FUNDAMENTAL TRUTH #82: “Too much debt is always a bad thing.” – Old Pithy

Posted by PITHOCRATES - September 6th, 2011

Paying Interest on Interest makes Credit Card Balances Soar

Some of us have been there.  Some of us are there now.  And hopefully some will learn this painful lesson without ever having to be there.  I’m talking about those seductive credit sirensCredit cards.  Who lure us with their access to a life we cannot yet afford.  Only to destroy us when we’re fully within their grasp.

For those who have lived it, I apologize for evoking the spirits of memories past.  For those feeling the full weight of despair and hopelessness now, hang in there.  You’ll get through.  It may be painful.  But time will mitigate that pain.  Just think of a point in time past the painful times.  Where it will be better.

It happens before we realize it.  You’re charging a little each month.  It doesn’t seem like a lot.  But it adds up.  Worse, the interest really adds up.  For two reasons.  High interest rates.  And because that interest is rolled into your outstanding balance.  So you’re paying interest on interest.  Which makes those balances soar.

The Credit Card Companies have High Interest Rates because it’s Unsecured Credit

The easiest way to look at this is with numbers.  So let’s do that.  Let’s look at a 5 year period.  Each year say you charge $6,000.  That’s $500 each month.  Or about $115 per week.  Charge a couple of dinners and you’re almost there already.  Buy some clothes.  Buy a round of drinks after work.  Say you buy a TV during the year.  Or some other toy.  Like a tablet PC.  Or charge a vacation.  It will add up faster than you ever thought possible.  Things are good at first.  Sure, you’re running a little deficit.  But you’re able to do things or have things you otherwise couldn’t.  Besides, it’s not that much really.  And you can stop at any time.

But it’s that interest that will get you.  Say your card has an APR of 29%.  That’s a huge rate.  Why is it so high?  Because it’s unsecured credit. When you get a mortgage and you default on your payments, the bank gets your house.  The credit card companies have no such claim.  All they have is your promise to pay them back.  And a lot don’t.  Hence the high APR.  To pay for those who don’t repay what they borrow.

Let’s assume your minimum monthly payment is a consistent 5% of your outstanding balance.  For simplicity, we’ll calculate interest on the beginning balance plus the new charges for that year.  That 5 year period looks something like this:

High Credit Card Balances require Austerity, Spending Cuts and a Second Job

In these 5 years you charge $30,000.  But your outstanding balance is almost twice that.  Because of paying interest on interest.  This is what really makes that monthly payment increase.  Which wasn’t too bad in the first year or so.  But by the third year you’re feeling it.  You’re finding it difficult to pay all your bills.  By the fourth year you’re struggling to make your house payment.  By the fifth year the collection agencies are calling you.

So you cut up your credit cards.  And start an austerity program.  Cut spending.  No more cable.  Cell phone.  Maybe take a part-time job.  You think you stopped the bleeding at least.  Now it’s just a matter of paying down that balance.  But it isn’t quite like that.  Because you’re still paying interest on interest.  So even though you’re not charging anymore, your balance is still increasing.  Only worse now.  So let’s take a look at the next 5 years.

That second job you took to help pay down this balance can’t stop it from growing.  Even with no new additional charges.  And that monthly payment just continues to grow.  It’s a losing battle.  However hard you try your balance and monthly payment continue to grow.  To unsustainable levels.

High Credit Card Balances makes Real Income Decline

Let’s say at the beginning of this 10 year period you earn $30,000.  And each year you get a 3% raise.  Enough to keep you ahead of inflation.  With a little left over.  During good economic times, at least.  Now let’s look at a simple graph.  Showing your income.  And your income less your credit card payments.  For this 10 year period.

Your income may have steady growth, but it’s all going to the credit cards.  While income rises 3% your ‘net’ income is flat.  Factor in inflation and this is a decline in real income.  Makes it hard to raise a family.  When your costs go up.  But your income doesn’t.  And it’s far worse than this graph indicates.

Credit Card Balances tend to Increase at a Rate greater than your Income

You may be stressing to just pay your bills.  Which is harder to do each year because of that growing credit card balance.  And nothing will get better until that balance goes down.  But that’s easier said than done.  Because of paying interest on interest.  You may run to get ahead of this increasing balance.  But it’s a race you will lose.  Because that balance will increase at a far greater rate than your income.  As shown here:

After the fifth year your options are limited.  Severe austerity won’t help.  A part time job won’t help.  The numbers are by then just too big.  If you’re married and have a grandparent that can provide free child care, two full-time incomes may help.  Provided your spouse has high income potential.

