>Really seems like Wall Street is in love with the term "shadow banking",
Actually, the hedge fund and private equity fund people hate that term because it implies something nefarious is happening. In reality, the new post-2008 crisis bank regulations in both Europe and USA to ensure stability causes a new phenomenon to emerge: Non-banks lending money to companies that banks are not allowed to lend to.
Every economist and financial regulator knows this became a side-effect of the more stringent financial regulations. So the "too big to fail" banks will still lend millions to big companies like Microsoft and Apple, but the $50m companies are too small and too risky to bother with.
Look how these "shadow" lending transactions keep emerging...
- a billion dollar pension fund is woefully short of its obligations to pensioners and needs a higher yield on its money. Buying safe US T-bills that yield 1% interest is not enough. They need to look at alternative asset classes that gets them in that ~8% range.
- a medium-size company needs $50 million loan to expand its business and is willing to pay a higher interest rate than 1% T-Bills. (That makes sense since the company doesn't have the same credit worthiness as the US Government.)
- If the pension fund (needing to put their money to work) and the company (needing a loan) can match up with each other, they can help each other's goals. But the pension fund isn't in the business of analyzing credit risk or providing loans directly. Likewise, the owner of the company doesn't have the time to fly all over the country and meet with 100 different pension fund officers.
That's where middlemen like private equity come in. They're the ones with the staff of credit analysts. The "back office" of the private equity fund that analyzes a company's credit worthiness does much of the same work that the credit analysts at JP Morgan, Bank of America, Wells Fargo, etc did. They become the "shadow bank". Of course, they also charge management fees and a % of the profits for their "financial intermediary" services.
The middle market's underlying need for credit never disappeared. The new bank regulations just inevitably shifted the loan transactions to a different set of players.
The shadow banking is fine. The taxpayer isn't responsible if a PE fund engaged in direct lending to the middle market loses all their money.
But shadow banking can and should be scrutinized, and potentially regulated, if there are systemic risks that will lead to the taxpayer being on the hook once again. If it's just isolated private actors losing money it doesn't matter.
And I think this hits the nail on the head for where the problems are going to come from. Low interest rates have made it very hard for pension funds to keep up with their (overgenerous) past promises with safe assets, and a frothy stock market seems like it’s been keeping them solvent.
the article claims that the banks (the same ones that were bailed out in 2008) are the source of the capital that the shadow banks lending to companies
so the taxpayer is on the line (at least, as much as they were in 2008)
Banks seem to be involved as well, ”According to the latest report from the Federal Reserve, unregulated credit funds now have access to more than $1 trillion in lines of credit from regulated banks, an increase of 65 percent over five years”
So instead of banks lending directly to the risky mid-size businesses, they are lending to trustworthy middle men?
None of that helps unless the PE firm can actually get that 8% return. The chase for yield during the recent (last ~15 years) "global savings glut" has been pretty disastrous.
> To fund all this loan-making, the shadow banks have turned to insurance companies, pension funds, university endowments and wealthy investors, offering them a chance to buy into a diversified pool of loans that offer returns ranging from 6 percent to 13 percent, depending on the level of risk they are willing to assume.
If some hedge funds and "wealthy investors" want to take on risky investments that are "unregulated" I'm all for it. Would you agree the risks for systemic collapse come in when it's straddled onto say insurance companies or pension funds?
The root issue of credit card bubbles is not that hedge funds and investors may loose on risky investments, but that those same investors are so interconnected with society that society has to bail them out if they end up loosing it all.
If everyone is making riskier bets for a significant, then those who do right may be outcompetes for long enough that they go by the wayside while the risk-takers dominate.
Then when the “black swan” comes the risk averse are already gone. Oh and the system is full of TBTF entities.
What shape would the regulation for the latter look like? Should policy holders or pensioners have the ability to veto these investments? I don't want someone to lose their pension over a poor investment by a greedy fund manager. But I also can't think of how you'd draw a line where the investment is "too risky", or rather "too high of a risk to justify the effects on the persons who would be affected if the investment fell through".
In principle, it seems like it would be pretty easy to limit pensions to a short list of conventional investments specified by a regulator, such as the sort of thing normally allowed in a 401k.
The line would be fairly arbitrary but I don't see why that would make it particularly hard to implement?
Hedge funds usually manage other people’s money in addition to their own, in fact, pension money is the most common source of other money that hedge funds manage.
