Tumbling Interest Rates in Europe Leaves Some Banks Owing Money on Loans | Hacker News Reader

Tumbling Interest Rates in Europe Leaves Some Banks Owing Money on Loans

wsj.com

38 pointspmcpinto35 comments

The thing is that the bank is still doing OK out of this (as is the customer obviously).

Banks have the ability to raise capital. Then they can do something with the capital or they can leave it in the bank, in this case the central bank, who would give them negative interest. If they lend it to a customer who buys a house then they will get slightly better return on their capital with that customer (Trying to avoid the term "a less bad return").

As long as it's a temporary thing then the banks will ride it out and the customers will remember it fondly.

Most banks raise capital by holding deposits from customers. If the bank now tells me that it's going to charge me -1% for my savings account, I'm going to pull that money out and keep it in a safe.

Think about how aggressively banks compete on "no fee" accounts, and how aggressive customers are about moving their money to avoid fees. Mint, for example, practically sounds an alarm on my phone whenever I get charged a bank fee.

You might think twice about the safe if you had to keep, say, $800,000 in there.

1% of $800,000 is $8,000. I can rent multiple large safe deposit boxes in that same bank, with plenty of room for 8,000 $100 bills, for a few hundred $ per year.

I'd like to borrow 100 trillion dollars please. I won't actually do anything with it, so you don't need to worry about my credit or ability to repay. In fact, I'll happily keep it in my account at your bank!

I think if you don't have 100 trillion in assets to secure the loan with they might not give you the favorable rates that people got on these mortgages.

Do the 100 trillion in assets have to be marked to market, or can I make up whatever price I'd like and they have to accept it as valid? If it's the latter, that'll be no problem at all!

I expect the banks would want to value the assets themselves.

I know, I'm making a tongue-in-cheek reference to the banking crisis in 2008 where for a time the banks didn't have to mark their assets to market, but were instead allowed to hold them at "other" valuations.

Mark-to-market really is the best thing since sliced bread -- until you end up with a liquidity crisis and the only market left is fire-sale prices, in which case it just amplifies the crisis and (further?) undermines the entire notion of banks being risk-tolerant entities who are in business for the long haul instead of just chasing after the next quarter's results.

Much like in 2008.

This isn't a problem with an easy answer.

You could probably take my stolid inability to get the joke as some sort of commentary on the quality of the humor.

(which sounds really hostile, I'm feeling lazy about phrasing it better, I don't mean it to be hostile, of course humor is subjective, blah, blah, blah)

That works awesome until there is a bail-in like Cyprus and Austria, then you are pretty well screwed, something like a 40% hair cut on your trillion $ will make you run for the tums.

If I'm not mistaken the reason interest rates are so low and the dollar so high is because people are looking for a safe place to put their money where they wont get a hair cut if the bank fails.

Don't worry, I'll be shipping every dollar over 100 trillion out daily to a place where it's harder to get at. If they want their 100 trillion back they can have it. If they want the money that's already left the country, well, I already spent it all! Whoops!

I'll happily keep it in my account at your bank!

Excellent. The interest rate on that account is -3%, but please make sure you maintain a minimum balance of $100 trillion, or we will need to foreclose on your firstborn.

Perfect! I'm in a head-I-win-tails-you-lose situation since I don't have kids. Is this what it's like being a bank? I like it.

Zero is an arbitrary limit - It may have a psychological signal, but there is no reason it should be more shocking that the rates drop under zero than when they dropped under 0.1% or any other number.

True.

One could argue it's the difference between making money (positive interest), being equal (0) or losing money (negative). But considering that inflation is generally 1-3%, the sub 1% interest rates are already losing money effectively in real terms (the only terms that actually matter).

Inflation of course is extremely low these days in most OECD countries. But still, real losses on loans don't start at sub 0% interest rates, they can start at positive interest rates, too.

I guess it does mark something peculiar, which is sort of new on this scale. Insane levels of QE that don't lead to any significant inflation, making negative interest rates a somewhat sensible approach. In the past we've seen very low interest rates, too, but usually there was at least some fear of inflation, and at times inflation skyrocketed.

Time value of money - meaning that its better to have a $1 today rather than a $1 tomorrow - isn't really an arbitrary thing. If its not true, then we have deflation.

There are two concepts here:

1. $1 today might buy you less stuff than $1 tomorrow would. For example, maybe today $1 will buy you three today-apples, but tomorrow $1 will buy you five tomorrow-apples. This is arbitrary. The example shows deflation in apples, but there's no reason, a priori, that today should be better or worse than tomorrow, whether measured in apples or any other dimension. Maybe tomorrow $1 will get you two tomorrow-apples.

2. Under the assumption that the buying power of $1 is fixed and eternal, $1 today is necessarily better than $1 tomorrow because you have more options. Among other things, you might die later today. This phenomenon can't reverse, it can only make earlier money (or anything else) more valuable than later money. But it's not the same idea as #1.

