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General Discussions => Brewery => Topic started by: dmp on October 10, 2018, 04:39:11 PM

Title: interest rates
Post by: dmp on October 10, 2018, 04:39:11 PM
To take a break from the politics... something interesting is happening with interest rates.

A 30 year decline looks like it might be over.  The 10 yr treasury rate has broken above the declining channel.

What happens when interest rates decline? For housing, people can refinance and lower the monthly payment. And for the same monthly payment, people can buy more expensive houses. So declining interest rates provide a continual boost to spending.

Rising interest rates will be challenging for areas like housing. But better rates give savers a safer way to get a return on investment.

Now if the economy crashes and we have a recession, interest rates will try to drop again. But they are bouncing off the floor now (0%). And negative interest rates seem like a greater fool theory.   
Title: Re: interest rates
Post by: dmp on October 11, 2018, 10:15:00 AM
Yeah, that's just how the math works out.  Every month you pay interest on the current amount of principal. So at the start the principal is highest, so the interest payment is pretty high (most of the monthly payment).  Every month though the principal decreases a little bit, so the interest steadily decreases over the loan term. It's a simple calculation though - every month you pay an interest charge of the interest rate * remaining principal.  For a 30 year mortgage, the math is to calculate a constant monthly payment so the whole thing is paid off in 30 years.  Most loans allow you to pay additional amounts against the principal if you want, which is a great way to knock down the interest.

A refinance starts a new loan for the remaining principal. So you're right - the principal might be pretty high still when you refinance.
From your example, if you refinance after 4 years, you have $200000-$12000 = $188000 in remaining principal. You get a new 30 year loan, at a lower interest rate, for $188000. You can do a new calculation for the monthly payments, at that interest rate.
Two things happen, the lower interest rate lowers the monthly payment, but you've also reset the clock to go out another 30 years (vs the 26 years remaining of the previous loan). Of course you could refinance into a shorter term loan.
I refinanced from my original 30 year loan @5.5% into a 15 year loan @ 2.99% and had a lower payment.  I might be wrong but I have a feeling people will look back on the interest rates of a few years ago as multi-generational lows.

Title: Re: interest rates
Post by: JohnRoberts on October 11, 2018, 10:29:00 AM
I'm still learning about finances. I wish they would make it a requirement for high school.

One thing that confuses me is the refinance thing. I get how getting a lower interest rate works in the long term as a whole in regards to a mortgage. The thing that I'm unclear about is that it seems that , in the beginning of a home loan, most of the money paid into it goes to the banks and towards the interest and it takes many years for that balance to reverse where more money goes to the principal instead. So the banks get their cut first so to speak off of the amount of the loan.? So a $300000 house will cost double that with the banks making most of their money before you pay off your home?

Example I found online

$200000
30 year at 6%
Payments $1200/month

$950 goes to interest
$250 goes to principal (around 17years for this to reverse course)

so 4 years in, $57,600 paid

$45,600 went to bank ( interest)

$12,000 went to principal



When you refinance at this point (4 years) , your loan will maybe have a lower rate,  but does this time clock reset and basically the new loan payments start going towards the interest first again and it again takes years to find that principal balance being paid more? . I hope I'm being clear.

This is personal finance 101...

There isn't a clock per se, but interest is calculated based on the amount of debt still outstanding every month.

For simplicity lets assume a fixed interest rate, constant monthly payment, installment mortgage loan.

From that monthly payment, first the interest due on the outstanding loan balance is deducted. Then the amount left over after the interest is paid, is used to reduce the loan balance (aka principal). 

In each subsequent month the debt balance (principal) gets smaller incurring less interest cost, and more of the payment is used to reduce the debt (principal).

The shorter the loan term, and higher the monthly payment, the faster the debt gets reduced. In a several decades long mortgage the early years monthly payments are indeed mostly consumed by interest.

An important thing to understand about "refinancing" is the extra fees and closing costs that banks charge. This is how the banks make their money, and why they are so happy to rewrite loans at lower interest rates (easy money in hand now, for less earned later over decades). Besides that many banks resell mortgage paper, so the fees from refi is their dominant revenue.   
=====

I have written about this before but many with large student loans do not understand the basic loan mechanics.

When student borrowers are granted relief from making monthly payments, the loan principal is still incurring an interest charge. That monthly interest due gets added to the principal, so over time the debt grows larger... not doing them much of a favor. (This is called negative amortization)

When getting a mortgage shorter is better (if you can afford the payments). Also confirm that there is no pre-payment penalty. I paid off my home mortgage years before it was due, because I had the cash and it was a good return for that cash. I don't recall the exact mortgage interest rate (I assumed an existing mortgage so didn't negotiate it). It was in the low teens and maybe adjustable.   

Historically fixed rate 30 year mortgages were as high as high teens in 1980s, but they also played games with ARMs (adjustable rate mortgages) to deal with changing interest rates.  ARMs started out lower than fixed rate loans, but could be adjusted higher later.

JR
Title: Re: interest rates
Post by: dmp on October 11, 2018, 10:53:45 AM
I have written about this before but many with large student loans do not understand the basic loan mechanics.
 

Not surprising that young people that aren't fully educated wouldn't be ready to make major decisions yet...
I was lucky to have parents that wouldn't hear of it and I was able to go to school when it was still affordable.

