no third solution

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Exploiting Ignorance: Money for Nothing

July 24th, 2008

This post is the tentative conclusion to a series of posts, loosely about the sorts of pseudo-scams that credit card companies use to keep borrowers in debt, which series began as a response to an article I read in Business Week. After all, the fact that most credit card debt collection is an outright scam, is both the tip of the iceberg, and the roundabout culmination of a business practice based on exploitation.

The process by which banks create money is so simple that the mind is repelled. – J.K. Galbraith

The scams are, in no particular order of importance (since they all feed off of, and enable one another):

A brief review is in order: when borrowers default on a credit card contract, arbitration is generally foisted upon the debtor, by the creditor. The credit card companies are able to game the informational asymmetry they acquire over the course of many proceedings, to exclude arbitrators who show any tendency towards siding with the debtor.

Lurking below the surface, are the pseudo-scams that are used to keep borrowers in debt. Credit card companies routinely apply payments towards the principle bearing the lowest interest rate first, in an effort to create negative-amortization, and so as to collect more unearned interest payments. They offer low-interest balance transfers in an attempt to create such a negative-amortization situation, especially to their most-worthy customers (who are not otherwise profitable for them). Often, a single late payment causes interest rates on all debts (sometimes even on other credit cards underwritten by the same company) to rise to usurious heights.

Most people do everything they can to stave off default until it is the only available option. At this point in time, they have probably had use of their card(s) suspended for several months, they’ve accumulated mountains of spurious fees, and excessive interest charges. This phantom debt is then presented to an arbitrator who is, for all intents and purposes, chosen by the creditor, and used as the starting point for default negotiations, liens or encumbrances to be filed against real property, structured repayment agreements, and so on.

The circle is complete.

Some people might posit that consumers should make more prudent decisions, but when every lender is in-fact a loan-shark, and the monetary system is a scam that destroys the value of savings, decisions are often made that would otherwise be deemed imprudent. Capitalmarkets are profoundly distorted by legislation and monetary policy, as a result institutions are able to “loan” money at teaser rates which no honest man could bear.

If everyone paid off their balance in full each month, credit card companies would quickly go out of business, because there are few things less profitable than giving out perpetually interest-free revolvers.

Credit card companies are, as a matter of fact incapable of profiting from responsible borrowers. It is impossible to profit from these borrowers, because it’s impossible to charge them. It’s impossible to charge them, because all credit card companies have the legal privilege of creating debt obligations from thin fucking air. If one credit card issuer wanted to issue 30-day notes payable, they would quickly be undercut by another issuer who wrote the same obligations at a lower interest rate, and so on. The result is that none of the companies are capable of charging these customers anything.

The credit card companies’ modus operandi, is to figure out new and creative ways to get people to violate some obtuse term in a contract of adhesion, such that they can then charge whatever they’d like. Precisely, the problem is that they don’t want you to pay off your “loan” every month. They want you, indeed, they need you to carry a balance. So they come up with neat little ways of trying to prevent you from paying off your balance. E.g., a “zero-interest balance transfer” is worthless, if you’re already carrying a balance – even a small one that you intend to pay off.

They prey primarily on financial ignorance, and although there is certainly some culpability on behalf of debtors, the primary reason for any of these situations is a political environment that encourages the creation of ex nihilo, no-interest debt obligations, and a legal environment that tolerates same.

Loans, or the extension of personal lines, always entails the lender’s sacrifice of present consumption in order to enjoy a greater future consumption. The “debt” embodied on a credit card statement is not, in any meaningful way, tied to any distinct amount of real, accumulated wealth. Nobody has lost anything when the borrower defaults, on the contrary, whosoever he purchased goods from has already received and has likely spent the money that was created out of nothing.

Fiat credit is NOT a loan for which anyone has put up any amount of collateral; it is a fiction and a fraud.

Comments on Comments #19

July 1st, 2008

Joe McHugh left a comment on McCainomics:

All good points, but your article ironically assumes that the gov’t will somehow be efficient with that $300m if it’s not spent on his little contest. We both know, that’s simply not the case.

I made no implications to that effect. I assume, as per usual, that if the people weren’t robbed of their $300M, everyone would be better off. The point is that politicians shouldn’t have the power to use money they took from you, against your will, and use it to bribe people to build things that they want to see built. When, (not “if”) there is a $300M profitable investment to be made in alternative energy, people will make that investment. In fact, people will start making those investments even though some of them will fail.

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Someone submitted one of my old posts about a man who was evicted from his homestead to reddit. I have no idea how sites like that work, and I don’t spend any time trying to get play there. Maybe I should: This post was the source of a considerable, one-time traffic spike. Like a 400% traffic spike. If you like my blog, submit posts to reddit, my blog is only as effective as the number of people who read it.

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Will celebrates the five year anniversary of his blog and notes that Bob Murphy’s Chaos Theory was instrumental in his intellectual development. I read Chaos Theory in early 2006, and it was the breaking point, beginning a phase shift that would take me away from the Randian, capitalist brand of libertarianism, to something much better.

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In Reader Mail #57 FSK notes that I missed several big points in my chain about Credit Card Scams, the most recent installment of which is Part IV: The Penalty Rate Scam.

David Z missed a big point. A credit card debt contract is a no interest contract. When you borrow via a credit card, the bank literally prints new money and loans it to you…

David Z missed another big point. Bankruptcy law was recently changed. It is much harder to discharge credit card debt in bankruptcy court…

Regarding the bankruptcy code, early this month, I wrote A Few Thoughts on the Credit Situation, mostly as a note to myself so that I would not forget for future purposes to reference it.

