economics

Many people who are in the general public don’t like “bankers” but without them, it is very difficult to build wealth and for a modern economy to function. Money is the means with which we engage in trade- it enables two people to trade goods and services.

Money permits the farmer to barter for medical services without having to travel to the doctor’s office with a lamb in tow to use for barter. It permits the doctor to barter with others for things that can’t readily be traded for- the doctor can’t mail a leg of lamb to the electric company, and it’s difficult for the electric company to barter with a bushel of electricity.

Once we admit that money is a necessary commodity that permits modern trade, we also realize that we sometimes don’t have enough liquidity to make large purchases. In these cases, we find someone willing to loan us the money. Seldom do we have friends and family that have enough in liquid assets to loan us money for a house or a car, so we enlist strangers and acquaintances to loan us money.

Those people aren’t going to loan us money without knowing the risks of not being repaid. They evaluate that risk, and looking at people with similar financial profiles, determine how risky it is to loan you money. That is, how likely is it that you will default on the debt and walk away with their cash? So let’s say that the lender determines that people whose financial situations are similar to yours default on loans 1% of the time.

The lender needs to be compensated for his administrative overhead, the risk he is undertaking, and still have enough for a profit. If he were to invest that same cash into a mutual fund, he would have significantly less risk and expense, so he needs to make more than he would make investing in that mutual fund.

In this case, the mutual fund would pay 2.5%. The lender’s overhead is another 1%. If the lender doesn’t get to charge at least 3.5% interest on this loan, he is only breaking even with that mutual fund, and that doesn’t even account for risk.

In order to measure risk, the lending industry has developed credit scoring, with Fair, Isaac, and Company (FICO) being the company with the most widely used scoring model. Let’s look at default rates for different FICO scores:

You can see that loaning money to people with a FICO score of 700 or higher means that you have a 6.4% chance of losing your investment. Using the numbers from our example above, if we were the lender, we would have to charge 9.9% interest to get the same 2.5% we would get from that mutual fund. In this case, we have one of two choices: we can lend to people with a 700 credit score or more, but at 10.9% interest, or we can loan to people with a 750 FICO or higher, and because the risk is lower, we could offer loans at 6.5%.

The issue here is that only 40% of the public has a score of 750 or higher, and everyone wants to lend to them because the risk is so low. For those reasons, competition is fierce for their business, and we will likely only be able to charge 5.9% for loans without collateral, and 5.7% for loans with collateral, because collateral reduces our risk.

This is of course a simplified example, but it does show that this is a simple math problem that balances risk with reward. This doesn’t mean that bankers are evil.

Let’s suppose that you had a chance to choose between two employers. One offered to pay you $20 an hour, and there was a 99% chance that your paycheck would cash without a problem. The second employer offers you $100 an hour, but there is a 35% chance that your paycheck will bounce. It’s a choice that you want to be careful with.

Banks do the same thing. Why would someone loan you money unless there was a reward for them doing so? Anyone who has loaned a friend or family member knows that there is a chance they will never see that money again, and that is for people you know. Absolute strangers are even more likely to walk.

I discovered that myself when I invested money in some peer to peer lending on Prosper.com. I put $500 into that website, loaning that money by partially funding several different loans. The terms there are simple- people see the credit scores of lenders, and bid on funding those loans at whatever interest rate they are comfortable.

So let’s say that you want to borrow $1,000 and your credit score is a 740. There is a 6.4% chance of a default, so the bidding begins. Your loan is funded by 30 people who offer to lend you the money at 8.9% interest. You have to repay that loan in 36 months, with a monthly payment of $31.75. At the end of the three years, the people who funded your loan would have received $1.10 in return for every dollar that they loaned you- a profit of 10% over three years. (some of the interest charged is given to Prosper to cover their expenses)

If you only make a year’s payments before defaulting, each dollar invested would only return 69 cents, meaning that the investors lost 31% of their investment.

That’s why interest gets charged, and a basic idea of how it’s calculated. If interest wasn’t charged, then there would be no money to lend to anyone.

