Americans racking up credit card debt like it's 2007! (Sears, visa, mortgages)
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Obviously, you don't understand the concept of using leverage.
Let's say, I have a really solid business plan that I realistically think can generate 10% ROI, but I don't have any money. I borrow money at 5% and make my idea work. Why do you think major corporations have debt? Because the opportunity cost of missing those opportunities often is higher than the debt service. Why not use equity financing? Because debt financing is locked in at a known rate...whereas equity costs can be variable depending on how good my idea is...and my debt is tax deductible.
Or I'm a student...I borrow money to become a CPA and then make stable income for decades...I would have never had the cash to pay for school upfront.
Or I own 3 rental properties...but I want to expand that to 10.
Let's say I have $5,000 cash. I also have $5,000 of credit card debt on an 18 month no interest card. Do I pay the debt off to be debt free? Or do I keep my cash to offer financial flexibility AND also keep the non-interest debt? In other words, I now have access to $10,000. Now I can pay other debts off that are carrying an interest rate. I'm earning cash back rewards. I have financial flexibility. I do this indefinitely to manage cash flow.
"Credit has done a thousand times more to enrich mankind than all the gold mines in the world. It has exalted labor, stimulated manufacture, and pushed commerce over every sea."
Actually you are mistaken. Rational corporations do not have debt due to some return arbitrage associated with leverage - this is debunked by the Modigliani-Miller theorem. The reason they have debt is to reduce frictions associated with selling and repurchasing equity. The tax code also favors debt.
Not to argue with you, but why, then, is there such a movement to make people not use credit, drive an old car, stay in their homes, not go into debt for college, etc, etc, etc? Guys like Dave Ramsey just swear by it. If we all took Dave's advice, would the US economy crumble into the dirt? what's the balance between what is healthy for a household to have on it's books as debt, and at what age do you turn off the debt incurrence by a household?
I ask these questions because our country seems to preach spend spend spend, but at the same time our political leaders and heads of state preach personal responsibility. Thoughts?
If everyone suddenly started following his advice, a significant recession would result. However, if it happened gradually, say over 30-50 years, it is entirely possible to smoothly transition from a debt-based economy to an equity-based economy without too much trouble. However, frictions would be tremendous. Instead of getting a small business line of credit at the bank, the small business would have to lure in investors and then buy them back out. Can you imagine just how enormous the overhead would be for businesses with a large seasonal dependence (such as agriculture, water parks, skiing, vacation rentals, Christmas-item-heavy retail outlets, etc.)? Get more investors every year?
It would have been Daniel Webster who was mistaken then.
Quote:
Originally Posted by ncole1
Rational corporations do not have debt due to some return arbitrage associated with leverage - this is debunked by the Modigliani-Miller theorem.
M-M states that in a world with taxes where interest on debt is tax-deductible, the worth of a company will increase in proportion with its use of debt.
Quote:
Originally Posted by ncole1
The reason they have debt is to reduce frictions associated with selling and repurchasing equity. The tax code also favors debt.
It would have been Daniel Webster who was mistaken then.
ok...
Quote:
Originally Posted by Pub-911
M-M states that in a world with taxes where interest on debt is tax-deductible, the worth of a company will increase in proportion with its use of debt.
If there are no other costs associated with debt, yes.
Quote:
Originally Posted by Pub-911
In other words, credit is a GOOD thing.
Not necessarily. Credit in some situations and in some amounts is a good thing. That does not by itself mean that all expansions of credit are a net good, without doing a cost-benefit analysis. Only that the ideal amount of credit is definitely not zero.
Credit has been the historical answer to that management notion of pay raises being a bad thing. Most of America has utilized credit as a way to put some elastic in their pay envelope, and, to enhance their overall financial position with regard to how they determine the "affordability" of all that stuff their hearts desire. The indulgence in shopping as a form of entertainment came with the advent of consumer credit, TV and web shopping has also risen due to easy credit terms coupled with the curse of a skewered view of prosperity.
How does people buying these things on credit help the economy in ways that buying them in cash cannot? Did I do the economy a disservice by buying my car in cash? How about paying for all my vacations in full?
It shows people are no longer sitting on their money and foregoing wants or highly expensive needs. Paying in full is good but paying off still helps the economy more. Think of it this way, while credit companies and lenders are often blood-suckers, they still give jobs. The more jobs you have, the more players we have in the economy.
Modern economies are characterized by the rule of law, high degrees of financial transparency, and instantaneous flows of information. In such worlds, a promise to pay becomes very nearly as good as actually being paid, so nearly that the two become nearly indistinguishable. Credit thus becomes the currency and lifeblood of such economies, allowing them to achieve significant reductions in economic friction and resulting gains in efficiency and productivity. Healthy and smoothly functioning credit systems are the foundation of modern economic activity.
Dream on.
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