Recession Economics

[NedKelly]

Are there any good economists here?

Conventional wisdom says that when money becomes tight then interest rates rise as there is a shortage of money to lend. But here we are in a time when banks won't lend to anyone but interest rates are relatively low. There is all this demand to borrow money out there so why haven't the rates increased?

 

[boomtown]

Because demand for credit has fallen off a cliff.

 

[Piston Broke]

Interest rates are being lowered across the globe to save the banks.
It's no different here, the RBA has injected >$1Bil into the banks.
Why would they if they did'nt need it? So the answer is there heading down the creek without a paddle, and everybody else is bailing them out.

 

[ok180]

There is all this demand to borrow money out there so why haven't the rates increased?

uummm? Where is this demand?

In a way the rates have increased you could say because the banks are not passing on the full rate cuts. The only thing that has fallen is the cash rate.

 

[NedKelly]

Because demand for credit has fallen off a cliff.

Well I don't see that. Look at the commercial property funds and in fact nearly all the ASX companies. BNB, Centro OZL to name a few. They want to borrow but cannot at any price. You cannot get a low doc loan for luv nor money these days. People/ companies want to borrow but are unable to.

 

[boomtown]

You did not specify you were talking commercial credit rather than consumer credit.

Bank profits are a function of the spread between the cost of funds and the rate charged to the borrower.

Yes you are correct to point out that commercial credit demand has not fallen. But the spread has massively increased because commercial credit costs are the same or higher while the cost of funds has fallen dramatically.

So you are quite wrong to say that commercial "rates" havent increased because they have - dramatically.

 

[NedKelly]

You did not specify you were talking commercial credit rather than consumer credit.

Bank profits are a function of the spread between the cost of funds and the rate charged to the borrower.

Yes you are correct to point out that commercial credit demand has not fallen. But the spread has massively increased because commercial credit costs are the same or higher while the cost of funds has fallen dramatically.

So you are quite wrong to say that commercial "rates" havent increased because they have - dramatically.

I don't see how you can say on the one hand that the cost of funds has fallen dramatically but on the other hand, because banks have increased their margin by not reducing interest rates then rates have increased dramatically. Give me a one handed economist please!

 

[boomtown]

The cost of funds to banks has sharply decreased.

The cost of borrowing paid by businesses has stayed the same or risen.

Therefore the margin (cost of borrowing less cost of funds), which is the bank's profit margin, has increased.

If you dont understand that then I can't help further.

 

[PrimeCommercial]

Your assuming that interest rates are determined by demand and supply. They're not. Monetary policy (Interest Rates) is used by the government to manipulate economic activity and as such the reserve bank sets the interest rates accordingly.
Even though Inflation, Unemployment rate, GDP et el are all economic indicators that are affected by demand and supply, IR rates are not determined by D/S directly.

 

[NedKelly]

The cost of funds to banks has sharply decreased.

The cost of borrowing paid by businesses has stayed the same or risen.

Therefore the margin (cost of borrowing less cost of funds), which is the bank's profit margin, has increased.

If you dont understand that then I can't help further.

I do understand that perfectly. But if you say the "cost of borrowing paid by businesses has stayed the same or risen" then you contradict yourself by saying that commercial "rates" have risen dramatically. If you don't understand that, which you obviously don't, I can only assume that you must be one of Wayne Swan's treasury advisers.

 

[boomtown]

Fine, commercial margins have risen dramatically. Commercial nominal rates have stayed the same, risen slightly or risen dramatically (dependent on a host of other factors such as whether you are AA or BBB-).

No matter which way you cut it - it represents severely tightening credit. And to address your initial question - you have to look at margins, not nominal rates.

 

[NedKelly]

No matter which way you cut it - it represents severely tightening credit. And to address your initial question - you have to look at margins, not nominal rates.

O.K, good. So in the situation of a tightening credit market do we get inflation or deflation of certain assets? I am thinking here of Commodities, Food, Gold, Land and Houses.

 

[BayView]

Because demand for credit has fallen off a cliff.

Not only that, but the qualifying criteria is different today than this time last year.

Far less people will qualify for finance today.

 

[Player]

Not only that, but the qualifying criteria is different today than this time last year.

Far less people will qualify for finance today.