In New York city, rents have become so unaffordable that people are paying to live in communal living spaces- you get a small bedroom to yourself while sharing a bathroom with one other person, then share a living room, a kitchen, and a gym with the rest of the building. You get a shelf in the refrigerator that you share with four other people, and a small locker to keep food in. Amenities include WiFi, breakfast once a month, and a weekly cleaning service. In all, you share this stuff with 23 other tenants for the low price of only $2100 a month.

The building in the story has four stories- six people to a floor. Each floor has a small living room and kitchen, three bathrooms, and six bedrooms. The basement has a laundry room with three washers and three dryers, as well as a small gym with a few workout machines.

When I was broke and young, I had roommates. What gets me here is both the price and the fact that these are people in their middle age years doing this. The guy in the story is 33 years old, and isn’t facing some new temporary situation like a divorce. He is choosing to live like this because he likes “the vibe” of living in New York city.

Modern monetary theory, the idea that the government can print all of the money it needs, is the pet idea of the left. MMT theorists explain that debt is simply money that the government put into the economy and didn’t tax back. That’s how you get morons who can’t explain how the economy works running the country, for example the Biden administration’s chief financial advisor:

This is who is running the country- leftists with as much understanding of how economics works as a child who thinks money comes from the ATM at the bank. I can explain MMT in their terms better than they can.

The adherents of MMT believe that the government can print all of the money it desires, without consequence. Bonds and taxes are the means with which the government controls inflation and levels the playing field. If the economy gets too hot and inflation results, all the government has to do is sell more bonds. This reduces the money supply and cools the economy. If this causes too many people to get rich, raise taxes on the rich, and that levels things back out.

Stupidity. It hurts me to even type that drivel. The simple fact is this- the left has little to no understanding of how economics, or even money, works. That’s why so few of them run businesses, why so many of them are struggling financially, and why our nation is in the financial crapper.

Let’s say that you are making and selling a product. You sell that product for $4 each, but no one really wants it. You won’t sell any. What to do? You change the product you are making to one that people actually want, and now you can sell them at $4 each all day long.

Until someone sees how much you are making on it and offers a similar product, but for $3 each. Your sales drop as customers buy your competitor’s product. So you make changes to make it even better, and now everyone wants it. The problem is that you can no longer keep up with demand, so people who NEED that product offer you $5 each. A bidding war ensues, and eventually you are offered $100 each. Do you turn it down? After all, that would be price gouging…

Of course you take the money. All transactions are a combination of a willing seller and a willing buyer. All sales of all products are negotiable.

That happens every day with your labor. The labor that you perform is the product you are selling. Michael Jordan played basketball like no one else, so he made millions. When people saw the shoes he wore, they wanted to be like Jordan, so millions bought his shoes. He added hundreds of millions of dollars of value to the Air Jordan brand, so they paid him.

Robert Downey Jr made the Avengers movies what they are. Few people would pay $20 to see a movie starring Steve Smith. However, tens (hundreds) of millions of people did so to see RDJ in the Avengers movies. That’s why he makes $40 million per movie. Without him, that movie is a losing proposition. Without RDJ, this movie isn’t going to be made at all. This makes RDJ’s value in the movie industry sky high. No one goes to see a movie because some rando that no one has even heard of was 1 of 40 other nobodies in the costume department. That’s why jealousy fueled rants like this are stupid.

If you aren’t happy with the money you are making, you need to find a way to make your labor more valuable. No one is going to pay you $50 an hour for labor that literally anyone can do, because there will be a line of people behind you who are willing to do that job for $40, $20, or even $15 an hour. In order to make more, the value that you add to the deal dictates how much you will make. Simply saying that the employer owes you “a living wage” as you whine and complain on Social Media isn’t helping.

That goes for literally any job. That’s why Gordon Ramsey makes what he does- he adds enough skill to the deal that people are willing to pay $40 for a hamburger (not me, but people). Find a skill that is valuable and become good at it. It may take some time, but the money will follow.

We can’t all be Robert Downey Jr, Michael Jordan, or even Steve Jobs, but all of us don’t have to be making minimum wage, either.

This is one of the reasons why renting houses has become so expensive. The risk of owning rentals has to be priced into the system.