The New York Times recently ran an article titled “Given a Shovel, Americans Dig Deeper Into Debt.”[1]
While the article raises a variety of issues regarding the proper use of debt and individual responsibility, here is the paragraph that stuck out to me:
“But with so many borrowers in trouble, some bankruptcy experts and regulators are beginning to focus on the responsibilities of lenders, like requiring them to make loans only if they are suitable to the borrowers applying for them. ”
Any private lender that has to be required by regulators to make good loans would, in the real world, go out of business overnight.
Why do ”bad lenders” make loans without taking the ability of the borrower to repay when earning a profit depends on it?
Bailouts.
Failure in business is not a crime but it is plenty painful.
Normally that fear of pain ensures that lenders will only give money to people that can pay them back.
Their survival depends on it.
But if lenders start to believe, with even a modicum of probability, that they won’t have to pay for the costs of bad business choices and get to keep the benefits of good ones, they, and rightly so, stop worrying about the distinction between good and bad loans and lend to anyone with a pulse.
Why shouldn’t they if they can count on the American taxpayer to pay for their mistakes?
Note to regulators: if you want lenders to act rationally and make good loans quit bailing them out and let a couple fail.
It’s one thing to “lend freely on good security” to stem panic as Walter Bagehot famously recommended.
Quite another to lend freely in the hope of making bad lenders go good.
