A new credit bubble gets ready to burst
greenwichtime.com
greenwichtime.com
Yet we know exactly who the participants are, the types of firms, and their practices.
Step 1 to better regulation of creative rent seeking is to stop treating it like it's nebulous.
Actually, the hedge fund and private equity fund people hate that term because it implies something nefarious is happening. In reality, the new post-2008 crisis bank regulations in both Europe and USA to ensure stability causes a new phenomenon to emerge: Non-banks lending money to companies that banks are not allowed to lend to.
Every economist and financial regulator knows this became a side-effect of the more stringent financial regulations. So the "too big to fail" banks will still lend millions to big companies like Microsoft and Apple, but the $50m companies are too small and too risky to bother with.
Look how these "shadow" lending transactions keep emerging...
- a billion dollar pension fund is woefully short of its obligations to pensioners and needs a higher yield on its money. Buying safe US T-bills that yield 1% interest is not enough. They need to look at alternative asset classes that gets them in that ~8% range.
- a medium-size company needs $50 million loan to expand its business and is willing to pay a higher interest rate than 1% T-Bills. (That makes sense since the company doesn't have the same credit worthiness as the US Government.)
- If the pension fund (needing to put their money to work) and the company (needing a loan) can match up with each other, they can help each other's goals. But the pension fund isn't in the business of analyzing credit risk or providing loans directly. Likewise, the owner of the company doesn't have the time to fly all over the country and meet with 100 different pension fund officers.
That's where middlemen like private equity come in. They're the ones with the staff of credit analysts. The "back office" of the private equity fund that analyzes a company's credit worthiness does much of the same work that the credit analysts at JP Morgan, Bank of America, Wells Fargo, etc did. They become the "shadow bank". Of course, they also charge management fees and a % of the profits for their "financial intermediary" services.
The middle market's underlying need for credit never disappeared. The new bank regulations just inevitably shifted the loan transactions to a different set of players.
But shadow banking can and should be scrutinized, and potentially regulated, if there are systemic risks that will lead to the taxpayer being on the hook once again. If it's just isolated private actors losing money it doesn't matter.
so the taxpayer is on the line (at least, as much as they were in 2008)
So instead of banks lending directly to the risky mid-size businesses, they are lending to trustworthy middle men?
> To fund all this loan-making, the shadow banks have turned to insurance companies, pension funds, university endowments and wealthy investors, offering them a chance to buy into a diversified pool of loans that offer returns ranging from 6 percent to 13 percent, depending on the level of risk they are willing to assume.
If some hedge funds and "wealthy investors" want to take on risky investments that are "unregulated" I'm all for it. Would you agree the risks for systemic collapse come in when it's straddled onto say insurance companies or pension funds?
If everyone is making riskier bets for a significant, then those who do right may be outcompetes for long enough that they go by the wayside while the risk-takers dominate.
Then when the “black swan” comes the risk averse are already gone. Oh and the system is full of TBTF entities.
The line would be fairly arbitrary but I don't see why that would make it particularly hard to implement?
Rent-seeking happens when a person or business uses their position or resources to get some additional benefit from the government. The most common occurrence is when a company or industry lobbies the government to receive special subsidies, grants, and tariff protection. The term "rent" in economics means receiving a payment that is over the costs involved in the production of the item or keeping the item in service. These actions do not produce any benefit for the community-at-large but only redistribute taxpayer's resources.[0]
>Rent-seeking is an attempt to obtain economic rent (i.e., the portion of income paid to a factor of production in excess of what is needed to keep it employed in its current use) by manipulating the social or political environment in which economic activities occur, rather than by creating new wealth.
The important bit in rent-seeking is "rather than creating new wealth."
Here is Wikipedia's:
"Rent-seeking is a concept in public choice theory as well as in economics, that involves seeking to increase one's share of existing wealth without creating new wealth. Rent-seeking results in reduced economic efficiency through misallocation of resources, reduced wealth-creation, lost government revenue, heightened income inequality, and potential national decline."
I'm not so sure about this - what I'm thinking is that the next (current?) bubble is in auto lending. I'm seeing tons of advertisements saying "We will lend up to 72 months with very little down". With the average new car priced around $37500 that's a payment in the mid $500's for someone with good credit. And I suspect the people doing this only have an average credit score so theirs will be higher.
