The Theory of Everything Debt
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In Hamlet, Shakespeare says, “Neither a borrower nor a lender be”
Is this a good approach to the modern world for governments, businesses and individuals? Would economies collapse if governments and individuals took Shakespeare’s advice?
SIMPLY PUT, NO, it is not a good approach, and yes, economies would collapse. Derek Holt, vice-president of Scotiabank Economics, explains why. “This describes a state in which you are spending every last dollar that comes in — it’s a subsistence model. Going into the crisis, the world borrowed far too much, but there is a very legitimate role debt can play in a person’s life cycle. One of the great accomplishments of the 20th century was the deepening
“There is a very legitimate role debt
of capital markets and the greater access to debt that enabled people to smooth their obligations [the cost of consumption] over their lives. Good luck trying to buy a car or a home on a 25-year-old’s paycheque without the ability to borrow.”
An explanation of the US subprime mortgage disaster that brought the world to its knees
GOVERNMENT, LENDERS, WALL STREET and individual borrowers all played a role in bringing down world markets. The root cause may date back to the mid-1990s when the Clinton administration gave government mortgage agencies Fannie Mae and Freddie Mac their affordability mandates in order to maximize home ownership in the US. California banks started outsourcing mortgage lending and the approval process to third-party brokers, which divorced ownership of the risk from the people originating the mortgages. US banks also introduced high-risk products such as teaser mortgages with low to zero interest rates and strategic default mortgages available in the southern US that gave borrowers the opportunity to walk away from the mortgage with impunity. People with modest incomes were assembling portfolios of homes they could not afford. Lawmakers played a role in allowing that kind of lack of accountability. The Federal Reserve, under the control of Alan Greenspan, kept interest rates too low for too long, causing a further lack of discipline on the part of borrowers who thought rates would never go up, according to Derek Holt. Wall Street joined the party and started to take debt and turn it into different kinds of debt, compounding debt upon debt. When one part of that chain started to default, it created a massive domino effect.
Did you know? According to the Fraser Institute, Canadian governments collectively spent an estimated $61.7 billion on interest payments in 2013/14.
38 | CPA MAGAZINE | MAY 2015
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