Title: Re: interest rates
Post by: JohnRoberts on October 11, 2018, 10:56:51 AM
To take a break from the politics...
But President Trump is now tweeting about it, perhaps to give himself a scape goat if/when the market corrects. (past due, probably a buying opportunity for kids with longer investment time horizon)
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something interesting is happening with interest rates.
Bond markets are supposed to be smart money and generally are. The fed can wiggle the short term interest rates but long term interest rates are a sentiment measure set by the bond markets.
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A 30 year decline looks like it might be over.  The 10 yr treasury rate has broken above the declining channel.
the fed is both raising short term rates, and reducing their portfolio...(so working two levers).  The international economy is softening and some signs of stress are showing in domestic market.
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What happens when interest rates decline? For housing, people can refinance and lower the monthly payment. And for the same monthly payment, people can buy more expensive houses. So declining interest rates provide a continual boost to spending.
The housing industry support is eroding... homebuilder stocks are down for the year.
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Rising interest rates will be challenging for areas like housing.
Automotive sales are hurting too... but auto has multiple factors working against them.
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But better rates give savers a safer way to get a return on investment.
wouldn't that be nice... best I could get on a CD was 2.75% a few months ago (for 2 year paper).
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Now if the economy crashes and we have a recession, interest rates will try to drop again.
the inverted yield curve generally presages a recession, but historic low unemployment is not consistent with that scenario (different this time?)
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But they are bouncing off the floor now (0%).
yup, you need to raise rates, so you can drop them later, but don't need to raise too much/too fast...  Inflation seems tame, but I don't trust all the inflation measures. Lots of input costs are rising this will have to show up eventually. 
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And negative interest rates seem like a greater fool theory.
Didn't stop EU from going there.  ::)

JR
Title: Re: interest rates
Post by: dmp on October 11, 2018, 11:54:45 AM
The fed can wiggle the short term interest rates but long term interest rates are a sentiment measure set by the bond markets.
Is it sentiment? This is something I have trouble wrapping my head around. It's supply and demand. If less buyers show up to bond markets, rates go up to try to bring in more buyers. The whole sentiment idea is confusing to me.

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the fed is both raising short term rates, and reducing their portfolio...(so working two levers). 

Don't forget the Federal deficit. Supply of Treasuries is increased with more debt.  This + QT is uncharted territory.

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the inverted yield curve generally presages a recession, but historic low unemployment is not consistent with that scenario (different this time?)

huh? Unemployment rate typically bottoms out before recessions.

https://fred.stlouisfed.org/series/UNRATE/ (https://fred.stlouisfed.org/series/UNRATE/)

Yield curve actually steepened recently as 10yr rates rose. Not inverted yet.  The fed controls the short end with the overnight lending rate but has more trouble with the long end (ie 10yr). They are hoping for a soft landing by raising rates.

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Didn't stop EU from going there.  ::)
Yes, and Japan I think. People have trouble accepting a change like this. There's been a 30 yr bull market in bonds. Why? Because every time interest rates fell, older bonds rose in value. So bond investors have been in a bull market for this whole time - their bond portfolios appreciated as interest rates fell. They don't want to let go of this paradigm so they might fool themselves into thinking this will last even as interest rates fall below zero (I've read this, I don't know any bond investors personally). So it's still a bull market (i.e. older bonds increase in value as the interest rates drop), even as rates drop below zero.  By why would a rational person buy an asset that they LOSE money on? That does worse than just holding cash? That's why I think of it as a greater fool scenario. 

Title: Re: interest rates
Post by: JohnRoberts on October 11, 2018, 01:08:49 PM
Is it sentiment? This is something I have trouble wrapping my head around. It's supply and demand. If less buyers show up to bond markets, rates go up to try to bring in more buyers. The whole sentiment idea is confusing to me.
sentiment about the future... Fear and uncertainty drives money to safety (like long term government debt). Not to mention that high bond rates, pulls investors out of bond equivalents (high dividend paying blue chips, like utilities). IMO there is more going on in the market as love for the big tech/communication stocks is fading. This could feed on itself if momentum traders jump ship as people and funds try to lock in gains for the end of the year.
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Don't forget the Federal deficit. Supply of Treasuries is increased with more debt.  This + QT is uncharted territory.
indeed... we are still unwinding the "Big experiment" Ben Bernanke put us into. Hopefully the faster GDP growth rate (4%?) will help, but Republicans have not exactly been paragons of fiscal restraint (they spend too much too).
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huh? Unemployment rate typically bottoms out before recessions.
Are you predicting a recession soon? I'm sure we will get one eventually, always do.

I'm not sure unemployment has bottomed yet.... some employers are actually waiving drug tests to get more eligible workers. That might explain some customer service issues, but the AI they increasingly use to replace workers isn't very smart either.  >:(
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https://fred.stlouisfed.org/series/UNRATE/ (https://fred.stlouisfed.org/series/UNRATE/)

Yield curve actually steepened recently as 10yr rates rose. Not inverted yet.  The fed controls the short end with the overnight lending rate but has more trouble with the long end (ie 10yr). They are hoping for a soft landing by raising rates.
Yes, and Japan I think. People have trouble accepting a change like this. There's been a 30 yr bull market in bonds. Why? Because every time interest rates fell, older bonds rose in value. So bond investors have been in a bull market for this whole time - their bond portfolios appreciated as interest rates fell. They don't want to let go of this paradigm so they might fool themselves into thinking this will last even as interest rates fall below zero (I've read this, I don't know any bond investors personally). So it's still a bull market (i.e. older bonds increase in value as the interest rates drop), even as rates drop below zero.  By why would a rational person buy an asset that they LOSE money on? That does worse than just holding cash? That's why I think of it as a greater fool scenario.
Sorry to make this about me,me,me... but. At my age I should hold a majority of bonds in my portfolio.... but I still can't wrap my head around buying bonds in an increasing interest rate environment (as rates go up bonds go down). Buying debt now is almost as bad as buying a new car, sure to drop in value (but cars don't pay interest) ::) .

JR

PS: There are other wild cards like China recently selling a few $B of dollar denominated debt (i wouldn't buy those either). China may be opportunistically building a position to use as leverage, who knows? China plays a long game but also has some short term issues with their domestic economy.
Title: Re: interest rates
Post by: dmp on October 11, 2018, 01:19:13 PM
Are you predicting a recession soon? I'm sure we will get one eventually, always do.

