Tuesday, 29 October 2013

Those annoying Lloyds adverts

See write up of "Moving Out" here, which is infuriating/patronising enough, but even worse is the small boy whose parents used to live with his grandparents (not clear whether on mother's or father's side) who can buy a house (in which the small boy is later born and grows up) because "The bank lent them some money".

No the bank did not lend them any money at all, quite the opposite:

1. If you lend somebody money, you are foregoing a consumption opportunity, for the time being at least. It's up to you whether you want to charge interest or not, how much you can get depends entirely on what the borrower is willing and able to pay and/or how much you want to get.

When banks grant mortgages they simultaneously take deposits and are not foregoing consumption opportunities, they are increasing their consumption opportunities by charging more interest on the loan than they take on the deposit.

2. Where does that "money" come from?

a) The bank is just a middleman who splits the zero (with a vested interest in high house prices as this means more lending and deposit taking).

b) It doesn't come from the vendor, because he never had that money, he had a house which he magically turns into a deposit. He can withdraw that money in future and spend it on something else (to which more below).

c) So actually, the "money" comes from the purchasers. They are the ones who go out to work, transform their labour into wealth for which they receive wages or salary, and they devote a large chunk of that into mortgage repayments, which flow via the bank (which takes its cut) back to the vendor. So they are the ones foregoing consumption opportunities!

3. The true position in 2(c) is not materially different to that small boy's parents renting a home (where they can still have sex and bring up kids etc). If they take out an interest-only mortgage, they are renting the money instead of renting the house, is all.

4. "Ah!" cry the Homeys, "But they have paid for the capital value of the house, they are building up their own capital by paying off the mortgage, this is a form of saving etc etc."

Nope, that supposed "capital value" is merely the estimated cost/value of all the future rent which they would have to pay, whether that is for a term of years (a lease) or to theoretically to infinity (a freehold). And borrowing is clearly not "saving" and neither is paying rent or interest - those make you poorer in the long run, not richer.

5. "Ah but…" cry the Homeys, "That house will go up in value, so they are getting richer etc etc."

Well yes and no, all it means is that the next purchaser in a few decades' time will be even poorer. It is no net addition to wealth, unlike proper capitalism and investment.

6. Finally, seeing as there is only a marginal difference between renting and buying with a mortgage in financial terms from the purchaser's point of view, why is it different for the current owner?

Answer: it isn't.

a) Superficially, if the current owner decides to rent out the house, he has to make do with £1,000 a month rental income minus voids and costs etc, and he can't spend any more than what he takes.

b) But if he sells, he is credited with a one-off deposit of £200,000, which he can withdraw and spend all in one fell swoop or just leave it in the bank and hopefully get a bit of interest (his share of the rent of interest that the bank is collecting).

c) However, what the bank is doing here is dealing with the admin hassle side of collecting the rent/interest (fair enough) and spreading the risk.

The banks has thousands or millions of mortgage borrowers, 99% of whom will be paying their mortgage every month, so that's £x million coming in every month, and on average, its depositors will be withdrawing rather less than £x million every month.

d) A large enough group of landlords could do exactly the same thing. If you only have two or three homes, there is a small but real risk that in any month, no rent will come in at all or that costs will exceed income.

But if thousands of landlords clubbed together and agreed that all the rents go into one account and all costs are paid from that account with each landlord entitled to his appropriate share of the whole, then those landlords would be in much the same position as depositors.

So £z million comes in as rent, £y million goes out as costs, leaving a maximum of £x million which can be withdrawn every month. Some landlords/depositors will withdraw their share each month, other will be happy to roll up their share and yet others will withdraw in advance, i.e. they contribute a home generating £10,000 net income every year and immediately withdraw £200,000 to splash out, knowing that they will only be able to withdraw very little in future.

e) The counter example is a really small bank, which only has two or three mortgage borrowers and one large depositor. It does not matter what it says on his bank statement, he cannot withdraw more than what the borrowers pay in each month. The risk spreading is not something that banks inherently do, they can only do it because of averaging out a few bad debts over a large number of depositors.

Just sayin', is all.


Kj said...

I´ve been thinking about the bank asset tax a bit. Ok, banks, as long as they can do interbank/central bank lending, or indeed take deposits that they themselves dole out to vendors, can always split the zero. Fine. But if we are to tax the opportunity banks has to do this, shouldn´t it be on the bit that is not witholding consumption, and that differentiates banks from a person lending cash to another? Say a bank has on the liabilities side: 10% equity, 10% bondholders, and out of customer deposits, 20% are closed deposits like restricted savings accounts. So if a bank has 40% of assets matching liabilities in maturity/risk capital that can be extinguished, it should be liable for a BAT on 60% of the assets. Or?

