Moody's Assessment of Overvalued Australian Housing: Local analysts don't know how serious it is; Stark warning bells sound: Australians blind to impending financial Armageddon
Tweet Topic Started: 16 Jul 2013, 09:36 AM (10,587 Views)
You pay 3 pebbles in interest and the depositor receives it and uses it to pay 3 pebbles for a haircut. The hairdresser does 1 more cut and then has 6 pebbles for a fish. You are the fisherman so you have enough pebbles to pay interest next month and get a haircut. And around and around.
Just to add to this.
Let's say that I live among lots of wannaby home buyers that don't own cars because they are trying to save up for their deposit. They can't buy in the current area because it's too expensive so I rent them my car to go to auctions on a Saturday. I charge 1% of the current value of the car (say $25k) so $250.
With me so far?
When the buyer gets to the auction they don't know if they'll need a 10% deposit as they don't know that they will be the successful buyer - the deposit can't be paid by personal cheque (and their own money is on term deposit at their bank which isn't open on the weekend). So as an extension of my service I keep $100k in cash on my boot. If the homebuyer wins the auction and needs the money they open the boot and use the hard currency (it doesn't have to be hard currency it could be a series of different denominated bank cheques). If they do this they must pay back the amount they borrowed plus 1% on the Monday after the auction.
Q. What is the difference between renting my car and renting my (up to) $100k bag of money/bank cheques?
A. Nothing.
“You Keep Using That Word, I Do Not Think It Means What You Think It Means” - Inigo Montoya
As suspected, you don't know how this non debt money is created. I don't see anyone else jumping in to offer up the answer either. Even if you are certain there is non-debt created money, but you don't know how that money is created, you should at least say that.
If you know how this non-debt money is created, who issues it, how it is distributed to either the population as cash or the banking system as a deposit, then simply tell me.
Now now Mike, don't try misdirection. I asked you some very simple questions. If there is non-debt money issued, who issues it? How does it get into general circulation without entering the banking system? If it enters the banking system, how does it do so without becoming a liability? This is not a philosophical discussion about what money actually is.
This is not the Austrian interpretation, it is just how the modern banking system works. The last person in Australia that tried to change that was Jack Lang.
To understand the current credit crisis, you need to understand how the modern banking system works. Then you can see that the credit crisis will continue until we have negative rates of interest or something equivalent such as a debt jubilee (Steve Keen's proposal). The inflation has already occurred, it just needs to be realised so we can get out of the liquidity trap.
I like this thread. Gen X makes a good point that even amongst the better educated in our society, very few people truly fully understand our banking system (myself included). Without being sure I was of the same belief that all new money in our economy is debt issued. I can't think of another way that money can enter the modern economy. Way back when money was gold or silver pieces obviously it would have been a different story.
Gen X you seem to be the best educated on this forum around the economy and banking system. Can you clear up a few things for me?
My understanding of how a typical property purchased with debt works is as follows: Buyer purchases a $500k house and borrows from the bank say $400k. Where does that $400k come from? I've heard the argument that people's deposits are the source of funding for that $400k, but I don't believe that is true. My understanding is that people's deposits form a reserve for the bank against which they are able to lend multiple times against for various types of lending. Known as fractional reserve banking. So if this is true the bank must then borrow the money from elsewhere to then on-lend to the house purchaser.
Where do they borrow that money from and what role does the RBA play? My understanding is that the RBA official rate is an overnight rate, do the banks actually borrow money from the RBA? If not, why not? Couldn't they just keep settling every day if it is an overnight rate, why must they borrow from other banks? Is it out of preference or necessity that they borrow from other banks? So my understanding is that in practice the bulk of the money that banks lend to the house purchaser is actually borrowed from other banks.
An example, a depositor puts $20k in savings in CBA. CBA are then able to use those funds as a reserve to lend out the $400k to the house purchaser. They borrow the money from NAB at 3.5%, charge the house purchaser 5.4%, and pay the depositor 2.5%. This gives CBA a gross return of around 35% on the $20k deposit before costs. If my example is largely correct what are the reserve requirements for lending, and are there different reserve requirements for different types of lending?