I've seen the term "rent seeking" used a few times here on HN, and I have no idea what it means. For those curious:
Rent-seeking happens when a person or business uses their position or resources to get some additional benefit from the government. The most common occurrence is when a company or industry lobbies the government to receive special subsidies, grants, and tariff protection. The term "rent" in economics means receiving a payment that is over the costs involved in the production of the item or keeping the item in service. These actions do not produce any benefit for the community-at-large but only redistribute taxpayer's resources.[0]
That's a very government centric definition but I prefer:
>Rent-seeking is an attempt to obtain economic rent (i.e., the portion of income paid to a factor of production in excess of what is needed to keep it employed in its current use) by manipulating the social or political environment in which economic activities occur, rather than by creating new wealth.
The important bit in rent-seeking is "rather than creating new wealth."
As wavefunction notes, that is at best a very narrow definition.
Here is Wikipedia's:
"Rent-seeking is a concept in public choice theory as well as in economics, that involves seeking to increase one's share of existing wealth without creating new wealth. Rent-seeking results in reduced economic efficiency through misallocation of resources, reduced wealth-creation, lost government revenue, heightened income inequality, and potential national decline."
> And household debt has grown no faster than household income and is concentrated in households best able to pay it back.
I'm not so sure about this - what I'm thinking is that the next (current?) bubble is in auto lending. I'm seeing tons of advertisements saying "We will lend up to 72 months with very little down". With the average new car priced around $37500 that's a payment in the mid $500's for someone with good credit. And I suspect the people doing this only have an average credit score so theirs will be higher.
That's absolutely jaw-dropping. I assumed that was a made-up Internet stat, and was going to ask for a cite, but some quick web searching confirms it.
I'm a used car guy, typically buying vehicles 2-3 years old, and would never contemplate paying above $20k. Even a brand new sedan (e.g. Nissan Altima, Honda Accord) is around $23k MSRP. A crossover family vehicle (e.g. Nissan Rogue, Honda CR-V) is around $25k.
What on earth are people purchasing, that the AVERAGE price is a low-to-mid range Mercedes?
There's a demand for them. SUV are quite popular for families who don't want to "drive minivans" but they still want a large vehicle to fit in everyone. Others buy it because of the perceived safety, larger vehicle so they feel more "protected".
Trucks are just what you drive in rural areas. And there are a lot of small towns and rural areas. Companies noticed that people are shelling out $40k for them, so they started selling them for $50k. $50k and they are being bought still? Ok, time to charge $60k, and so on.
> Others buy it because of the perceived safety, larger vehicle so they feel more "protected".
It's not just perceived safety though. Heavier cars are objectively safer when crashing into a lighter car. IIHS did several tests on this. The fact that SUVs are higher means that they have an advantage if crashing head on with a sedan.
It also means less safety for everyone, though. Especially pedestrians and people on motor(bikes) are endangered by heavier, bigger cars. Not counting emissions and climate change from moving a ton of decorative metal around.
I don't disagree. But I don't see a better solution. Why would someone with a family take a risk for instance? I know that Volvo are taking safety very seriously, and want to have 0 fatalities (even pedestrians) sometime this coming decade.
I think emissions can be improved with things like hybrid drive trains and electric motors.
Think about this - the same amount of tech, of engineering, of “stuff” like window regulators, speakers, steering wheel, etc goes into a subcompact 4 door as does a 4 door SUV, minus cheap stuff like body panels interior carpet.
They have them because people are wiling to pay for them. People are willing to pay because they think they are worth it. I would guess that the fact they are bigger make people think they cost a lot more to build, when they do not.
Because that’s where manufacturers need to make money. These things typically have fuel economy numbers at or below CAFE standards, so they’re banking on these and selling more efficient vehicles closer to cost.
At least some part of it, and perhaps a majority of it is due to chicken tax. Trucks in the US enjoy a level of protectionism few other industrial products do. US manufacturers, as a result, can increase their margins without losing market share to foreign competition.
My brother in law probably makes $80k and my sister about the same. He's got a $50K truck and she's got a $40K SUV and they were bragging to me about the deals they got on them. Granted, their house note is very respectable due to the time they bought the property and built their house, and I'm sure that his parents have helped out given that he's an only child and they both make good money. Even still, they each have 20 minute commutes and are rarely in the vehicles other than grocery shopping otherwise.
STILL... I'm paying about $500 a month on my car when you count insurance and car note, and mine is only $24K. The only way anyone is ever getting me to pay more than $30K for a vehicle in this day and age is if I win the lottery or if I absolutely HAD to have a more expensive vehicle to do my job (such as towing or sales).
