How to Make Loans Scarce in Two Words: Cap Rates

Mish

Here's perfect free market example of what not to do about allegedly high interest rates.

Interest Rate Caps

Reuters reports Peru Passes Law Allowing Central Bank to Cap Interest Rates on Bank Loans.

Peru’s Congress approved on Wednesday a law that will allow policymakers to cap interest rates on loans granted by banks, a controversial measure that has been deeply critiqued by the Andean nation’s government and financial institutions.  

The law empowers the country’s central bank to set maximum and minimum interest rates every six months in order to regulate the loan market, a measure lawmakers said is necessary to protect Peruvians from abusive lending practices.

Loophole

The loophole in the bill is that it "allows" rather than "requires" the Central Bank to cap rates on bank loans.

Regardless, this is a horrible idea.

If the Central Bank or government set rates that are too low, loans will dry up. 

This is similar to Venezuela setting the price of gasoline at 10 cents a gallon. That's the official price but the supply at that price is zero.

The government set the price of gasoline but it cannot secure the supply. 

The result is a huge black market. 

What About the Fed?

The Fed does not set bank loan rates directly, but it does influence them. 

For example, mortgages loan rates are generally tied to interest rates on 10-year US Treasuries that the Fed does manipulate.

Interest Rate Floors and Subsidies

Unlike the setup in Venezuela, the Fed can indeed provide all the supply of dollars it wants. And as long as borrowers use the money for speculation, housing, and other items that do not show up in official inflation stats, the Fed can get away with it.

Low interest rates helped fuel the stock market bubble and other speculative activities. The result is three major bubbles in 20 years, with allegedly low inflation. 

Few see the current bubble only because it has not popped yet.

These are all good reasons to end the Fed and let the market set rates.

Mish

Comments (70)
No. 1-18
Carl_R
Carl_R

In general I agree, yet it still bothers me to see the payday lenders out there. Are people really better off when they have access to loans at 1200% or higher interest? Loan sharking is a business that has been around for thousands of years, but that doesn't necessarily make it a good thing.

cudmeister
cudmeister

A good example of communism at work.

Eddie_T
Eddie_T

“Few see the current bubble only because it hasn’t popped yet.”

I don’t think it’s quite that simple....it’s easy to see the problems....but right now the Fed is NOT about to go away....it’s the only game in town....and you have to play it. You have to try to make strategies that use Fed policy to your own benefit...as best you can.

So if you have access to cheap credit that you can lock in for a generation at historically low rates...why not use it? Buy some solid tangible asset that has cash flow and a chance of keeping up with inflation. Is there anything like that? Yes, there is.

Quite likely most of us will be pushing up daisies and the Fed will still be the Fed....I sure don’t expect to outlive it.

Johnson1
Johnson1

Yes. I agree there is a bubble. I was a huge bear in 2007 because the easy money financial engineering was creating a housing bubble that was going to pop. I did not realize it would spread so much.

This time feels different. This feels like the verge of inflation. Ray Dalio said he could see PE go to 50. That is crazy talk as he is bearish long term as he see a bubble.

Your Peru scenario is a good one. I think Governments are looking for the CBs to keep interest rates low. Trump kept asking the FED to follow the ECB and go NIRP.

There is so much debt that has been taken on by Governments and Corporations and consumers. I wonder how they can raise interest rates anytime soon? Rising interest rates anywhere above 4% would be very bad.

The world needs inflation to deflate all this debt.

What happens next....I have no idea.

Greggg
Greggg

Cap interest rates and loans dry up. Raise interest rates and buyers dry up. Somewhere in the middle is a market that would control that anyway. So the Peruvian Congress wants to take a political stance on what is "fair", even though there is no such thing as fair. There's just markets and that's it.

njbr
njbr

My guess is that this is a pre-emptive move.

They may see an Argentina-style crisis coming upon them. Current rates in Argentina 38%, over 60% last year.

...Peru's economy collapsed at a record pace in the second quarter as the pandemic shuttered businesses and put almost half the country's urban population out of work. Gross domestic product plunged 30.2% from a year earlier, the deepest slump of any major economy, the country's statistics agency said Thursday....

Default on bonds?

RonJ
RonJ

"These are all good reasons to end the Fed and let the market set rates."

The more things should change, the more they stay the same. Not one bubble, but three. Not one Covid stimulus check, but two. Not one crisis to not let go to waste, but many. It is like Groundhog Day. Human nature never changes.

No gold standard anywhere, has not been broken. Human nature demands that it be broken. Even looting the Aztecs and Inca's of their golden treasures couldn't keep the Kings of Europe from debasing their money due to profligate debt.

Klaus Schwab is pushing for a Great (debt) Reset, which would be a dramatic change in how the world operates. Communism 3.0, as Martin Armstrong calls it. Is everyone ready to own nothing and be happy, according to Scwab's world Economic Forum grand plan?

