Sunday, December 14, 2008


The American economy is credit based. Credit runs the daily lives of people. People go to a store and swipe the plastic to pay. Then, when the bill comes in at the end of the month, they pay only the minimum and keep the rest of the debt on the card. They take out home loans(or mortgages, as they are called) for hundreds of thousands of dollars(that most times they cannot afford) and then when they need money at a later time to pay for their kids' college etc, they take a loan against that home loan. The result? They owe their home loan, AND the loan on the loan. This results in them trying to pay off their loans all their life. The holiday season rolls in and they walk into the nearest bestbuy or circuit city and buy that huge plasma TV or LCD TV or worse, the home theater, and don't pay a dime at the store because the store is running a 'Buy with no down payment and no payments for a year' scheme. Does that mean they only have to pay back the TV cost later? NO! They have to pay the original cost of the TV AND the ultra high interest rate that goes with it. Result? They owe huge amounts, and continue to charge their credit cards with more 'Holiday Shopping'. Substitute the TV with that awesome, dream furniture and the story repeats. Retail therapy rules people's lives. And all retail therapy is paid for by good old plastic!
This worked very well in the 90s and the early 2000s. Starting last year, things began to change. People who could actually not afford huge home loans were anyway given loans with zero down payment etc. This resulted in the people not paying their monthly payments on time, or in some cases, not at all. The mortgage companies then foreclosed those homes and in a few years, had too many foreclosed homes to contend with, and not many people ready to buy, either because they realised, finally that they could not afford a house, or their credit for so bad that they could not get any good loans. Thus began the great real estate crash.
The same story held true for the credit market. People had too much debt on the credit cards, defaulted on the payments and their credit hurt as a result. They stopped buying as much as they used to, resulting in the retailers' suffering, the credit card companies losing their investment as a result of defaulters and one thing reinforced the other. Thus began the credit market collapse.
President Bush signed an economic stimulus package a few months back, and people got free money from the federal government so they could go and spend that money and infuse some life into the economy. Didn't work! Now we have all economists, politicians, policymakers shouting from their rooftops that people should get out there and SPEND money so the economy improves! So here we are. Go and spend so the economy improves. Then do not pay your debt in full, and rack up your debt, so the credit market suffers again, again go and spend so you can pull the economy out of the resulting slump...and the cycle continues. Has anyone thought about maybe moving away from such a credit-heavy economy?


  1. Very well explained!!!

    I think that way Indians are reasonably money savvy. We have only one credit card, and only for online transactions, and that too is paid instantly. I have already learnt that shopping with Debit cards makes you spend much more, no matter how convenient ... trying to stay out of this trap too.

    And property for investment should pay it's own EMIs.(rent) If you can't get any rent immediately then you are taking a chance.

  2. You are right IHM! We both have 1 credit card each and we pay the WHOLE balance in full each month! If we cannot pay something in full, then we cannot afford it. I still believe Indian habits are the best. Now all financial advisors are shouting at the TV askin people to save!


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