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Dr. Kalinda Rose Stevenson
The Lending Game Gone Bad: The Money Reason Why Banks And Corporate Giants Are In Trouble
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One of the factors creating turmoil in the economy is the blurring of financial roles.
In the Monopoly Game®, the rules are clear. The players have a clear set of rules, which determine what they can and cannot do with money. The banker also has a clear set of rules, which allows the banker to use money differently than the players do.
This distinction between the money rules for players and the money rules for bankers is a critical element in No Money Limits.
In the real economic world, we have experienced significant blurring of roles among various institutions, as the rules have changed and evolved over time.
Banks are a prime example. It used to be that the lines between different types of banks were clearly defined. In broadest terms, commercial banks served businesses, thrifts served consumers by taking deposits and originating home mortgages, and investment banks help businesses acquire capital. In recent years, through a series of legal changes, these lines have become so blurred that most of us have only the vaguest idea of the difference between various types of banks.
During the same period of time, there has also been significant blurring of the lines between bankers, non-banking companies, and private lenders related to lending.
One particular example concerns large companies that have become both sellers and lenders.
Analysts point to two key reasons why some of the nation’s largest companies have unraveled in the current downturn. One is that they had come to rely on providing financing to their customers, lending money for sales of their own products. When the credit markets ground to a halt in mid-September, it set off chain reaction of pain, hurting consumers and manufacturers alike. Corporate America’s Giants Crumbling
As we analyze what went wrong with the economy, to lead us to this state of economic crisis, one theme keeps recurring. The economic crisis originated with lending practices gone bad.
Lending money can be extremely profitable. To get in on the profits, various types of banks kept expanding their services and their capacity to make loans. At the same time, big corporations realized that they could increase their profits if they became lenders for consumers who wanted to buy their products.
In the process, bankers made risky mortgages to people who could never repay them, because the lending process itself was highly profitable. Meanwhile, big companies set up their own lending divisions. Instead of sending car buyers to the bank to get car loans, why not provide financing directly to your customers? As a result, a company such as General Motors became both the maker of cars and financer of cars through its financing arm, GMAC.
In retrospect, [Ed] Yardeni said, the business model was essentially flawed. When companies like GM and GE financed customers, the loans must have been cheaper than what the customers could get elsewhere and must have meant that the risk of lending to them wasn’t being reflected in the loan rates. Corporate America’s Giants Crumbling
Self-financing by big companies led to the same trap that ensnared the banks that got caught up in making subprime mortgages.
“Self-financing is inherently a dangerous game,” Yardeni said. “You’re biased. You want to convince yourself that the borrower is good for it, and you want to make the sale. You’re not going to be an objective lender. That may be one of the problems here.” Corporate America’s Giants Crumbling
The driving force behind the expansion of their traditional roles—both for banks and large companies involved in self-financing—is the intention to create profit by increasing transactions. This is the essential goal of any business.
Ultimately, the nature of money made all of this possible. Money is not a commodity in limited supply. Money is created in transactions. By creating more transactions, banks and self-financing companies could make more money. The more transactions they made, the more money they would make.
The primary insight of No Money Limits is that the only limit to money is the belief that money is limited. What we are seeing in the current economic crisis is the result of people who took this insight too far.
In the desire to increase profits, banks and self-financing companies made more and more bad loans, throwing prudent lending practices out of the window, until the whole financial structure teetered on the edge of collapse.
Dr. Kalinda Rose Stevenson
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