April 26, 2004

Rates I - US moves to raise rates

Scuttlebut has it that banks have heard Mr G's suggestions and are responding. A month or so back he said "banks are missing out on the opportunity to sell variable rate product to consumers."

What strange language! Yet insiders knew that what he was saying was that the time to balance your books is now, and sharpish, before he raises rates. Now comes rumour that the banks are moving to consolidate their customers into variable rate packages.

Here's how one bank does it. Take a customer who's awash with credit card debt, but has some equity on a fixed rate loan. Offer them the chance to switch their credit card debt (variable) and their mortgage (fixed) into a new mortgage (variable) with a higher valuation (90% instead of 80%).

Bingo, the bank has got rid of two headaches in one. The consumer "benefits" because they have expunged their credit card debt. There's only one problem left: if the variable rate mortgage suffers an increased default rate as the interest rates rise to pay back the 90's hangover, the banks might be left holding a lot of collapsed real estate. (This sort of sweet deal may only be available in coastal, stable areas....).

And here's the clincher: no, even that doesn't happen, because the banks don't hold the loan. They've already sold the securitized packages off into the market, by the time the rate increase bites. So not only have they got rid of their credit card debt (uncollateralised, so not saleable) they've repaired the prior securitised portfolios with the chance to take a new origination fee.

Banks in the US no longer do much in the way of banking. That is, they don't borrow and lend to the public. What they do instead is originate loans which are sold to the market. Each group of a thousand mortgages becomes its own little community IPO. Which means, banks are in the process of selling securities (or, is it buying securities? no matter). They've solved the balance sheet problem - the term rate misbalance - that made banking special.

As sellers of securities, banks are now more like brokers. Yet, they are still supervised by the bank regulators. Expect more mystical and godly pronouncements from the regulatory sector, as they catch up to the recognition of the Arrow observation: as the cost of transactions shrinks to zero, banking disappears and everyone goes to market.

Posted by iang at April 26, 2004 09:31 AM | TrackBack