But chances are you won’t get this far in the graph.  Your credit will probably be shot by the fifth or sixth year.  The collections agencies will be telling you to sell your assets (tools, cars, wedding wings, etc.).  That won’t be pleasant.  But there is some light at this end of the tunnel.  Once they throw you to collections, there should be no more interest charges.  So your credit will be shot.  But you’ll at least be paying down a falling balance.

Living beyond your Means leads to Austerity then Bankruptcy

Credit cards are convenient.  But you should use them as cash.  Pay them off in full every month.  Because living beyond your means will only saddle you with debt.  And too much debt is always a bad thing.  The bigger the debt the more of your money goes to paying the interest on that debt.  Leaving less for the things you currently enjoy.  That you will have to give up so you can pay that interest.

And if your debt grows past the point of no return bankruptcy may be your only option.  And everything bad that comes with it.  A bad credit rating.  Making it more difficult to buy a car.  Or a house.  Even getting a store credit card so you can buy your kid a computer for school.  Something you could afford in 6 monthly payments.  In one of those 6 months same as cash offers.  But not cash out of pocket.

It is inevitable.  When it comes to living beyond your means.  Austerity.  Then bankruptcy.  Unless you’re the government.  And can simply print money.  But that can only postpone the inevitable.  And the longer you postpone the inevitable, the more painful the inevitable will be.  Whether you’re an individual.  Or a government.


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LESSONS LEARNED #28: “Politicians love failure because no one ever asked government to fix something that was working.” -Old Pithy

Posted by PITHOCRATES - August 26th, 2010

THE TELEVISION SHOW Gomer Pyle, U.S.M.C. aired from 1964-1969.  It was a spinoff from the Andy Griffith Show.  Gomer, a naive country bumpkin who worked at Wally’s filling station, joined the Marines Corps.  And there was much mirth and merriment.  To the chagrin of Sergeant Carter, Pyle’s drill instructor (DI).  Think of Gunny Sergeant R. Lee Ermey’s Sergeant Hartman in the movie Full Metal Jacket only with no profanity or mature subject matter.  Sergeant Carter was a tough DI like Sergeant Hartman.  But more suitable for the family hour on prime time television.

Gunny sergeants are tough as nails.  And good leaders.  They take pride in this.  But sometimes a gunny starts to feel that he’s not himself anymore.  This was the subject of an episode.  And Gomer, seeing that Sergeant Carter was feeling down, wanted to help.  So he stuffed Sergeant Carter’s backpack with hay before a long march.  While the platoon was worn and tired, Sergeant Carter was not.  He was feeling good.  Like his old self.  Until he found out he was not carrying the same load his men were.  He asked Pyle, “why hay?”  He could understand rocks, but hay?  Because if he outlasted his men while carrying a heavier load, he would feel strong.  But knowing he had carried a lighter load only made him feel weak.

This is human nature.  People take pride in their achievements.  They don’t take pride in any achievement attained by an unfair advantage.  Self-esteem matters.  And you can’t feel good about yourself if you need help to do what others can do without help. 

AN OLD CHINESE proverb goes, “Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.”  Let’s say I am a fisherman in a small village.  I catch fish to feed my family and sell/trade for other family needs.  There’s a man in my village who asks me for a fish each day so he can eat.  I’m a caring person.  So I give him a fish each day.  So a pattern develops.  Each day he shows up when I come in from my fishing.  He takes the fish and goes away.  It works out well for him.  He doesn’t have to work.  He can live off of my kind charity.  Then I move.  Without me being there to give him a fish each day, he no longer can eat.  And dies.  If I only had taught that man to fish. 

Kindness can lead to dependency.  And once dependent, you become lazy.  Why develop marketable skills to provide for yourself when someone else will provide for you?  The problem is, of course, what happens when that charity ends?  If you’re unable to provide for yourself and there is no longer someone providing for you, what do you do?  Steal?

Dependency and a lack of self-esteem are a dangerous combination.  And they feed off of each other.  This combination can lead to depression.  Behavioral problems.  Resentment.  Bitterness.  Envy.  Or a defeatist attitude.

These are often unintended consequences of government programs.  A failed program, then, has far reaching consequences beyond the initial economic costs of a program.

