How does the method of Frank's tenants paying rent got to do with how banks treat unemployed people as zero sovereign risk and lend them as much as they want to borrow?
Because the money goes straight from the government to the bank. It is as if the bank is loaning the money directly to the government.
Here is how (hypothetically) it could work.
1. Reductio ad absurdum of ZIRP gives you 4 generation mortgages at 50bps. 2. Repayments on 465,000 mortgage on above terms, $144 per week. 3. Family unemployment benefits, $444 per week. 4. Bank puts in place a garnishment of the unemployment benefit of $144 per week, which is deducted from the mortgagee's benefit payment before it reaches their account. 5. Unemployed mortgagee receives $300 per week in their account, net of mortgage payment.
As long as the government continues to pay unemployment benefits, there is zero credit risk for the bank in the above hypothetical. Don't you agree?
The only credit risk the bank is exposed to is the government defaulting on it's obligations. But under the fiat MMT monetary system we have, that can't happen. The government simply 'borrows' more from the RBA in the form of bonds (i.e. it literally prints more money to pay it's 'debts').
So the reason there are not record numbers of mortgages being written in countries that have ZIRP is twofold. (1) The US does not pay unemployment benefits indefinitely. (2) No ZIRP country has extended the terms of their loans far enough into the future for someone on unemployment benefits to pay their mortgage from their benefit cheque. It's not because the banks won't lend to unemployed people.
"Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works". -- John Stuart Mill
Because the money goes straight from the government to the bank. It is as if the bank is loaning the money directly to the government.
Here is how (hypothetically) it could work.
The government doesn't dock centerlink benefits to repay the loans before paying the remainder. Banks won't lend you $465k to buy a home when your only income is unemployment benefits
Don't you think its a very long bow to: Assume the RBA will hit 0% with its monetary policy Then assume the RBA will extend that to 30 years - the length of a home loan Then assume the banks lend out at 50 basis point margin at a fixed rate for 30 years Then assume the assessment rates of the banks is exactly at its current lending rate and no buffer of 1.5% like they currently do Then assume the government will change their policy and start docking centerlink benefits to repay the benefit receiver's loans Then assume banks will write a new mortgage where the only income is centerlink benefits and treat it as if the only risk is the Federal Government's ability to repay the loan. Then assume everyone will then go and borrow to the max of their unemployment benefits will allow Then assume no one will want to work under this regime
First assumption has a small chance of it happening. But I can't see it getting past the second assumption - much less the 6 assumptions after that.
The government doesn't dock centerlink benefits to repay the loans before paying the remainder.
A creditor can apply for a garnishment on any source of income, including unemployment benefits or any other government payment.
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Banks won't lend you $465k to buy a home when your only income is unemployment benefits
How do you know? Have you ever worked for a bank?
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Don't you think its a very long bow to:
You must be a riot at parties.
Of course I think it's a long bow. The point of reductio ad absurdum is to test the limits of your assumptions about how a system behaves. Extreme variances of conditions over short periods of time in human societies are remarkably frequent. Much more frequent than you would intuitively expect. The probable reason for this is that we build systems to manage our societies and our economies that contain many hidden assumptions. Assumptions which often fail to hold up under extreme duress, or sometimes not even extreme duress, sometimes systems simply spiral out of control. Slowly at first, so nobody notices it, then faster and faster until nobody can stop it. It's like the petri dish with bacteria. The bacteria population double every day. If the dish is full of bacteria on day 30, then on day 28 it was only 1/4 full. The bacteria were celebrating how much supply could come online to meet the demand for dish space, after all, the dish is only 1/4 full.
Now lets look at our current system. Prices rise until they hit a ceiling of affordability. The central bank lowers rates, effectively adding to the disposable income or serviceability of loans. Prices rise again until they hit the same ceiling, central bank lowers rates again, and the cycle begins anew. The bacteria are now at day 27, and the dish is only 1/8th full. Now the system adapts to the new behavior. Whenever prices stall, the central bank lowers rates. New buyers are nervous about the risks, but they are re-assured by the certainty that the central bank will continue to lower rates whenever prices fall, so they buy, sending prices upwards.
And lo, their faith is rewarded, because when prices stall again, the central bank again lowers rates, so they go on internet forums and tell everyone there that there is no downside risk, and they tell all their friends, and their nieces and nephews. Now the system has adapted itself to the conditions put in place by the central bank. The central bank now has no choice but to keep lowering rates until they hit zero. Once the central bank hits the zero rate, it can only keep the music playing by extending terms (BOJ did exactly this btw). Two generation mortgages, three generation mortgages, four generation mortgages. Now the petri dish is at day 29, the only way to keep the music playing is for the government to print money to give to mortgagees to give to banks in return for loans to buy ever rising in price houses. On day 30, the population lose faith in the currency, and hyperinflation ensues.
"Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works". -- John Stuart Mill
1. Reductio ad absurdum of ZIRP gives you 4 generation mortgages at 50bps. 2. Repayments on 465,000 mortgage on above terms, $144 per week. 3. Family unemployment benefits, $444 per week. 4. Bank puts in place a garnishment of the unemployment benefit of $144 per week, which is deducted from the mortgagee's benefit payment before it reaches their account. 5. Unemployed mortgagee receives $300 per week in their account, net of mortgage payment.
LOL. I was wondering when someone would point out the obvious flaw in my plan.
"Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works". -- John Stuart Mill
1. Reductio ad absurdum of ZIRP gives you 4 generation mortgages at 50bps. 2. Repayments on 465,000 mortgage on above terms, $144 per week. 3. Family unemployment benefits, $444 per week. 4. Bank puts in place a garnishment of the unemployment benefit of $144 per week, which is deducted from the mortgagee's benefit payment before it reaches their account. 5. Unemployed mortgagee receives $300 per week in their account, net of mortgage payment.
I like reductio ad absurdum because it is useful to find the flaws.
What happens here is of course is that rental yields would approach zero (rent can never be much more than the tenant would have to pay to service the loan to buy a similar property for long), as prices go to the moon. Smart PIs will have a window in which to sell out to all the renters buying into ever-increasing home values. Really you are saying that if we start to see term extensions beyond 30 years, it is definitely time to sell all residential property, buy gold, and rent. I am not convinced it is even likely to happen, but it is a good sell trigger to keep in the back of ones mind.
Recently I have noticed that banks seem to prefer 25-year terms over 30-year terms but that is observation of a small sample and could be bollocks.
The truth will set you free. But first, it will piss you off. --Gloria Steinem AREPS™
With 2 young kids, the only parties I go to are toddler birthday parties and we don't talk properties and economics there Ok, now I know where you are coming from, forgive me if I don't keep playing hypothetical games with close to zero chance of happening.
I put trolls and time wasters on my ignore list so if I don't respond to you, you are probably on it ....
With 2 young kids, the only parties I go to are toddler birthday parties and we don't talk properties and economics there
I still remember that time. Thankfully mine are in school now.
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Ok, now I know where you are coming from, forgive me if I don't keep playing hypothetical games with close to zero chance of happening.
I think you still might be missing the point of hypothetical conditions that are 'reductio ad absurdum'. You get to test the behaviour of the system as it approaches it's extremes. The point of my hypothetical example is to show that property prices and interest rates appear to be in a feedback loop, at least at the time when central banks begin heading to ZIRP. Feedback loops continue compounding the behaviour of the system until either the feedback mechanism breaks, or the system breaks.
My hypothetical example was missing a couple of factors though, one of which was pointed out by GloomDoomBoom (inflationary effects) and the other by miw (house prices to the moon). To arrive at the starting conditions I began with, bread would most likely cost $100 a loaf and 465K would get you a 6 cubic meter lockup storage box in in Penrith. Those are the assumptions you should have been testing. On the other hand, government benefits are (sometimes) indexed to inflation, so the starting conditions for your benefit payments would be different also.
miw
21 Oct 2012, 11:42 PM
Really you are saying that if we start to see term extensions beyond 30 years, it is definitely time to sell all residential property, buy gold, and rent. I am not convinced it is even likely to happen, but it is a good sell trigger to keep in the back of ones mind.
Yes, except my strategy would be to buy farmland instead of gold. 2 billion new T-bone steak eaters are about to come online in the next 20-50 years, and they will be hungry.
"Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works". -- John Stuart Mill
Yes, except my strategy would be to buy farmland instead of gold. 2 billion new T-bone steak eaters are about to come online in the next 20-50 years, and they will be hungry.
Funny you should say that. I almost added farmland. Any hard asset that has value or produces value outside of Australia would do.
For a 50-year horizon, I have some worries about farmland that is not cultivatable though. Watching how ethical philosophy is going, I am not so sure we'll be eating dead cow in 50 years. I'd be going for land that can produce a relatively reliable and sustainable wheat crop without the need for irrigation. A lot of the Eastern Darling Downs would be in that category. I also hear New England land prices are still pretty depressed, but have not investigated myself.
The truth will set you free. But first, it will piss you off. --Gloria Steinem AREPS™
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