Following on from this example, CBA have borrowed the money from NAB. Did NAB have that sitting as idle funds - I don't think so? So how does that work, can NAB "create" that money for the purpose of the loan? If I'm on the right track here are all the banks lending each other money that they've "created"? Once again what is the role of the RBA official rate in all of this?
Thanks in advance for any time you spend on this. I may be way off but am keen to improve my understanding of this system so feel free to correct all my errors.
My understanding of how a typical property purchased with debt works is as follows: Buyer purchases a $500k house and borrows from the bank say $400k. Where does that $400k come from? I've heard the argument that people's deposits are the source of funding for that $400k, but I don't believe that is true. My understanding is that people's deposits form a reserve for the bank against which they are able to lend multiple times against for various types of lending. Known as fractional reserve banking.
Australia doesn't have a fractional reserve banking system.
Australia doesn't have a fractional reserve banking system.
I think what you mean is that in Australia the reserve requirement was abolished in 1988, essentially meaning that Australian banks reserve requirement is zero. Apparently we are one of only 6 countries in the world whose banks are allowed to operate with zero monetary reserves. Fractional reserve banking refers to a banking system where only a fraction of lending is required to be monetarily backed by deposits, I guess for Australia you could say that fraction has been reduced to zero. However as far as I know our banking system is still largely the same as the countries who have reserve requirements and operate under the modern fractional reserve banking system, but correct me if I'm wrong.
I was more interested in the actual operation of the banking system and how the banks interact with each other, however you raise an interesting point Strindberg, does having a zero reserve requirement backing make our banks more risky than other countries banks? It would mean there would be more reliance on the central bank (RBA) to get us out of trouble in the event of a property downturn I'd assume?
I believe there are still capital reserve requirements for Australian banks, however I think this is in place to provide protection for shareholders, not depositors.
Anyone who knows more about this than me fill me in. How much are Aussie banks indebted to each other? Why do our Aussie banks need to source funds from overseas?
Without being sure I was of the same belief that all new money in our economy is debt issued. I can't think of another way that money can enter the modern economy.
I am also 99.9% sure that is the case. If Mike has information to the contrary I would be interested to hear it.
Quote:
Gen X you seem to be the best educated on this forum around the economy and banking system.
Not by a long shot. Yossarian would probably be the best educated. b_b also, although I think there are some gaps in b_b's understanding.
Quote:
Can you clear up a few things for me?
Maybe.
Quote:
My understanding of how a typical property purchased with debt works is as follows: Buyer purchases a $500k house and borrows from the bank say $400k. Where does that $400k come from?
There is no $400k, there is only promissory note.
Quote:
I've heard the argument that people's deposits are the source of funding for that $400k, but I don't believe that is true.
It's not quite true. Deposits are one type of loan the bank uses to fund lending. They also borrow from other banks and from the central bank. The difference between funds on deposit and loans out is the amount the bank needs to borrow from other sources.
Quote:
My understanding is that people's deposits form a reserve for the bank against which they are able to lend multiple times against for various types of lending. Known as fractional reserve banking.
No, deposits are not reserves. Deposits are loans , i.e. liabilities. Reserves are composed of assets: usually debt instruments such as deposits at the central bank, sovereign bonds or other credit grade bonds, but sometimes gold.
Quote:
So if this is true the bank must then borrow the money from elsewhere to then on-lend to the house purchaser.
The bank does that anyway. Deposits are on call. They are a type of overnight lending. While they don't fluctuate a lot, they do fluctuate every day. At the end of the day the banks net off deposits and withdrawals and borrow any shortfall.
Quote:
Where do they borrow that money from and what role does the RBA play?
They borrow the money from whoever will lend it to them at the lowest rate. The RBA is generally considered to be a lender of last resort if a bank cannot borrow from any other lender.
