Banks ‘n Loans – Revisited

Duncan has a bit of a spray at banks raising their loan rates at greater than the increases being applied by the Reserve Bank.

But actually, if you look at both history and the current environment, its hardly surprising.

The History Lesson

Once upon a time, a long time ago, when knights were bold and maidens were fair… you get the idea. Anyhow, if you wanted a home loan you went to a bank. The banks raised funds from depositors and in wholesale markets (the money market and so on). The banks had to make their profit from the Spread - the difference between what they loaned money for, and what they paid depositors or on the wholesale market.

Then, a few years ago, along came deregulation and the emergence of the non-bank lenders. These guys ONLY raised wholesale money, either in the wholesale markets or by borrowing huge sums from a big bank and then slicing and dicing it into little chunks. The non-bank lenders also packaged mortgages into loan books and sold them off (called Securitising), leading to the stories of the mythical Belgian Dentists who earned a tidy income from owning a portfolio of Australian home loans.

The emergence of the non-bank lenders gave the banks serious competition. Over the last 15 years, the spread (that’s the difference between the loan and the deposit rates) has roughly halved.

And now folks… the Current Environment

Back in about August 2007, a bunch of clever dicks in the USA suddenly realised the Emporer had no clothes.

Until then, they had been making large numbers of home loans to people who could not pay. These were of an even lower standard than the Australian “low-doc” loans. These were to people who never had a hope in hell of paying. In the parlance, they were “sub-prime” loans. But the game was about making loans and collecting fees and to hell with tomorrow.

houseofcards.jpgTo help keep the merry-go-round spinning merrily, these loans were packaged (securitised, as above) and sold off all over the place. A bunch of even cleverer folks made managed funds out of packages of these crappy loans, and sold the funds. And on and on the game went. Some of these low quality loans were tucked and folded so many times they even became classed as high quality, such was the obscurity! Lots of yummy fees collected, but eventually the house of cards came a-falling down. Along the way, a few methaphors were mixed as well.

All it took was a bit of an economic slowdown in the USA, and those people who struggled to may their mortgages simply stopped paying. A lot just walked out of their homes. In that kind of environment, there are no buyers so house prices have tumbled, and an economic decline spiral has started. When the borrowers don’t pay, suddenly all those people with sub-prime loans, and funds, and what-not stop receiving an income and want to know why.

Poof! Like Merlin waving the magic wand, the light of realisation suddenly appears as people realise their “investment” was merely an illusion.

Like they have been in everything else, the politicians and leaders in the USA are completely incompetent – even if they knew what to do, they can’t fix this mess overnight. They allowed it to happen over a period of many years, and many years is what it will take to fix. At the moment they are in denial – just listen to President Bush.

In this environment, there is no confidence in any markets for anybody who wants to borrow money. There is still money available to borrowers, just a lot less of it, at much higher interest rates.

Because the lenders have generally departed, leaving only a cloud of dust and the sound of receding running shoes, the unravelling is spreading. Now, any company with large amounts of short term debt is considered suspect, irrespective of the assurances they give about having sources of funding lined up. (Witness the declines of Allco, ABC Learning, Asciano, RAMS and many many more). Funding is harder to get, and bankers are about the only sources left – and they are nervous.

So we’ve seen massive declines in the share market, as companies with large loans (called “highly geared”) have had to reassure investors that they can survive. They try, but it’s not working very well. The loss of confidence is contagious.

For the poor old home owner, the tables have turned. The non-bank lenders have no easy sources of funds – apart from our friends the big banks. They can’t borrow on the wholesale market – because there isn’t one for the likes of them. The only wholesale money market left is for the banks – big, solid, and dependable. And the rates being charged are higher.

The banks don’t source all the funds they loan out from depositors, much has to come from those wholesale markets. When the rates there go up, the banks only have two choices: absorb it, reducing returns to shareholders; or pass them on to customers, increasing their pain.

And that is why the banks are raising rates at greater than the rate set by the Reserve Bank.

Cos the money they are loaning out is costing them more.


Oh c’mon.. you dont think there ANY element of profiteering in this at all??


Comment by Duncan Margetts | March 10th, 2008 7:55 pm | Permalink

What a brilliant way to describe it all, Wally! Seriously. THis is the sort of thing that not only teachers but BORROWERS should read.

As a ‘graduate trainee’ at the ANZ bank in 1989, I was an assistant bank manager when interest rates hit 17.5% in early 1991. Even in my puzzled, English-graduate mind (why on EARTH did they hire me? At least it was a job), I used to wonder at the stupidity of most of the borrowers.

A common example: a couple can comfortably borrow $60K (work with me, it was 19 years ago) for a 3 br house in an OK neighbourhood. However, with a recent payrise, they see the posher neighbourhood and want a larger house. So, they include hubby’s overtime and forget that the wife is statistically pretty likely to take one or two years (minimum) out of paid work to have a couple of offspring. They also don’t bother to check out (in 1989 parlance) any ‘interest amortisation’ tables to check that 1) should interest rates rise; 2) overtime cease; and 3) they’re on one salary; that they can pay for the damn thing.

Over in the UK in 1992 (yep, I quit the ANZ and decided to do the beer and travel thing), I had a fun job repossessing homes. Thankfully via the telephone, but they were Britain’s version of packaged loans that were sometimes for borrowings of over 100% of the home’s value a few years earlier. I had instances of people posting in their keys, for me to ring them and say, “I’m really sorry, but selling your house isn’t enough. With the additional interest on the bit of the loan you never paid for, plus the falling house prices, you still owe us forty thousand quid.”

Why do people never learn? Why do we have to read stupid stories in the Despiser and Sunday Fail about the ‘tough times’ facing mortgagees when an interest rate increases by 0.5%?

Moral – stick with the modest amount you were going to borrow to begin with. Always factor in a huge wedge of money to cover any rate increases, salary drops or unforeseen changes. DON’T, get greedy about what you think you need to live in.

Rant over.

Comment by MillyMoo | March 11th, 2008 9:50 am | Permalink

Thanks for the explanation, and I think MillyMoo is spot on.
Last weekend our local paper ran a story about a bloke who would have to ‘miss out on meals’ because the mortgage payments on his 3 beddroom house in a good suburb were too much to bear. The paper really drew it up as a sob story.
I’ve no pity though. The bloke was 21 years old!
I recall at that age, working as a professional, the only way to live in a 3 bedroom house in a nice suburb was to share it with at least 3 others and split the rent.
People expect an awful lot to be handed to them these days, and the media loves to glorify the stupid and selfish.

Comment by don | March 11th, 2008 11:50 am | Permalink


When I was 21 I still lived at home, I think I moved out at about 22. After moving out, the rent, running a car and buying food meant I had very little left over.

I put the engagement ring on lay-by, and put off buying new shoes for at least 5 months by dint of doing various repairs at work using glue and so on “borrowed” from the workshop of my employer.

AND go take a look at the sizes of houses built now, with an expectation that everything will be there. No sheets on the windows for todays generation.

I lived through the 17.5% interest rates as well…

I have NO sympathy at all for those who don’t expect times to change for the worse!

Comment by Wally | March 11th, 2008 12:56 pm | Permalink

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