrower limits than formerly, when a smaller volume of investment was under public control and when even this part tended to follow, rather than correct, fluctuations of investment in the strictly private sector of the economy. Moreover the proportion of investment represented by the balance of trade, which is not easily brought under short-term control, may be smaller than before. The main task should be to prevent large fluctuations by a stable long-term programme. If this is successful it should not be too difficult to offset small fluctuations by expediting or retarding some items in this long-term programme.
8. I do not believe that it is useful to try to predict the scale of this long-term programme. It will depend on the social habits and propensities of a community with a distribution of taxed income significantly different from any of which we have experience, on the nature of the tax system and on the practices and conventions of business. But perhaps one can say that it is unlikely to be less than 7 per cent or more than 20 per cent of the net national income, except under new influences, deliberate or accidental, which are not yet in sight.
9. It is still more difficult to predict the length of the second, than of the first, phase. But one might expect it to last another five or ten years and to pass insensibly into the third phase.
10. As the third phase comes into sight; the problem stressed by Sir H. Henderson begins to be pressing. It becomes necessary to encourage wise consumption and discourage saving,-and to absorb some part of the unwanted surplus by increased leisure, more holidays (which are a wonderfully good way of getting rid of money) and shorter hours.
11. Various means will be open to us with the onset of this golden age. The object will be slowly to change social practices and habits so as to reduce the indicated level of saving. Eventually depreciation funds should be almost sufficient to provide all the gross investment that is required.
12. Emphasis should be placed primarily on measures to maintain a steady level of employment and thus to prevent fluctuations. If a large fluctuation is allowed to occur, it will be difficult to find adequate offsetting measures of sufficiently quick action. This can only be done through flexible methods by means of trial and error on the basis of experience, which has still to be gained. If the authorities know quite clearly what they are trying to do and are given sufficient powers, reasonable success in the performance of the task should not be too difficult.
13. I doubt if much is to be hoped from proposals to offset unforeseen short-period fluctuations in investment by stimulating short-period changes in consumption. But I see very great attractions and practical advantage in Mr Meade's proposal for varying social security contributions according to the state of employment.
14. The second and third phases are still academic. Is it necessary at the present time for Ministers to go beyond the first phase in preparing administrative measures? The main problems of the first phase appear to be covered by various memoranda already in course of preparation. insofar as it is useful to look ahead, I agree with Sir H. Henderson that we should be aiming at a steady long-period trend towards a reduction in the scale of net investment and an increase in the scale of consumption (or, alternatively, of leisure) but the saturation of investment is far from being in sight to-day The immediate task is the establishment and the adjustment of a double system of control and of sensitive, flexible means for gradually relaxing these controls in the light of day-by-day experience
I would conclude by two quotations from Sir H. Henderson's paper, which seem to me to embody much wisdom.
"Opponents of Socialism are on strong ground when they argue that the State would be unlikely in practice to run complicated industries more efficiency than they are run at present. Socialists are on strong ground when they argue that reliance on supply and demand, and the forces of market competition, as the mainspring of our economic system, produces most unsatisfactory results. Might we not conceivably find a modus vivendi for the next decade or so in an arrangement under which the State would fill the vacant post of entrepreneur-in-chief, while not interfering with the ownership or management of particular businesses, or rather only doing so on the merits of the case and not at the behests of dogma?
"We are more likely to succeed in maintaining employment if we do not make this our sole, or even our first, aim. Perhaps employment, like happiness, will come most readily when it is not sought for its own sake. The real problem is to use our productive powers to secure the greatest human welfare. Let us start then with the human welfare, and consider what is most needed to increase it. The needs will change from tune to time, they may shift, for example, from capital goods to consumers' goods and to services. Let us think in terms of organising and directing our productive resources, so as to meet these changing needs, and we shall be less likely to waste them."
