Monday, August 22, 2011

Guest Post: The Probity And Morality Of Borrowing For Inidviduals, Families, Business And Government

The assumptions behind making loans and incurring debt for the individual should apply to business and government as well. When you and I apply for a loan, the lender evaluates our cash flow, i.e., the normal inflow of funds (income, interest earnings, investment return, etc.) to determine if we are creditworthy. The lenders also look at our assets, "collateral." If in the event we default, can the lender recover his principal? Thus, in addition to the competition the lender faces, the interest rate he charges incorporates the time value of money + a premium for the risk that in default principal cannot be fully recovered + profit.

Under what circumstances should individuals receive loans? Obviously any purpose for which the borrower enjoys the benefit of the funds extended by the lender that both parties agree correspond to the time frame of the benefits enjoyed and the borrower's ability to repay the loan.

What this means is that except for the famously wealthy, whose cash flow and asset base immunize them from having to justify the purpose of the loan, there is a certain moral basis for loans to the rest of us that is based on the business principle cited above. The loans we qualify for are for a defined purpose, usually for a home, a car, business or education. These purposes are actually investments that are intended to produce a financial gain in future income or long term asset growth. Loans for vacations or to pay off credit card debt (unless a loan consolidation is to facilitate paying off debt at a substantially lower interest rate) will generally not qualify unless the term is short enough to ensure the the borrower who enjoys the use of the funds is extremely likely to pay it back.

No legally chartered lender is going to extend a loan to an individual for a purpose and term that goes beyond the borrower's predicted ability to repay. A loan is certainly not going to be offered if the obligation to repay is predicated upon the heirs or estate of the borrower to repay.

This principle should apply to government. A school district borrows to build a school whose useful life is 30 to 50 years or more. Likewise a sewer line or bridge have lifespans of many decades. The loan to be repaid by the taxing entity's citizens is for the enjoyment of the benefits of these improvements over the lifetime of the asset created. It is not appropriate for government to borrow to fund ongoing operations because revenues are insufficient to cover the expenses today and represent a proliferating obligation for future taxpayers who may not have enjoyed the current benefit. This is the moral problem with many of the social entitlement programs. A stream of benefits is created that becomes a perpetual obligation of the government that must be repaid by future taxpayers who gave no consent to the transaction and who may not enjoy the benefits of their payments. This is especially so (1) if current beneficiaries reap benefits for a longer term than originally designed, (2) if fewer taxpayers are available to fund the system and (3) if the government votes to enlarge the scope of benefits without sufficient funding. This is known as a "Ponzi scheme."  Ponzi schemes are both immoral and illegal and are punishable by both civil and criminal law.

When any level of government assumes a "legal" debt obligation that extends beyond the finite term of beneficiaries who pay for them, growing indebtedness is inevitable. The options then are higher taxation on taxpayers who may never reap benefits,(immoral), default--in essence defrauding the lenders and beneficiaries, or a restructuring of such programs over time to make them self-sustaining financially and in terms of matching obligations with beneficiaries--painful, but the only way to sustain benefits and make the obligations fair for future generations.

Larry Greenberg

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