Deflation is an idea related to concept #1. $1 today being better than $1 tomorrow is concept #2.

The traditional point made for #2 isn't about the fact you could die but more that $1 today could be invested in some profit-making enterprise (directly or through a bank account paying interest).

For a concrete non-financial-system example, $1000 today could let you re-insulate your home, saving you $250 over the course of the next winter. Every year you put off that $1000 then costs you around $250 (modulo any depreciation and the variability of heating costs).

The thing that's a little different with the banking system is that you're not just getting paid for the time value of your deposited money and the returns it could get in the economy writ large, you're losing a little bit for the sake of safety (deposit insurance) and liquidity (you can withdraw money from a bank account any time, unlike if you had issued a mortgage loan directly yourself).

Some short term Gilts/Bonds now have negative rates ie you pay to buy them (Switzerland is one example)

Why would banks lend to homeowners at less than 1% spread? That seems extremely low.

A mortgage is basically a commodity, so a as long as you have several competing actors margins should approach zero. Secondly banks can bundle a bunch of other services together with a mortgage so they can condition the low rates on the customer buying into other higher margin products .

> A mortgage is basically a commodity, so a as long as you have several competing actors margins should approach zero.

No, it should approach the chance that it won't get paid back, which is decidedly not zero.

The margins the banks make should approach zero, and that takes into account the fact that sometimes they'll get back slightly less than they lend out. However to get the type of interest rates we are talking about here you can probably only borrow at about 75-80% the price of the house and only for a relatively secure house, so the expected payback for the banks is pretty close to 1.0.

I borrowed at 90% LTV at 0.59% over Bank of Englands base rate.

But yes, the expected payback is pretty close to 1. Especially since of course you're required to insure the house etc., so their risk is mainly that property values could tank but of course that risk for any given loan diminishes rapidly over time as more gets repaid, so the average risk across a large pool of loans is pretty low.

Would you like to explain that to all of the American banks who lost billions of dollars when housing prices crashed?

Also, when a customer defaults on a mortgage, the bank gets "one house", not the cash value of the house. The bank then has to care for the house, list it with a broker who takes a sales commission, pay property taxes on the house, fix any damages that the prior owner may have left, and sell the house (which in the US housing crash meant competing against dozens of other foreclosures on the market in the same neighborhood).

when a customer defaults on a mortgage, the bank gets "one house", not the cash value of the house.

In the US. We're talking about Europe here and the laws are different. But in most parts of Europe you can't just hand over the keys to your house and be clear of your loan.

The fact that banks were so competitive going after mortgage business that they ended up losing money on houses is actually a very good illustration of the grandparent poster's description of pressure on margins. "We'll give everyone a rate so low we'll lose money!" -- that's some killer competition right there.

The article says that some of the loan rates are set below the benchmark.

I guess the cost of the money is usually still below that, or they wouldn't do it (they are also moving to put rate floors into their contracts).

What I wish all these stories would do is capture what the net-impact is at the end of the month after all the fees are considered.

For example, is there anyone who has ever netted a positive return at the end of the month?

Banks have quite a few tricks up their sleeves.

I know of some cases where they massively mark up the life insurance policy fee % for their loans (particularly mortgages such as in this case), it's not such a significant fee but it's very profitable and it adds up (and more than offsets the interest rate loss I guess). You can hypothetically switch life insurance providers, but they probably don't even have a procedure and the bank would end up declining your loan.

This is interesting, so this mean that you can not change the insurance company of your house offered by the bank to other company during the mortage?

I'm talking about life insurance on loans (Mortgage Protection Insurance), not fire or house insurance on mortgages which is much more flexible.

Also, it depends on the bank. I'm pretty sure it must be much easier in the U.S., the cases I know of are in South America (they basically won't give you the mortgage unless you use their approved overpriced life insurance, which is very low compared to the principal anyways).

It seems that it's a little less dodgy in the U.S., but not too much:

http://www.investopedia.com/articles/personal-finance/052014...

Edit: a related case in Canada:

http://thetyee.ca/News/2015/04/15/Insurance-Giant-Defraud/

Edit: exactly what I'm talking about, an English example

http://www.consumeractiongroup.co.uk/forum/showthread.php?39...

Edit: another example of how banks use other products to drive profits, but this one misfired:

http://www.thisismoney.co.uk/money/markets/article-3035922/B...

Wikipedia article:

http://en.wikipedia.org/wiki/Payment_protection_insurance

" the insurance would commonly make the bank/provider more money than the interest on the original loan, such that many mainstream personal loan providers made little or no profit on the loans themselves; all or almost all profit was derived from PPI commission and profit share "

I'm sure their respective governments can do something about this tragedy. The banks always win, everyone else always loses; that's Capitalism 101!

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