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Comment by ganeshkrishnan | Hacker News Reader

>Banks turn away borrowers because they end up with too many loans on their books and no real incentive to get more

Banks would never turn away borrowers even if there is 0 percent mortgage or even slight negative (where they have to pay borrowers for the loan). That's because these loans are then sold to investment banks and are packaged as CDOs (and swaps and synth CDOs and so on ad nauseam) .

This was the whole subprime mortgage credit crisis. The stock market goes up as there are now more 'SPEs' (https://en.wikipedia.org/wiki/Special_purpose_entity) being listed and more money being poured into stock markets.

Banks usually don't keep the loans. They are sold off quickly for a higher profit.

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This varies depending on the market but many banks in Europe at least do retain large parts of their loan books, in part because the securitisation market was always and still is less developed here.

Banks can and do routinely turn away higher grade borrowers with no other relationship angle (ie no short or long-term profitable cross-sell) because those loans are unprofitable for them and they can only make money on riskier credits.

More broadly, sub-zero base rates are a real problem for banks and may actually hurt rather than help credit creation (since banks are likely to do less of something which is less profitable).

The reason they're a problem is that most banks have a large portion of their funding in the form of deposits and passing on negative rates to depositors is very very hard - in my experience only the very largest (billions of dollars) overnight deposits get charged negative rates.

All this does contribute towards the search for yield phase of the credit cycle (CDOs were just a part of that - everyone likes to blame them but they didn't cause the credit cycle which is really a "natural" phenomenon, although they did act to obscure the amount of leverage in the system and thus the likely size of the damage when the bubble burst). Everyone across the board wants to take more risk because they can't make their numbers stack up with the less risky part of the credit spectrum. As a result over the long term some credit becomes mispriced and when there's a wave of defaults credit investors wind up losing money overall then we start the cycle again.

> The reason they're a problem is that most banks have a large portion of their funding in the form of deposits and passing on negative rates to depositors is very very hard - in my experience only the very largest (billions of dollars) overnight deposits get charged negative rates.

It's been quite some time Switzerland have negative rates and the threshold for charging the customer are getting lower and lower, closer to 100k than to 1B (base fees have also increased as a result of negative interest rates, easier to increase the banking fees than charge negative rates :))

Fair point - I was thinking about Euro deposits.

Where is the profit on a 0% loan? Who would pay more than face value for a stream of payments going into the future?

Lenders make money on the currency exchange.

This doesn't make sense for Americans because they use a single currency for everything, but in Europe, there is a benefit to having a revenue stream in a desirable currency which is appreciating relative to the Euro.

To the buyer, the loan looks like 0% because the buyer pays back the loan in Franks or whatever. The bank, meanwhile, gave out a loan of X Euros, and is receiving payments in a currency whose aggregate value is X+Y Euros. Their profit is Y. There's also the opportunity to make even more money selling options backed by these payments.

This is a completely valid means of making money, but it carries substantially higher risk than single currency lending. Which is probably the reason most banks don't want to carry too many of these on their balance sheets.

Where is that Y coming from? The rates of say EUR and CHF diverging?

Yes. If CHF outperforms EUR, and the mortgage payments are in CHF, a bank that has most expenses in EUR is making a profit.

You can hedge against the performance of CHF by keeping proportional revenue streams of EUR.

This theory doesn't make sense to me. Banks could simply buy foreign currency to achieve the same without the additional risk of defaulting lenders.

I'm not sure if / how this is done in Europe, but do these banks presumably also package these loans for sale, where a potential buyer of the note simply wants the recurring income stream for the next 15 or 30 years? That's the basic scheme here in the US anyway.

I'm having trouble following (maybe it's because I'm thinking in terms of residential loans, and the commercial market works differently or something).

If I purchase property in Switzerland with a Euro denominated loan, I have to convert my payments from CHF to EUR. If I'm depositing into a CHF denominated bank account that is owned by the bank I'm borrowing from and they charge me currency exchange fee, ok, but if I'm savvy enough to go with a foreign currency denominated mortgage, I'm also savvy enough to find a cheaper way to convert CHF to EUR. Otherwise I have to take on the onus of arranging the currency exchange myself, in which case the bank I'm borrowing from doesn't have a chance to benefit from the exchange fee.

If I'm a European bank and I want to engage in currency speculation, like the other people said below, there's no reason for me to have to go through the administrative hassle of making the loan in the first place.

Someone who can only lend at negative real interest rates and/or projects negative market growth.

When bond rates go negative, 0% keeps people neutral.