I'm not sure unemployment has bottomed yet....
I think there are many signs pointing to a recession in the near future... but I don't want to make predictions because I'm terrible at it.
 I thought there was going to be a recession in 2016 when manufacturing and oil slumped... now that is being called a 'mini' recession (not many people really noticed).
I definitely was surprised by the 2017-2018 appreciation in equities.
It's really hard to time markets - almost as hard as beating the house at a casino /s

The big question in unemployment is how many people are on the sidelines, not in the official stats. Looking at the overall participation rate gives another important piece of info.

The classic headwinds for the economy late in the debt cycle is increasing wages (pressuring profit margins), increasing interest rates (higher debt service payments), and a pullback in consumer spending (after skyhigh enthusiasm, which is where we are now). Housing and Autos are already in decline.
Zombie companies start to crash (sears is filing for bankruptcy currently)
Title: Re: interest rates
Post by: Phrazemaster on October 11, 2018, 01:35:21 PM
Yeah, that's just how the math works out. 
Actually - that’s just how theyworked out the math. Totally and completely to their (the bankers’) advantage.

It wasn’t just a quirk of math...but you knew that...
Title: Re: interest rates
Post by: Phrazemaster on October 11, 2018, 01:41:56 PM
Historically fixed rate 30 year mortgages were as high as high teens in 1980s,
Yes but housing was much, MUCH cheaper...
Title: Re: interest rates
Post by: dmp on October 11, 2018, 01:50:05 PM
Actually - that’s just how theyworked out the math. Totally and completely to their (the bankers’) advantage.

It wasn’t just a quirk of math...but you knew that...

Maybe I'm not following what you're saying... but what I meant was you can work out the same thing in a simple Excel spreadsheet. There's no complicated shenanigans to it.
You are borrowing money (say $200,000) and paying a fixed interest rate. For the first year you calculate the interest, and increase it by some amount to pay off some principal. Next year same thing. There isn't any conspiracy to how the P&I is calculated for a fixed interest, fixed term loan. 
Now adjustable rate mortgages are a different ballgame and that's where banks really get people into a loan that they shouldn't be doing.  Or student loan terms that are awful, high interest rates and ineligibility for bankruptcy etc...
And you should always make sure there is not early payment penalties.

It is to the banks advantage when interest rates fall because they are getting interest on old loans at a higher rate than the bank can currently borrow more $ at. But as rates rise and people have loans locked in at lower rates, then the banks aren't at an advantage.

Right now I have a 2.99% loan that the bank would love to get rid of I assume, since they are now lending money at 4.5%


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Yes but housing was much, MUCH cheaper...

And what will happen if interest rates do reverse the trend of the last 30 years.... I'm guessing housing will get much much cheaper. It will be a painful situation. best we can hope for is interest rates remain low for the next few decades.

I saw this pretty cool plot of interest rates over the last 3000 years. Not sure what the pre 1800 data is based on...
But the late '70s peak was definitely a noticeable outlier
Title: Re: interest rates
Post by: JohnRoberts on October 11, 2018, 02:29:15 PM
I think there are many signs pointing to a recession in the near future... but I don't want to make predictions because I'm terrible at it.
 I thought there was going to be a recession in 2016 when manufacturing and oil slumped... now that is being called a 'mini' recession (not many people really noticed).
I definitely was surprised by the 2017-2018 appreciation in equities.
So was George Soros who shorted the market and lost something like $1B before covering his short.
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It's really hard to time markets - almost as hard as beating the house at a casino /s
can't beat the house either statistically
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The big question in unemployment is how many people are on the sidelines, not in the official stats. Looking at the overall participation rate gives another important piece of info.
yup, workers still coming out of the woodwork, but we also have boomers (those losers) retiring....  8)
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The classic headwinds for the economy late in the debt cycle is increasing wages (pressuring profit margins), increasing interest rates (higher debt service payments), and a pullback in consumer spending (after skyhigh enthusiasm, which is where we are now). Housing and Autos are already in decline.
indeed interest sensitive housing and car loans are already soft... bad time to be selling new harleys, but maybe good time to buy used.

The consumer is still alive and well, still increasing household debt.. This will end eventually, has to, but strong employment helps consumer enthusiam.

I can't predict the future either, but consensus is for maybe next year...
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Zombie companies start to crash (sears is filing for bankruptcy currently)
Sears has been a basket case for a long time. They bought KMART at the wrong time to dive into brick and mortar, and is downhill since then. Eddie Lambert is still a billionaire doing some self dealing with sears holding through his closely held ESL hedge fund. 

Sears will likely declare bankruptcy to scrub off more real estate leases in unprofitable malls shrinking in size again. Eddie has already sold off craftsman (iconic tool brand), and is selling Kenmore appliances on Amazon. That brand may be sold too.

Sears has gone full circle they were the original mail order disruptor, to now being disrupted by web sales. I could imagine them ending up a profitable website, but much smaller.

Indeed the tide going out as credit tightens will reveal who isn't wearing their trunks. The too easy credit has distorted the economy longer than some have been paying attention. It is always amusing to listen to young analysts.  ::)

JR

PS: I can't help myself I just bought another common stock... it was on sale at a deep discount from when I first looked at it a few weeks ago (down over 30%). Not good judgement to try to catch a falling knife so we'll see, how deep this dip goes, and if I bought a value trap.

[edit-  for any worried I managed to catch the falling knife with minimal injury.... stock fell another 1% or so after I bought it before bouncing. I am now up over 5% including the transaction cost, so it appears it was indeed oversold. Better to be lucky than good. [/edit] 

@Phrazemaster. Yes, houses were cheaper back in the 80s, but I still had trouble getting a mortgage back then as a small business owner.  :( My current house that I bought in '85 was much easier, because in MS it was silly cheap, and I was able to cover the original owner's equity out of my pocket cash (actually bank account balance). I assumed his existing mortgage, and then paid that off within a few years, as better use for my spare cash.

