Credit Cards, Bombs and Politics | Talking Points Memo

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The Center for American Progress put on a conference today on debt. Terrific people, terrific presentations. Over the next couple of days, I’ll write about a couple of them. But I want to start with the most amazing part: a new survey that should turn the head of every politician in America.

This is a companion discussion topic for the original entry at https://talkingpointsmemo.com/?p=1250349
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OK. I’m going to be near the top of the comments here so I’m hoping people will accept the explanation below as fact derived from courses I took at The Wharton School (yes, where Trump went) and how debt and interest rates really work.

When someone takes on a debt, they can use that to finance a long-term purchase such as a house or car, for which they don’t have cash to complete the transaction, or as a convenience for a shorter-term purchase such as clothing or gifts for the holidays. Both are reasonable actions based on the good faith promises to repay the debt to the lender the full amount, plus any interest the borrower has agreed to pay to the lender under contract. This is true of an individual, corporation or government.

The interest rate the person agrees to pay is the result of competitive commerce between the pool of lenders – those with excess funds – and borrowers – those in need of funds. In general, the less confidence a lender has in the borrowers ability to repay, the shorter the term of the loan, the collateralization of the loan (that is, the assets the borrower pledges to use to repay the loan amount and interest), and the market power balance between the lender and borrower determines the interest rate the borrower will agree to pay.

Hence, the interest rate is composed of FOUR parts:

  1. The risk the lender assesses for the likelihood that the borrower will be unable to pay the loan and any accumulated interest. This is known as default risk.
  2. The risk the lender assesses for the likelihood that inflation will result in the borrower paying back the loan and interest with cheaper money due to inflation, aka inflation risk.
  3. The costs associated with the lender servicing the loan, including paperwork, sending statements, processing payments, etc. This is known as expense premium.
  4. The profit the lender requires to actually loan the funds to the borrower, as the value they provide to the borrower in providing the funds. This is known as the real interest rate.

Taken together, these four components produce the nominal interest rate that banks and credit cards quote to borrowers.

When inflation is low and steady, inflationary risk is also low. Default risk depends on a lot of factors, but it’s the reason that when wealthy people borrow they get preferred rates. When the government in all its forms is borrowing lots of money, that raises the real interest rate – giving people with extra money even more benefit for making the loan – and anyone else competing with governments for that money pays more.

The result of huge national and other public debt is that the rich get richer and the poor get poorer with every mortgage, car, credit card and other private debt that happens. So called “individual responsibility” can’t do anything about the real interest rate, which is what has perpetuated the wealth gap.