LIQUIDITY CRISES CAUSE a lot of economic damage.  If capital is not available for businesses to borrow, businesses can’t grow.  Or create jobs.  And we need jobs.  People have to work.  To support themselves.  And to pay taxes to fund the government.  So everyone is in favor of businesses growing to create jobs.  We all would like to see money being easy and cheap to borrow if it creates jobs.

But there is a downside to easy money.  Inflation.  Too much borrowing can create inflation.  By increasing the money supply (via fractional reserve banking).  More money means higher prices.  Because each additional dollar is worth a little less. This can lead to overvalued assets as prices are ‘bid’ up with less valuable dollars.  And higher prices can inflate business profits.  Looks good on paper.  But too much of this creates a bubble.  Because those high asset values and business profits are not real.  They’re inflated.  Like a bubble.  And just as fragile.  When bubbles burst, asset values and business profits drop.  To real values.  People are no longer ‘bidding’ up prices.  They stop buying until they think prices have sunk to their lowest.  We call this deflation.  A little bit of inflation or deflation is normal.  Too much can be painful economically.  Like in the Panic of 1907.

Without going into details, there was a speculative bubble that burst in 1907.  This led to a liquidity crisis as banks failed.  Defaults on loans left banks owing more money than they had (i.e., they became illiquid).  They tried to borrow money and recall loans to restore their liquidity.  Borrowers grew concerned that their bank may fail.  So they withdrew their money.  This compounded the banks problems.  This caused deflation.  Money was unavailable.  Causing bank runs.  And bank failures.  Business failures.  And unemployment grew. So government passed the Federal Reserve Act of 1913 to prevent a crisis like this from ever happening again.  The government gave the Federal Reserve System (the Fed) great powers to tweak the monetary system.  The smartest people at the time had figured out what had gone wrong in 1907.  And they created a system that made it impossible for it to happen again.

The worst liquidity crisis of all time happened from 1929-1933.  It’s part of what we call the Great Depression.  The 1920s had a booming economy.  Real income was rising.  Until the Fed took action.  Concerned that people were borrowing money for speculative purposes (in paper investments instead of labor, plant and material), they put on the brakes.  Made it harder and more expensive to borrow money.  Then a whole series of things happened along the way that turned a recession into a depression.  When people needed money, they made it harder to get it, causing a deflationary spiral.  The Great Depression was the result of bad decisions made by too few men with too much power.  It made a crisis far worse than the one in 1907.  And the Roosevelt administration made good use of this new crisis.  FDR exploded the size of government to respond to the unprecedented crisis they found themselves in.  The New Deal changed America from a nation of limited government to a country where Big Government reigns supreme.

ONE PROGRAM OF the New Deal was Social Security.  Unemployment in the 1930s ran at or above 14%.  This is for one whole decade.  Never before nor since has this happened.  Older workers generally earn more than younger ones.  Their experience commands a higher pay rate.  Which allows them to buy more things.  Resulting in more bills.  Therefore, the Great Depression hit older workers especially hard.  A decade of unemployment would have eaten through any life savings of even the most prudent savers.  And what does this get you?  A great crisis.

The government took a very atypical moment of history and changed the life of every American.  The government forced people to save for retirement.  In a very poor savings plan.  That paid poorly by comparison to private pensions or annuities.  And gave the government control over vast amounts of money.  It was a pervasive program.  They say FDR quipped, “Let them try to undo this.” 

With government taking care of you in retirement, more people stopped providing for themselves.  When they retired, they scrimped by on their ‘fixed’ incomes.  And because Social Security became law before widespread use of birth control and abortion, the actuaries of the day were very optimistic.  They used the birth rate then throughout their projections.  But with birth control and abortion came a huge baby bust.  The bottom fell out of the birth rate.  A baby bust generation followed a baby boom generation.  Actually, all succeeding generations were of the bust kind.  The trend is growing where fewer and fewer people pay for more and more people collecting benefits.  And these people were living longer.  To stay solvent, the system has to raise taxes on those working and reduce benefits on those who are not.  Or raise the retirement age.  All these factors have made it more difficult on our aged population.  Making them working longer than they planned.  Or by making that fixed income grow smaller.

