NO FREE LUNCH!!!!

I think a lot of the political craziness and the market panic we're suffering through right now is the result of sheer economic illiteracy, and an utter lack of analytic ability on the part of the general public. This includes people who otherwise make a shit-ton of money, who have advanced degrees, and who fancy themselves quite bright.

The key lesson of economics is there is no such thing as a free lunch. Say you go to a conference where you get a free lunch. You enjoy the free lunch, because it's free. But in reality, you have to pay.

What? Can this be true?

Yes, my friends, it is. I know it's hard news to take, but it's true.

It's possible that you get your lunch without paying for it up front - but you actually do pay for the "free" lunch by paying for the entry fee into the conference. (You, or if the conference is sponsored, the people who will try to sell you something). Yes, that's right - the people organizing the ABC-A-Always-B-Be-C-Closing Sales Conference have lied to you. The cost of the "free" lunch is actually incorporated in your event fees. Or the administrative fees. Or if it's a government conference, the taxpayers pick up the tab because they are generous like that. But somebody has to pay; nothing is ever free.

This is true everywhere in life. I was having a discussion about this with somebody in my life who is close to me, somebody who is probably close enough to me to cut my throat in my sleep for having incessantly assaulted her with relentless financial reasoning on this point.

The person made a statement that a zero-down, no interest and payments for a year financing was a good deal. "No, it's not," I said. You still pay a finance fee, they just incorporate it into the retail price." "No they don't," the person said. "It's free financing if you pay within a year." Yeah, then it goes to 17.9% percent, or 29.99% if you're late on a payment. NOT FREE! Especially not free if you screw up. The bank always wins, eventually.

Let me illustrate.

Few big businesses that retail big ticket items actually own the gear they sell. They have "floor plan," a pile of stuff on the sales floor and in the warehouse that is "purchased" using some kind of credit arrangement. In reality, a bank owns the cars at the local Ford dealer. The bank floats the dealer $3 million to have a few hundred cars in the lot, at some sort of preferred commercial rate - more preferred now than ever, since the Fed stepped up to guarantee bank-to-bank commercial loans. Anyhow...

All businesses have more or less predictable overhead to cover, including payroll, facilities, insurance, capital investment requirements, and so forth. Let's say that car dealer needs to make 10% profit on a car - a figure lower than a lot of car dealers probably usually make but we'll use it - to cover overhead. Let's also assume a 7% simple interest rate, non-compounded, for loans relating to that car.

The dealer gets a car from Michigan. It costs $10k from the factory. The bank covers this cost, giving Ford $10k, and sending the bill to the dealer. The dealer doesn't need to pay for the car right now, but the bank expects interest payments on the loan. If that car sits on the lot for a year, the dealer needs to eventually cough up $10,700 to pay back the bank. (7% x $10k = $700, right?). Whoops, there goes that 10% profit rate the dealer needs to keep the door open. So the dealer has a big incentive to sell - a few hundred cars racking up a hundred bucks interest every six weeks starts to be real money pretty soon.

Now assume somebody wants to buy the car on day 1. The dealer can sell the car for $11,000, make the necessary 10% profit, and everybody is happy. Ford Motors already has their money - so who cares about them. The bank gets their $10k (we're ignoring service fees here, which are the bank's profit margin) so they're happy enough, and you get a car. Everybody's happy. Especially if the dealer managed to sell you on some highly profitable loan program. (E.g. $10k financed over 5 years. Mmmmmmmm...oney!)

Now assume the dealer is having trouble moving that car. After six months on the lot, the dealer owes $10,350. To make a 10% profit, the car has to sell for $11,380 or so - a slight price hike. But the car is both higher priced (less likely to move) and the new model year is coming, so they have to move it. How to move the thing out?

What they do is fiddle with the price a little bit, and offer really attractive financing. The ads you see will be for 'zero down, zero interest for a year.' So you go in to buy the car. You find out that the car is priced a little more expensively than at the Ford dealer across town - just a few hundred bucks - which unbenknownst to you is precisely how much it will take to pay the interest and principle on the floor plan loan. So the car is selling for $11,700, as opposed to $11,250. (The guys across town know the deal; they were selling at $11k but have hiked prices 'cuz your dealer hiked prices - it's what the market will bear).