Mark Wadsworth said...

Kj, why bother?

The assets (the source of monopoly or rental or windfall income) are the same whatever the liabilities side looks like (shares, bonds, deposits are all shades of grey).

If a bank is 100% financed by shareholders and retained profits, then it can de-register as a bank - this is effectly person-to-person lending.

In fact, if it were up to me, I would tax each bank on the higher of a) total financial assets and b) total deposits.

Kj said...

But what monopoly income are you referring to? The opportunity to split the zero, to indirectly receive land rents, deposit insurance?
I´ve gone over some bank annual reports, and it seems to me that post-losses and payable costs, the average margin in lending seems to be in the 1-1,2% range, and the return on capital, although in the better end, isn´t breathtaking; but, market capitalisation of the banks are ofcourse way out of proportion to the actual equity capital on the books, and looks like an accelerated function of the housing market, so that does indicate monopoly profits above the straight-faced "return on what i bought the stock for" idea.
But is your point about the BAT that the margins should be even wider?

Kj said...

But as you said, a bank can delist as a bank and fund itself. But if a bank funds itself halfway, shouldn´t it then be rewarded with less tax than a bank that funds itself as only a one-digit portion of it´s assets.

Mark Wadsworth said...

Kj: "But what monopoly income are you referring to? The opportunity to split the zero, to indirectly receive land rents, deposit insurance?"

Yes, yes and yes.

As to the precise amount of the BAT, we will have to arrive at this by trial and error.

UK banks boast that they pay total taxes (including payroll taxes) of £50 billion a year and have a total balance sheet of about £5,000 billion.

So assuming we get rid of the other taxes, a fair rate would be 1%.

Of course, half of that £5,000 billion is made up numbers and double counting, so banks will be encouraged to downsize to real figures and to focus on profitable stuff.

But their taxable capacity will stay the same, so if they halve their total assets, then the ideal rate is 2%.

Mark Wadsworth said...

Kj: "if a bank funds itself halfway, shouldn´t it then be rewarded with less tax than a bank that funds itself as only a one-digit portion of its assets."

No no no!

The safest/best banks from the point of view of the outside world are actually:

a) those funded 100% by depositors (like building societies) because these are the most cautious, and

b) those funded 100% by shareholders (because no systemic risk).

The worst kind of bank funding is mish-mash of shareholders, bondholders and depositors, because the bankers take massive risks and they all expect to be bailed out.

Kj said...

But their taxable capacity will stay the same, so if they halve their total assets, then the ideal rate is 2%.

For revenue neutrality reasons, yes, but is it really in the interest of anyone, or actually taxing a monopoly income, when smaller spreads are achieved in reality? Isn´t banks competing down these spreads a good thing? If we assume that higher interest lending is better for the economy, this entails larger risks as well, and if you set the rate too high, it will increase the "equillibrium" interest rate won´t it?

Mark Wadsworth said...

Kj: "Isn´t banks competing down these spreads a good thing? If we assume that higher interest lending is better for the economy, this entails larger risks as well.."

Again, no, and this is the clever bit about a BAT.

a) The highest risk lending and the worst for the economy is the lowest margin lending, i.e. lending on mortgages for 4% while paying depositors 3%.

b) High margin lending (credit cards, HP loans for a car etc) is probably good for the economy, and because it is lots of small loans not tied to a single class of asset, is surprisingly safe, on average.

So by setting the BAT at (say) 2%, banks will limit themselves to productive lending (credit cards, HP loans) where they can earn more than 2% spread anyway. Those rates will not go up.

And they will do less or no high risk-low margin lending of no economic benefit (land speculation). Yippee!

And don't forget that 2% BAT revenue does not disappear into a black hole - that is still our money, it just goes to everybody instead of the pockets of The One Per Cent.

Kj said...

Hmm. I´m in the thinking box about it :) Here´s a presentation on the BAT in Hungary:

Mark Wadsworth said...

Kj, I've printed and read. In the short term, they have a point - existing borrowers with large mortgage will probably end up paying a large share of it.

But in future, such big loans will not be taken out in the first place, as the thing says, so sorted.

Secondly, there is not a normal supply-demand curve graph for "money" there is actually just a demand curve, which is inelastic at high interest rates and elastic at low interest rates.

The quantity of money "supplied" is always equal to amount borrowed.