"What on earth are people purchasing, that the AVERAGE price is a low-to-mid range Mercedes?"
I think that's a classic median vs average situation. The median purchase price is probably a lot lower than $37500, while the average is skewed up by a minority of buyers purchasing very expensive cars.
> Even a brand new sedan (e.g. Nissan Altima, Honda Accord) is around $23k MSRP. A crossover family vehicle (e.g. Nissan Rogue, Honda CR-V) is around $25k.
An accord/ultima start around that price for the base models and the lowest package. I doubt most people buy those models. People like options and get plenty of them.
Also keep in mind you pay a ton of tax and also registration. Registration is insanely expensive in states like CA.
The price of a low mercedes is much higher than that, not sure where you're getting your numbers, but they're off, WAY off.
There's significantly higher demand for used cars than there was a decade ago, which has allowed banks to extend finance terms out to 96 months.
For example, take a look at this depreciation curve for a Ford F-150: http://usedfirst.com/cars/ford/f-150/ There is very little depreciation from 2017 - 2015, meaning that if you keep the truck in good condition, you can basically drive a truck for just its operational costs (fuel, maintenance, etc.) Not a bad deal assuming market demand stays hot for these vehicles.
My theory 2 years ago was that the likes of Uber, Lyft et al. would cause more and more people to buy new cars that couldn't really afford it. Should demand for ride sharing ever stall or fall off, the continued increase in people entering the "gig economy" workforce in such a levered manner would be catastrophic to the auto loan industry.
I think uber recently killed of it's in-house leasing program. But I imagine they may have a huge amount of liability on the books depending on how many of those leases haven't expired yet.
Very different from a housing crash in important ways, that's for sure.
Vehicles are much more "liquid" -- they're portable and fungible to some extent. A bank repossessing many vehicles will get much more of its money back than a bank trying to sell foreclosed houses.
Vehicles also lose much more of their value than houses. The second you drive a new car out of the dealership, you are underwater unless you made a good downpayment; and it is not uncommon for people financing cars to find themselves underwater on their current one if they want to upgrade (or sell/downgrade to get out of debt). And that is in a good market. If there is a surge in used car supplies, we will see them depreciate even more.
In contrast, in a typical market, it is uncommon for houses to be underwater, as they tend to appreciate in value. It took a crisis in the housing market for a large portion to go underwater. A simmilar crisis in a market where underwater is the norm would just push them further under.
While I would totally love to see a used vehicle price crash because it would be good for me personally and to stick it to the "hurr durr, muh resale value" types, I'm not convinced that wouldn't have reverberations throughout the market.
Banks, and really all loans, make mad cash the first few years, 90%+ of the payment is interest. For cars, that's like 18mo, for homes it's a few years of good cash flow for the bank, and the home appreciate (cars don't) so when the bank is flipping a flipping a foreclosure, they still make out great.
Brex, at least currently, isn’t the kind of card where you carry a balance. Instead they look at your bank account and say “you have a million dollars in there, you can spend 100K this month” (not real numbers). You pay it all back at the end of the month.
So while not immune from risk, it’s considerably less risky, and works over a shorter time frame, than other credit options.
Zero down payment isn't even legal in Canada and anything less than 20% down and you must purchase mortgage insurance. I'm amazed that 0% is allowed in the US after 2008.
Mortgage insurance is required for nearly all sub 20% down mortgages in the US too. Most banks won’t do straight 0% down either, but will do ~3%. A notable exception to both of the above are VA loans, which will finance 100% with no PMI, but VA loans are only available to a very small segment of the population.
3% is typically only available for a primary residence if you haven't owned in the past X years. Otherwise, it's pretty much impossible to find anything less than 5% down.
That's not a terrible thing either. If you are not able to save up for 5 or more % down, odds are good you will be house-rich and money-poor, which can really suck a lot of enjoyment out of owning a home.
Say, for example: a $300k home with a 285k mortgage will work out to around $2,000 per month. Add in a vehicle payment or two, maybe a higher bill if you have high property taxes, phone, internet, paying down credit cards, whatever, and you're easily in the 3-4k per month just in bills. If you can afford that and not feel financially constricted, then you can afford to wait a bit, get more saved up to put more down, and you'll have more available for vacations, repairs, additions, appliances, etc.
3% should be outlawed. If you sell your house for exactly the price you paid for it, you would have just lost at least 6% to realtor costs. Even more when you consider expenses like title insurance, taxes, and other fees.
Anything less than 10% is insane, and less than 20% means you can’t afford it.
