The ins and outs of taking out debt

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There is a debate at the national level about the level of debt being contracted by the country and if there is capacity in the future to pay back the loans that are being or have been contracted. Several people have weighed in on this matter, most notably the Members of the National Assembly. Others are interested citizens who are free to offer their opinions in the newspapers and such fora. The National Debt is an important factor in the life of the nation. It has a bearing on the present and future sustainability of the economic, social and political health of the country.

We are not alone in these matters.

There is a growing debate around the full impact of the Greek debt crisis on the survival of the country as a whole. In fact it is only now that it is formally being addressed as a ‘crisis’. This story is in the international news every day and it has been analyzed from every angle. There are many reasons for the crisis. Some are internal; like the structure of the economy, others are historical, like the inability of successive governments to achieve fiscal levels that would enable the country to fund its public services. Some of the problems are cumulative, like the overhang of domestic debt and indeed others reasons are external, like the imposition of the Euro and fiscal conditions that come with it. Ultimately the financial crisis of 2008 and its effects on national European economies also had a role to play. Greece is in great trouble indeed. Even the International Monetary Fund (IMF) does not quite know how to bring Greece to a balanced state in which problems can be prioritized with measures of intervention.

Debt is a private activity which if not properly managed can have an impact on your public standing.

So what is the issue here? Well, debt has a bearing on the well-being of any nation including individuals. If at the individual level one is highly geared or too indebted it affects your choices to make certain decisions; it affects your ability to deal with long term goals and even forgo some of your short term ones. It determines where the children go to school, where you live and, in some countries, it determines whether you can run for public office.

Debt is a private activity which if not properly managed can have an impact on your public standing. It is awarded out of respect, understanding and trust. It is often collected in frustration, acrimony and sometimes force. The end game is as a result of what happens in between.

I did not intend to discuss debt in this blog but I rationalized that it was an opportunity to recap on what it takes to contract and manage debt. There are many examples of what happens when we disrespect or ignore debt as an obligation. I will focus on examples that are already in the public domain, like the financial crisis of 2008, and examples that take place at a personal level.

As a former banker I will remind you of one of the greatest things that banks do. They are able to create money through loans. Out of thin air, suddenly there is money for a borrower to access for various things. That is why, if and when the banks get their eye off the ball, the creation of money creates problems well beyond the walls of the bank. Bad debts means the bank has lost money and the shareholders have lost a good return. Bad debts lead to closed businesses and shattered families. Bad debts lead to increase in the cost of money as the perceived risk of lending is deemed to be high etc.

So what is our role in the borrowing cycle?

  1. Have a plan: Regardless of the prevailing economic conditions you and I as the borrower must have clear plans about why we are borrowing. Ideally use of borrowed money to build assets is as old as the hills; but this adage is not true for everyone. Increase in assets ensures that future production will increase and other benefits will follow. Unfortunately, the ease of borrowing sometimes entices even marginal borrowers to receive loans. Access to loans, in my view, is the easy bit. Building the commitment and acumen to sustain and eventually pay back the loans is what separates the men from the boys.

In a nutshell, have an idea about where the money will be used. That purpose should still subsist and continue to generate funds after the loan is repaid. This could be investment in a business directly or via shareholding of listed securities.

  • Another purpose could also be fixed income securities where periodic interest payments can help you service the interest demanded.
  •  If the money is going into fixed assets, ensure that such assets have the ability to generate cash streams e.g. a farming venture or a rented building.

It is important to think through on these lines; borrowing to create assets is great. Ensure that the revenue streams from those assets help you to pay back the monies owed. The assets must work for you to pay back.

It is also true that some borrowings are used to tidy up a fragmented liabilities situation. This means a situation where you have several small loans with various repayments tenures. One can borrow to pay off all the smaller loans and remain with a consolidated debt, which is easier and sometimes cheaper to deal with. Such an opportunity can be used to re-calibrate the interest rates applicable as well as the repayment period to fit with your current financial situation.

  1. Have understanding. I am using understanding loosely. Understand your needs; understand where the lender is coming from. Understand most fundamentally that, more times than not, the lender is giving you money he does not have or is giving you money that does not belong to him. What should happen when you understand that? It should give you the level of vulnerability of the lender in trusting you to borrow this money. In order not to break the trust and so that you can do this again in the future, do your best to pay it back. Do what it takes to nurture the funds, build them up and pay back the money. On the side of the lender, try and understand the borrower and his motives. Help him to be aware of some of his choices which may lead him to failure. Where there is mutual trust, understanding can be maximized.
  2. Have respect. If either party does not respect the other, default will happen. Lack of respect equals lack of trust and or understanding equals contempt pain and anger. The borrower will squander the money and wait to see you in court. If the lender does not respect the borrower, he will try to frustrate him and change the rules as they go along. Such acts disrupt the smooth operations of the business and increases stress. Either way, litigation is the way out and this can be costly and time consuming. After such a process, there is no relationship left.
  3. Relationship building: When you are borrowing or lending money you are establishing with the hope of building a relationship. The precondition of this exchange is that the borrower has to disclose a lot of information personal and business wise to the lender. This evokes feelings of confidentiality, that at no time will the lender divulge this information… (That’s why litigation, like divorce is so acrimonious). The parties divulge all the confidential information about their relationship to the reading public. Therefore when you create and build the relationship, everything possible must be done to keep it clean.
  4. Goodwill: Like trust and understanding, the relationship must have goodwill. This is all non-verbal action of each party to ensure that the relationship survives for the long term both during and after the loan has been repaid.

If one cares to look at what has happened to Greece or indeed any bad debts situation, it will be found that either party ceased to adhere to the terms and conditions of the relationship, stopped respecting the other and refused to understand or appreciate the perspective of the other party.

We must all start to take on some of these attributes and our encounters with lenders will be less painful.

BN

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