There is some serious food for thought here, especially that it "becomes necessary to encourage wise consumption and discourage saving,-and to absorb some part of the unwanted surplus by increased leisure, more holidays (which are a wonderfully good way of getting rid of money) and shorter hours." But this train has left the station. We picked increased consumption to leisure and kept on working ourselves to death in a neverending rat´s race to keep up with the Joneses and driven by manufactured wants. What exactly is it about the 8 hour work day that is sacrosanct? Why does the conventional wisdom insist on equating happiness or welfare with consumption? Is consumption really the be all and end all of human existence? What a poor existence that would be. Unfortunately Keynes was all too soon forgotten and those pesky vested interests he mentioned in the closing pages of his General Theory have to date not stopped trying to discredit his ideas, many of which were misunderstood, never even implemented or seriously considered. Now we are left picking up the pieces of our orgy of consumption, excess and greed that began in the 1980´s. We would do well to read Keynes once more. The General Theory of Employment, Interest, and Money
The Washington Post reports today that many banks have taken to actually lowering the interest rate on credit card debt when someone becomes unable to pay and are also actually forgiving debt in some cases. Keeping in mind that the refusal to pay any further by the debtor in the previous post is probably not an isolated incident, it certainly does make sense to try working with people, thereby getting something instead of nothing.
As more Americans lose work, many are increasingly struggling to pay their credit card bills, forcing banks to do what they had been loath to do in the past: forgive some of the debt or modify it in the cardholders' favor.
Lenders are looking to restructure credit card accounts by lowering interest rates or minimum monthly payments for a specific period of time, waiving fees, or settling the debt by accepting less than what is owed.
Consumer advocacy groups, however, have pointed out that credit card firms have increased interest rates and cut lines of credit in the past year in anticipation of a new law limiting their practices.
"The card companies are giving with one hand but taking away from the other," said Ed Mierzwinski, consumer program director for U.S. PIRG, a consumer advocacy group. "The problem is the credit card companies are treating consumers randomly. A small number are getting helped. A larger number are being hurt."
Some will approach only customers who are delinquent. Some will reach out at the first signs of trouble. Experts said other factors that might be taken into consideration are income, debt loads and payment history.
And borrowers can pay a price if they're granted a modification. Forgiven debt could be taxable and can tarnish the borrower's credit report for up to seven years. If the bank reports to credit bureaus that it forced the borrower to close the account, that, too, could damage the credit history, jeopardizing chances for future loans. Finally, if a borrower has a lot of debt, a closed account could hurt a credit score. If the borrower has to give up his card, then a key figure used by lenders to determine creditworthiness -- the ratio of outstanding debt to available credit -- can soar, harming the credit score even further.
Also uncertain is how the new credit card law adopted by Congress in May will affect banks' ability to modify loans. The law, parts of which took effect last month, restricts card issuers' latitude to change rates and decide in what order to apply payments when different balances have different rates.
So it seems as if the banks´ strategy is to screw over people by first raising rates up to 30%, cutting credit lines, charging ourageous overdraft and other fees, and then, if people stop making payments, to do any and everything to salvage just a bit of scraps.
This is going to go viral and I do not believe to be going out on a limb by saying that many other consumers are going to echo these sentiments and simply stop paying their bills, be they credit card, mortgage, whatever. It only remains to be seen whether credit cards or commercial real estate is going to be the next shoe to drop. I fully sympathize with her and understand that when a bank decides out of the blue to raise the interest rate to such usurious levels simply in order to scrounge up revenue that they desperately need because they screwed up and helped precipitate the worst recession since the Great Depression, then, well, they are asking for a response along the lines outlined here.
One cannot read the following excerpt from Keynes without being impressed and disturbed by the fact that the same reasons were and are being set forth in support of neo-classical economics even after their complete and utter failure to predict, explain or provide solutions for the current crisis.
The completeness of the Ricardian victory is something of a curiosity and a mystery. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpaltable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely on the whole to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted it to the support of the dominant social forces behind authority. But although the doctrine itself has remained unquestioned by orthodox economists up to a late date, its signal failure for purposes of scientific prediction has greatly impaired, in the course of time, the prestige of its practitioners. For professional economists...were apparently unmoved by the lack of correspondence between the results of their theory and the facts of observation;-a discrepancy which the ordinary man has not failed to observe, with the result of his growing unwillingness to accord economists that measure of respect which he gives to other groups of scientists whose theoretical results are confirmed by observation when they are applied to the facts.
John Maynard Keynes (1936) The General Theory of Employment, Interest and Money, Chapter 3