Jumbo loans have no such requirement in the US (anything over 650ish-thousand dollars).
Instead of Private Mortgage Insurance, the banks (typically?) require that you have a certain amount of cash in the bank as reserves. x% cash, y% investments discounted at 30%, z% retirement discounted at 40%, and so on. More at 10% than at 20%. And so on. But I don't think these are required; there's no reason a bank couldn't just decide to let you go without. And while they require pretty extensive documentation, you can still game the system.
When we bought (2015), interest rates for jumbo loans were LOWER than confirming loans, and no PMI requirement. win/win.
Zerodown is a combination lease and option to purchase. You're technically a renter for two to five years, just with a fixed cost for eventually purchasing a specific house.
All they have to do is bundle these mortgages together with safer ones and sell the resulting bundle as a security. The market will accurately assess the risk of the combined product and set prices accordingly. Because of the way this spreads out risk and incentivizes smart, objective analysis of the products, this is guaranteed to work well.
The default risk must be uncorrelated though or else you get no gains from diversification. This was a big part of how CDOs justified the security of a AAA tranche, when in reality everything was correlated because bad loans were made to everyone.
There's a roughly 3.6% spread between the purchase price appreciation schedule and purchase credit schedule, no option to extend the lease past five years, and a two-year minimum for accumulating leasing fees. This points pretty strongly towards partnering with a "hard money" lender willing to put up balloon loans and happy to collect either the above-market-rate interest or the property in lieu of repayment. It's likely arbitraged so that 100% of the risk gets offloaded. The appreciation schedule on the purchase option pays for the excessive interest demanded by lenders happy to take possession of property in downturns.
Furthermore, Zerodown is structured so that it will never go through the foreclosure process. They own the property and lease it out, so the worst they'll need to do is an eviction.
Much higher interest rates presumably. I don't think there's any fundamental reason why you shouldn't be able to buy a house without a deposit. A deposit just shows you can be sensible with money, and therefore the loan is much lower risk for the bank.
But if a bank is willing to take on the high risk in return for very high interest rates there's no particular reason why it shouldn't be possible. It may end up being exploitative, like payday loans, but not necessarily.
> A deposit just shows you can be sensible with money, and therefore the loan is much lower risk for the bank.
Is is lower risk, but it's not because it's some weird moral test.
The reason is that the lender only loses money once the value of the house has declined by the amount of the deposit. Say you buy a house with 20% down. If you sell the house at 80% of the value, you've wiped out your deposit but the bank loses nothing.
On the flip side if the house goes up and you sell for 120% you've doubled your money, but the bank isn't any better off.
Credit ratings are an attempt to turn weird moral tests into a concrete number, and they have a massive effect on one’s ability to get a mortgage. It wouldn’t be at all surprising for a bank to try to account for factors the credit score misses.
Well, yes, the down payment does reduce the bank's loss in some cases, but it does also function as a "moral test" in the sense the parent meant.
Every mortgage application asks if someone else is contributing to the down payment. That wouldn't matter unless there were a difference in risk classes between the two groups of people, so it's not purely a matter of a better loan-to-(initial-)value ratio.
Edit: looks like that's not the (dominant) reason; see follow up thread.
> Well, yes, the down payment does reduce the bank's loss in some cases, but it does also functional as a "moral test" in the sense the parent meant.
> Every mortgage application asks if someone else is contributing to the down payment. That wouldn't matter unless there were a difference in risk classes between the two groups of people, so it's not purely a matter of a better loan-to-(initial-)value ratio.
Don't they ask if someone is contributing to the down payment because it could be categorized as a loan that would factor into your income to debt ratio?
I just googled the issues related to mortgage downpayment gifts, and it looks like you're correct. This is the best summary of issues I've found and it doesn't mention anything about being higher risk in and of itself:
From that page, the bank wants to make sure it's not a loan or a side-payment from one of the parties to the transaction.
Still, I'd be really, really surprised if there weren't a correlation between "fraction of DP as gift" and "default rate", but I don't have anything concrete to cite ATM.
My argument is that zero-percent down loans will always end badly, because if you don't have the discipline to pull together even a measly 5%, you don't have the discipline required for home-ownership. And it's not like banks can charge payday-loan like rates on a mortgage, because if you can't afford a small down payment you also can't afford high monthly rates.
These types of loans always increase when credit is cheap, and then they end badly (sometimes very badly) when the economy eventually turns.
