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High Interest Rates Fix Everything


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2008 Nov 16, 10:02am   21,111 views  251 comments

by Patrick   ➕follow (55)   💰tip   ignore  

moon

Perhaps the entire credit crunch could be fixed with very high interest rates. Currently, banks and other institutions have to compete with the suicidally low interest rates of the Fed and the Treasury bailout programs.

Say you're a bank and you know that a new mortgage loan has a 10% risk of default. Then you have to charge at least 10% to compensate for this risk before you can even begin to make a profit. But you can't charge 10%, because you're competing with the Fed's 2% rates, and the Fed is lending without regard to default risk. So you would be committing bank suicide to make loans in a market poisoned by the Fed's rates, knowing such loans will generate a large loss on average.

OK, the bank can get something from the defaulted loans by foreclosing and selling off the houses, but still, the point holds: the Fed is ruining the market for credit. It's kind of like American manufacturers being ruined by cheap Chinese imports, only it's American banks and savers being ruined from within our own country, by the Fed.

The directors of the Bank of England once bragged that a 10% interest rate could "draw gold from the moon". If it's credit we lack, let rates rise, and watch credit problems disappear.

Patrick

#housing

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1   frank649   2008 Nov 16, 11:56am  

The economy has more credit than it needs. It's made this abundantly clear. Trying to control the rate is not the answer. We should abolish the Fed.

2   shordov   2008 Nov 16, 11:57am  

I think that's what Volcker did in the beginning of the '80s, and it worked, but I was still in kindergarten myself at the time. Can anyone who was here at the time comment on how well it worked, as well as the downsides?

3   danville woman   2008 Nov 16, 12:36pm  

@shordov

What I remember most about the high interest rates, is that the value of our house dropped dramatically within one week. We were waiting to put our house on the market until we painted one bathroom and we waited one week too long.

The real estate market tanked for 1 year, and there was a short reprieve of a few months and then it tanked again even more.

The interest rates were great, and I still have some retirement money making 10% interest. Unfortunately the term is up in 2009. Many astute people took advantage of the 18% or more interest rates which seems unbelievable at this point in time.

4   Malcolm   2008 Nov 16, 12:49pm  

Patrick, I know what you're saying, and yes there is plenty of credit out there. I think it was pretty aparant, but for those who view credit as a tool and not an extension of income I see no reason to want to punish them. More good than harm comes from the activities people undertake borrowing for.
Yes, it is annoying to see some boomer maxing himself out to buy a boat to impress his friends but it took a few people to build that boat, it took more to produce the materials to go into the process and someone has a business selling boats and still others have businesses relating to the dock slip and maintaining the boat. I'd ask people to think bigger picture than just saying, credit should be more expensive.

5   kewp   2008 Nov 16, 2:01pm  

theres nothing wrong with credit as long as it is payed back.

Exactly. And low interest rates provide liquidity that stimulates the economy (and discourages savings, which are deflationary).

The solution to this mess it to abolish fractional reserve lending and provide credit directly to consumers and business from the federal reserve; with income and hard assets as the collateral. Establish a clear debt ceiling so the min. wage workers can't end up owing 500K to Fed.

No defaults allowed, other than death. The Fed can print to make up for those (ain't a fiat currency grand?)

6   bikes2work   2008 Nov 16, 2:12pm  

Higher rates would do a lot to solve the problems. I remember the awesome CD rates of the early 80's. Banks were giving away all sorts of goodies to get your deposits. I only recently discarded the very nice clock radio that I got in addition to a great interest rate.

Bernanke and Greenspan just never seemed to understand why getting Americans to save was important. Ben is still taking us down the rabbit whole. We're going to end up like Japan (or worse). The crash of 1929 didn't bottom out until 1932. We're reliving it right now. We should hit bottom in 2011. Hold on tight.

