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A new credit bubble gets ready to burst

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Re: A new credit bubble gets ready to burst

#31

Post by Waterluvian »

0xffff2 wrote: post #27
Waterluvian wrote: post #24

Earlier quoted context omitted.

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.

Interesting, thanks.

I'm curious if it's that most banks "won't do" or "legally cannot do"?

Re: A new credit bubble gets ready to burst

#32

Post by rmah »

cascom wrote: post #3

The huge difference here is leverage. The typical bank in the US is levered ~5-12x which means, many of these "shadow banks" are unlevered, this creates an entirely different dynamic

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.

Re: A new credit bubble gets ready to burst

#33

Post by jasode »

not_a_moth wrote: post #11

Really seems like Wall Street is in love with the term "shadow banking", because it implies "can't regulate it". 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.

>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.

Re: A new credit bubble gets ready to burst

#34

Post by SilasX »

lordnacho wrote: post #21
IshKebab wrote: post #14

Earlier quoted context omitted.

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…

> 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 los…

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.

Re: A new credit bubble gets ready to burst

#35

Post by SilasX »

hn_throwaway_99 wrote: post #18
IshKebab wrote: post #14

Earlier quoted context omitted.

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…

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 ch…

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.)

Re: A new credit bubble gets ready to burst

#36

Post by vageli »

SilasX wrote: post #34
lordnacho wrote: post #21

Earlier quoted context omitted.

> 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 los…

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…

> 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?

Re: A new credit bubble gets ready to burst

#37

Post by YeahSureWhyNot »

temp129038 wrote: post #7

If SF, I'm seeing ads all over for 1) Brex (corporate credit cards for startups) and 2) Zerodown (pitching no down payment for homes). It would be quite something if tech and not banks caused the next great recession.

wasnt there a 'startup' in most recent YC batch that was all about flipping houses in Bay area?

Re: A new credit bubble gets ready to burst

#38

Post by mikeash »

nugget wrote: post #9
temp129038 wrote: post #7

If SF, I'm seeing ads all over for 1) Brex (corporate credit cards for startups) and 2) Zerodown (pitching no down payment for homes). It would be quite something if tech and not banks caused the next great recession.

I just looked up Zerodown. How does their model account for the foreclosure risk if there's a real estate recession?

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.

Re: A new credit bubble gets ready to burst

#39

Post by mikeash »

lordnacho wrote: post #21
IshKebab wrote: post #14

Earlier quoted context omitted.

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…

> 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 los…

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.

Re: A new credit bubble gets ready to burst

#40

Post by wrong_variable »

jasode wrote: post #33
not_a_moth wrote: post #11

Really seems like Wall Street is in love with the term "shadow banking", because it implies "can't regulate it". 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.

>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 economis…

Thanks for that explanation, I have been so confused with the term "shadow banking" - it makes perfect sense now.
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