The (government) bonds in Netherlands are negative going out 30Y:

* https://ca.investing.com/rates-bonds/netherlands-government-...

Commercial bonds may not be too far off, so the spread may be enough for them to make a profit.

The loans are packaged into a company and then traded on the stock market. Your loan repayments are the company's "profits".

Bonds are created and then sold to share holders and you may even have a bond with your own mortgage in it.

Depending on the class of bond, you get paid more or less (this is the CDO)

The profits are from the bonds on the loan in the stock market.

I think these days the US and UK require originating banks to keep part of the loan to avoid the whole "sub prime", "it doesn't matter if it's shit as long as you're not the one holding it" approach.

At least in the US, it's not quite like that. There typically -are- penalties for certain things (i.e. if a loan goes into default or gets paid off via a refinance within X months) as well as regulatory rules and the ever-present GSEs, Fannie and Freddie.

As long as the loan is 'conforming' (which the majority of loans on the up-and-up are) then Fannie or Freddie will guarantee it. Conforming loans must meet a number of criteria (Debt to income, income versus home value, etc.) to have a level of trust that the borrower will repay.

Edit: And yes, if you get caught selling a non-conforming loan to Fannie/Freddie (i.e. underwriting discrepancies) you can get fined and forced to buy back the loan. In fact sometimes they will go on fishing expeditions and companies will have to prove their innocence, almost like an IRS Audit.

There is also the 'servicing' aspect of a loan. Servicers basically collect payments for loans and forward them on to whomever backs the Mortgage. For Fannie/Freddie loans, what this means in case of a default is that the servicer will have to 'front' the money; this is what the housing industry was worried about at the start of COVID: before the guideline changes related to the virus, there were concerns about liquidity in that 'gap' between forbearance and (potential) forclosure.

Depends on the size of the loan, but what you say is true for most. In my personal case I have a “jumbo” loan which is not covered by US government Freddie Mac rules so the bank has to hold the loan on its books. This is pretty common in the Bay Area due to the stupid level cost of housing. In my area the median housing price is $1.785M. From a US tax perspective it made sense for me to take out the largest loan, $1M, because of the interest tax deductions. That, charity and capital loss is pretty much the only tax deductions I have. Not complaining as I understand how lucky I am.

Does this work the same way in Europe?

Its works the same across the world as everywhere there is fractional reserve banking. The other "Shariah Banking" is also just repackaged fractional reserve banking.

As a Muslim, almost every "Shariah compliant" financing contract I came across is not compatible with Islamic Law (Shariah). Unfortunately, we're just taking modern parasitic and usurious financial contracts, and wrapping them under "Islamic" terms, and selling them as such. Any actual investigation of such contracts reveals that they're nothing but interest and usury in disguise. Islam seriously warns about this sort of behavior.

Under Islam, loans are are strictly an act of charity. There can be absolutely no contractual obligation for the lender to receive any benefit of any kind (monetary or otherwise) from the borrower in return for the loan. The borrower is encouraged to return more than the amount he borrowed, purely as a show of gratitude, but it can in no way be part of the contract, and in no way implied one way or another (like "off the record" sort of thing).

True Islamic finance is pro risk sharing, with no exploitative and parasitic practices that we see today. Want to start a business? Pitch your idea to an investor willing to put money into it, you put in the effort and he (or multiple investors) puts in the money. If the business succeeds, all parties benefit, if it fails, investors lose their money, and you lose the time and effort you put into it. Fair across the board. Zero debt.

Applying actual Islamic finance rules, we would immediately rule out things like stock shorting, put and call options, margin and leverage trading, mortgages, interest bearing loans, selling debt for debt, and so on. Now you can bet that Wall Street won't be happy, but time and time again those practices have proven destructive to the economy, and further increase the wage divide.

What about futures contracts?

In Islam, there exists a notion of a Salam sale (بيع السلم), or (advance sale). These are sales contracts in which the price is paid for goods to be delivered at a later time.

> The Prophet (ﷺ) came to Medina and the people used to pay in advance the price of dates to be delivered within two or three years. He said (to them), "Whoever pays in advance the price of a thing to be delivered later should pay it for a specified measure at specified weight for a specified period."

Does that sale describe future contracts (without any other stipulations or clauses, e.g. no shorting, no leverage, etc.)?

Note that Islam places restrictions on certain sales. Currencies are to be traded hand by hand, on the spot. For example, it's impermissible to purchase gold using a credit card because the settlement does not take place immediately. So things are a bit more nuanced there, as gold and currencies cannot be bought using Salam sales for example.