7   Malcolm   2008 Nov 16, 2:14pm  

Guys, I suspect this site is viewed with credibility from some policymakers. Please don't kid around because everytime something is said like that off-the-cuff, a few weeks later I turn on C-SPAN and watch Congress vote on something we joked could never happen.

8   Malcolm   2008 Nov 16, 2:15pm  

every time, I know I have spacing issues.

9   Chuck Ponzi   2008 Nov 16, 2:54pm  

Malcolm,

After reading this I have to say..

WTF?

We are in the midst of a deflationary event that could spiral out of control downward. Just look at treasuries, stocks, commodities. Everything points to deflation. We have just successfully sucked several trillion dollars of value and liquidity out of the US economy over the past 12 months. Whether you see this as a good thing or a bad thing, the correct policy response is definitely not higher rates, whether you're Keynesian or Austrian.

Jeebus, did anyone here actually take more than Econ 101? The world is in a f#C*ing downward spiral, and the only solution offered up is to dance on Boomer graves and scatter their ashes to the four winds? Even with how poorly I have been treated as an Xer, I have no ill will towards the idiots who played this last bubble. In fact, I feel only sympathy as they will never know the satisfaction of being right when everyone else was wrong.

Personally, I'm buying everything that was punished to the downside in this whirlwind. Some day its true value will come back, just not today. Then, as now, I will not only have the satisfaction of having been right when everyone else was wrong, but hopefully I'll have made my life a little easier in the effort.

Chuck Ponzi

Chuck Ponzi

10   Owner Earnings   2008 Nov 16, 8:01pm  

15 reasons the US economy will get worse: Link Here

11   kewp   2008 Nov 16, 8:53pm  

kewp, thats brilliant.

so what do we do if they default?

Defaults simply aren't allowed; other than via death or disability. We can add a point of interest to insure against that; or simply make it up via the printing press. This won't be inflationary unless more people die than are born, which is of course impossible.

Your line of credit is capped and secured by your income. Say a personal credit line of 1/3 yearly income (to replace credit cards and auto loans) and a home loan at 3 X. That's it. Existing debt is serviced/deducted directly from your salary. If you get laid off your debt payments are suspended until you find another job. Again, we can add 1% of interest to go into a slush fund to cover the edge cases.

12   justme   2008 Nov 16, 10:18pm  

Kewp, it seems like the system can be easily rigged or gamed by loading up the older generation with debt that will be forgiven after they die. I'm not getting it. Or maybe I am.

13   Duke   2008 Nov 16, 10:25pm  

Volcker raised intrest rates in the face of Carter's massive stagnate economy and super high inflation, brougt on by a wage price spiral.
Standard economic theory holds that in a deflationary scenario you lower rates. If that fails you are in a liquidity trap and you may have to resort to other stimulative measures: quantitative easing, direct stimulus, etc.

Of course there is the presumjtion here that we had the correct level of employment prior to now. That the demand gap can be filled as if the previous, pre-gap amount is the correct level of output.

For me, the truth is that we had a bunch of non-viable business models predicated on too low a cost of capital. We need to accept higher unemployment and lower GDP if for no other reason than it was/is impossible to maintain a debt-fueled economy. Real gains come fro putting real savings to work, not just borrowing from the future.

So, read with a jaundiced eye any economist that advises means to return to previous output. We are a $14t economy heading to a $13t and probably lower.

14   Malcolm   2008 Nov 16, 11:31pm  

Duke is making good sense here, and Chuck, thanks, I think we are on the same page. I think if people use their heads like Chuck is talking about they stand to do well. Not forcing rates up helps people like Chuck and even me because doing so increases the carrying costs of what in my opinion is a true investment; buying something at a fundamental price and waiting for harvest time.

The approach of high rates then creates an absolute crash that hurts everyone and then does invite more of the dreaded S word. We are not going to get this country back on track with more stimulus checks where people run out and buy Chinese garbage, it is going to take real investment and private people investing in things that make real sense to them is the best way to accomplish this.

