Here is another big difference between the 1 percenters and everyone else. They get paid to co-sign loans.
Ever co-sign a loan? Maybe your kid is in college and you needed to co-sign for the student loans from Sallie Mae. Or maybe a friend or a relative’s car broke down and the only way they could get a new one in order to be able to get to work was for you to co-sign the loan.
Now, here’s the question: Is Sallie Mae paying you for co-signing that loan? How about the auto finance company, are they sending you regular checks for having co-signed that auto loan?
Probably not. Not if you’re part of the 99 percent.
For most of us, co-signing a loan is a very strange transaction. We agree to provide a valuable service to the lender, in exchange for which the lender gives us nothing. Very strange indeed.
The lender wants to make a loan. This is their business model. It’s how they make their money — no lending, no profits. But every loan they make entails taking on a bit more risk. What if the borrower defaults? To insure themselves against that risk, lenders can buy insurance against defaults. Or they can just take it without ever paying for it.
The latter is what they’re doing when they get you to co-sign a loan. They’re making you provide them insurance for free.
Like most people, for the past four years I’ve been reading and hearing a great deal about credit default swaps and trying to wrap my head around what exactly those are and how they work. And from what I’ve figured out,* they seem to me to be not much more than a way of getting a third party to co-sign a loan. They don’t call it that, but it works the same way. If the borrower defaults on the loan, the co-signer — the finance or insurance company selling the CDS — becomes liable for paying off the balance.
But no finance or insurance company is going to accept that potential liability free of charge. The lender wants to get rid of some risk so the seller of the CDS offers to take on that risk instead — for a price. The lender pays that price willingly because this service is extremely valuable.
Basically it’s loan insurance. That’s what those companies are offering when they sell each other credit default swaps. And that’s what you are offering when you co-sign a loan.
The only difference is that those companies are getting paid to take on the risk of this potential liability. You are not. You’re just doing a huge favor for Sallie Mae or the auto finance company because you’re such a nice person.
Or because you’re getting ripped off.
If every parent, friend, relative or roommate who’d ever been suckered into co-signing a student loan, car loan or mortgage had been paid even half the market rate that lenders pay each other for this kind of insurance, that gap between the 1 percenters and the rest of us might not be quite so huge.
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* People who understand this better than I do, please feel free to correct me if I’m getting this wrong.