BayView makes a good point and I would add that far less people will qualify for (re)finance today, in particular those coming off fixed rate loan terms.

Saw this and lived though this in early 90's. LVR's became skinny and you were at the mercy of the valuers and their instruction received from the lenders......cash inject sir or would you prefer to run your own campaign or would you prefer us to sell it for you?

 

[boomtown]

BayView makes a good point and I would add that far less people will qualify for (re)finance today, in particular those coming off fixed rate loan terms.

Saw this and lived though this in early 90's. LVR's became skinny and you were at the mercy of the valuers and their instruction received from the lenders......cash inject sir or would you prefer to run your own campaign or would you prefer us to sell it for you?

So far as I am aware, most people coming off fixed rate loans do not have to refi, it simply reverts to the standard variable rate at that time.

For example my loans are 10 year IO with the first 3 years being fixed and the next 7 standard variable. Im not going to have to refi until 2017 at the earliest.

 

[Player]

Sorry for the confusion boomtown,

to clarify, I should have stated if they wished to enter another fixed term and lock in lower rates, people may find (if they bought high) they don't have the equity available to do that, even with LMI. And they have just prompted the lender to look at their file. Depends of course on each person's individual situation and portfolio position.

I stand to be corrected, however an event like reversion to a variable rate, could itself trigger a review by the bank anyway and LVR's might be challenged if they smell more risk. They were doing this in the early nineties. I'm not a lender nor too savvy with finance, however some loan products may have the discretion to do this. I'm merely stating what was evident and occuring with frequency in that period between '91 and '93

Personally, I have two loans coming off fixed terms later this year and will decide how long I ride it variable and when I'll lock them up again. I fix as much as possible as it suits my temperament and suits my financial circumstances by making certain my interest outgoings. I have learnt the lessons of the past and have very conservative LVR's these days.

 

[Token Funder]

Sorry for the confusion boomtown,

to clarify, I should have stated if they wished to enter another fixed term and lock in lower rates, people may find (if they bought high) they don't have the equity available to do that, even with LMI. And they have just prompted the lender to look at their file. Depends of course on each person's individual situation and portfolio position.

I stand to be corrected, however an event like reversion to a variable rate, could itself trigger a review by the bank anyway and LVR's might be challenged if they smell more risk. They were doing this in the early nineties. I'm not a lender nor too savvy with finance, however some loan products may have the discretion to do this. I'm merely stating what was evident and occuring with frequency in that period between '91 and '93

Personally, I have two loans coming off fixed terms later this year and will decide how long I ride it variable and when I'll lock them up again. I fix as much as possible as it suits my temperament and suits my financial circumstances by making certain my interest outgoings. I have learnt the lessons of the past and have very conservative LVR's these days.

Assuming you're not talking about changing borrowing limits or terms, simply moving between fixed and variable at anniversary won't generall prompt any form of credit review.

Looking at it from the other side, :

• a bank doesn't need any excuse to do a credit review
• "whole of portfolio" reviews and stress testing is far more common these days
• if they *really* want to, a bank can and will call in a loan whenever they want to.

 

[boomtown]

I regard reversion to variable as unlikely to trigger margin calls. Ditto "applying" for a fixed rate. Remember we are talking resi not commercial here.

If the banks want to say 'no' to fixed rates so be it. Given that we appear to be headed for lower for longer - again thats not looking like it will drive people to the wall.

EDIT: TF said it better than me.

 

[keithj]

Assuming you're not talking about changing borrowing limits or terms, simply moving between fixed and variable at anniversary won't generall prompt any form of credit review.

Looking at it from the other side, :

• a bank doesn't need any excuse to do a credit review
• "whole of portfolio" reviews and stress testing is far more common these days
• if they *really* want to, a bank can and will call in a loan whenever they want to.

Sure.... I accept that down on page 93 of the loan contract they can take your first born too....

In practice, is moving the other way (ie from a relatively high variable of the last few yrs to the relatively low fixed of today) likely to cause a 2nd look/review ?

 

[Piston Broke]

The cost of funds to banks has sharply decreased.
The cost of borrowing paid by businesses has stayed the same or risen.
Therefore the margin (cost of borrowing less cost of funds), which is the bank's profit margin, has increased.
If you dont understand that then I can't help further.

They need that to "protect their profits" and stay solvent if we go the same way the US & UK has.