Tuesday, June 12, 2007

Interest Rates and Boom and Bust

Tyler Cowen sometimes makes real sense, sometimes he doesn’t. In this Case, he makes an incredible amount of sense, but no One will recognize it. There is almost no correlation between Risk and Interest rates, and little more relationship between Risk and the extension of Capital. Tyler would be on my Case for these Statements, but hopefully would basically agree with the Sentiment.

I have always seen Credit facilities as a Supply Side Push, rather than a natural economic model continuum. What this means is current Production facilities produce a continuous flow of Profits, a great share of those Profits without fitting recapitalization potential in the Businesses which generate the Overflow. These Profits are of such magnitude that there is disinclination for distribution of the funds for Consumption (do I sound like an Economist?). The alternative is to push these funds into the Credit market. Interest rates are partially set by the availability of these funds for Credit extension, partly are set by financial institutions insisting on what they consider a relevant rate of Return for the extension of these funds (based upon the largesse of funds extended).

Here is the reason One cannot find a correlation between Risk and Credit extension. Award of funds is based upon the Supply Side Push to get these funds committed, and drawing Interest in the first place. Greater Risk will be borne by the lending institutions if there is appreciable increase in the supply of funds through Depositors etc. The only inhibition to high Interest rates is the difficulty of getting the total volume of these funds engaged in Profitable returns. Interest rates are designed to entice Borrowers into exploitation of less Profitable endeavors, simply to increase the flow of funds in Interest-bearing structure; Consumption Credit being priced to increase the total amount of funds engaged in profitable return.

Here is the real conflict with Economic theory. The setting of Interest rates is a graph maximizing the Profits of financial institutions, for the benefit of financial institutions, not the promotion of the economy. It is not a Concern to generate most efficient Economic performance, some of the loan extension debacles conducted by financial institutions highlight this fact; many poor business risks have attained incredible amounts of loans. There is a basic disconnect between financial stability and the extension of Credit, based solely on the desire to get the Profit return of Interest payments, regardless of the actual ability to repay the loans. This reality contravenes successful economic policy, and propels much of the Boom and Bust mechanism adversely operating upon the Economy. lgl

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