tag:blogger.com,1999:blog-4224339055433915363.post4612125163521008519..comments2020-07-20T14:57:22.006-07:00Comments on Bobby V's Blog: Pragmatism is Killing You - Part 2Bobby Vhttp://www.blogger.com/profile/03530625914213463734noreply@blogger.comBlogger1125tag:blogger.com,1999:blog-4224339055433915363.post-54180962082011137132009-05-04T08:21:00.000-07:002009-05-04T08:21:00.000-07:00Comment from Principlex and Response:
“I like thi...Comment from Principlex and Response:<br /><br />“I like this post and follow your logic to about half way through. <br /><br />When you say, "For instance, let’s assume the government decides that interest rates on loans are too high and sets the rate at a level it deems proper. The result is that people now have no ability to choose loans that fit their particular needs." I don't understand how the lower rate prevents people from selecting loans that fit their needs. Do you mean that given the "price control" on interest, all loans that don't work at that price go out of existence?”<br /><br />Answer:<br /><br />Keep in mind, this example is intended to provide an example of how pragmatist politicians interfere with the market place as an outgrowth of their false practicality. I was not making an argument against interest rate controls. It is merely an example of how the government interferes in the market place and the result is not at all the practical outcome intended.<br /><br />Interest rate controls by government are subject the same economic consequences as price controls of other commodities. Interest rates are the “prices” of loans and if you manipulate prices, you have unintended consequences that harm people. Interest rates follow the law of supply and demand and if you manipulate demand you necessarily manipulate supply. <br /><br />Generally, when the government wants to “stimulate” the economy using interest rates, it will set interest rates below what the free market would demand in order to benefit borrowers. This means that lenders who cannot make a profit at the lower rates will go out of business. <br /><br />When the government attempts to lower the price any commodity, this creates a run on that product which means people will buy the product more quickly and this will lower supply. Since the price is set too low, the provider of that product cannot reproduce the product at a loss so he/she goes out of business and the product is removed from the market. So yes, I mean that “all loans that don’t work at that price go out of existence.” <br /><br />“In the recent case where the government required banks to loan to credit unworthy consumers, more people were able to get loans. The problem came, of course, when the bubble burst and it was discovered that there was no way for the borrowers to make their payments nor even work to make them since they put up little or no investment when they got their loan.”<br /><br />Answer: <br /><br />This situation of the sub-prime crisis was not the “pure” case of merely lowering interest rates. In addition to this, government lowered lending standards…and more importantly, the government was not limited to the number of loans it could make because it had the backing of the government and Federal Reserve. In a situation where the government only lowers interest rates, you’ll have a flood of loans to companies that offer the lower rates but with other companies with marginally lower profit pictures going out of business because they can no longer make a profit.<br /><br />“"Lenders can’t adjust their loans to the credit rating of the borrowers and as a result they will give some bad loans." It seems to me that they will make many bad loans if they are forced to violate their underwriting standards.”<br /><br />Answer:<br /><br />Again, I am speaking to just the practice of lowering interest rates…not to a situation where the government also lowers lending standards. The “bad loan” here is for the lender who would have been able to make a larger profit by lending at a higher rate. He is not allowed to consider the potential return to the borrower and thereby loses money that he otherwise would have made with an unregulated interest rate.<br /><br />"Smaller lenders must go out of business because the larger companies can offer borrowers additional benefits due to their size." Isn't this true in a free market as well?”<br /><br />Answer:<br /><br />Yes, but in a free market the smaller lenders can appeal to other benefits such as personal service, local proximity and customer service, etc. When the government lowers interest rates, the larger companies make profits on lower margins but with significantly more loans. In some cases, because of their larger range of services, they may even take a loss on some loans and make it up on other services. They can also cut a lot of dead weight from their larger businesses such as consolidating locations and streamlining businesses processes, laying off people, etc. Smaller lenders are often already lean and may not be able to cut corners due to their small size. To further exacerbate the situation the larger companies will use advertising and other inducements to make people forego the benefits of the smaller companies. <br /><br />To quote Henry Hazlitt:<br /><br />“Now we cannot hold the price of any commodity below its market level without in time bringing about two consequences. The first is to increase the demand for that commodity. Because the commodity is cheaper, people are both tempted to buy, and can afford to buy, more of it. The second consequence is to reduce the supply of that commodity. Because people buy more, the accumulated supply is more quickly taken from the shelves of merchants. But in addition to this, production of that commodity is discouraged. Profit margins are reduced or wiped out. The marginal producers are driven out of business. Even the most efficient producers may be called upon to turn out their product at a loss.”Bobby Vhttps://www.blogger.com/profile/03530625914213463734noreply@blogger.com