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A Proper Understanding of Debt

‘Debt’, simply put is a means of using future purchasing power to obtain goods or services before they have been earned. It is nothing more, nothing less. Companies and governments, as well as individuals have long used debt as part of their finance strategies. Such debt is created when a debtor agrees (by word or contract) to lend a certain sum of assets to a debtor. Repayment involves a scheme (terms), timeframe and agreed interest. Debt comes in many forms—loans, syndicates, bonds (a debt security is issued by an institution, a government, or a company). Securitization of debt occurs when an institution groups together similar assets or receivables and sells them in units to the market. Any asset with a cash flow can in principle be securitized.

There is a rather complex economic relationship between debt, inflation and the money supply. Suffice it to say that the store of money in any nations’ economy is based on that state’s ability to guarantee and make repayment of its debts. Countries, states, municipalities, companies, or persons who fail to do so pay the consequences: they pay higher interest rates or cannot borrow any longer and have to workout their situations through protracted legal negotiations and even foreclosure. The ratings of institutions, companies and even individuals nowadays affect the cost of borrowing and depend on what is termed “creditworthiness”. Short of bankruptcy, debt is not typically forgiven. You may recall in the 1980s third world debt became problematic and reached a level and scale that prompted many, including developed country governments and notable economists, to urge that we (and the global financial institutions) cancel debt obligations of the poorest of countries. Such policies were seen as a way to restore equity and improve relationships with developing countries that borrowed too much and were unable to meet their original obligations. But ‘workouts’ as they are known are always messy — whether they involve sovereigns or families that lose jobs or are caught in the newfangled subprime housing situation.

Over the long course of history but especially in modern times, debt has been a useful way to grow economies because it allows people and companies (even small ones as in micro-lending) to do things they would not otherwise be able to do. Companies use various debt instruments to leverage the investments in their assets. However excesses in debt accumulation have been blamed for exacerbating economic problems and damaging both firms and individuals in a culture where debt has become far too easy to secure and is often based on instant gratification of wants, not needs. A culture of debt has grown up where we used instead to practice both personal and public thrift.

There are many arguments against debt. Islam forbids lending with interest even today. The Catholic Church only allowed it since 1822 and the Torah states all debts should be erased every seven years. But markets are in part sustained by debt and they typically win out over dogma.

Debt does increase over time and if not repaid the level of interest can be heavy, even onerous. ‘Usury’ (above reasonable interest rates for the risk assumed) has been a long-standing moral issue in just about every culture around the globe. Debt bondage or indentured servants remain present in many settings outside the West. Peonage may be over in the US proper but it still exists elsewhere in the world in this 21st century. Yet some Americans seem unable ever to get out from under their plaguing debt, racking up more and more as life unfolds. We have an atrocious savings rate and the societal emphasis has shifted to material accumulation and away from delayed gratification.

Debt is neither a good or bad thing in and of itself. It can be useful when done in moderation and with a fair scheme for repayment. Today the debt industry is a large and growing one in global capital markets. Debt underwriting continues to grow and has totaled over $6 trillion a year in the most recent years. Debt continues to fuel economic growth but in recessionary periods it is obviously more difficult to repay past debts. Debt, like many things is best when ‘your eyes are not bigger than your stomach’. Or as one of my more crass hedge fund manager friends put it, “ If you can fly it, float it or *&#$ it, lease it.” How much stuff do you need anyway, since to date no one has yet invented a way to take it with him or her, after death?

In reality gambling generates more than $20 billion a year in taxes and lottery revenues for state budgets, according to industry estimates that don’t even include fees from Native American-run casinos. Just as America’s poor gamble away money they are getting pay advances on, our government has gambled on the funding of school programs on the bet that gamblers will keep giving them those billions each year. How can a government expect its citizens to respect personal debts when it is leading the charge in racking up its’ own debt? $9 trillion, last time I checked. http://www.treasurydirect.gov/

The annual deficit is this year’s spending minus this year’s income. If the general fund spends $900B with income of $600B in one year, the annual deficit is $300B. That makes the national debt go up by exactly $300B. And all that debt has to be financed! The annual deficit is how much the debt increases each year. If someone ran a household like that they would not have a very good credit score … unless they were able to print money in the basement, which is what our government literally does to repay its growing (foreign) debt. Other countries, China, Japan and the Middle East hold more and more of American paper. Is that a good thing? For how long can it go on?

So you could ask the question: should this same government now significantly increase its debt further to help the Americans who were given the privilege to borrow from it? And should they also write-off their interest as a tax deductible expense, which never made sense in the first place – thereby encouraging people through taxation to buy houses that they had no right buying in the first place? Can I have a tax-deductible interest only loan, please! The larger the loan, the better, with subsidies on top. There are two answers, one is, why not? It seems like the government has already chosen the path of borrowing until severe consequences set in but before then sweep critics under the rug and pretend like you have a clean house. The second answer would be to do what the financial markets are doing right now and tell these people to delever, just like the credit card companies and other debt collectors do when they face overexposure to a non- creditworthy client.

What happens what you buy something with your credit card that you can’t afford but is ‘within’ your credit limit of say 25k? You default on your credit card bill (after some harassing calls and threats) and unfortunately can’t buy anything for a long while and sometimes the stuff you bought actually gets repossessed. Why shouldn’t leveraging yourself up in a house loan be any different? You can be for the forgiveness of sins, but loans are not sins, they are contracts. The American Dream (warped from ‘owning a place to live’ to ‘getting rich by owning no equity in a house but paying interest until you can sell the house for a profit’). Unfortunately, that has now become more like the American Nightmare for millions of families. So perhaps, we should borrow more from Social Security to fund something we can’t afford in the first place? Another war or maybe developing a newer space station called Noah’s Ark II, where we could shoot two of every mammal on earth to live on Mars may be in the offing? Both would probably incur the same amount of debt that we never intend to pay off if one wanted to be cynical. My point is we are in a shambles because both public and private thrift have been squandered and exchanged for a hollow but costly fool’s gold.

In Christianity the fact of debt has at times outstripped its evils. On television even today some preachers rail against debt altogether, including for home or church mortgages. But in truth the Bible neither expressly forbids nor allows the borrowing of money. Wisdom down the ages suggests debt should be entered into sparingly and in good faith. Paul’s charge in Romans is a reminder of God’s distaste for all forms of debt not paid in a timely manner. All of us are debtors, as the Lord’s Prayer forcefully reminds us and we need forgiveness and God’s grace – for ourselves, and all those around us. The biblical example certainly allows for charging interest (Matt. 25 and Proverbs 28 both). At the same time the ancient law also allowed for mercy in forgiving interest. Christ’s own parables (in Matt. 10 and 18) perhaps most instructively give this advice to His followers: “Freely you have received, freely give.” My best advice is to live within your means, save and take (little) debt, use it, but don’t let it use or ruin you and yours.

Dr. Theodore Roosevelt Malloch is the author of the newly released book, Spiritual Enterprise: Doing Virtuous Business, Encounter Books, 2008. He is founder and Chairman of the Spiritual Enterprise Institute. He has been a global strategist, ambassador, Wall Streeter, and has been involved in politics and economic policy at the US Senate, US State Department, and the United Nations.

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