You are correct that interest rates do directly affect the ability of people to afford houses, modulating home prices up/down. Future expectations of prices also is a factor. As during the housing bubble people gambled that house prices would keep going up to the sky (they didn't).   

While its all relative, interest rates now seem too cheap IMO.
Title: Re: interest rates
Post by: Phrazemaster on October 11, 2018, 04:38:45 PM
Maybe I'm not following what you're saying... but what I meant was you can work out the same thing in a simple Excel spreadsheet. There's no complicated shenanigans to it.
You are borrowing money (say $200,000) and paying a fixed interest rate. For the first year you calculate the interest, and increase it by some amount to pay off some principal. Next year same thing. There isn't any conspiracy to how the P&I is calculated for a fixed interest, fixed term loan. 
Now adjustable rate mortgages are a different ballgame and that's where banks really get people into a loan that they shouldn't be doing.  Or student loan terms that are awful, high interest rates and ineligibility for bankruptcy etc...
And you should always make sure there is not early payment penalties.

It is to the banks advantage when interest rates fall because they are getting interest on old loans at a higher rate than the bank can currently borrow more $ at. But as rates rise and people have loans locked in at lower rates, then the banks aren't at an advantage.

Right now I have a 2.99% loan that the bank would love to get rid of I assume, since they are now lending money at 4.5%


And what will happen if interest rates do reverse the trend of the last 30 years.... I'm guessing housing will get much much cheaper. It will be a painful situation. best we can hope for is interest rates remain low for the next few decades.

I saw this pretty cool plot of interest rates over the last 3000 years. Not sure what the pre 1800 data is based on...
But the late '70s peak was definitely a noticeable outlier
Hey dmp, no disrespect meant. I appreciate your thoughtful posts and enjoy reading them.

You are correct that’s “just how the math works out” but step back - who decided to use that math in that way?

As Scott said the interest is stacked in favor of the banksters. If you look at how much interest is paid over 30 years it’s often over 85% of the original loan, sometimes even more than 100% interest. I get “that’s how compound interest works” but let’s be honest, who invented it and why?

Math is a construct, a human invention or discovery. How we use it is up to us.

So yeah, the deck is stacked against the borrower and of course it’s on purpose. But knowledge is power, and if you pay off faster as mentioned you pay far far less.

JR thanks for sharing.
Title: Re: interest rates
Post by: john12ax7 on October 11, 2018, 04:57:57 PM
There is nothing mischievous about amortized loans,  and certainly not math in general. People like fixed payments,  so you pay a greater ratio  of interest in the beginning.  You could also do it with fixed principal payments,  you would pay less in total,  but the initial payments would be higher and then decrease over time.

Homeowners tend to benefit overall with the arrangement,  the victims are more those who can't afford to get in the game.  And the actual mischievous part is how the banks aquire (create)  the money to lend.
Title: Re: interest rates
Post by: Phrazemaster on October 11, 2018, 05:05:26 PM
There is nothing mischievous about amortized loans,  and certainly not math in general. People like fixed payments,  so you pay a greater ratio  of interest in the beginning.  You could also do it with fixed principal payments,  you would pay less in total,  but the initial payments would be higher and then decrease over time.

Homeowners tend to benefit overall with the arrangement,  the victims are more those who can't afford to get in the game.  And the actual mischievous part is how the banks aquire (create)  the money to lend.
Respectfully I disagree. The math is designed so the bankers get a ton of money up front. It's not right, it's not fair, and I'm sure a different math could be created to make it even.

Are you really telling me no one could come up with another scheme mathematically that would make the interest and principal payments equal?
Title: Re: interest rates
Post by: dmp on October 11, 2018, 05:07:27 PM
Hey dmp, no disrespect meant. I appreciate your thoughtful posts and enjoy reading them.

You are correct that’s “just how the math works out” but step back - who decided to use that math in that way?

As Scott said the interest is stacked in favor of the banksters. If you look at how much interest is paid over 30 years it’s often over 85% of the original loan, sometimes even more than 100% interest. I get “that’s how compound interest works” but let’s be honest, who invented it and why?

Math is a construct, a human invention or discovery. How we use it is up to us.

So yeah, the deck is stacked against the borrower and of course it’s on purpose. But knowledge is power, and if you pay off faster as mentioned you pay far far less.

JR thanks for sharing.

Phrazemaster,
No problem, I see where you are coming from now. I think you are talking about debt in general - not the specifics of a 30 yr fixed rate mortgage.   I've been very interested in this lately. 
The greek word for sin in the Bible can alternately be translated as debt. There is a passage in the bible that specifically uses it in this way.
A really interesting book that goes into the history of debt (including that detail about the bible) is Payback: debt and the shadow side of wealth by Margaret Atwood. I read it last year and learned a lot from it. 
Title: Re: interest rates
Post by: Phrazemaster on October 11, 2018, 05:24:23 PM
Phrazemaster,
No problem, I see where you are coming from now. I think you are talking about debt in general - not the specifics of a 30 yr fixed rate mortgage.   I've been very interested in this lately. 
The greek word for sin in the Bible can alternately be translated as debt. There is a passage in the bible that specifically uses it in this way.
A really interesting book that goes into the history of debt (including that detail about the bible) is Payback: debt and the shadow side of wealth by Margaret Atwood. I read it last year and learned a lot from it.
Love it! Man you write some quality posts!

Thanks for sharing.