Quote:
My understanding is that the RBA official rate is an overnight rate, do the banks actually borrow money from the RBA?
Yes they do. The RBA is basically a liquidity facility to smooth over any problems with interbank lending i.e. it is a lender of last resort.
Quote:
If not, why not? Couldn't they just keep settling every day if it is an overnight rate, why must they borrow from other banks? Is it out of preference or necessity that they borrow from other banks?
The reason banks don't borrow all their money from the RBA is due to a mixture of collateral requirements, credit spreads, tenor matching and so on.
Quote:
So my understanding is that in practice the bulk of the money that banks lend to the house purchaser is actually borrowed from other banks.
All money is borrowed, whether the source is a depositor, a bank,or a central bank is really a function of the term structure, the spread and the collateral requirements. Deposits (traditionally) have the advantage of the highest spread and the lowest collateral requirements (i.e. none), but the disadvantage of the shortest maturity (i.e. one business day for a standard savings account). Generally there is a term premium for all types of lending, although having an inverted yield curve for years implies there may no longer be so.
Quote:
An example, a depositor puts $20k in savings in CBA. CBA are then able to use those funds as a reserve to lend out the $400k to the house purchaser. They borrow the money from NAB at 3.5%, charge the house purchaser 5.4%, and pay the depositor 2.5%. This gives CBA a gross return of around 35% on the $20k deposit before costs.
In your example, CBA borrows 20k from the depositor and 380k from NAB. There is no reserve in that example.
Quote:
If my example is largely correct what are the reserve requirements for lending, and are there different reserve requirements for different types of lending?
Your example is not correct. The reserve requirements for lending is that the bank needs to hold the expected shortfall of any type of lending multiplied by a risk-weighting for that asset. If the expected shortfall for housing is: 1.7% default rate with a 90% expected recovery rate i.e. expected loss of 0.17%, and the risk weighting is say, 2.3, then the reserve requirement for mortgage lending would be 2.3X0.17=0.391% of the notional outstanding. If the default rate is 2.5% and the expected recovery rate is 80%, then the bank would need to hold 1.15% of notional outstanding as a reserve.
Quote:
Following on from this example, CBA have borrowed the money from NAB. Did NAB have that sitting as idle funds - I don't think so? So how does that work, can NAB "create" that money for the purpose of the loan? If I'm on the right track here are all the banks lending each other money that they've "created"? Once again what is the role of the RBA official rate in all of this?
I think the confusion arises because people believe (as I once did) that money and loans are two different things, but they are not.
Every instrument in the modern banking/monetary system is a promissory note. That includes cash, deposits, cheques, demand drafts, letters of credit, bills,bonds, loans, swaps and anything else that meets the definition of a contract or promise to pay the bearer on presentation of the note. Once upon a time, a promissory note was a promise to deliver some precious metal such as silver or gold. That is, a bank note for 1 pound sterling was a promissory note for a pound of sterling silver. These days, the issuer of the note only promises to deliver another note (one of the strange infinite loops of modern fiat currency).
NAB doesn't create anything in the scenario above. CBA creates a promissory note, which NAB accepts. The holder of the note considers the note to be an asset (because it is a promise to pay) and the issuer of the note considers it to be a liability (because they have promised to pay). Money and promissory notes are synonymous. When I say all money is issued as debt, it is semantic convenience. It would be more accurate to say, all debt is issued as debt, or all forms of modern money are promissory notes (i.e. debt). If NAB does not want to hold CBA's note, and no other bank wants to hold CBA's note, then the RBA can either hold the note, or print some 'money' to lend to CBA so they can pay the bank where the note was presented.
When I came to understand the modern banking system, my first question was: "What prevents banks from creating an infinite number of loans and funding them by borrowing from the central bank?". The answer is fairly complex, but at it's simplest, most lending is secured. That is, every liability has a matching asset. So in the case of mortgage lending, the amount the banks can lend is a function of the housing stock currently for sale. That's one part. The second part has to do with lending spreads. Typically, the more you lend, the greater the chance you will lend to people who don't repay their loans. i.e. the quality of your assets decreases, and when that happens, the other lenders who fund your lending business will raise their lending rates to you. That is, your margin compresses. Lending is only profitable when the spread is greater than your operating costs plus your expected shortfall (i.e. the default rate and the recovery rate). If your margin compresses to the point where it is no longer profitable to lend, you stop.
