Whether rates are high or low, interest if mismanaged, can be the financial demise of a household, a company or a country.

The banking crisis which caused the market to crash in 2008 will historically be viewed as a world-wide “debt crisis”. Too much money was borrowed in relation to real current income: speculators sold homes to people who could not afford them. Banks facilitated this deception by creating escalating payments within mortgage instruments. Credit cards by the score were held by both spouses and often their student-children, while household debt per person rose well above $10,000 on average in North America.

The increase in consumer indebtedness has been exasperated by a plethora of debt-creating financial products designed to earn money principally within the banking and credit card firms of the financial sector. The rise of personal debt now exceeds growth in the manufacturing sector in North America. This occurred as debt became  wildly promoted and increasingly profitable versus the manufacturing of goods. Struggling General Motors owned credit card and mortgage divisions!

Little wonder more capital flowed into the capital markets for use in the production of debt instruments such as variable mortgages, debt insurances, fancy derivatives, hedge funds, and a plethora of credit cards offered by every banking and/or financial institution.

Consumer credit interest rates are deplorably high

Consolidation loans are becoming increasingly popular at upwards to 50% of interest! One young woman consolidated two credit cards that she had paid an 18-19% rate of interest, for a replacement loan at an American finance firm marketing in Canada for whopping 39% interest rate. Additionally, to protect the financial firm’s loan she was sold credit insurances: unemployment risk insurance; disability, accidental and life insurance; with a road-side assistance package to boot for $800 per annum. The stickler is that these annualized insurance premiums were added to the loan’s up-front principal borrowed. So a total new loan amount above the consolidated monies originally applied for meant that more money was lent out at a near-40% interest. After three payments of $180 she still owed considerably more than she borrowed.

Guess Where Your Deposits Go

Interest rates and endless service fees on capital flowing in and out of bank’s saving and chequing accounts also produce bank income. Making loans and charging interest while using the average man’s capital on deposit in millions of bank accounts, is the norm.
As more money entered the financial system, risk became less regulated, and two things occurred, a) interest rates were manipulated without any interest rate ceiling established by law especially in the US (though Obama is trying to regulate this now) and b) loans were made with little regulation as to the viability of being repaid.

As long as we do not regulate both interest rates on loans, and the cost of money (the spread of interest determined by the risk), where capital is readily available to the financial sector, speculators—gamblers—designing fancy derivative instruments such escalating mortgages, will continue to pump out products to the non-discerning consumer.

Evidently what happens in the U.S.A. is important to every other country as financial instruments are bought and sold daily around the world.

The Realty Paradox

The paradox of having more money flowing into the financial sector versus manufacturing was increasing consumer debt and that of inflating real estate. The more money that flowed into the financial sector versus manufacturing, the more readily was money made available for debt and the biggest debt instruments to purchase are real estate mortgages. Thus bigger and more homes and mortgages became available. At the same time with home equity climbing in value, credit-line indebtedness rose, with increasingly more credit card debt (often linked to the home equity). The house-rich became the cash-poor, to whom the banks gladly offered more credit cards. The consumer in North America became debt-enslaved, cash-strapped consumers, buying based on wants versus needs with credit.

Debt Helped Push Markets Higher

Fuelled by debt, companies continued to move hastily forward, with illusionary promises of the next perfect widget. The consumer would be rewarded with more goodies to buy with debt; translating to better returns on their stocks and dividend payments. As their stocks increased in price mountainously high, the debt bubble when it would burst, would concomitantly burst the stock markets’ equity bubble world-wide.

Cheap debt can also be dangerous

On the one hand very high interest rates were charged on credit cards and consumer loans. Conversely cheap loans were allowed in the real estate industry.

Because of a rich supply of money coming into the financial sector, interest rate spreads were thinning as banks competed to offer comparable mortgage loans in order to compete for capital investment in mortgages world-wide. Thus reduced profit-margins on billion-dollar portfolios of mortgages allowing for little error became the normative practice.

Sneaky contracts began to affect the consumer of credit

Many step-rated mortgage-loan contracts designed to tempt homeowners to buy above their means (essentially luring them into buying the larger debt contracts), were written with a design to allow for increasing payments, which later increased the potential for more consumers eventually to default.

The Credit Card Boom

Thanks to uncapped interest rates on credit cards, the consumer helped shift yet more capital into the financial sector’s credit engine, indirectly necessitating debt-based consumption. Banks took less risk lending to middle class entrepreneurial businesses (such as smaller manufacturers or ma and pa shops). They could make more money pounding out high interest loans to the unwary masses, especially if John and Sally Doe took forever to repay these high-usury loans!

More About the GM Paradox

Another paradox is that teetering giant manufacturers such as General Motors (GM) and General Electric (GE), saw that money could by made hand-over-fist by charging interest. GM, indirectly biting the hands that fed them, now enabled more money to flow away from manufacturing into finance. Now as developers of financial debt instruments such loans and credit cards, they lost sight of staying competitive in their own manufacturing arena.  They gladly become a financier to the proletariat.

If they go bankrupt, lawyers can rid them of their under performing assets, and sell off lands and plants while they restructure. Will their financial businesses regroup and continue, perhaps under a different name? Probably.

The terror of speculative, derivative contracts

Derivatives are contracts derived from an underlying asset's value. They include complicated stock options used by traders such as puts and calls, and futures and forward contracts. Derivatives are used to hedge against risk, namely the selling firm’s risk. With the leverage they provide, a firm can earn substantial gains.

The demonic duo

What we need to ponder is the incredulous ethical failure of these banking and financial institutions, and the governments that let them run rampant. Intelligent men and women solely devoted to endless legal deception used their mental powers, not to protect, but to harm the poorer class. They did this in two foolish ways.

Selfish powers slithered into the financial sectors’ credit business to leverage the high stakes against the consumer. Two perilous practices persist in the world of commerce, yet unregulated: the high interest rates on credit cards, and the low interest rates given to high-risk borrowers—both evil practices that have destroyed much of the world’s wealth which had heretofore rewarded the average productive individual.

Regulation must go this far

There must be laws established to regulate these perversities of finance for a recovery to be enabled. Interest rates must be curtailed on credit cards, perhaps from double to single digit rates. Proper buffers and proven ability to re-pay must be established on home loans in all major world economies trading mortgage-backed securities.

Moreover, derivative contracts must not increase the risk of the homeowner by penetrating the legal documentation of the consumers’ mortgage contracts.