I teach Excel a lot. We spend time developing a Loan Calculator for paying off a house. So this topic is near and dear to my heart. But yes the specifics of how the first years, the bank gets so much interest and the principal gets no love, is not right. According to the only person who matters, me.  ;)

Now if I was a bankster I might think differently...

Thanks,

Mike
Title: Re: interest rates
Post by: Phrazemaster on October 11, 2018, 05:36:11 PM
I had a buddy that tried to explain this to me some time ago..... It was pretty interesting....Also the creation of debt..... I kinda brushed it off as he was kinda radical and I was young but over the years I've kinda put some pieces together that seem to fit his thinking... Definitely wild stuff....
Well...ahem...the banks actually don't acquire the money they lend. They "make it up" - they only have to have 10% in reserve to make a loan. The rest is a digital counterfeit - but no actual bills are ever printed. But the borrower has to pay back with "real" money that the bank never actually had. That's why they say "banks create money" when they make loans. Somehow, it's "legal." Look up Fractional Reserve Lending.

Then normally you have to make a down payment. If you pay them 20% down, they just made a 100% return on their investment the day escrow closes. The rest of the 30 years' worth of interest you pay them is pure gravy on top of having doubled their money. No wonder they are always in such a hurry to close a loan.

It's the biggest con job ever and it's right in front of us the whole time.
Title: Re: interest rates
Post by: dmp on October 11, 2018, 05:52:11 PM
There is something really neat about compound interest... which is that in the limit of compounding the irrational number e comes out, (e=2.718.... ,Euler number).

This was how the number e was first discovered. Later on the implications of natural logarithms and calculus. 

Basically the more frequently interest is calculated, or compounded, (yearly, monthly, daily, every second, etc) the faster the principal grows (or declines in the case of debt). The formula (1+r/n)^n, where n is the compounding goes to e, 2.718..., when n goes to inf.
I think I got that right but a google search should fix any goofs I made.

Title: Re: interest rates
Post by: dmp on October 11, 2018, 06:10:44 PM
I had a buddy that tried to explain this to me some time ago..... It was pretty interesting....Also the creation of debt..... I kinda brushed it off as he was kinda radical and I was young but over the years I've kinda put some pieces together that seem to fit his thinking... Definitely wild stuff....

Yeah, and that gets into fractional reserve banking and why the Fed sets an overnight interest rate in the first place.
I swear there is more misunderstanding of what this is than just about anything on the internet!
People love to demonize the Fed.
 
The way it works is the Government says banks can only lend 10% of what they have on deposit.
Say one person (frank) deposits $1000. The bank has to keep $100 on reserve (10% on deposit with the Fed) . They lend out the other $900 to another person (wendy). 
Now say wendy buys a boat from mark for $900 and mark deposits the money at the bank. The bank puts $90 on reserve and again lends out the remaining $810.  So now the bank has $1900 in deposits, $1710 in loans, and $190 in reserve.
This continues through a bunch of people... 
You'll find that the original $1000 grows to $10000 in deposits, $1000 in reserves, and $9000 in debts. Money is conserved, but the bank only has $1000 in reality (on deposit at the Fed) while the rest of the money is out in loans.  I repeat, no money is created out of thin air!
So the reserve rate sets the multiplier of the money supply (in this case 1/0.1 = 10). In good times this works fine and is very stimulative for the economy.  But in bad times (i.e. recession), a high money multiplier leads to instability.  If Frank, Mark, etc all go to the bank at the same time to get there deposits, the bank does not have the money for them.  This is a 'run on the bank' scenario.
Another detail is the US Government insures deposits when the banks obey the reserve requirement, i.e. the gov acts as the lender of last resort, when depositors all come for their money. 

Title: Re: interest rates
Post by: dmp on October 11, 2018, 06:12:00 PM
And the overnight lending rate that the Fed sets is the interest paid on the reserve deposits of banks.
Title: Re: interest rates
Post by: john12ax7 on October 11, 2018, 06:16:34 PM
Are you really telling me no one could come up with another scheme mathematically that would make the interest and principal payments equal?

It already exists.  Fixed principal loan payments is one example.  Loans can be structured in a number of ways and do not need to amortized. It's just that many people want amortization so they can buy bigger houses.

Make a spreadsheet of fixed principal,  amortized, and any other loan structure you might want, then compare.
Title: Re: interest rates
Post by: Matador on October 11, 2018, 08:37:33 PM
For some historical context, most mortgages in the 80's and 90's were granted under a 'Rule of 78'.  This weighted interest payments toward the front-end of the loan, which penalized pre-paying the loan and allowed the bank to collect more interest in the beginning (the total interest over the life of the loan would be the same however).

Fortunately these types of loans were technically made illegal, but lenders can still work in pre-payment penalties in the form of fees if you don't read the T's and C's carefully.
Title: Re: interest rates
Post by: Phrazemaster on October 12, 2018, 03:33:19 AM
Yeah, and that gets into fractional reserve banking and why the Fed sets an overnight interest rate in the first place.
I swear there is more misunderstanding of what this is than just about anything on the internet!
People love to demonize the Fed.
 
The way it works is the Government says banks can only lend 10% of what they have on deposit.
Say one person (frank) deposits $1000. The bank has to keep $100 on reserve (10% on deposit with the Fed) . They lend out the other $900 to another person (wendy). 
Now say wendy buys a boat from mark for $900 and mark deposits the money at the bank. The bank puts $90 on reserve and again lends out the remaining $810.  So now the bank has $1900 in deposits, $1710 in loans, and $190 in reserve.
This continues through a bunch of people... 
You'll find that the original $1000 grows to $10000 in deposits, $1000 in reserves, and $9000 in debts. Money is conserved, but the bank only has $1000 in reality (on deposit at the Fed) while the rest of the money is out in loans.  I repeat, no money is created out of thin air!
So the reserve rate sets the multiplier of the money supply (in this case 1/0.1 = 10). In good times this works fine and is very stimulative for the economy.  But in bad times (i.e. recession), a high money multiplier leads to instability.  If Frank, Mark, etc all go to the bank at the same time to get there deposits, the bank does not have the money for them.  This is a 'run on the bank' scenario.
Another detail is the US Government insures deposits when the banks obey the reserve requirement, i.e. the gov acts as the lender of last resort, when depositors all come for their money.
The upshot of your thoughtful explanation is that the banks lend out 10x more money than they have - isn’t it?