So the price is a little high, but there's this great free financing deal. Like the person close to me, you assume you can get it paid off in a year. If you don't, then you get charged finance charges back to day 1 of the purchase - compounded. If you're so much as a millisecond late making a payment, your interest will get hiked to the statutory maximum, something in the 25% - 30% depending on where you live.

But boy howdy, the financing is free right now, 12 months same-as-cash. So you go for it.

Do you see what's happened here? You just paid for the year's worth of finance charges that the dealer would have had to pay, had the car not moved. But not only did the car move, it also moved at a profit, since your credit isn't perfect and you are grateful as hell you could get such a good deal. Ultimately, even if you pay the thing off in under a year, you will pay 700 more than you would have paid otherwise. No, you aren't going to get the great financing plus the $1000 rebate that you saw in another ad - you can ask for it but they will tell you it's one or the other. And since you don't have cash on hand necessary to qualify for the $1000 rebate (small print: $2,000 down, excellent credit rating, Venus on the cusp of Uranus), you'll take the interest-free financing.

What's really nice about it, is the bank gets paid immediately, so those troublesome floor plan interest payments are gone. The dealer is off the hook, with ~$1300 in his pocket - better than he could have done selling the thing at barebones Manufacturer's Recommended Price of $11,000. And, there's always the prospect of you screwing up on your payments, followed by a highly profitable interest rate hike. Oh, happy day!!!

Now here's where the person close to me and I differed in opinion. Said person commented, "but they only sell the cars at one price."

"Yep," I said. And the higher retail price that they charge reflects the cost of financing your purchase "interest free" for a year. Some people may come in and buy the car with cash up front, and they pay the premium too, since the cost of the promotion has to be reflected in the sticker price. They might get the rebate. If they don't, well, SUCKER!

Thing is, you can't run a business offering free financing if the cost of "free" financing isn't reflected in the sticker price. Not going to happen. You gotta cover that overhead.

The person close to me commented, "but the place I got the washer and dryer from several years ago on that arrangement was the cheapest retail price I could find."

My response was, as you'd expect, infuriating to the person.

I said that the penalties and interest in the arrangements - which the business counts on a lot of dummies getting stuck with - more than makes up for any losses if the margin is narrow. When the "free" financing is issued, they have a pretty good idea of who will pay early and who won't, and that is reflected in the price of the item - quick payers pay a little for credit, slow ones pay lots. But everybody pays.

Similarly, if you look hard enough, you'll find a business selling the exact same item, at a marginally lower price. It won't be a lot lower - if the car is fetching $11,700 at this dealer it will be $11,250 across town, they need to drop the price enough to induce you to drive your old hoopty across town to buy the new one, but they'd be silly to go below that level. So, to some extent, a lot of other consumers are paying for "free" financing deals. See how easy credit distorts the market a bit?

Now there are some exceptions to this. If a retailer is really getting hammered on finance charges, they will liquidate stock. Say the car has sat there for a year. The profit margin at $11,000 is now down to $300, because the floor plan interest charge for one whole year was $700. But the dealer needs cash flow to pay the interest, and has to move the thing, so they'll sell it for $10,750 - "all stock must go!" But you'll notice, they aren't actually taking a loss on it, and again, the price of financing ($700/year) is still reflected in the sticker price.

You still following me here?

The bottom line is that there's *no free lunch*. Everything has to be paid for by somebody. If you are the final consumer of a product, you or similarly situated people are the folks who have to pay. There are a lot of complexities to it that I glossed over or ignored, but I beg you to remember that everybody pays sometimes.

Keep this in mind when you're buying cars, attending conferences, or listening to people promise you free healthcare, mortgage bailouts, or anything else.

It ain't free, the only real question is who is going to pay, and who will profit.