15   SP   2008 Nov 16, 11:41pm  

# kewp Says:
No defaults allowed, other than death.

The Original Bankster Says:
so what do we do if they default?

If death = default, then default = death. :-)

16   SP   2008 Nov 16, 11:45pm  

Didn't someone here already say a few months ago that the reason for the "credit crunch" is that the government is not leaving any room for lenders to actually charge interest that is sufficient to cover the risk?

The problem is that in the short term, letting interest rates go high enough will cause intense pain and disruption (to banks and borrowers). In the long term, it is not clear what the outcome will be, because of side-effects of the short term pain.

Short term pain for long term benefit is hard to sell; short term pain for no clear long term benefit is impossible to sell.

17   Patrick   2008 Nov 17, 12:10am  

Yeah, what SP said.

I'm not advocating *forcing* interest rates up, just *letting* them rise to the market level that they would be without the Fed ruining the private market for credit.

And what Duke said: "Real gains come from putting real savings to work, not just borrowing from the future." So the example about the boomer not being able to buy a boat at high interest ignores the fact that the boomer can buy TWO boats if he does it with cash and not credit. Borrowing for consumption is always a mistake.

Borrowing for investment in production makes sense, but there is a natural rate that will let profitable ideas be funded without excessive risk of default. That natural rate is being undercut so that the risk of default is now eliminating credit. So we have low rates currently hurting investment in production rather than helping it.

18   justme   2008 Nov 17, 12:21am  

SP,

Maybe someone said that, but I disagree with that person (but not with what you said):

How does the Fed regulate the spread between interest paid and interest charged? I don't think they do. Credit card rates would be a "prime" (pun alert) example.

The Fed setting of interest rates only affects what rate the banks have to pay their customers on deposits. As far as I can tell, the main function of the discount window and rate (in normal times) is that the banks can point to it and say "we can get loans there for X%, why should we pay you any more?". In crisis times, it works the same way, except the banks actually DO borrow money at the discount window (and other "facilities").

Nice for the banks that the Fed Funds rate is so low. That means that they can have a big spread and make up for the losses they created by lending haphazardly in the previous bubble.

I think the real reason for the credit crunch is that banks simply will not loan out money against collateral that is dropping in value unless customers provide a big padding between loan amount and the current value. Most people cannot, hence credit crunch for many (but not all) customers, and a yield squeeze for those who DO have money to deposit.

Bad for everyone except the banks.

19   justme   2008 Nov 17, 12:25am  

And, yes, I am in favor of a considerably higher interest rate.

20   Malcolm   2008 Nov 17, 12:40am  

The spread is market driven and is contained by competition. Yes, it sucks to be a saver and the side effect is that savers do have to move from the purely safe rate to get a better return. That's the downside but then again on a macro level you're promoting further investment.

On the upside, the lower rates lower costs throughout the economy and up the value chain so theoretically you're keeping inflation low which is better for savers than higher inflation.

Now, barring anyone providing evidence to the contrary yes I would agree that Fed intervention does make the rates lower than a purely market driven banking system. The problem, especially now, is that if the free market rates don't stay below a certain point we could have a real collapse as many things won't be feasible from a personal or business standpoint. This would be great for savers but only in the short term because your ability to save depends on your ability to make money so unless you're set up to never have to work again I see more harm than good from a total collapse.

That's how I see the tradeoffs.

21   justme   2008 Nov 17, 1:10am  

Malcolm, right.

In summary, I think the purpose of low interest rates is two-fold:

1. increase the profit margin of banks
2. push/force savers into riskier investments (read: prop up the stock market)

One other way of looking at it: When the stock market is on the rise, banks tempt savers with high deposit interest because they are going to lend the money out to speculators that will more than make up for the interest rate in the stock market gains.

When the stock market drops, the bank (and big stock market players) want the savers to get a low rate so that they are incentiviced to buy overpriced crap in the stock market rather than putting money in the bank.