That's absolutely jaw-dropping. I assumed that was a made-up Internet stat, and was going to ask for a cite, but some quick web searching confirms it.
I'm a used car guy, typically buying vehicles 2-3 years old, and would never contemplate paying above $20k. Even a brand new sedan (e.g. Nissan Altima, Honda Accord) is around $23k MSRP. A crossover family vehicle (e.g. Nissan Rogue, Honda CR-V) is around $25k.
What on earth are people purchasing, that the AVERAGE price is a low-to-mid range Mercedes?
A Ford F150 Raptor's MSRP is something like $60-70k.
dumb question: why do pickups/suvs have insane markups/profit margins?
Trucks are just what you drive in rural areas. And there are a lot of small towns and rural areas. Companies noticed that people are shelling out $40k for them, so they started selling them for $50k. $50k and they are being bought still? Ok, time to charge $60k, and so on.
It's not just perceived safety though. Heavier cars are objectively safer when crashing into a lighter car. IIHS did several tests on this. The fact that SUVs are higher means that they have an advantage if crashing head on with a sedan.
I think emissions can be improved with things like hybrid drive trains and electric motors.
As utility vehicles, they also tend to have really good resale value, so they might not be quite the poor 'investment' you imagine.
Because the resale is good, margins can creep up. There's nothing holding them down.
STILL... I'm paying about $500 a month on my car when you count insurance and car note, and mine is only $24K. The only way anyone is ever getting me to pay more than $30K for a vehicle in this day and age is if I win the lottery or if I absolutely HAD to have a more expensive vehicle to do my job (such as towing or sales).
I think that's a classic median vs average situation. The median purchase price is probably a lot lower than $37500, while the average is skewed up by a minority of buyers purchasing very expensive cars.
An accord/ultima start around that price for the base models and the lowest package. I doubt most people buy those models. People like options and get plenty of them.
Also keep in mind you pay a ton of tax and also registration. Registration is insanely expensive in states like CA.
The price of a low mercedes is much higher than that, not sure where you're getting your numbers, but they're off, WAY off.
For example, take a look at this depreciation curve for a Ford F-150: http://usedfirst.com/cars/ford/f-150/ There is very little depreciation from 2017 - 2015, meaning that if you keep the truck in good condition, you can basically drive a truck for just its operational costs (fuel, maintenance, etc.) Not a bad deal assuming market demand stays hot for these vehicles.
F150 was one of (if not the) most popular vehicle(s) sold in the US for a long time. It's not cheap.
Vehicles are much more "liquid" -- they're portable and fungible to some extent. A bank repossessing many vehicles will get much more of its money back than a bank trying to sell foreclosed houses.
In contrast, in a typical market, it is uncommon for houses to be underwater, as they tend to appreciate in value. It took a crisis in the housing market for a large portion to go underwater. A simmilar crisis in a market where underwater is the norm would just push them further under.
In a housing bubble, houses lose a lot of their value because the buyer side of the market shrivels up.
In a housing crash, this is exactly what doesn't happen.
It would be quite something if tech and not banks caused the next great recession.
So while not immune from risk, it’s considerably less risky, and works over a shorter time frame, than other credit options.
That's not a terrible thing either. If you are not able to save up for 5 or more % down, odds are good you will be house-rich and money-poor, which can really suck a lot of enjoyment out of owning a home.
Say, for example: a $300k home with a 285k mortgage will work out to around $2,000 per month. Add in a vehicle payment or two, maybe a higher bill if you have high property taxes, phone, internet, paying down credit cards, whatever, and you're easily in the 3-4k per month just in bills. If you can afford that and not feel financially constricted, then you can afford to wait a bit, get more saved up to put more down, and you'll have more available for vacations, repairs, additions, appliances, etc.
Anything less than 10% is insane, and less than 20% means you can’t afford it.
Instead of Private Mortgage Insurance, the banks (typically?) require that you have a certain amount of cash in the bank as reserves. x% cash, y% investments discounted at 30%, z% retirement discounted at 40%, and so on. More at 10% than at 20%. And so on. But I don't think these are required; there's no reason a bank couldn't just decide to let you go without. And while they require pretty extensive documentation, you can still game the system.
When we bought (2015), interest rates for jumbo loans were LOWER than confirming loans, and no PMI requirement. win/win.
