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Consumer Lending Doesn’t Make Sense

By: Steve Johnson

4/4/2008 - 18 Comments

The idea of lending money to consumers to buy consumable products that have little or no value the minute they are purchased doesn’t make any sense.

I average credit card debt in the US is eight thousand dollars. That money has been spent and consumable products that no longer have any value, like a morning coffee and a gas tan fill.  Business lending is completely different because, unlike consumer lending, the merchandise purchased has value that can be resold or used as collateral or used to produce revenue for the business to pay back the loan.

The only hope of getting money back from consumer lenders is based on their future earnings. Future earning means the borrower will be able to either earn more money in the future or be able to reduce their expenses to pay back the money they have spent. A consumer loan cannot be used for collateral because it has zero value. You cannot go to a bank and ask for a car loan and put up your credit card bill as collateral because it has zero value. 

Spreading the Risk

The risk in consumer lending is the borrowers’ future earning potential. The consumer lending industry has been successful for decades primarily because of the low unemployment rate in the US, which allows banks to lend to consumers with a relatively low risk of getting their money back. To further reduce their risks, they socialize the lossed from default borrowers by charging the good borrowers a higher interest rate.

The better the economy, the better the business – but in times of recession, the consumer lending business is not the best business to be in.  Rising unemployment creates a higher percent of defaults, and raising the interest rates on the rest of the borrowers causes them to borrow less money and increases the likelihood of more defaults. This is already in full swing, with late payments on consumer loans at a 16-year high.

Reference Article: Late Payments on Consumer Loans at 16-Yr. High

Consumers Pay More

Consumer lending only makes sense in a really good economy, with almost guaranteed income and job growth, which some would say we have had for the last decade. But, now that the housing market has collapsed and the increased prices have been deflated – we realize that the booming economy of the last decade was a phony. Moreover, the borrowers of consumer lending who have borrowed lots of money are now faced with paying 30, 50, even 100 dollars for a cup of coffee they bought on their credit card three years ago. 

The Death of Consumer Lending 

If the economy continues into a long recession, more and more consumers will not be able to pay back the money they have spend – which will lead the consumer lenders to bankruptcy. The entire industry is based on the same model, and therefore if one lender fails – their is a good chance they will all fail.  If the coming recession drags on a few years, the entire consumer lending industry may perhaps come to an end. Consumers will no longer be able to borrow money to purchase consumable products, as in every other nation.

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