Friday, January 02, 2009

The Zero Percent Solution

At what point does a bank go out of business or when does it cease to have a purpose? As interest rates approach zero, the money to be made loaning it out disappears. Why keep it in a bank if the inflation rate is higher than the interest rate? Keep it in a shoe box.

Remember back to the Savings & Loan mess of the 1990’s? They loaned money long at low interest rates (home loans) and when short term interest rates went up, these institutions went broke. There sure is a lot of refinancing going on right now. Bill Seidman get ready, we may need you again.

Let’s say you want to buy a car and get it financed. If you have lousy credit, you’ll be looking at 10% interest. But if you are a car manufacturer, the leasing aspect looks real nice. Joe6pack gets to lease it at full book with a roll in of 12 % interest. God Bless GMAC.

The only places getting a realistic return on their money are the credit card companies. And they give you money back for spending money, go figure.

Stock broker loans with stock as collateral are in vogue; the current rate is about 1.5% plus the yield on the 10 year treasury, for a million dollars or more (4.5%). Add two points if you’re a piker and want to borrow less than 50k (6.5%). Hop on; the DOW will hit 30,000 (yea right!).

If you are retired, living off the interest on your investments, I would suggest getting a seed catalogue and carefully pick out what you want to eat/grow a lot of, in the coming years. Step two, chickens are low maintenance, but the local CC&R’s might not allow for it, check first. You’ll be living on straight principle within months. The stress of retirement, isn't it fun?

Something is severely wrong with the current interest rates. The Alt-A paper has been discounted to 18%, of face amount, that equates to an interest rate range between 25% to 50% interest; using an original issue interest rate range of 6% to 12%. A bid of 12 million might buy the whole city of Detroit (the back taxes will kill you)

Figure inflation is 9% and a fair interest rate would be 3% added on, to get a 30 year T bond rate of 12%. The rate is currently at less than 3%. So if an investor went out and bought a million dollar 30 year treasury bond with a 3% rate (paying 30K in interest), what would it be worth if interest rates suddenly went to 12%? The purchaser would have a loss of 3/4th of a million dollars (if they needed to convert it to cash now). They could wait 30 years and get the full million back. Visualize it this way. What amount of money at 12% interest pays 30K per year in interest, answer 225K? That’s how you value a bond if it has a long maturity.

If the real interest rate jumped to 12%, the interest on the national debt would double in size twice. Instead of 412 billion dollars it would be 1.648 trillion dollars PER YEAR(824 billion at 6% and 1.648 trillion at 12%).

Common sense says something is wrong. The government can borrow and print massive amounts of money and the interest rates remains at historic lows? It’s kind of like using grease to wax the floors in a hospital; it keeps your patient count high for all the wrong reasons.

Copyright 2009 All rights reserved


Tyrone said...

This is making my head spin. A few minutes I was saying to myself, I've had enough.

Jim in San Marcos said...

Hi Tyrone

Let me guess, it was the reference to the seed catalogue and chickens that did it.

Take care

Anonymous said...


I do not claim to be an expert in monetary policy of the government or banks, however for the reading masses I do claim to be a blubbering idiot to save them the time. But does any of this sound right to you..?

J-N-SM bank in California wants to borrow (or is given) $10mm from the Federal Reserve Bank at 0% interest. J-N-SM bank then makes several business loans and home loans at say 5% interest. The bank may also make several credit card loans at 12%.

Cheap money for the banks, right?... J6P gets the big end of the interest stick, right?... Multiply this borrowing and loaning activity 100x and then consolidate them, sell them to FredM, FanM, and in the markets in the form of Alphabet Soup, right?...Wash, rinse and repeat over and over again... right?

Low/zero interest for the banks sounds like a wonderful money making machine for them... now only if the banks could throw J6P a bone. I get the sense that the government knows EXACTLY whats its doing.

I also do not believe the government ever has J6P's best interest in mind, only to those spending billions on lobbyist to ensure the government protects Big Business. Like you mentioned before, if they government provided no protection for the rich, there would be no sense in playing the game.


Jim in San Marcos said...

Hi Tom

You don't have to be an expert if you have common sense. Looks like you're good there.

We could be looking at zero down buyers of foreclosures of Fannie and Freddie's bad note holdings.

The government loans the bank the dollars to loan to the buyer of a foreclosure.

This removes the REO from Fannie and turns it into a performing loan. Then Fannie buys the banks paper.

It seems to boil down to the bank finding someone to take over the note with nothing down. All the bank is doing is due diligence on the creditworthiness of the buyer. The cost to the taxpayer is the difference between the old purchase price and the new and the bank gets a .005% management fee for the loan.

As for J6P he is out of the loop and in the best of both worlds. He has no savings so inflation can't hurt him. At the same time minimum contributions to his SSI,are guaranteed to have inflation adjusted retirement returns.

Between the two of us, it isn't hard to arrive at the conclusion that something is not quite right.

Anonymous said...

Hey Jim,
A personal benefit one can derive from this crisis...
If one has 100k, one can sit on it and wait until residential real estate foreclosures and REOs are at the bottom. When the time is right, strike and acquire a beautiful home (free and clear) to live in for the rest of one's life. 100k for a home that was priced at 450k only 3-4 years earlier... that's what I call getting great value. This is not an opportunity of a lifetime... it is the opportunity of a century or more!

Cash was king only when we were on a gold standard. It is a prince now... but only until the current deflation is eventually stopped by massive inflation. WARNING: Use your cash wisely over the next year or so before it loses its purchasing power.

AngryTaxPayer said...