Yes that sounds like a classic futures contract to me. I'd never heard that usury rules applied to financial contracts before.

Its interesting because advance sales are a positional bet similar to a short sell. Are you allowed to sell the Salam sale contract to a third party? Apologies for all the questions this is fascinating.

Short selling has several issues. Brokers usually charge a fee for the borrowed asset (stock), this fee is clearly usury/interest. Also, it creates risk with the hope of gaining money, without any corresponding value being created. Shorting exposes three parties to the risk of a stock or asset (the shorter, the original owner, and the new owner), compared to a regular trade where risk is transferred from one party to another, and no new risk is created. I found this article[0] that goes into details about the dangers of short selling (see the sections on margins and overshooting specifically). Salam sales do not have those issues.

Furthermore, goods for which the quality and quantity cannot be specified cannot be sold by Salam contracts, as per the Hadith in my previous post (e.g. gems or precious stones since each is considered different), and I've seen at least one source that also exempts stocks from being tradable in Salam contracts due to high uncertainty (called Gharar sales in Islam, also prohibited).

As far as selling Salam contracts before they are fulfilled, I do not know. What sorts of issues or benefits can result from selling such a contract before it is fulfilled?

Edit: I think it is prohibited as well, as now the buyer is selling something that he does not yet possess. So you have the same item being sold multiple times before taking delivery. This narration should be the basis of prohibition:

> The Prophet (peace and blessings of Allah be upon him) forbade selling goods in the place where they were bought until the merchants had moved them to their own location.

> Apologies for all the questions this is fascinating

No problem! I'll do my best to answer what I know.

[0] https://practicalislamicfinance.com/2020/02/17/short-selling...

One important thing to note is that Islam also prohibits chaining together permitted contracts, with the intention being trying to circumvent or dance around the prohibition. For example, you and I can engage in the following set of transactions: I can sell you my phone for a certain price in installments (say $120 over 12 months, and $120 is the fair market value). Then, I go back and buy back my phone from you for $100 cash. The net result is that I paid you $100 and you owe me $120 over the course of the year. This is clearly usury, and placing an item in between is just kidding ourselves.

The same applies to more elaborate schemes that involve multiple parties or transactions. For example, it is possible to engage in a futures contract with the intention of gambling (buy oil or some commodity, and never take delivery of it and sell it immediately when the contract is due). This is gambling, your intention was never to actually possess the item, but only to immediately sell and either make a loss or profit.

> I'd never heard that usury rules applied to financial contracts before.

Islam prohibits something called Riba. Interest and usury fall under it, but Riba encompasses more than just loans. The example about purchasing gold on credit falls under riba for instance.

>we would immediately rule out things like stock shorting, put and call options, margin and leverage trading, mortgages, interest bearing loans, selling debt for debt, and so on.

These are the very foundations on which modern society is built and which drives the entire humanity forward. Sure, some people have managed to race ahead but on a whole we, as humans, have progressed from clubbing each other for food to arguing anonymously over the internet thanks to all these

With all due respect, this is a very fallacious argument. Just because it is widespread today does not make it acceptable or good in any way or form. It does not mean that it is the cause for our advancement (association fallacy, and correlation vs. causation fallacy).

As a matter of fact, I would wager that these practices are a main driving force of the wage gap we see today, causing instability and unrest, inflation, and tons of other problems. We have better solutions, it's just that no politician I've seen so far is going to dare admit that the modern foundations are corrupt. Very powerful people are not going to be happy (note that I'm not arguing for socialism or communism either, they are destructive in their own ways).

That is a sweeping (and incorrect) generalization. Except the credit part, all the other things are optional.

And even for credit, I am not sure interest is needed. That leads to the world devouring growth that we have.

Just because we inherited a world where these things exist, the tendency to attribute them all to these things is not wise. I don't know what to call this fallacy.

> And even for credit, I am not sure interest is needed. That leads to the world devouring growth that we have.

Exactly. It's not needed. It causes a growth at all cost situation we see today (and one cost is debt slavery for a large portion of the population, increasing the wealth gap).

Could you point me to some reading material that establishes that all those were necessary for the forward movement of humanity. Its not a snark, I would be genuinely interested in learning about this point of view.

I have no trouble accepting that these things co-occurred with the movement. I don't have a good reason/foundation to argue that they were necessary, or even beneficial, apart from artifacts that smoothen and/or amortize risks, insurance, for example.

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