Q: Why did the lenders overextend borrowers in the past Decade?
This has been a hot discussion topic in mainstream media. It is hard to understand the rationale of lenders, be they mortgage companies or credit card issues. The answer to this puzzle seems to be that the financial wizardly wisdom of the past decade was that high-risk loans could be collateralized and packaged (into collateralized debt obligations) so that the overall risk would be lower than the risk of any individual loan. Add in rating agencies that were - for lack of better terms - sleep at the wheel, bonuses affiliated with selling debt and debt-backed securities, and the false sense of security that credit default swaps (insurance policies for CDOs), to create a perfect storm of reckless behavior by lenders that encouraged reckless behavior by borrowers. Once the house of cards fell apart, the tipping point being Lehman Brother's bankruptcy, the wheels of the wheeling and dealing debt market came off.
Q: Why do lenders continue to overextend borrowers through credit card debts?
Credit card companies are (comparatively) actively turning away customers, increasing their borrowing rates, or lowering the credit limits of their most risky customers. American Express is a case in point. As a result, we may see lower credit card debt levels in the ensuing months; however, credit card limits are preset. Other than active intervention by financial institutions mentioned previously, there is nothing to stop consumers from borrowing until they reach their credit limits.
Q: Will higher debt interest rate obligations further reduce consumption?
Absolutely. Lower consumption will occur either because a higher percentage of disposable income will become allocated to servicing debt or because the consumer becomes insolvent. In either case, this bodes poorly for US' short-term economic growth.
No comments:
Post a Comment