Hi Jim,

No disagreement that there will be numerous no-money-down and giveaway programs under the Newest Deal, dubbed the American Recovery and Reinvestment Plan by the pres-elect. BTW, which he refuses to place a price tag on.

Part of the ARRP calls for $300b in tax cuts in the form of $500 ($1000 for couples) less taken from our pay checks. This sound wonderful as were all gonna get that tax cut he promised us. However the p-e does not specify how he intends to pay for it. Seems like smoke and mirror economics if you ask me.

OK, so Fannie/Freddie get to clean up the REO books, banks get a .005% management fee, new homeowners (actually investors, wink wink) get zero down at half the original price price? Got it... I say investors because more and more J6Ps are becoming jobless these days.

Sshhh... be very quiet Jim, we wouldn't want word getting out about this great restaurant. You have to love the Feces sandwiches they're serving up and at these prices were sure to come back for more.

Waiter... Check please!


Anonymous said...

The rush treasuries isn't about yield, dont know why you even bother to mention it, it's about preserving their capital.
It's ok to suggest shoving $10k under the mattress, but try shoving $10B under it!

Jim in San Marcos said...

Hi Anon 2:44

I'm using the same game plan. There are going to be some real deals out there. OCRenter who writes the Bubble Market Inventory Blog just bought a house in SD at year 2000 prices.

I'm going to wait another year possibly. The interest only loans start resetting in mass this year.

Jim in San Marcos said...

Hi Tom

I like your new name.

I think that you are right, it's all smoke and mirrors. I just guessing that the government has spent about 3 trillion total so far and all of it off budget.

Now the PE wants to add to it. It doesn't look good.

Anonymous said...

The government--solidly locked into Keynesian and Friedman economic principles-- will do what they think is necessary... prop up the status quo. Yet, propping up the status quo is propping up the weak, the incompetent, the inefficient, the criminal, the unworkable, the malinvestments, and the obsolete. Mr. Market is trying to purge our system of these viruses but the government isn't going to allow it. They will totally destroy the remaining value of our currency and greatly inhibit the chance of a recovery (or possibly put us into a depression) by their actions to "save the economy". Hey Congress! The people want and need to save not spend; they need to be frugal and efficient; they need to produce products and services... not consume!

Jim in San Marcos said...

Hi Anon 4:08

Putting money in a mattress is a euphemism for taking dollars out of circulation. This leads to deflation by decreasing the amount of money available to loan out. The people that want to loan their money to the government at zero percent are just being foolish. Investing in government treasuries doesn't guarantee future buying power.

I would even go so far as to suggest that the fools doing the investing are banks. If there weren't enough bidders at the T-Bill auction rates would climb. This would make the housing mess even worse and at the same time increase the interest on the national debt. We are only talking 20 billion a week on 3 month T-bills, so the net investment is only 40 billion if you roll over the first 20 billion on the third month.

Alt A paper is paying as high as 50% interest a year. That is the discount that brings in a buyer usually. Right now, first trust deed in the Detroit area are not even marketable.

Lets face it we are looking at an absurdity, investing your money for zero interest. The conclusion that people are interested in preserving their principle sounds great, but think about it. It makes no cents/sense. I might offer my son a rate like that and even the IRS would question it.

Look for my next post to include this discussion.

Thank you for your comments.

Jim in San Marcos said...

Hi Anon 7:07

I agree totally.

It's rather wild to think that there may be an economic theory to save us, when no economist even predict the current mess.

A lot of things work themselves out if given time, without any intervention. This could be one of them. It isn't going to be pretty, but it won't last forever.

It's kind of like knocking up your girlfriend. It's a serious problem, but it will solve itself, even though the immediate problems seem insurmountable. Trying to make things the way they were, is not going to cut it.

Thank you for your comments

Anonymous said...


The smart individual has cut his losses by liquidating his assets into cash. Only problem is he can't stick it anywhere where it can earn... treasuries? money markets? CDs? Forget that! He just has to hold on to it to preserve it. Yet, he must be VERY vigilant and be FULLY PREPARED to deploy his capital back into sustainable assets exactly at the point when deflation switches over to inflation and then goes hyper.

Otherwise, his earlier action of having liquidated and preserved his capital will have been in vain... because his money will now have next to no value.

Those assets better be sustainable ones too because the new economy is going to bring us VERY high taxes, VERY high living expenses and a VERY high cost of doing business. When was the last time we were in an economic environment like that?!

I think there will be a lot of businesses and individuals moving off shore in the next decade. Don't you agree?

The Governator wants to increase sales tax by 20%, triple DMV fees, and raise all other government fees and costs in an attempt to save California (a microcosm of the macrocosm). Obama isn't even in office yet and is stating that we are in very dire circumstances and it will take a lot of time and effort to get out of this problem. With concepts like that being verbalized to the public, isn't that enough to see what is coming?

Heck! politicians are always sugar coating everything. And if that is the case... man, I don't want to see what is under that sugar coating.

FACT: The US government has reached a state where its long term budget is in a state of permanent imbalance... it will NEVER be able to pull in as much money as it is obligated to spend.

What will Congress do to solve this nightmare? I'm afraid to ponder that question.

Maybe taking my cash, moving to Panama and opening a grocery store will be my destiny. Yikes!

AngryTaxPayer said...


Its been 3 years now that I have followed your website. Leaving the stock market out of the equation (as who knows who is really driving it these days)... would you say that the log has started to circle the bowl in real terms of a Depression or have we not met the prerequisites yet?


Jim in San Marcos said...

Hi Tom

We still have a way to go. A depression is financial destruction without any physical damage. You can experience the effects, but you can't point to it.

More and more people are becoming involved and the rate of the collapse is picking up speed. I would guess that it should be very obvious by May or June.