And depositors seem to be happy with low interest rates. So if depositors demand at least 3% and the BAT is 2% and running costs/margin are 1%, then banks will not be able to lend out at less than 6%.

Therefore if current mortgage rates are 4% and go up to 6%, then in future, house prices will come down by a third at least to offset this.

Sorted (in the medium or long term).

TheFatBigot said...

"When banks grant mortgages ..."

They don't. Banks lend money and the borrowers grant mortgages as security for the loans.

You probably know that, if so you should say it.

Being something of an old fart I find it immensely irritating to hear of borrowers referred to as "mortgagees".

Mark Wadsworth said...

TFB, you are probably right on the legalese but you are wrong to say that "banks lend money" that is the whole point and of rather greater importance than all this cod Latin.

Bayard said...

Banks do lend money. It's just a different form of lending than what you or I would do. Perhaps the banks want us to think it's the same, perhaps they don't, but it's not wrong to say that they lend money. English is often not as precise a language as we think it is.

Mark Wadsworth said...

B, no they don't.

Thought experiment:

a) You sell your house for £200,000 to somebody who takes out a large mortgage on it and commits himself to paying £1,000 a month (including interest) for twenty years. You have a bank balance.

b) You sell your house to somebody and he promises to pay you in instalments (including interest) of £1,000 a month for twenty years. This liability is secured on the house, i.e. if he doesn't pay, you can take the house back and between you you settle up the differences. A client of mine once did this, it is not as unusual as you might think.

In Scenario a) people say that the bank has lent money.

But Scenario b) is very, very similar but there is no apparent lending of money or splitting the zero or even "creation of new money" there is just legal recognition of a debt, which is little different to you agreeing to rent out your house to somebody for twenty years for slightly less than £1,000 a month.

The notion that banks "create new money" is because they can pool millions of monthly payments and allow millions of vendors/depositors to choose when and whether how much to withdraw.

See 6a) of the original post.

Dinero said...

reminds me of this

Quote - Henry Hazlitt -

"There is a strange idea abroad, held by all monetary cranks, that credit is something a banker gives to a man. Credit, on the contrary, is something a man already has. He has it, perhaps, because he already has marketable assets of a greater cash value than the loan for which he is asking. Or he has it because his character and past record have earned it. He brings it into the bank with him. That is why the banker makes him the loan. The banker is not giving something for nothing. He feels assured of repayment. He is merely exchanging a more liquid form of asset or credit for a less liquid form. Sometimes he makes a mistake, and then it is not only the banker who suffers, but the whole community;for values which were supposed to be produced by the lender are not produced and resources are wasted."

Mark Wadsworth said...

Din, spot on, exactly.

If you stop to think about it for a few seconds, you know that this must be true and always has been. It's not as if I'm saying anything new or radical here.

Which shows that most people never stop to think.

Perhaps I should refer the advert to the ASA on the basis it is entirely misleading?

Dinero said...

As for selling a house in installments I saw a persons home made sign on a lamp post advertising just that propersition two years ago.

RE Bayard's comment

Fundamentally The bank does not lend pre existing money but I think it helps to explain the process if you ackmowledge that a bank converts a person's bond into a more easily divisible and trusted currency.

Bayard said...

"But Scenario b) is very, very similar"

Not that similar. In scenario a) the seller has £200,000 he can now spend on a boat, a very expensive car or even another house. He can do that at once, without resorting to any borrowing. In scenario b) he can't. Just because no-one is lending anyone anything in scenario b) doesn't make the same true for scenario a).
In scenario a) the bank is giving the buyer money, which the buyer will have to return some time in the future, all of it. This is the dictionary definition of lending. It is the same as if I lend you a fiver, or a wheelbarrow, or my car. I expect all of it back at some point in the future. Whether the bank has magicked the money out of thin air, borrowed it off someone else or found it down the back of the sofa is neither here nor there. The source of the money doesn't affect the act of lending any more than whether I had originally bought, borrowed, built or stolen the wheelbarrow. Mr Hazlitt isn't saying that banks don't lend money, he is saying that they don't give a borrower credit, which is a different word and a more precise concept.

Mark Wadsworth said...

B, it is similar enough, it is a question of degree.

The £200,000 which our vendor can withdraw and spend is, if anything, lent to him by all the other vendors with deposits who must be withdrawing £200,000 less than otherwise.

Similarly, what if all vendors sold direct for monthly payments, but agree to pool these future receipts and to be able to withdraw at will (analogous to 6.)?

Is that "pool" now magically a bank? It certainly leads to the same outcome, even though the "pool" clearly has not lent any money, it has merely been assigned all the future inflows.