5 Oct 2013

Two simple rules for lending money that could make a big difference

Hopefully you will all be aware of the fact that banks create money out of thin air when they make loans. I am convinced that the way out of many of the world's most serious problems will involve changing this insane system to one in which all new money creation is debt free, and done by a public authority that is working in the interests of citizens - not personal profit.

But I realise that it is going to be hard work getting the system fixed. Despite their clear and well argued proposals, Positive Money in the UK is still only beginning to scratch the surface. They now have just over 13,700 followers, but they will need a lot more than that before the politicians start paying any attention. And my own Monnaie Honnête website that recently went public has only had a handful of visitors so far. Of course, it is early days... and I haven't given up hope (yet).

Nevertheless when I see the latest news from the US and UK I can't help thinking that there are some absolute basic rules that could be imposed on the commercial banks that would already make a big difference.

Fixed Rate Loans

One remarkable difference between the way that Banks lend money in France and the UK is that in France, almost all mortgage loans are made using fixed rate loans. Currently, you can take out 15 year loans with fixed interest rates as low as 2.60%. You can even get 25 year loans at 2.95% - see this site for examples.

In the UK, for some inexplicable reason, fixed rate loans are difficult to find and all almost always limited to periods of  2 years or 5 years.  There's a site that compares what's on offer and you can see that there is just one outfit (Halifax) that offers 7 year fixed period loans, and it's for first time buyers only. And the rates proposed are pretty terrible - 4.49% for the 7 years, followed by 3.99% thereafter (although I presume that there is no guarantee that this rate will be maintained).

One wonders why UK home buyers can't get the 2.60% 15 year rates available rates to French home buyers. Aren't we all in the EU? Methinks that it is just yet another illustration of the UK banking system ripping people off.

But there is another wierd thing about the lack of fixed term loans. What is going on here? If we accept that the banks do not actually have the money they lend, why on earth should they be able to change the rate of interest during the term of the loan? It's not as if they are going to be forced to go anywhere to find more money half way through the loan period.

It's bad enough that the banks can lend money that they don't have. But if you add to that a license to double the interest rates whenever they like, isn't that just a recipe for disaster??

The US subprime crisis was caused when the people with low incomes who had taken on excessive debt woke up to discover that the rate of interest had changed and they could no longer afford to make their repayments. And in the UK, there are signs that the governments latest "Help to buy" scheme is going to end up with large numbers of people taking on massive amounts of debt. And of course, if at some point in the future, the banks decide to increase the interest rates mid term, then you are guaranteed to have yet another financial crisis.

Wouldn't it be straightforward to massively decrease the systemic risk by passing a law making it illegal for banks to make loans with variable rates? That way, people buying property would know exactly how much they have to find for the entire period of the loan.  Seems simple to me.

Progressive compulsory repayment

The second simple idea that I would like to propose is that any bank that makes a loan would have to have a repayment schedule so that the entire loan plus interest is paid off during a fixed term. Thus if you borrow €120,000 over 10 years, you would have to pay back approximately €1000 every month (plus the interest) for the entire period of the loan. That way, you know that the amount of debt will have to decrease progressively.

It seems perfectly sensible but it's not at all what happens at the present time - particularly with loans made to governments.  The problem is that currently, when a government needs money, it goes to the markets who will kindly loan them whatever they want using money that they create out of thin air. After all, as I showed last week, creating money to lend to governments doesn't even count - the banks can create as much money as they want, and don't even have to have capital to back them up. And once they have made those loans with their fictive money, they can then just sit back and let the interest accumulate.  Easy. You don't have to have a PhD in rocket science to make money that way.

Importantly, the government in question has no requirement to pay anything until the loan term is due, with the result that they will almost never pay off the loan at all. And then, surprise surprise, at the end of the loan term, they now owe the bank not only the money that they bank created out of thin air, but the interest too.

Thus, if a government borrows €10 billion from the markets by selling bonds with a maturity of 10 years, and the interest rate is 7%, at the end of the 10 years it will end up owing nearly twice as much. It's a brilliant scheme - if you are part of the banking industry that has a licence to create money out of thin air. But a total unmitigated disaster for everyone else.

But of course, if you are an elected politician, there is a pretty good chance that you won't still be around after 10 years to pick up the tab! So not much incentive there not to take advantage of all that easy debt.

Is it any wonder that the US government will soon need to  increase its debt ceiling by another trillion dollars just to keep from defaulting on its repayments?

So, here's a straightforward way to prevent this insanity. Make it illegal to make a loan with money that you don't have that doesn't include progressive repayment  over the loan period. That would immediately make it much less tempting for politicians to borrow money from the banking system.

Conclusion

So, there you have it. Two simple and sensible moves that could make debt much less dangerous. Make all loans fixed rate loans, and only allows loans if there is a progressive repayment plan throughout the loan period.

Of course, I still believe that the true solution is simple to ban all loans with fictive money - i.e. ban money creation by commercial banks. But maybe we need to do this by stages.

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