If the cash rate drops to -25bps but the risk premium increases by 250bps, then the central bank is unable to control the rate the final borrower pays.
Even though the intermediary has a negative funding rate (getting paid to borrow), money lending still ALWAYS consists of two factors: the funding/lending spread and the probability of default. Even if the funding rate went to -10%, no bank is going to lend to someone who has a 100% chance of NOT paying back the loan. (Technically, you would be able to pay off the loan in ~10 years, even if the borrower defaulted immediately, but there are other (artificial) constraints on banks that would prevent them from being able to do this, plus inflation, asset bubble and discounting effects). **
This is the fundamental thing that is missed in the discussion on ZIRP, NIRP, QE. Interest rates are only half of the lending equation. The other half is the probability of default, which affects lending spreads.
If incomes or employment or both incomes and employment do not recover, no matter how low interest rates go, then the probability of default will eventually rise, and when that happens you get something called "credit migration", where a change in the credit risk of one large entity or tranche of borrower has a cascading effect through the entire financial system.
For example, if ACME Corporation issues some bonds, and ACME Corp gets downgraded from BB to CCC, then any other entity that owns ACME Corp bonds and has used those bonds as collateral to borrow some money, will also have their internal credit rating downgraded, and so on and so forth. Or, another example, a tranche of mortgagors suddenly start defaulting in large numbers, and derivatives such as CDOs begin dropping in price, and insurance contracts called CDS on those CDOs start rising in price, and loans collateralised with CDOs get collateral calls or increased lending spreads, and so on until Goldman Sachs infiltrates and takes over the US government in a bloodless coup and makes everyone whole on the taxpayers tab.
Edit ** Sorry, I wrote that bit in a hurry. I wanted to clarify. If interest rates were -25bps, then technically you could borrow an infinite amount and let the loans self-liquidate over the next 400 years. However, you would then have an infinite exposure to rising interest rates. If you borrowed a trillion, and rates went back up to 25bps, you would be on the hook for 2.5 billion a year. If interest rates went to -10%, and you borrow a trillion, the loan will self-liquidate in about 10 years (technically never, but you could always make a balloon payment at the end), and there is a trillion for nothing and your chicks for free. However, that kind of scenario is uncharted territory, but it is really no different from Zimbabwe printing 100 trillion dollar notes. Asset prices would have no ceiling and would rise as fast as people could borrow and buy.
This is the fundamental thing that is missed in the discussion on ZIRP, NIRP, QE. Interest rates are only half of the lending equation. The other half is the probability of default, which affects lending spreads.
I cannot see how anybody is missing it. It was part of the point I was making earlier where the fed cannot control interest rates against the wishes of the market. On overnight rates the fed can crash rates because it is the monopoly supplier with an infinite supply, but it cannot force them down for longer terms against the wishes of the market.
The fed can do what it can do because of existential realities rather than because it has some other ability. No weak and feeble county can do what what these Central banks are doing.
I cannot see how anybody is missing it. It was part of the point I was making earlier where the fed cannot control interest rates against the wishes of the market. On overnight rates the fed can crash rates because it is the monopoly supplier with an infinite supply, but it cannot force them down for longer terms against the wishes of the market.
Well, I am not sure about your terminology i.e. "wishes of the market". However, if pushing down interest rates to zero actually had the effect that Keynesians think it does, then QE would be very effective. Incomes and employment would rise, credit risk would go down, banks would expand credit and lower spreads, and everything would be back to normal.
Unfortunately, monetary easing stopped working the way Keynesians expect it to 30 years ago and none of them noticed. Now they are caught in their own version of insanity, doing the same thing over and over again and expecting a different result.
Quote:
The fed can do what it can do because of existential realities rather than because it has some other ability. No weak and feeble county can do what what these Central banks are doing.
That's different from your position that it is "only an asset swap". It is because of those existential realities that it is NOT only an asset swap. Pushing up bond prices by buying lots of bonds absolutely has an effect on financial markets and the banking system. It lowers the cost of borrowing. However, when credit risk starts increasing DESPITE low interest rates, then it no longer works at all.
“Talk sense to a fool and he calls you foolish.” - Euripides
Well, I am not sure about your terminology i.e. "wishes of the market". However, if pushing down interest rates to zero actually had the effect that Keynesians think it does, then QE would be very effective. Incomes and employment would rise, credit risk would go down, banks would expand credit and lower spreads, and everything would be back to normal.
Unfortunately, monetary easing stopped working the way Keynesians expect it to 30 years ago and none of them noticed. Now they are caught in their own version of insanity, doing the same thing over and over again and expecting a different result.
That's different from your position that it is "only an asset swap". It is because of those existential realities that it is NOT only an asset swap. Pushing up bond prices by buying lots of bonds absolutely has an effect on financial markets and the banking system. It lowers the cost of borrowing. However, when credit risk starts increasing DESPITE low interest rates, then it no longer works at all.
