2008-10-20

Subprime mortgage vs. loan sharks

At the end of an otherwise fine article comparing loan sharking to subprime lending, Mark Gimein makes a doo-doo.

The core of Mark's article explains how loan sharking is not as profitable as you might think. Advance America charges $17.50 as its fee on a two-week $100 advance. If that were an annual interest rate, it would be 450+%. However, a huge proportion of borrowers default on their loans: the defaults work out to $49 per customer, while the average loan is $366. Advance America loses most of its fees to those who fail to repay their advances.

Then, Mark Gimein waltzes off into fantasy world and makes the following conclusion:
We've yet to see what lesson lenders draw from the subprime debacle. One possibility is that they will conclude that they need to stay away from any but the safest borrowers at all costs-that seems to be the direction they're heading in. And it's likely to be bad news for the economy. That'll mean less credit for those at the bottom and higher rates for everyone else. Another possibility, however, is that lenders will be very careful about raising rates in the hope that borrowers will be more likely to repay more affordable loans. Then they will run less risk of crossing what looks like the "fairness threshold" at which borrowers throw up their hands and give up. They might conclude, in other words, that they want to stay as far away from the payday-loan/sky-high-rate model as they can. That would take a little bit of rethinking of interest rates and risk from the credit industry. But then, it sure feels like this is a good time for some rethinking, doesn't it?
In his next article, I suggest that Mark could explain how rain is associated with umbrella use, so if everyone just left their umbrellas at home, it would stop raining.

The thing with risky borrowers is, they don't become less risky if you just charge them lower interest rates. If that were the case, the government could just give everyone free money, charge no interest rate, and count on 100% repayment. Who needs banks, eh?

It doesn't work that way.

The former of Mark's predictions is realistic and will come true. There will be less credit. Especially for people who cannot be relied on to repay.

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