Always found this a very strange metaphore. Banks seem to always face criticism for 1) when they don't lend to people who need it most and 2) when they do lend to people who are likely to default. It seems fairly obvious that there is a very large overlap between those groups.
1) Lending, insurance, and investment as a social service. People need homes. Businesses sometimes need to weather crises without bankruptcy. Startups need funding. People need educations.
2) Lending as a private investment. You want interest rate to reflect risk.
Evolving monetary theory means federal interest rates are set to reflect #1. The underlying view is that financial system is a bunch of bits used for accounting designed to keep businesses productive, people working, and the economy running, much as you might have in a video game. You make and destroy money as needed to support what needs to happen to make that work, much as a game developer might engineering money sources and sinks into an MMORPG. It's just bits on a computer.
Historical practice and the structure of banks is set around #2. This is a really sound theory if your currency is either backed by gold, or even is fiat currency, but running on the same principles.
Defaults aren't a problem with #1, unless they encourage bad behavior. If a bunch of poor people buy homes, and later default on mortgages, it's really not a big deal; bits on a computer appear and disappear. If 50% of those people come out owning homes, you're still ahead if 100% were still renting. But in #2, it's a financial crisis. Conversely, if a bunch of poor people can't buy homes and have to rent, it's a crisis in #1. It's not a problem in #2.
I'm not sure the mixture model works well -- indeed, I think that's the source of our problems. I think if we killed the banking sector, and folded all of this into the fed, it'd work great (that's what China does). I think if we had the gold standard again, that'd work pretty well too. But when you mix the two, things get a bit ugly.
It's good to have banks of different sizes serving different niches, as long as they assess risk prudently and price rationally. What you don't want is politicians micromanaging in domains in which they have no expertise, especially when they are driven by short-term, personal political objectives.
The problem comes when you force a business that really wants to align to the profit incentive (banks) to provide social subsidy by effectively charging their profit-generating customer base a premium. 1. They're incentivized to do the bare minimum necessary. 2. They're incentivized to stick to the letter and not the spirit of the law. 3. The transfer of wealth from paying to subsidized customers is opaque and nobody can do proper accounting.
This is a major source of corruption and inefficiency. It's the sort of problem that's all over the place whenever the private sector is forced into providing this sort of opaque cross-subsidy.
If I were to re-do this from scratch I'd privatize all the banks and let them do just the profit-making part, and have social programs solely as a function of the government, with a set yearly budget.
We could do better than the Fed in 2020. Tech makes transparency easier.
If you keep strict controls on the amount of fiat currency issued, and lend for reasons other than earning a good interest for financing risk, then you end up with a shortage of capital to lend. Then loans are issued for criteria that aren't publicized - in polite terms, politically motivated lending. Society stagnates as the engine of progress itself turns into a zero-sum game.
There is a better way to ensure the delivery of socially-beneficial goods - to deliver them directly, taking care that public options provide only minimally sufficient goods and services, and only in response to the failure of the private market to provide alternatives.
* Very few people want to lose their homes or to go bankrupt.
* Investors try to act optimally from a game-theoretic point of view. This usually means maximizing their own income (which isn't always the same as maximizing returns on the many they manage).
* People aren't always rational.
Let's look at the two systems for how we handle bankruptcies and defaults:
1) Money is bits / a game: We attempt to structure penalties to minimize structural damage to the system, while slapping you hard enough on the wrist to make defaults an undesirable outcome.
2) Money is real: We attempt to extract enough money out of you to balance interest. If we have harder penalties, with rational investors, interest rates go down, so keeping high penalties promotes a strong economy.
And for how we decide to loan:
1) Money is bits / a game: I loan you if the loan is perceived to benefit society. E.g. if you are engaged in an activity with a lot of positive externalities (e.g. going to school, buying a home for your family, or making a new startup), I will give loans with lower interest. I discourage bad debt (e.g. credit card debt, or mortgages I know will fail.
