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Friday, January 20, 2012

A tale for children

Imagine a very large farm with a large family living and working there. The family makes a satisfactory living.

A bank comes along and offers the family cheap credit. The family figures that if they take the credit, they need to work a lot less and can still afford the same standard of living. They could even increase their standard of living. So, they take the credit and start spending money on other things than the ones they really need. And they work a lot less.

The family does all of its buying at a shopping mall which belongs to the bank.

One day, the bank informs the family that they have reached their credit limit. After long discussions, the bank agrees to extend further credit. It obviously helped that the shopping mall intervened on the part of the family because they didn't want to lose their business.

What should the bank have done instead? The bank should have told the family that they had to start running their farm again. The family might have said that they no longer had the tools and know-how for it in which case the bank should have made a loan, but only for that purpose.

So the family could again run the farm and support its own living standard. There are only 2 problems: the living standard is much lower and, then, there is still this debt which had been accumulated.

Again, the bank could play a meaningful role. It could "brainstorm" with the family how they could raise additional money. Perhaps a couple of the family members could get a job outside the farm. Perhaps they could rent some of the farm to tourists. Perhaps they could even sell some of the property.

One way or another, the family would have to understand again that they needed to work hard and smart enough to generate enough income to support their standard of living and to service their debt.

Who would lose if the family had to reduce their standard of living? You guessed right --- the shopping mall!

1 comment:

  1. Cheap credit: how did this come about? Why was credit so cheap to people that were not, rightly speaking, credit worthy. My ancestry comes from a long line of farmers and I know the sort of living standards they had - and despite hard work, not much income.

    This cheap credit raises serious questions in my mind - especially given the analagous position of the European periphery. (1) Why was it considered right and proper by the agencies to consider Greece AAA. I am not interested in their reasonings which I consider baloney.

    (2) Where was the ECB in all this? It's absence from the watch is either collusion or incompetence.

    (3) What were the banks thinking of?? You did tell the tale of a young German banker, but surely people like him that are in a responsible position should take more care. When I helped run the family firm it was often the case that our best (self employed) guys would need a helping hand at the end of the month. Usually they were owed money from businesses paying six weeks in arrears or some such. It was a useful quid pro quo that whilst costing us little kept them faithful to our cause (and we paid better too - I saw to that!!*)(*20% better productivity and quality for 10% extra pay? A v. good deal, and everyone was happy).

    To my mind there is a lot of muddled thinking going on in the big businesses.

    I would like to add that this business of GS steering the herd only to pull back at the last moment to me is wholly immoral: it is the sort of market manipulation I despise. It epitomizes the cancers at the heart of our so-called "free markets".

    There are ways to run a market where everyone gets to go home happier, seller and buyer alike.

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