How can they “lend” money they don’t have? They couldn’t if it was physical money. This only works on paper or digitally. Hence the phrase, “banks create money.” Because they do. Or credit rather. But which must be repaid with money. Same difference.

It’s a fraudulent house of cards. If everyone asks for their money, the bank doesn’t have it - because they never did. It’s not that they merely lent it out - they “lent out” money they don’t have.

Or am I missing something here?
Title: Re: interest rates
Post by: dmp on October 12, 2018, 10:27:21 AM
The upshot of your thoughtful explanation is that the banks lend out 10x more money than they have - isn’t it?

How can they “lend” money they don’t have? They couldn’t if it was physical money. This only works on paper or digitally. Hence the phrase, “banks create money.” Because they do. Or credit rather. But which must be repaid with money. Same difference.

It’s a fraudulent house of cards. If everyone asks for their money, the bank doesn’t have it - because they never did. It’s not that they merely lent it out - they “lent out” money they don’t have.

Or am I missing something here?
It is the concept of 'debt' - which is a human invention (I think)
Money is conserved but there are I.O.U.s throughout the system that make it seem like there is 10x money than there actually is.
People lending money to one another, through banks or peer-to-peer, does create a house of cards.
The modern method to make it work is fractional reserve banking and the government as lender of last resort. And fiat money, which opens another can of worms.
hundreds of years ago, Usury was illegal for Christians which effectively made lending money & debt illegal.

https://en.wikipedia.org/wiki/Usury (https://en.wikipedia.org/wiki/Usury)
Title: Re: interest rates
Post by: JohnRoberts on October 12, 2018, 10:39:16 AM
we have well discussed this before too in the brewery but perhaps the more appropriate wiki link

https://en.wikipedia.org/wiki/Fractional-reserve_banking (https://en.wikipedia.org/wiki/Fractional-reserve_banking)  that explains how banks can lend more money than they have.

on the subject of interest (thread topic) and religion.... Shariah law prohibits "riba" (usury).
https://en.wikipedia.org/wiki/Islamic_banking_and_finance (https://en.wikipedia.org/wiki/Islamic_banking_and_finance)

The wall street types have worked to make shariah compliant investment vehicles.

JR
Title: Re: interest rates
Post by: Phrazemaster on October 12, 2018, 02:48:52 PM
we have well discussed this before too in the brewery but perhaps the more appropriate wiki link

https://en.wikipedia.org/wiki/Fractional-reserve_banking (https://en.wikipedia.org/wiki/Fractional-reserve_banking)  that explains how banks can lend more money than they have.

on the subject of interest (thread topic) and religion.... Shariah law prohibits "riba" (usury).
https://en.wikipedia.org/wiki/Islamic_banking_and_finance (https://en.wikipedia.org/wiki/Islamic_banking_and_finance)

The wall street types have worked to make shariah compliant investment vehicles.

JR
Thank you for the link JR.

The first sentence tells it all:

Quote
Fractional-reserve banking is the practice whereby a bank accepts deposits, makes loans or investments, but is required to hold reserves equal to only a fraction of its deposit liabilities.
They lend out more money than they actually have.

That’s Fraudulent Reserve Lending.
Title: Re: interest rates
Post by: dmp on October 12, 2018, 03:07:35 PM
The first sentence tells it all:
They lend out more money than they actually have.

That’s Fraudulent Reserve Lending.

I understand that as saying the bank can lend out less than they actually have. If they have $1000 on deposit, they are allowed to only lend 90%, or $900. They are required to keep $100 on reserve.
If they weren't allowed to lend more than they held on reserve, they wouldn't be able to lend any money at all.
i.e. if a bank had $1000 on deposit and had to always keep that $1000 in cash on hand, it couldn't be lent out.  Prohibiting all lending and debt.
The money 'creation' (money multiplier) works as I described above. It is just a circulation of debt to make it seem like there is more money than the basis.

The only reason you can earn any return on savings, whether it is a savings account, CD, or bond, is because the money is being used (borrowed) by someone else.



Title: Re: interest rates
Post by: Phrazemaster on October 12, 2018, 03:35:51 PM
I understand that as saying the bank can lend out less than they actually have. If they have $1000 on deposit, they are allowed to only lend 90%, or $900. They are required to keep $100 on reserve.
If they weren't allowed to lend more than they held on reserve, they wouldn't be able to lend any money at all.
i.e. if a bank had $1000 on deposit and had to always keep that $1000 in cash on hand, it couldn't be lent out.  Prohibiting all lending and debt.
The money 'creation' (money multiplier) works as I described above. It is just a circulation of debt to make it seem like there is more money than the basis.

The only reason you can earn any return on savings, whether it is a savings account, CD, or bond, is because the money is being used (borrowed) by someone else.
It’s very simple. If I have $1 and I “lend” you $10 - digitally or on paper - and you then pay me back $10, I have gained $9 plus interest.

The fraud is, I didn’t have $10 to lend you.

Wouldn’t you like to be able to pay your mortgage that way? You only have $250, but you get to “pay” the bank $2500?

What a scam.
Title: Re: interest rates
Post by: dmp on October 12, 2018, 03:51:11 PM
It’s very simple. If I have $1 and I “lend” you $10 - digitally or on paper - and you then pay me back $10, I have gained $9 plus interest.
The fraud is, I didn’t have $10 to lend you.