PecuniaNonOlet
PecuniaNonOlet

It isnt as simple as borrowers and lenders. When borrowers default, where do lenders go? They go to the court system to seek redress. Court systems cost money so do judgements that then need to be enforced. In a normal system that wouldnt matter too much but when we have a distorted central bank scheme printing to infinity then we have a cascade of problems that cost even more money or judgements to fix like evictions, garnishments, seizures, late fees, etc. It turns into a vicious cycle growing and growing onto itself while eating itself.

I dont know what Peru is trying to do but the whole system likely needs an overhaul just like everywhere else. Perhaps it is a start.

Sechel
Sechel

in general i agree but there comes a point where that's no longer the case. we're talking about usury rates. the pay-day lending space is an example. the rates offered have little to do with economics but prey on borrowers not understanding their options , being desperate and being preyed upon.

Dodge Demon
Dodge Demon

Two words: don’t borrow

Sechel
Sechel

As someone in the industry at least on the periphery i can tell you once you get to sub-sub-sub-prime credit where rates are 18% , 20% or 25% etc the market is totally inefficient , way under-regulated and predatory. Those taking loans are usually quite desperate and non-repayment is not only probable but anticipated. This is why states have usury laws and why companies involved in pay day lending schemes have gotten super-sophisticated in evading the laws and sourcing funds in ways that make legal recourse extremely difficult.

Doug78
Doug78

You are seeing the utility of a central from purely economic reasons when the value of a central bank is much more than that. First of all central banks came into being basically to manage the repayment of debts taken on during costly wars. By that they were able to instill confidence in bondholders as well as rationalizing the methods of taxation. The result was that a country with a good central bank in war could muster much more money to pursue war than one without a good central bank. The classic example is thanks to the Bank of England Great Britain with one third the wealth and population could defeat France in the Seven Years War. Other countries took note and set up their own central banks if they could. One of them was France who attempted to clone the Bank of England, with a French flavor of course, but failed. France failed because of the complicated interlocking of interest groups prevented any reform. They all agreed that something must be done but when a reform Finance minister tried to do it these interest groups would gang together and get him fired. By the way these interest groups were not just the nobles or clergy. It encompassed all layers of society. Essentially all groups had rock-solid reasons why their taxes shouldn’t rise and those of other groups should. The Estates-General was called to cut through this financial Gordian Knot and we know what happened after.
Fast forward to today and the central banks have a new problem they didn’t have before. Government financing depends above all on taxation and borrowing is a much smaller part. In the last twenty years or so the very wealth corporations and individual (the very very wealthy) have found ways to avoid taxes to an extent never seen before. On top of it a great share of taxable assets have been switched into foundations many of which are just means of keeping a part of their money tax-free while still being able to control it totally. The result is the tax burden more and more on fewer shoulders. Let’s be realistic and recognize that meaningful tax reform will not take place for the same reasons it couldn’t take place in pre-revolutionary France. There are too many interlocking interest groups and can block any reform they don’t like and get rid of anyone who doesn’t play ball. Central Bank governors are very smart and what they see is the tax base collapsing. When it happens to a state like Illinois people like Mish can just pack up and leave. There is a safety value. If it happens to a whole country people can no longer do that. What it comes down to is that the Fed is no longer the lender of last resort. That is past. The Fed sees its role now is to be the tax payer of last resort. That is what they are doing now and that changes everything.

Flatlaxity
Flatlaxity

"...For example, mortgages loan rates are generally tied to interest rates on 10-year US Treasuries that the Fed does manipulate..."

The Fed is stepping on the yield curve's tail. While the head (30 Yr UST) and body (other bonds, notes and bills) can move, that change is constrained.

Also, the Fed is buying $40B of GSE debt/mo (Fannie Mae, Freddie Mac, Ginnie Mae, etc.)

With the $1.4T continuing Congressional budget resolution, plus the $0.9T stimulus, the Fed will have to increase its UST purchases in order to keep interest rates down where they are. This creates more monetary inflation, and given the misallocation to businesses that should have failed/faltered, GDP will only be moderately, positively affected. This should be positive for anti-inflationary investments such as gold.

Tip-toe through the tulips....

njbr
njbr

Meanwhile, in another world...

PARIS (Reuters) - The father of British Prime Minister Boris Johnson said on Thursday he was in the process of applying for a French passport to maintain his ties with the European Union after Brexit.

Stanley Johnson, a former member of the European Parliament who voted Remain in Britain’s 2016 referendum, told RTL radio he wanted to become a French citizen because of strong family links to France.

Salmo Trutta
Salmo Trutta

Capping lending rates is necessary. We have regulated capitalism, not lassez faire capitalism. Loans should dry up at usurious levels.

What's worse is paying interest on bank deposits. That's money that the banks already own.

Casual_Observer
Casual_Observer

Cap bank profits on loans and a bunch of problems will be solved. We live in a banking structure that is a cartel.

niphtrique
niphtrique

There is too much debt alreasy so balking at the solution is a bad idea. Negative interest rates are deflationary and banning positive interest rates will eliminate bad debt.


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