I'm curious if it's that most banks "won't do" or "legally cannot do"?
PMI doesn’t protect the buyer, it protects the bank. If the buyer stops making payments and housing prices are dropping, the bank could be screwed.
Sounds strikingly familiar...
Furthermore, Zerodown is structured so that it will never go through the foreclosure process. They own the property and lease it out, so the worst they'll need to do is an eviction.
Same as any other startup failure, just with REO bargains on the back end.
But if a bank is willing to take on the high risk in return for very high interest rates there's no particular reason why it shouldn't be possible. It may end up being exploitative, like payday loans, but not necessarily.
Is is lower risk, but it's not because it's some weird moral test.
The reason is that the lender only loses money once the value of the house has declined by the amount of the deposit. Say you buy a house with 20% down. If you sell the house at 80% of the value, you've wiped out your deposit but the bank loses nothing.
On the flip side if the house goes up and you sell for 120% you've doubled your money, but the bank isn't any better off.
Every mortgage application asks if someone else is contributing to the down payment. That wouldn't matter unless there were a difference in risk classes between the two groups of people, so it's not purely a matter of a better loan-to-(initial-)value ratio.
Edit: looks like that's not the (dominant) reason; see follow up thread.
> Every mortgage application asks if someone else is contributing to the down payment. That wouldn't matter unless there were a difference in risk classes between the two groups of people, so it's not purely a matter of a better loan-to-(initial-)value ratio.
Don't they ask if someone is contributing to the down payment because it could be categorized as a loan that would factor into your income to debt ratio?
https://www.accunet.com/buying-a-home/can-my-down-payment-co...
From that page, the bank wants to make sure it's not a loan or a side-payment from one of the parties to the transaction.
Still, I'd be really, really surprised if there weren't a correlation between "fraction of DP as gift" and "default rate", but I don't have anything concrete to cite ATM.
These types of loans always increase when credit is cheap, and then they end badly (sometimes very badly) when the economy eventually turns.
Of course, to my knowledge, the only environment where zero down mortgages were really widespread was the mid-aughts housing bubble, but even with an n of 1 I still think it's a bad omen.
The typical bank in the US is levered ~5-12x which means, many of these "shadow banks" are unlevered, this creates an entirely different dynamic
The "shadow banking" services that are rising are coming about because normal banks are unwilling to take on even moderately risky lending. Their demands for loans are now extremely stringent, especially for smaller and middle-tier business customers. This demand is thus being filled by different, non-traditional, sources, i.e. "shadow banking".
The situation in overseas, especially Europe, is very very different. Many large European banks are currently operating with reserve ratios of only a few %. I don't know if this means there is less "shadow banking" in europe or if they just have far too much sovereign debt on their books.
On https://fred.stlouisfed.org/graph/?g=o4OS I've included updated source data from that article, and you can see that M1 has continued to grow while fed reserve balances have fallen, but neither was ever close to M2 (which includes things like savings accounts and small CDs).
A better indication of banks' leverage is Total Equity to Total Assets, which is similar to the Basel Tier 1 capital ratio: https://fred.stlouisfed.org/series/EQTA
This has steadily gotten healthier over time overall as banks have tended to reduce their leverage over the last few decades.
If we are leveraged at 100% when we take the real valuation of assets into account, then, if we jack up the valuation on assets we hold, then we can chip away at the leverage ratio and get it to go down.
It feels very much like we're in 2002-2005-ish again.
What do we know about the pre-crash market in association with these signals? We know that (1) these things sound like a get rich quick scheme and (2) that they legitimately were a get rich quick scheme, because they actually worked up until the crash where many people were left holding the bags (houses that could no longer be flipped given the post-crash market conditions).
Especially now with new technologies coming up all the time, companies will just go around the laws.
Doing something like that is pretty far-fetched and would require a new type of technological government. But to me there is a structural problem with the relationship between money and government (in their current low-tech forms) in society.
Can you expand on this? Your comment intrigued me.
The solution is a high tech type of money that is integrated with government.
If the government had even more control over money, they could arbitrarily blacklist people from having access to currency. While this sounds like a good tool to use against criminals, recall that, in America at least, there exist things such as the no fly list [0], which impacts people's rights without due process.
But the problem with the relationship between money and government is so significant, a real solution would require dramatic changes all around. So that would mean that government could not be anything like it is today.