Wouldn’t you like to be able to pay your mortgage that way? You only have $250, but you get to “pay” the bank $2500?
What a scam.
I don't think that is how it works, based on the reading I've done. Nobody can 'create' money (except the Fed). A bank cannot lend out money it does not have. There's a whole lot of misinformation on this around though.
If a bank has $1 they can lend $0.90 and they are required to keep the other $0.10 on reserve
The example I did above goes through how it works and shows the money multiplier effect. A bunch of people have debt and a bunch of people have savings, but when you add it up, there is the same net amount of money. 
Title: Re: interest rates
Post by: JohnRoberts on October 12, 2018, 04:20:13 PM
Thank you for the link JR.

The first sentence tells it all:
They lend out more money than they actually have.

That’s Fraudulent Reserve Lending.
We have debated this extensively right here over the years... (maybe I've been posting here too long).  ::)

Fractional reserve banking creates new money/capital based on the statistical likelihood of deposits remaining untouched, so they can be put to work elsewhere to expand the economy. 

The bank lends money to Joe homebuilder to buy land and build a new house, creating jobs and wealth, as the new house is worth more than the undeveloped land, and more jobs allow wage  wealth to spread through the economy.

Of course there is no free lunch, and this is a bit of a confidence game, as depositors need to trust the bank that they always can get all of their money back if/when they want their money back.  If all depositors want their money back at the same time, this run on the bank could end badly... that is why the government provides depositor insurance to keep the confidence game working with the backing of federal government guarantees.

You can argue that it adds risk, but it also adds growth to the economy that has proven worth the risk (GDP growth is good).

 This is not a new concept, and pretty well managed, but regulators need to insure that bank balance sheet assets are worth what they say they are...  If those fractional reserve assets are dicey, the house of cards can collapse.



JR 
Title: Re: interest rates
Post by: Phrazemaster on October 12, 2018, 04:24:39 PM
We have debated this extensively right here over the years... (maybe I've been posting here too long).  ::)

Fractional reserve banking creates new money/capital based on the statistical likelihood of deposits remaining untouched, so they can be put to work elsewhere to expand the economy. 

The bank lends money to Joe homebuilder to buy land and build a new house, creating jobs and wealth, as the new house is worth more than the undeveloped land, and more jobs allow wage  wealth to spread through the economy.

Of course there is no free lunch, and this is a bit of a confidence game, as depositors need to trust the bank that they always can get all of their money back if/when they want their money back.  If all depositors want their money back at the same time, this run on the bank could end badly... that is why the government provides depositor insurance to keep the confidence game working with the backing of federal government guarantees.

You can argue that it adds risk, but it also adds growth to the economy that has proven worth the risk (GDP growth is good).

 This is not a new concept, and pretty well managed, but regulators need to insure that bank balance sheet assets are worth what they say they are...  If those fractional reserve assets are dicey, the house of cards can collapse.



JR
So...looking past your eloquence - and you are incredible JR - basically it is what I said. But you add this is a good thing as it created economic growth...

I still can’t wrap my head around this being right...it is a house of cards that not only is waiting to fall, but fall again and again as it has so many times in the past...

When will they ever learn?

Where has all the money gone? Long time passing,
Where has all the money gone, long time ago...
Title: Re: interest rates
Post by: john12ax7 on October 12, 2018, 05:55:49 PM
Phrazemaster,  some of your details are off,  but your underlying thinking is correct.  It is basically a house cards that will inevitably fail, mathematically that is the only possible outcome.  Essentially banks do create money out of thin air which they then loan out with interest. Money is created through debt, and since that debt carries interest it can never fully be repaid.

The outcome of all this is that it syphons money from people at the bottom to those at the top. This is the actual reason for the wealth disparity. It's really one of the greatest con jobs ever,  get the people to choose teams (R or D)  so they will blame each other and not address the real problem.
Title: Re: interest rates
Post by: JohnRoberts on October 12, 2018, 06:49:33 PM
Fractional reserve banking is centuries old.... While federal depositors insurance isn't (more like only one century old).

The next ice age may arrive before fractional reserve banking collapses and goes out of favor. Of course some specific country banking systems are weaker than others, and stuff happens when bank regulators play fast and loose with reserve ratios and asset quality, to juice growth.

I repeat IMO economic growth is a good thing, but like everything we must manage (regulate) banks to avoid abuse and excesses. (IMO banks are more like a utility than a private business.)

JR
Title: Re: interest rates
Post by: Banzai on October 12, 2018, 06:56:23 PM
I don't think that is how it works, based on the reading I've done. Nobody can 'create' money (except the Fed). A bank cannot lend out money it does not have. There's a whole lot of misinformation on this around though.
If a bank has $1 they can lend $0.90 and they are required to keep the other $0.10 on reserve
The example I did above goes through how it works and shows the money multiplier effect. A bunch of people have debt and a bunch of people have savings, but when you add it up, there is the same net amount of money.

Banks can and do lend out money they don't have:

In reality they give out loans first, then look for a way to meet their capital/regulatory requirements. Creating money out of thin air is an accurate description for what they do.
Title: Re: interest rates
Post by: desol on October 12, 2018, 07:19:04 PM
Creating money out of thin air is an accurate description for what they do.

I would like to able to do that. I would be very rich!
Title: Re: interest rates
Post by: Phrazemaster on October 12, 2018, 11:47:15 PM
I would like to able to do that. I would be very rich!
And full circle, that was also my point...
Title: Re: interest rates
Post by: JohnRoberts on October 13, 2018, 10:06:44 AM
I would like to able to do that. I would be very rich!
Yes we are all rich (at least the western world)... thanks to things like this.