It is convenient that immediately preceding the current credit-crunch, a few notable things happened. The bankruptcy code was changed, and the laws surrounding the payment structure for unsecured debt were changed, which resulted in minimum payments that are about twice what they previously were. Shortly thereafter, the Federal Reserve began targeting higher short term rates (the discount rate) which results in contraction of the monetary base, and a diminution of the supply of loanable funds. If you were a politically connected banking insider, you probably knew all about these turns of events before they happened, and were able to profit immensely.

Despite my best intentions, it seems I forgot, anyways. My post on credit card scams omits this detail. I could backtrack and say that it wasn’t topical, since the bankruptcy code isn’t one of the scams (like trying to force people into negative-amortization debts) that they use, but it is relevant and I should’ve mentioned it.

I didn’t miss the first point, either, I just haven’t gotten there yet. I’m covering credit card scams one at a time. The ideas of ex nihilo currency has been mentioned in several of my gold-bugging posts in the past, the relationship between our current financial institutions, debt and no-interest contracts are forthcoming in the series’ conclusion.

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Hans Hoppe has practically made a career out of deconstructing the Hobbesian myth, the alleged “war of all against all” that most people envision as life without a government. His latest:

There is no way out of this predicament [the Hobbesian War] by means of agreements; for who would enforce these agreements? Whenever the situation appeared advantageous, one or both parties would break the agreement. Hence, people recognize that there is but one solution…the establishment, per agreement, of a state, i.e., a third, independent party as ultimate judge and enforcer.

Yet if this thesis is correct and agreements require an outside enforcer to make them binding, then a state-by-agreement can never come into existence.

Thanks to Stef at Democracy Sucks

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Regarding Heller (my opinion, here) and the presidential candidates’ statements in response thereto, Chris at The Liberty Papers concludes:

So either play the game by the rules, don’t play the game, or change the rules.

I have a couple questions, Chris:

What does that even mean?
What?

Don’t you see the problem inherent in this empty rhetoric? You’ve presented three options from which to choose, when in-fact, only one of them is actually possible. There’s no choice. Not playing the game is simply not an option. I don’t want to play the game, but I have to. I can’t change the rules so I play by them. Just because you chide me not to “play the game” doesn’t mean that it’s actually an option. That’s the damn problem, Chris!

Credit Card Scams Part IV: The Penalty Rate Scam

June 20th, 2008

Among the other scams perpetrated by credit card issuers, the Penalty Rate Scam is equally nefarious. All of the scams implemented by credit card issuers work in lock-step with at least one of the other scams.

Under the terms of most (all?) credit card use agreements, the borrower accepts a default of Penalty Rate which goes in to effect in the event that borrower is late in remitting a single payment. The Penalty Rate is usually the maximum allowed by law, and often in excess of 24%. I have seen or heard of Penalty Rates as high as 29.99% but I suspect that in some jurisdictions they might be even higher.

It could be argued that there is justification for the Penalty Rate, as borrowers who are late or miss a payment are greater default risks. This very well may be true, but suffers from some variant of the post hoc, ergo propter hoc logical fallacy.

Borrower misses a payment
…
Borrower defaults

Did you see what happened there? They intentionally left out the interim step; the one where the borrower’s rate jumps from 9% to 25%, doubling or tripling the interest portion of the monthly payment!

This causes a negative feedback loop: If someone is diligently trying to pay down a credit card balance, paying $300 each month when the minimum payment was $150, the new, penalty minimum payment amount will be approximately $300. This effectively relegates the borrower to making interest-only payments (i.e., no amortization, whatsoever) for the duration which the Penalty Rate is in effect. This may be for a period of six months or longer. During this time, the borrower may continue to make payments in the amount which his or her budget permits, but is unable to reduce his balance in any meaningful manner.

The ability to repay or to pay down the balance is without a doubt negatively impacted by the imposition of a Penalty Rate.

I submit that the Penalty Rate, by itself might be sufficient cause for a large proportion of defaults. Before objecting, think on the margin: any borrower who was scraping by, is now unable to scrape by. These borrowers who would’ve been OK, had they tightened their belt, are now forced into default by the new, higher interest rate. Theory dictates that the Penalty Rate is indisputably a prime contributing factor to default.

When analyzing data through extrapolated variables, there will always be an unusually strong correlation between the new variable, and the definitional components thereof. It is of paramount importance to avoid making value judgments or inferring causal relationships under such circumstances. There may well be a causal relation between a single missed payment and default, but the noise-to-signal ratio here is about a billion to one. Since the Penalty Rate has a 1:1 correlation with default (by definition, default always occurs after the imposition of the Penalty Rate) there is simply no way to know what the true default rate would be if the penalty were less onerous.

Under more proper loan provisions, there is usually a penalty for late payment, but it is almost never usurious (frequent readers of this blog will recognize that I rarely use this term, and then only carefully). Credit card companies seem to do everything they can to encourage default.

The Penalty Rate works in tandem with the Debt Collection Scam: interest and penalties pile up in order that the lender can claim a larger debt than would otherwise be due. This new debt bears no relationship whatsoever to any anticipated return on investment primarily because there was never any investment to begin with. The higher debt, now in default, is the starting point for any negotiations, arbitrations or legal action. In essence, the creditor creates phantom debt which is treated by the courts and by corrupt arbitrators as valid. This is not about earning a fair return on borrowed money, it’s about exploiting people’s ignorance and subsidizing interest-free loans to people who don’t need them, none of which would be possible in a free market where debt couldn’t be created out of thin air.