Tuesday, July 29, 2008

Fixing bad credit with bad credit

I was debating a friend of mine a while back about the current financial problems. He was arguing against my ‘hands off’ policy, saying that in times of economic downturn the government borrowing and spending money is a good thing. Operating in debt will help jump start the economy, and the money can be paid back after we’re experiencing growth again.

At the time I didn’t have an answer, but I finally thought of a response.

Lets say we’re talking about a person who’s just lost their job and has some money put in the bank. Now, if this person opens up a line of credit he can continue his usual lifestyle until he can find a new source of income. This seems like a sound financial plan, except it ignores a property of human behavior, in that we don’t plan well for the future. If you have a credit card, chances are this person could get caught up in purchasing unnecessary luxuries which he’s not going to be able to pay back if he doesn’t find another well-paying job soon.

Similarly, operating the federal budget at a $10 trillion deficit is a sure way to screw ourselves in the future. Who knows if and when the economy will pick back up? Especially since the current problems are caused in part by bad credit practices in the first place.

What Washington politicians are offering is basically more of the same. They want to fix problems caused by bad credit with more bad credit. These giant investment banks which are going under because they thought they could take advantage of people who wouldn’t be able to pay their credit card bills are now being saved by congress and the Federal reserve. And how does the Fed bail them out? By borrowing and printing money, which causes inflation and devalues the dollar.

The Fed is opening a line of credit through the American dollar and isn’t providing a deadline in which it’ll pay us back. Instead, congress is giving the IRS permission to survey every credit card transaction Americans make, and expects the IRS to be able to solve our problems. As far as I’m aware, the IRS has created more problems than it has solved. While I do like new laws that protect consumers from being frauded by creditors, the problem isn’t going to be solved by giving the IRS more power and fingerprinting federal employees (yep, that’s in the new “Housing” Bill too).

At some point, we’re going to have to realize that more protectionism and spending isn’t going to fix problems caused by bad credit. Consumers need to realize that there’s no such thing as free credit. Investing in yourself (or in your future self, as it were) is risky just like investing in the stock market. If a market fails, or if you can’t pay their credit card bills, the government taking care of your investments is only going to create weaker markets, untrustworthy consumers and a weak economy.

A poor economy will only be fixed in the long term by tightening your belt, cutting out luxuries, saving money, and making safe investment decisions. The beauty of the free market is that while companies may go under from time to time, that will ultimately strengthen the economy because it is the weak ones that are going under.

You wouldn’t buy stock in a company that’s about to declare bankrupcy, so why should the government weaken the dollar in order to do the same?

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