2) Money is real: I expect returns. This might be due to good debt (e.g. business investment) or bad debt (e.g. you're buying a home you can't afford, but interest + sales price when you default results in net income for me when / if you do default, payday loans, etc.).
Both of these systems are rational. Both, in practice, have politics we need to manage. The problem happens when e.g. monetary policy sets interest rates, in conflict with what the market wants. The risk is astronomical right now, and system #2 says don't loan, which is where the private sector wants to go. But without cheap credit, the economy goes down, which is where the fed steps in. And, of course, private investors can try to arbitrage the two forces.
3) Lending "responsibly", where responsible means protecting borrowers by not allowing borrowers to get into more debt than is good for them. (As opposed to responsible being for the lender's benefit.)
There's a paradox in this, because it exarcerbates some problems that it is supposed to be helping with (the assumption is it's to protect would-be borrowers from problems).
For example, if someone has multiple high interest loans with different providers and would like to convert them to one lower interest loan with a longer payback period (a consolidation loan), that would be good for the borrower. It would be a responsible thing to provide that. But it's all but impossible for borrowers who would be most helped by these to get one.
In the UK it is has been the law for a few years that lenders are not allowed to lend to private borrowers without evidence that the borrower can repay, regardless of what criteria the lender would like to apply. This is separate from credit risk assessment, and is done after the borrower has been approved for the loan. The result is that a number of borrowers would could pay, are no longer able to obtain good quality credit because the necessary evidence is too difficult to provide, and end up in a more vulnerable situation as a result. For example, self-certified mortgages for self-employed small-business owners used to be a thing, now borrowers in that position can only get a foreign self-certified mortgage, with significant loss of protections. Personal loans are subject to income proof now, which mean people with variable income use credit cards instead at much higher rates of interest.
The mortgage thing, combined with high property prices and very low interest rates, has widened the "haves and have nots" gap, where those who managed to get a mortgage at some time have much lower property costs and falling while gaining equity, compared with those who didn't get one and are trapped with high and rising rents. It would seem responsible to offer the latter mortgages when they have shown a long-term pattern of consistently paying higher rents than an equivalent mortgage, but it is not taken into account, bizarrely.
Does any business operate this way, including the one you work at? That is, selling things to the people who need it most for the amount that "minimizes default" (ie lowest price).
>we're allowed to expect institutions to do things that are in the public interest
This article is about wealthy mortgage borrowers. The first guy is 60 years old with a $700k mortgage who wants a lower rate. How is it in the public's interest to grant him that? Perhaps it's in the public's interest for this man to continue to pay his modestly higher rate in order to cover expected losses from those who truly need it?
No. But then again, being a businessman isn't seen as unqualified virtue in many places in the world. You'll also note that "selling things to the people who need it most for the lowest price" is literally the justification given for why free and competitive markets are good. It's the goal societies want to achieve. In this, competitive pressure is a hack to force the businesses to reduce prices.
If you think "price that minimizes default" and "lowest economic price" are equivalent, you need to brush up on your Econ 101.
I think a business that sells something for a small markup but makes it up in volume does something like this. So I guess the answer would be - yes - probably most businesses actually do this.
Define a "small markup".
Maybe it means that some institutions, especially ones with such a critical role as controlling the money supply, perhaps should not be run with a for-profit model, but some other model that better ensures the institution will serve the public interest, rather than the interest of an exceedingly small handful of elites. Typing this out it seems even more obvious.
It may come as a shock to some people, but capitalism isn't an immutable law of nature. There are such things as alternatives.
Your social concerns are completely detached from reality if you're shedding tears over people with jumbo loans that are unable to refinance their million dollar mortgages from 4% to 2%. It's theatre.
I appreciate your white-collar, anti-capitalist rant, though. Unfortunately, when SHTF, the truly down trodden might even consider people like this part of the problem. I don't think they'll buy the idea that "we're all on the same team!".
>It may come as a shock to some people, but capitalism isn't an immutable law of nature. There are such things as alternatives.