JR
Title: Re: interest rates
Post by: dmp on January 25, 2019, 11:58:10 AM
Banks can and do lend out money they don't have:
In reality they give out loans first, then look for a way to meet their capital/regulatory requirements. Creating money out of thin air is an accurate description for what they do.

Phrazemaster,  some of your details are off,  but your underlying thinking is correct.  It is basically a house cards that will inevitably fail, mathematically that is the only possible outcome.  Essentially banks do create money out of thin air which they then loan out with interest. Money is created through debt, and since that debt carries interest it can never fully be repaid.

So I've done some more reading on this to try to understand it. In the USA, individual banks can and do create money along the lines you guys are saying according to the reserve banking rules.
The key detail is money is conserved at the Federal level. The problem I had with the idea was how could this system work if money wasn't conserved? But all banks need to belong to a Federal Reserve bank (12 regional Fed banks exist)  and money is conserved at that level (except when the Federal Reserve changes it's balance sheet).
All payments between banks need to be settled through the Federal Reserve Bank.
So a bank you do business with can create money by giving you a loan. You ask for $1000 and they just credit $1000 to your account. They don't actually need the money on hand. But if you transfer it to someone else at a different bank, the bank needs to have the money to settle that, since it is sent to a different bank through the Federal Reserve system.

And actually individuals can create money also - say I build a microphone and 'sell' it to someone  for $1000 but instead of paying me money, they owe me the money. Now $1000 has been created through that debt.

Title: Re: interest rates
Post by: JohnRoberts on January 25, 2019, 01:06:43 PM
So I've done some more reading on this to try to understand it. In the USA, individual banks can and do create money along the lines you guys are saying according to the reserve banking rules.
The key detail is money is conserved at the Federal level. The problem I had with the idea was how could this system work if money wasn't conserved? But all banks need to belong to a Federal Reserve bank (12 regional Fed banks exist)  and money is conserved at that level (except when the Federal Reserve changes it's balance sheet).
All payments between banks need to be settled through the Federal Reserve Bank.
So a bank you do business with can create money by giving you a loan. You ask for $1000 and they just credit $1000 to your account. They don't actually need the money on hand. But if you transfer it to someone else at a different bank, the bank needs to have the money to settle that, since it is sent to a different bank through the Federal Reserve system.

And actually individuals can create money also - say I build a microphone and 'sell' it to someone  for $1000 but instead of paying me money, they owe me the money. Now $1000 has been created through that debt.
We have discussed this at length before... "fractional reserve banking" creates money supply and supports faster economic growth, a good thing, but comes with risk, should depositors all want their money back at the same time.  That would create a classic run on the bank, made popular in old movies (like "A wonderful life" with Jimmy Stewart), or more recently in real life (Cypress 2013).

Since fractional reserve banking depends on depositor confidence that they will always get their money back, FDIC (federal deposit insurance corporation) puts the full weight of the US federal government behind guaranteeing these deposits, to prevent bank runs caused by skittish low information depositors. Cypress lacked that 100% guarantee facility and shut down the banks before giving depositors a hair cut. But there were irregular circumstances surrounding many of those Cypress deposits.

Since the federal government is on the hook for insured bank deposits, they are more diligent about vetting bank balance sheets, to avoid overstated worthless assets (like non-performing loans).

JR

[edit- Speaking of interest rates, I was just looking at picking up another CD and couldn't find 3% interest... I thought interest rates were supposed to be going up... not fast enough IMO   ::) /edit]
Title: Re: interest rates
Post by: Phrazemaster on January 25, 2019, 01:19:54 PM
And actually individuals can create money also - say I build a microphone and 'sell' it to someone  for $1000 but instead of paying me money, they owe me the money. Now $1000 has been created through that debt.
Well...not quite.

I can't go spend that $1000 that you say was created from the debt - there is no money created at all. With a bank, they "deposit" money (fake money, credit, aka "air") into your account that you CAN go "spend" somewhere else because it's "in" your account as an actual credit or spendable money.

With your buddy you who you lent the microphone to (you haven't sold anything until he gives you something in return) - there's no way you can go spend that non-existent money that he hasn't yet given you. Because you actually haven't sold it to him until he pays you real money. Big difference.

Banks get away with murder. And it's all legalized with a special name. Amazing.
Title: Re: interest rates
Post by: JohnRoberts on January 25, 2019, 03:44:47 PM
Well...not quite.
If he created a new mic from parts and sold that for $1000 irrespective of how he got paid, he created wealth from the difference between his cost, and selling price (affectionately known as profit).
Quote
I can't go spend that $1000 that you say was created from the debt - there is no money created at all. With a bank, they "deposit" money (fake money, credit, aka "air") into your account that you CAN go "spend" somewhere else because it's "in" your account as an actual credit or spendable money.
Banks do not create "wealth" from fractional reserve banking, but they do expand the money supply which encourages GDP growth (which actually does create wealth).
Quote
With your buddy you who you lent the microphone to (you haven't sold anything until he gives you something in return) - there's no way you can go spend that non-existent money that he hasn't yet given you. Because you actually haven't sold it to him until he pays you real money. Big difference.
If he "promised" to pay $1000 that promise is a receivable that can be carried on your balance sheet (perhaps discounted for expectation of full payment).
Quote
Banks get away with murder. And it's all legalized with a special name. Amazing.
Banks are so heavily regulated it is hard to imagine legally sanctioned murder, while they are guilty of less than lethal shenanigans that routinely get exposed. Wells Fargo had to pay $B in fines to federal regulators for shady practices that defrauded customers.

JR

PS: I saw a blurb about efforts to privatize Fannie and Freddie the federally backed mortgage insurers that were at the center of the last housing melt down. About friggin time. We need to get taxpayers off the hook for this, while I suspect it will always enjoy some level of government guarantees... because it is such a key part of mortgage origination.