Big money always tries to buy low and sell high. It did not quite work this time, at least not for all hedge funds, although they had a nice ride.

22   DennisN   2008 Nov 17, 1:33am  

If death = default, then default = death.

Garnish by gibbet?

As a retired boomer with lots of cash, from my perspective bring on the 10% CD rates.

23   Duke   2008 Nov 17, 2:51am  

The real problem(s) with high interest now are:

1. We already have insolvent municipalities. If cities had to compete for people's dollars when higher rates are allowd, we would see cities shed jobs and projects like crazy. Bad time to have the public sector go bad since we are already seeing the private sector shed so many jobs.

2. There are a crazy number of Adjustable mortages out there. These borrows could no sustain the higher payments.

3. There are a great many companies that used debt to expand. If they cannot roll this debt due to price, we again lose jobs.

Look, in princple I comepltely agree. We have had malinvestment for years since people wanted to chase rates but have safety as well. If intrest rates would have been held higher we would have blunted the RE bubble, had people happy to save since the rates were attractive, had companies with viable business models based on realstic costs of capital.

But for now, jobs are the driving force of the Fed. Fix our current problem all at once and we could get 15% unemplyment - or worse. I think we are just going to have to get used to the idea that Uncle Ben is gonna keep rates low, therefor the world will keep rates low and we will ALL have stagnate economies for a very long time.

24   Malcolm   2008 Nov 17, 3:18am  

Yes Justme, that's pretty much how I see it, although I don't think it is as sinister as that. Basically if the bank isn't lending it doesn't want your money as much so it doesn't pay very much. If there is a lot of borrowing going on, the bank wants more money so it can lend more so it pays more.

Now the system is in a bind because banks want to lend but assets are falling and now they are being conservative so they can't lend. In other words banks want cash to stay afloat but don't want to lend it on more bad assets so they can't offer savers very much. That is the reason this bailout was a disaster, it didn't get banks to lend any more than they would have otherwise because there are more lenders competing for the same fewer numbers of safe loans.

25   Malcolm   2008 Nov 17, 3:32am  

More good points Duke, and in principle the original drop to 1% caused the bubble. That's obviously the flip side of forcing rates too low. Now we are in a situation where only us in the absolute top tiers can borrow, everyone else is just out of luck. A pure argument can be made to say that's how it should be, the problem is the country as a whole is overextended and many innocent people will be ruined because of the fallout.

My solution would have involved no bailout, other than making money more freely (lowering the ratest to raise them slowly) to the banks and letting the bad ones fail. Even that has a limit though because all those deposits are guaranteed, so would we rather risk a smaller amount of tax dollars or write off a larger number of tax dollars? Don't get me wrong, a couple of years ago we did some rough math and knew that proposed solutions were a joke since the problem was bigger than the entire budget.

26   kewp   2008 Nov 17, 3:38am  

Kewp, it seems like the system can be easily rigged or gamed by loading up the older generation with debt that will be forgiven after they die. I’m not getting it. Or maybe I am.

Again, the idea is that all debt is both capped and secured against income. If you croak with debt the state should seize your assets to pay it off.

27   justme   2008 Nov 17, 4:25am  

Kewp,

What if your income drops, as it often does in retirement? Does the grip reaper show up with a margin call?

(sorry, couldn't resist the sarcastic joke).

28   kewp   2008 Nov 17, 4:31am  

Your income drops, your debt ceiling drops right along with it. No new debt until the old is paid off.

I guess my point is that its still too easy for the average Joe to bury himself in debt. I want to make it impossible.

29   justme   2008 Nov 17, 5:08am  

TOB,

You think that job post is just a parody or what? Sometimes it is hard to tell...

30   Peter P   2008 Nov 17, 5:09am  

I guess my point is that its still too easy for the average Joe to bury himself in debt. I want to make it impossible.

Remember, wealth... flow... weak hands... strong hands...