You're right, we should put our non-elite, galaxy brain politicians, the Trumps and Pelosis and Bidens and Bush's of the world, in charge of controlling the money supply.
Yes
> This article is about wealthy mortgage borrowers. The first guy is 60 years old with a $700k mortgage who wants a lower rate. How is it in the public's interest to grant him that? Perhaps it's in the public's interest for this man to continue to pay his modestly higher rate in order to cover expected losses from those who truly need it?
I wasn't responding to the article.
What are his options now? He can go to a Bank B that accepts more risky borrowers with a still acceptable but slightly higher interest rate of 5%. What happens is that all the reliable lenders go to Bank A because they get a great deal there and have no trouble getting a loan. They don't even bother with Bank B. Since Bank B fails to attract reliable lenders the only borrowers at Bank B are those who couldn't get a loan at Bank A. Bank B now has two choices. Either keep the risk profile or tighten it and only allow reliable lenders. If they keep it then they will notice a much higher than usual default rate. Bank B is losing money from all the defaulting loans and that money has to come from the borrowers of Bank B that didn't default.
Now imagine that there is a Bank C. What if it's risk profile is so lenient that it accepts anyone with no questions asked. Literally everyone who comes to you is defaulting. You're throwing money into a black hole with no chance of getting it back. You have to crank up the interest rate to absurd levels to cover the defaults.
You know what the problem is? It's not that Bank C is evil and exploiting the poor. Those people should have never gotten a loan at all. The act of giving them a loan is exploitation itself, not the interest rate or whatever conditions that Bank C needs to stay in business. It's as simple as that. Those individuals do not need a loan, they need support from the government in a way that doesn't require the money to be paid back. e.g. free housing, unemployment benefits or even straight up UBI.
Don't criticize Banks for not lending to those who need it most. For some reason people don't understand that Banks are businesses that have to at least cover their costs. They think a Bank is a charity that should take on responsibilities that really only belong to the government.
Your final paragraph is exactly what my earlier comment rejects. The general public has every right to criticise banks for acting in the banks' private interest. Banks are not charities, it is true. But they are groups of moral agents acting in a community, and the community has every right to hold the moral agents to whatever standards the community wishes to.
The bank has the legal right to pursue its own private interests, so long as it acts legally, and has the legal right to not act as a charity. But that is not an argument against the view that the bank should act in conformance with community expectations, and if necessary the law should be changed to ensure that they do.
The fact that banks make ridiculous profits - they're not just covering costs - is also relevant. If your business is making billion dollar profits, you're vulnerable to the claim that you should give greater weight to public opinion, and the notion that you're only acting to cover costs is a red herring.
Everyone hates them as well.
Everyone hates student loans and they fill a different gap.
Basically, people hate people who lend money.
That's because they offer a very dangerous financial tool, and at the same time they work hard to put this tool in hands of people who can't handle it safely. In this way, they make money off destroying people.
> Everyone hates student loans and they fill a different gap.
The problem with student loans is on the higher level in the system; their existence causes runaway cost increase of higher education.
If the loan is meant to pay for tuition then perhaps that's true. My loan was something like £1600/yr which covered about 5 months of rent, but the government paid for my tuition.
When I ran a service business & wanted to borrow money for growth, even though I was profitable, there was no risk formula I fit into that would allow the bank to determine the likelihood my business would pay them back, so they wouldn't lend to me (unless I used personal assets as collateral).
In the UK there are credit card companies that specialise in borrowers with poor credit. They offer cards with a rate of up to 100% and a contract which gives them first call on any assets, including the borrower's house.
Is it hard to understand that this is entirely conscious and predatory? They could lend at lower rates and minimise the risk of default, but they make more money by pushing high-risk borrowers into default and selling off their property.
It's a similar story with bank loans for small businesses. Banks will often call in a loan and bankrupt a small company at the first sign of any trouble, including a wider recession that the company may be perfectly able to handle.
There's a huge gap between prudent and sensible lending and aggressively destructive profiteering, and banks are often on the wrong side of that line.