>>if pushing down interest rates to zero actually had the effect that Keynesians think it does, then QE would be very effective
Seems to me you are mixing up common misunderstandings in the publics mind of
1. 'loads of reserves making it easier for banks to lend money,' with
2. the dramatically different version that is believed by central bankers where they believe QE is an extension of ordinary monetary policy at the zero bound, where QE even at the zero bound can still have some traction by changing longer term interest rates, but other than the interest changing impact has almost no impact at all.
>>if pushing down interest rates to zero actually had the effect that Keynesians think it does, then QE would be very effective
Seems to me you are mixing up common misunderstandings in the publics mind of
1. 'loads of reserves making it easier for banks to lend money,' with
2. the dramatically different version that is believed by central bankers where they believe QE is an extension of ordinary monetary policy at the zero bound, where QE even at the zero bound can still have some traction by changing longer term interest rates, but other than the interest changing impact has almost no impact at all.
No, I'm not.
“Talk sense to a fool and he calls you foolish.” - Euripides
Then why do you think QE would have had such a big impact 'according to others? Yes others were talking about money printing. That is not the 'expert' view.
I notice when you are talking about QE you are also including ZIRP. And it reads as if you think ZIRP is part of QE. And i do not think you believe that but it makes what you are saying unclear.
If the cash rate drops to -25bps but the risk premium increases by 250bps, then the central bank is unable to control the rate the final borrower pays.
Even though the intermediary has a negative funding rate (getting paid to borrow), money lending still ALWAYS consists of two factors: the funding/lending spread and the probability of default. Even if the funding rate went to -10%, no bank is going to lend to someone who has a 100% chance of NOT paying back the loan. (Technically, you would be able to pay off the loan in ~10 years, even if the borrower defaulted immediately, but there are other (artificial) constraints on banks that would prevent them from being able to do this, plus inflation, asset bubble and discounting effects). **
This is the fundamental thing that is missed in the discussion on ZIRP, NIRP, QE. Interest rates are only half of the lending equation. The other half is the probability of default, which affects lending spreads.
If incomes or employment or both incomes and employment do not recover, no matter how low interest rates go, then the probability of default will eventually rise, and when that happens you get something called "credit migration", where a change in the credit risk of one large entity or tranche of borrower has a cascading effect through the entire financial system.
For example, if ACME Corporation issues some bonds, and ACME Corp gets downgraded from BB to CCC, then any other entity that owns ACME Corp bonds and has used those bonds as collateral to borrow some money, will also have their internal credit rating downgraded, and so on and so forth. Or, another example, a tranche of mortgagors suddenly start defaulting in large numbers, and derivatives such as CDOs begin dropping in price, and insurance contracts called CDS on those CDOs start rising in price, and loans collateralised with CDOs get collateral calls or increased lending spreads, and so on until Goldman Sachs infiltrates and takes over the US government in a bloodless coup and makes everyone whole on the taxpayers tab.
Edit ** Sorry, I wrote that bit in a hurry. I wanted to clarify. If interest rates were -25bps, then technically you could borrow an infinite amount and let the loans self-liquidate over the next 400 years. However, you would then have an infinite exposure to rising interest rates. If you borrowed a trillion, and rates went back up to 25bps, you would be on the hook for 2.5 billion a year. If interest rates went to -10%, and you borrow a trillion, the loan will self-liquidate in about 10 years (technically never, but you could always make a balloon payment at the end), and there is a trillion for nothing and your chicks for free. However, that kind of scenario is uncharted territory, but it is really no different from Zimbabwe printing 100 trillion dollar notes. Asset prices would have no ceiling and would rise as fast as people could borrow and buy.
Precisely,however one wouldn't really be a slave to rates as one would ...oh lets say... bundle the risky loans into AAA top crap cap investment vehicles that could be sold to local councils around the world. The probability of default is a dynamic variable which no trading desk f..ks with..that advice come from the suits...
Have I mentioned rolling over the -25% into treasuries or a massive short on the Euro or (the list is endless)....this could get ugly.
"I was going to give up drinking today, but I couldn't because these outside influences beyond my control made me carry on drinking. But seriously, I am still going to give up drinking in the near future and most likely it will be next month (or at the very latest, some time next year). I know I have made these kinds of promises before, but trust me, this time I mean it. Of course I am going to give up drinking because if I don't, I will end up wasted and you will lose all faith in me. So I promise that I will kick the drink and get strong again, but not just now. OK?"
Matthew, 30 Jan 2016, 09:21 AM Your simplistic view is so flawed it is not worth debating. The current oversupply will be swallowed in 12 months. By the time dumb shits like you realise this prices will already be rising.
Then why do you think QE would have had such a big impact 'according to others? Yes others were talking about money printing. That is not the 'expert' view.
I notice when you are talking about QE you are also including ZIRP. And it reads as if you think ZIRP is part of QE. And i do not think you believe that but it makes what you are saying unclear.
Because puppies?
“Talk sense to a fool and he calls you foolish.” - Euripides
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