Fools always part with their money. There is no point protecting people from themselves.

31   kewp   2008 Nov 17, 6:41am  

You think that job post is just a parody or what? Sometimes it is hard to tell…

Reminds me of the time I saw job posting looking for someone with five years of experience with Windows 2000 Server. In 2002!

32   SP   2008 Nov 17, 7:41am  

# The Original Bankster Says:
hilarious job posting

Sounds like they get paid in Kool-aid.

33   OO   2008 Nov 17, 7:51am  

There are lots of sweat shops in the BA that offer jobs exactly like the one advertised, but they don't say it out loud :-)

You need to sugar coat it, sugar coat...

Or instead of sugar coating, you only need the following line to get the idea across: Only those who are desperate for a green card need to apply.

34   SP   2008 Nov 17, 7:53am  

Found this on Patrick's front page:
http://www.dailynews.lk/2008/11/15/fea02.asp?ref=patrick.net

"The need of the hour is the injection of demand through direct fiscal action by Governments across the world. For activating Governments for this, two conditions have to be satisfied.

The first is control over cross-border financial flows, for otherwise Governments will continue to remain prisoners to the caprices of globally-mobile speculative finance capital.

The second is the setting up of an international financial facility, operated on principles different from the Bretton Woods Institutions, which not only makes concessional finance available to developing economies, but also enables them to substitute long-term loans for their current short-term borrowing. "

The above concluding remarks were presented at the UN General Assembly - although it is driven from the viewpoint of developing nations, it gives a clear indication of what governments are thinking. Currency Controls to prevent capital flight, followed by a move away from Bretton Woods.

If the US government follows the same prescription, it would have profound implications for anyone who has USD savings. I have seen a situation when currency controls were imposed literally overnight - it is an indication of huge bad news, which you can't avoid because you cannot convert.

35   Peter P   2008 Nov 17, 8:13am  

Who cares about development nations?

Don't we want to buy goods from them at ever lower costs?

36   Peter P   2008 Nov 17, 8:37am  

Anyway, food will be the next big thing.

And, there is such a thing as population bubble in developing countries.

We are living in interesting times.

TOB, I will not say anything about protectionism here. One way or the other, it serves our interests to maintain low trade barriers for us in other countries.

37   OO   2008 Nov 17, 9:07am  

There are usually signs of capital control before it is suddenly imposed.

1) Rapidly deteriorating government finance (check, but not there yet)
2) Rapidly depreciating currency (not checked, right now USD is very strong due to deleveraging, the interesting thing to see is what happens AFTER the deleveraging)
3) Rapidly deteriorating stock market which indicates possible capital flight by foreigners (half check)

It will be of no use if you keep FX in Argentina, Thailand or Indonesia during the financial crisis, because all your currency holding will be FORCED to convert to the local currency at the "official rate".

But, somehow I am more optimistic about the US because after all this is not a developing country, so the reset will be much milder, although I am sure it is not going to be pleasant.

38   OO   2008 Nov 17, 9:14am  

TOB,

people were looking up how much SiPort was paying their employees and it turned out all the green card petitioners are getting paid $60K to $85K despite their years of experience and education background.

Similar jobs would be paying $110-120K for a startup (cos the only attraction of startup is higher pay, since stock option is usually worth crap), and that is how lots of companies keep their cost low in BA.

People shouldn't worry about illegal labor, it is impossible for a Mexican labor migrant hanging outside of HD to steal your job. However, H1B and green card applicants will keep the wage rate compressed for a long time, if you do not have something highly unique and skillful to offer, which is the case for many BA worker bees.

39   justme   2008 Nov 17, 9:32am  

OO,

how did you find out how much SiPort was paying?

40   OO   2008 Nov 17, 9:57am  

I didn't find out, I read about it from some blogs where people dug up SiPort's green card petitions and the salary information is public.

http://www.myvisajobs.com/Green-Card-Sponsor/Siport.htm

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