One way that US banks dealt with this problem in the lending spree from roughly 2000-2006 is something called rehypothecation, which is really like re-insurance. You sell securities which are derivatives of the original loans, which has the effect of spreading the risk, and making lower margin lending more profitable (i.e. the losses and the profits are shared). As we saw in the GFC, this had the effect of transforming credit risk into systemic risk, because the same institutions that were selling these securities were also buying them, thus concentrating risk rather than distributing it.
I think what you mean is that in Australia the reserve requirement was abolished in 1988, essentially meaning that Australian banks reserve requirement is zero. Apparently we are one of only 6 countries in the world whose banks are allowed to operate with zero monetary reserves. Fractional reserve banking refers to a banking system where only a fraction of lending is required to be monetarily backed by deposits, I guess for Australia you could say that fraction has been reduced to zero. However as far as I know our banking system is still largely the same as the countries who have reserve requirements and operate under the modern fractional reserve banking system, but correct me if I'm wrong.
I was more interested in the actual operation of the banking system and how the banks interact with each other, however you raise an interesting point Strindberg, does having a zero reserve requirement backing make our banks more risky than other countries banks? It would mean there would be more reliance on the central bank (RBA) to get us out of trouble in the event of a property downturn I'd assume?
I believe there are still capital reserve requirements for Australian banks, however I think this is in place to provide protection for shareholders, not depositors.
Anyone who knows more about this than me fill me in. How much are Aussie banks indebted to each other? Why do our Aussie banks need to source funds from overseas?
Bank lending in Australia is simply not constrained by deposits. Saying that Australia has a fractional reserve system with the fractional reserve ratio at zero deceptively suggests that such a system still operates. It doesn't.
Bank lending in Australia is constrained by specific rules based on a bank's risk weighted assets (ie mainly its loans) and not based on its deposits.
Australian banks deal with each other through their ESAs (Exchange Settlement Accounts) which are the banks' deposits with the RBA. After the day's cheques and whatnot have been cleared the banks calculate what they owe or are owed between each other and their ESAs are adjusted accordingly.
Bank lending in Australia is simply not constrained by deposits. Saying that Australia has a fractional reserve system with the fractional reserve ratio at zero deceptively suggests that such a system still operates. It doesn't.
Bank lending in Australia is constrained by specific rules based on a bank's risk weighted assets (ie mainly its loans) and not based on its deposits.
Australian banks deal with each other through their ESAs (Exchange Settlement Accounts) which are the banks' deposits with the RBA. After the day's cheques and whatnot have been cleared the banks calculate what they owe or are owed between each other and their ESAs are adjusted accordingly.
So essentially we would have the potential to keep going where others are forced to stop? Im honestly not being a smart alec here but i did look into it a couple of years ago and came to that conclusion.
APF - a place where serious people don't take themselves too seriously. There's nothing else like it.
So essentially we would have the potential to keep going where others are forced to stop? Im honestly not being a smart alec here but i did look into it a couple of years ago and came to that conclusion.
No. See my post above. Banks are constrained by available assets and margin compression.
They are also constrained by the Tier 1 capital requirements. The banks need to have around 8% to 10% cover in acceptable form - eg cash bonds etc.
True, but if the expected loss for a particular type of asset is not particularly onerous, then Tier 1 rarely becomes a constraint. Margin compression due to perceived credit risk would constrain a banks lending long before Tier 1 capital requirements did. Tier 1 capital requirements are based on expected losses, and as such don't change much until greater losses are realised. Credit spreads however change much faster, a 50bp margin compression would put the brakes on most Australian banks. 100bps and stick a fork in it.