FDR used a crisis to create Social Security.  Now our elderly people are dependent on that system.  It may suck when they compare it to private pensions or annuities, but it may be all they have.  If so, they’ll quake in their shoes anytime anyone mentions reforming Social Security.  Because of this it has become the 3rd rail of politics.  A politician does not touch it lest he or she wishes to die politically.  But it’s not all bad.  For the politician.  Because government forced the elderly to rely on them for their retirement, it has made the Social Security recipient dependent on government.  In particular, the party of government who favors Big Government.  The Democrats.  And with a declining birth rate and growing aged population, this has turned into a large and loyal voting bloc indeed.  Out of fear.

A PROGRAM THAT straddled the New Deal and LBJ’s Great Society was Aid to Families with Dependent Children (AFDC).  Its original New Deal purpose was to help widows take care of their children.  When program outlays peaked in the 1970s, the majority of recipients were unmarried women and divorced women.  Because this was a program based on need, the more need you had the more you got.  Hence more children meant more money.  It also reduced the importance of marriage as the government could replace the support typically provided by a husband/father.  Noted economist Dr. Thomas Sowell blames AFDC as greatly contributing to the breakdown of the black family (which has the highest incidence of single-parent households).

With the women’s liberation movement, women have come to depend less on men.  Some affluent women conceive and raise children without a husband.  Or they adopt.  And the affluent no doubt can provide all the material needs their children will ever need.  Without a husband.  Or a father for their children.  But is that enough?

The existence of ‘big brother’ programs would appear to prove otherwise.  Troubled children are often the products of broken families.  Mothers search for big brothers to mentor these fatherless sons.  To be role models.  To show an interest in these children’s lives.  To care.  When no such role models are available, some of these troubled children turn to other sources of acceptance and guidance.  Like gangs.

AFDC has compounded this problem by providing the environment that fosters fatherless children.  And another government program compounds that problem.  Public housing.

POOR HOUSING CONDITIONS hurt families.  They especially hurt broken families.  Without a working husband, these families are destined to live in the cheapest housing available.  These are often in the worst of neighborhoods.  This is an unfair advantage to the children raised in those families.  For it wasn’t their fault they were born into those conditions.  So, to solve that problem, government would build good public housing for these poorest of the poor to move into.  Problem solved.

Well, not exactly.  Public housing concentrates these broken families together.  Usually in large apartment buildings.  This, then, concentrates large numbers of troubled children together.  So, instead of having these children dispersed in a community, public housing gathers them together.  Where bad behavior reinforces bad behavior.  It becomes the rule, not the exception.  Making a mother’s job that much more difficult.  And because these children live together, they also go to school together.  And this extends the bad behavior problem to the school.  Is it any wonder that public housing (i.e., the projects) have the worst living conditions?  And some of the highest gang activity? 

Government didn’t plan it this way.  It’s just the unintended consequences of their actions.  And those consequences are devastating.  To the poor in general.  To the black family in particular.  AFDC and public housing enabled irresponsible/bad behavior.  That behavior destroyed families.  As well as a generation or two.  But it wasn’t all bad.  For the politicians.  It made a very large constituency dependent on government.

THERE ARE SO many more examples.  But the story is almost always the same.  Dependency and a lack of self-esteem will beat down a person’s will.  Like an addict, it will make the dependent accept poorer and poorer living standards in exchange for their fix of dependency.  Eventually, the dependency will reach the point where they will not know how to provide for themselves.  The dependency will become permanent.  As will the lack of self-esteem.  Conscious or not of their actions, Big Government benefits from the wretched state they give these constituencies.  With no choice but continued dependence, they vote for the party that promises to give the most.  Which is typically the Democrat Party.

But how can you fault these politicians?  They acted with the best of intentions.  And they can fix these new problems.  They’ll gather the brightest minds.  They’ll study these problems.  And they will produce the best programs to solve these problems.  All it will take is more government spending.  And how can you refuse?  When people are hungry.  Or homeless.  Or have children that they can’t care for.  How can anyone not want to help the children?  How can anyone not have compassion?

Well, compassion is one thing.  When the innocent suffer.  But when government manufactures that suffering, it’s a different story.  Planned or not the result is the same whenever government tries to fix things.  The cost is high.  The solution is typically worse than the original problem.  And the poorest of the poor are pawns.  To be used by Big Government in the name of compassion. 

Of course, if Big Government were successful in fixing these problems, they would fix themselves right out of existence.  So as long as they want to run Big Government programs, they’ll need a stock of wretched, suffering masses that need their help.  And, of course, lots of crises.


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