A Loan is A Margin Play

A loan is not the same thing as a direct capital investment. We know that loans are not an investment because loans tend to have an indirect relation with the risk and rewards of the investment.

Let's say I had a project with low risks and a high potential reward. I would have a better credit rating for this loan and would get a lower interest rate. Conversely, if I had an investement with a higher risk or lower potential reward, I would find that I have to pay a higher interest rate on the loan.

An interest bearing loan is not the same thing as a direct investment. Such loans are better understood as margin plays. The parties involved in an interest loan are not working together to bring an investment idea to fruition. In most loans, the parties are simply looking to leverage off each other. The lender is looking for a guaranteed stream of income (with profit) from the loan. The borrower is hoping to leverage the money borrowed in the market.

It is not as healthy a relation as a direct investment.

Our overuse of credit appears to be a result of the regulations of the Federal Reserve. The Federal Reserve has created a system of fractional credit. The Feds lend money to banks. These banks then make multiple loans with this money. The Feds create seemingly cheap credit.

This system of highly leveraged positions appears to work in boom times. But boom times can't last forever. Since this highly leveraged position of boom times is premised on people paying back fixed interest loans, the economy collapses in times of economic uncertainty.

The Federal Reserve floods the market with credit. On occuasion, there is a market collapse which rakes in all the bad margin plays.

In a system of direct investment, investors share the booms and busts together.

The Austrian School of economics wants to eliminate the regulations that allow fractional lending.

My belief is that the pathway to sustainable economic prosperity is to lower our dependence on loans and to increase direct personal investments in equities.

If these sentiments are true, then our political leaders have us on the wrong track.

The bullet points below come from WhiteHouse.gov summarize the goals of the president's initiative which are to:

• Expand opportunities for automatic enrollment in 401(k) and other retirement savings plans,
• Make it easier for more than 100 million families to save a portion or all of their tax refunds,
• Enable workers to convert their unused vacation or other similar leave into additional retirement savings, and
• Help workers and their employers better understand the available options for tax-favored retirement saving through clear, easy-to-understand language.

The focus of this initiative is improved retirement savings through tax-savings.

I don't care how much people save on their taxes. Saving on taxes is not wealth creation.

The primary target of the initiative is small business. President Obama wants small businesses to act more like big business. The bill wants people in small companies to invest more of their retirement funds in 401Ks.

Obama demands this change as if small businesses were the ones responsible for the financial collapse on Wall Street.

In recent business cycles, small businesses have proven to be a buffer between the excesses of Wall Street and government policy. Forcing small business into the mold of big business runs the risk of making the next bust even more catastrophic.

Anyone who has looked at the books of a small business realizes that there is a fluid line between the business owners and the finances of the business. Personal money flows into the business when it needs extra money, and money flows out when capital needs are relaxed.

This happens in part because the business is the savings account of the small business owner.

If the small business owner locked money into a 401K, that resource is no longer available for use in the business!!!!!!!

It is true that the business owner can borrow against the 401K. But, wait a second, this action forces the business owner to take a margined position. Such a leveraged position is dangerous.

If there is an economic downturn, the business owner will see both the 401K plan fall and the business retract. This double whammy creates twice the hardship for the business owner. To make matters even worse, the business owner must eat a 10% penalty if the business owner draws down the 401K to pay off the loan.

It is good that President Obama has addressed the problem of low savings rate. Forcing people to invest in 401Ks doesn't really solve our problem if it forces small businesses to take leveraged positions against their assets.

What we need to get out of this business cycle is to de-emphasize leveraged investments, and to concentrate on building real equity.