Australian Property Forum is an economics and finance forum dedicated to discussion of Australian and global real estate markets and macroeconomics, including house prices, housing affordability, and the likelihood of a property crash. Is there an Australian housing bubble? Will house prices crash, boom or stagnate? Is the Australian property market a pyramid scheme or Ponzi scheme? Can house prices really rise forever? These are the questions we address on Australian Property Forum, the premier real estate site for property bears, bulls, investors, and speculators. Members may also discuss matters related to finance, modern monetary theory (MMT), debt deflation, cryptocurrencies like Bitcoin Ethereum and Ripple, property investing, landlords, tenants, debt consolidation, reverse home equity loans, the housing shortage, negative gearing, capital gains tax, land tax and macro prudential regulation.
Forum Rules:
The main forum may be used to discuss property, politics, economics and finance, precious metals, crypto currency, debt management, generational divides, climate change, sustainability, alternative energy, environmental topics, human rights or social justice issues, and other topics on a case by case basis. Topics unsuitable for the main forum may be discussed in the lounge. You agree you won't use this forum to post material that is illegal, private, defamatory, pornographic, excessively abusive or profane, threatening, or invasive of another forum member's privacy. Don't post NSFW content. Racist or ethnic slurs and homophobic comments aren't tolerated. Accusing forum members of serious crimes is not permitted. Accusations, attacks, abuse or threats, litigious or otherwise, directed against the forum or forum administrators aren't tolerated and will result in immediate suspension of your account for a number of days depending on the severity of the attack. No spamming or advertising in the main forum. Spamming includes repeating the same message over and over again within a short period of time. Don't post ALL CAPS thread titles. The Advertising and Promotion Subforum may be used to promote your Australian property related business or service. Active members of the forum who contribute regularly to main forum discussions may also include a link to their product or service in their signature block. Members are limited to one actively posting account each. A secondary account may be used solely for the purpose of maintaining a blog as long as that account no longer posts in threads. Any member who believes another member has violated these rules may report the offending post using the report button.
Australian Property Forum complies with ASIC Regulatory Guide 162 regarding Internet Discussion Sites. Australian Property Forum is not a provider of financial advice. Australian Property Forum does not in any way endorse the views and opinions of its members, nor does it vouch for for the accuracy or authenticity of their posts. It is not permitted for any Australian Property Forum member to post in the role of a licensed financial advisor or to post as the representative of a financial advisor. It is not permitted for Australian Property Forum members to ask for or offer specific buy, sell or hold recommendations on particular stocks, as a response to a request of this nature may be considered the provision of financial advice.
Views expressed on this forum are not representative of the forum owners. The forum owners are not liable or responsible for comments posted. Information posted does not constitute financial or legal advice. The forum owners accept no liability for information posted, nor for consequences of actions taken on the basis of that information. By visiting or using this forum, members and guests agree to be bound by the Zetaboards Terms of Use.
This site may contain copyright material (i.e. attributed snippets from online news reports), the use of which has not always been specifically authorized by the copyright owner. Such content is posted to advance understanding of environmental, political, human rights, economic, democratic, scientific, and social justice issues. This constitutes 'fair use' of such copyright material as provided for in section 107 of US Copyright Law. In accordance with Title 17 U.S.C. Section 107, the material on this site is distributed for research and educational purposes only. If you wish to use this material for purposes that go beyond 'fair use', you must obtain permission from the copyright owner. Such material is credited to the true owner or licensee. We will remove from the forum any such material upon the request of the owners of the copyright of said material, as we claim no credit for such material.
Privacy Policy: Australian Property Forum uses third party advertising companies to serve ads when you visit our site. These third party advertising companies may collect and use information about your visits to Australian Property Forum as well as other web sites in order to provide advertisements about goods and services of interest to you. If you would like more information about this practice and to know your choices about not having this information used by these companies, click here: Google Advertising Privacy FAQ
Australian Property Forum is hosted by Zetaboards. Please refer also to the Zetaboards Privacy Policy