Those are good points (and I said something similar in my cousin comment), but you're overstating it by saying they always end badly. Obviously, some percentage of such mortgages are paid back. (I'd agree if you meant they go bad at the macroeconomic level, but you specifically clarified that you were referring to the individual who can't make a down payment and saying they will also fail to pay it back.)
Yes, you are correct, I'm not arguing every single mortgage will end in default, but that every macro environment where zero down mortgages proliferate will always end in tears to whoever is left holding the bag (currently homeowners and investors, and, crucially, rarely loan originators).
Of course, to my knowledge, the only environment where zero down mortgages were really widespread was the mid-aughts housing bubble, but even with an n of 1 I still think it's a bad omen.
US banks, overall, have the highest reserve ratio in recent history. US banks currently have a reserve ratio of nearly 100% or apx 1x leverage (see https://seekingalpha.com/article/2484795-u-s-banks-are-now-o... for more details). IIRC, the reserve requirement for large banks is 10% and historically, as cascom alludes, this is about where most US banks were at (i.e. about 5x to 10x leveraged) historically. But the that has not been the case for almost a decade now. So US banks have plenty of capital assets to offset loan losses.
The "shadow banking" services that are rising are coming about because normal banks are unwilling to take on even moderately risky lending. Their demands for loans are now extremely stringent, especially for smaller and middle-tier business customers. This demand is thus being filled by different, non-traditional, sources, i.e. "shadow banking".
The situation in overseas, especially Europe, is very very different. Many large European banks are currently operating with reserve ratios of only a few %. I don't know if this means there is less "shadow banking" in europe or if they just have far too much sovereign debt on their books.
The comparison being made in that article is sort of a weird one and is not really reflective of banks' true reserve ratios (nor is the ~100% M1/reserve deposits that they were excited about true any longer).
On https://fred.stlouisfed.org/graph/?g=o4OS I've included updated source data from that article, and you can see that M1 has continued to grow while fed reserve balances have fallen, but neither was ever close to M2 (which includes things like savings accounts and small CDs).
A better indication of banks' leverage is Total Equity to Total Assets, which is similar to the Basel Tier 1 capital ratio: https://fred.stlouisfed.org/series/EQTA
This has steadily gotten healthier over time overall as banks have tended to reduce their leverage over the last few decades.
If we are leveraged at 100% when we take the real valuation of assets into account, then, if we jack up the valuation on assets we hold, then we can chip away at the leverage ratio and get it to go down.
Is this why I've been seeing signs advertising something like "learn how to flip houses like a PRO! Call 555-555-5555" popping up around my little suburban town? Also bank managers hitting up my elderly relatives for home equity loans again.
It feels very much like we're in 2002-2005-ish again.
My point was that I'm seeing signals that we're repeating history. Why do these home flipping courses pop up? You think they just come out of thin air? No. It means that there are market conditions that would allow an entrepreneur to sell their information.
What do we know about the pre-crash market in association with these signals? We know that (1) these things sound like a get rich quick scheme and (2) that they legitimately were a get rich quick scheme, because they actually worked up until the crash where many people were left holding the bags (houses that could no longer be flipped given the post-crash market conditions).
I suspect that there cannot be effective regulation of any industry without a technological overhaul to money such as moving to cryptocurrency and smart contracts.
Especially now with new technologies coming up all the time, companies will just go around the laws.
Doing something like that is pretty far-fetched and would require a new type of technological government. But to me there is a structural problem with the relationship between money and government (in their current low-tech forms) in society.
The primary motivator for people is money. Government attempts to regulate all aspects of behavior, but it cannot effectively control or monitor the exchange of money. The most obvious symptoms of this are usually called corruption. It is less obvious (but still obvious to me) that corruption is just the tip of the iceberg. The problem is structural. Government cannot be effective because it is superceded or corrupted by the real motivator.
The solution is a high tech type of money that is integrated with government.
That makes sense, but is also a nightmare IMO. The lack of oversight of money means that you cannot be totally barred from participating in the economic system by the goverement.
If the government had even more control over money, they could arbitrarily blacklist people from having access to currency. While this sounds like a good tool to use against criminals, recall that, in America at least, there exist things such as the no fly list [0], which impacts people's rights without due process.
The way governments actually work in practice these days, yes, it would be a nightmare.
But the problem with the relationship between money and government is so significant, a real solution would require dramatic changes all around. So that would mean that government could not be anything like it is today.
Yet we know exactly who the participants are, the types of firms, and their practices.
Step 1 to better regulation of creative rent seeking is to stop treating it like it's nebulous.