Being Debt Free is Stupid?

[John Picard]

Think again.

Debt-free policies mean big success in Tulsa
Companies who don’t owe are having less trouble now

I tend to irk people, especially those who advocate "being in the norm", which these days are those who advise others to get a credit card, borrow money for cars, and practice bad financial judgement. I was always pooh-pooh'd when I responded that if a person loses his job, there's no way to pay bills and make ends meet. Look no further than the evening news for people who were once "on top of the world" and are now struggling or are even losing their house.

Once, someone stated companies borrow money to run their operations. Well, that's partially true -- it's companies with a lack for foresight and planning. Every economic boom leads to a recession, because growth cannot be sustained. In other words, the market has to correct itself before it can expand again. Before wild credit was the norm, companies would, more often than not, be more frugal during the good years so that they could survive the lean years. Had that been done during this past boom, this Recession wouldn't be quite as bad.

 

[Holdfast]

You have a very narrow way of looking at wealth, finance, accounting and business.

That doesn't make it wrong, but it fails to recognise the competitive nature of the economy. Look, it's perfectly possible to run a business without ever borrowing a cent. However, it will NOT grow as rapidly as possible, nor will it use available resources in the most effective fashion.

As efficiency of operations increases, sooner or later you hit upon a cashflow bottleneck. Temporary financing allows businesses to artificially overcome those bottlenecks, permitting what you would consider an "artificial" or "unreal" increase in profits as a result, during good times. Similarly, borrowed money can be used to further leverage positions during good times, again accelerating profit growth. To use a Trekkie analogy, it's like when they override the ship safeties and run the engines at 110% of capacity - a way of increasing results at the cost of increased risk.

Of course, the more you borrow, the riskier your position becomes. That is undeniable. But it is utterly wrong to say that the BEST position is one of zero risk. Accepting and USING risk is inherent to maximising profit and UNDERSTANDING risk is the key to running a business optimally. The current problem is not that companies borrowed but that key financial institutions underpinning the credit system used instruments so complicated (and vast) that they lost the ability to understand the risks they were taking and therefore how to manage the risk appropriately. It's a failure of the securitisation process not the concept.

Finally, you assume that just because a business fails in a recession due to borrowing, that is a bad thing. It is not. A business can fail and it can do no net harm to the shareholders in the company (over the lifetime of the company, that is) provided they made enough money when the business was doing well and protected those profits.

A similar argument can be extended to the wider economy - running an economy on zero debt would be very inefficient. Growth is still possible, but it would be MUCH lower. Using debt to grease the system allows for faster rates of growth (but increases the risk, and therefore the chances of more severe recessions). Again, it doesn't mean that using debt was wrong - the USA grew FAR more over the debt boom, than it will contract during the recession.

You might say it would be better to have a more sustainable, long-term view of economic growth and that's a fair position to take. But it's inconsistent with capitalism, which your past posts have generally been in favour of. A capitalist system will always naturally gravitate to maximising immediate profits. And maximisation of profits is often aided by increased efficiency, which is boosted by artificially large cashflow removing a bottleneck ie using debt. And as long as the good times outweigh the bad, is there really a problem?

 

[LaxScrutiny]

Or to put it more simply, what Holdfast is describing is capitalisation. That is capitalism. At best, there is a distinction to be made between selling shares of equity, or "renting out" ie borrowing. In either case, it's about raising capital.

What John Picard is describing is barter. We would be using currency to barter with, but it would be a system where immediate value is exchanged for value. Money is simply a way of storing the value of perishable goods and services. A system based totally on cash is still just barter. Doing business would require making small savings each month until you have enough to build yourself a new factory, or hospital, or nuclear reactor, or whatever. It's a reasonable model if you're running a small business.

 

[Lookingglassman]

I guess I'm stupid. My only bill is my mortgage and just living expenses. My car is paid off and in good shape, I paid off all my credit cards and loans and I never really played the stock market so I'm not tearing my hair out over it. I am pretty much rolling in the dough. I save a lot of it, but I got money to spend on what I want and if I ever have an emergency I have the cash to deal with it. This financial crisis isnt hurting me at all.

 

[Small White Car]

I guess I'm stupid. My only bill is my mortgage...

If you have a mortgage than you are not 'debt free.'

If you save until you're 50 and THEN buy a house, then you're living debt free.

But I would consider that stupid, rather than what you're doing to be stupid.

 

[JoeZhang]

I guess I'm stupid. My only bill is my mortgage and just living expenses. My car is paid off and in good shape, I paid off all my credit cards and loans and I never really played the stock market so I'm not tearing my hair out over it. I am pretty much rolling in the dough. I save a lot of it, but I got money to spend on what I want and if I ever have an emergency I have the cash to deal with it. This financial crisis isnt hurting me at all.

And I borrowed against everything I owned to start up my last business and it paid off and I own a series of houses and I have no mortage on any of them.


As far people have said - the idea that Debt = BAD is just too simplistic. You couldn't have a enterprising culture without it.

 

[cultcross]

As far people have said - the idea that Debt = BAD is just too simplistic. You couldn't have a enterprising culture without it.

Exactly. You would have a tiny fraction of the professionally qualified people that we need if university had to be paid up front without debt. We would not advance technologically, economically or culturally without companies taking sensible risks to advance their futures.

Debt you can't afford is bad.
Sensibly thought out debt with a purpose and contingency plans is fine.

 

[DanTheGrey]

When the debt is a long term thing (like a mortgage) it's not a bad thing. It's a way of deferring expenses while getting the benefits within reason. Feeling that you need a McMansion with 2500+ sq ft for 2 people is not within reason IMHO. Feeling that you need a new BMW on a middling income is not within reason. The debt in those cases need to be manageable without turning you house poor.

Education is another place where debt is useful, to a degree. I personally think that the amount of debt students going through University/Trade School is out of hand and another potential economic timebomb.

Now in my world, debt for totally consumable things (groceries/petrol) that you will burn through before the bill comes due, and then not pay it off, even though you could is where the problems are.