Cutting out the middle man

By Dave Anderson:

Credit card debt is expensive debt.  It is not unusual to see "cheap" permanent rates of 12%, typical rates of 18%, and usurious rates of 25% or 30%.  Making debt service for indebted consumers is a significant portion of personal disposable income. 

If an individual  has $10,000 in credit card debt at 18%, their initial monthly payment (assuming no penalties or other fees) is $250 per month.  At the end of the year, the individual will have paid down $1,000 in principal, and $1,570 in interest expenses.  This assumes no new purchases, fees, penalties or anything else with minimum payments only.  Moving to a flat payment of $250 a month instead of slowly declining minimum payments shows a debt burden of $8,900 at the end of the year and $1,560 in interest expenses.

The US government is good at three things; blowing people up, collecting money and cutting checks.  Why not use the last two core competencies to help the economy, reduce the aggregate debt burden and engage in some long term arbitrage.  Cutting those interest expenses would either free up significant current cash flow for consumption, or give an individual the ability to more rapidly clean up their personal balance sheet.  Either outcome would be an improvement for the US economy.   

The New York Times has an interesting Op-ed that echoes what some 'Hog guest writers were saying in February 2009 on a way to stimulate the economy, improve consumer cash flow and balance sheets as well as generate some short term federal revenue... offer consumers a chance to refinance high interest revolving debt with lower interest debt offered by the federal government:

rates on 10-year Treasury bonds are only about 3 percent, many consumers still carry tens of thousands of dollars of credit card debt at 20 percent or more. This burden has been a continuing drag on spending. The federal government could reduce it by borrowing at 3 percent and lending to consumers at 8 percent under a one-time debt-restructuring plan.

With their debt service payments cut by more than half, consumers could increase spending immediately. And the five-percentage-point spread on money lent under the program would help cover its administrative costs, and maybe even relieve short-run government budget pressure.

(Banks might complain, but because the money owed to them would be repaid in full, and because they insist that their high interest rates barely cover their costs, such complaints would ring hollow.)

Going from 18% to 8% interest, the individual with $10,000 in credit card debt would see their initial monthly payment go from $250 a month to $167 per month.  Using a declining minimum payment formula  (monthly interest expense +1% of current balance), the debt burden at the end of the year is still $9,000 but the interest expense declines from $1,570 to $700.  That gap of $870 is greater than the ARRA Making Work Pay tax credit and it most likely would be targeted at individuals with a high marginal propensity to spend (as evidenced by credit card debt.)  If balances or interest rates are higher, the freed up cash flow would be even greater. 

This debt would be relatively secure and low-risk for the US government to issue as the IRS could be made the collection agency for the debt.  Long term risk could be lowered by changing the minimal monthly payment formula so that the monthly minimum would be interest expenses plus 1% of principal + half the savings from the interest arbitrage.  That change would accelerate the repayment of debt while also freeing up cash flow for consumers to either spend or save. 

We won't see this because it was first proposed by DFHs, and the banks would scream bloody murder that they can't extract every single dollar that is available from the people with near usurious interest rates, but this idea could work if people would not scream Socialism at offering a public option for banking.