Systemic shift to floating rates...

[WildspitzE]

In light of all the inflation expectations, on a random thread here I threw out the idea that I believe that we may see a systemic shift to floating rates in the US.

Every banana republic that has had to deal with mass inflation (and even hyperinflation) has floating rate as the dominant interest rate convention, including government paper. Most saw a re-shift or re-testing of fixed rate lending during this recent bubble, e.g. 2004-2008 Mexico as they developed a nascent MBS market.

Today, I get a notice from BofA telling me that my credit card (I rarely use it, as I get better mileage and points with my amex charge card) is now going to be based of off prime rate, instead of the misnomered "fixed" rate.

I know that using prime is pretty standard too, but I find it interesting that they're getting to the point that they're moving the 800+ FICO people to floating rate....

Given what I've been reading about the circle jerk of LIBOR, it will be interesting to see if Prime makes a comeback as a benchmark.

Any others? Thoughts?

[newnewthing]

Re: Systemic shift to floating rates...

A major defect of FICO is that it doesn't reflect ability to pay, only willingness to pay. It doesn't reflect whether you own a home (mortgage free) or rent. Nor does it reflect whether you are employed or have a savings account with a large balance. If you have paid off all your debts and use only a debit card you may not even have a credit score.

Been there done that. One good feature is no one will steal your identity.

Quite amazing.

[Chomsky]

Re: Systemic shift to floating rates...

In light of all the inflation expectations, on a random thread here I threw out the idea that I believe that we may see a systemic shift to floating rates in the US.

Every banana republic that has had to deal with mass inflation (and even hyperinflation) has floating rate as the dominant interest rate convention, including government paper. Most saw a re-shift or re-testing of fixed rate lending during this recent bubble, e.g. 2004-2008 Mexico as they developed a nascent MBS market.

Today, I get a notice from BofA telling me that my credit card (I rarely use it, as I get better mileage and points with my amex charge card) is now going to be based of off prime rate, instead of the misnomered "fixed" rate.

I know that using prime is pretty standard too, but I find it interesting that they're getting to the point that they're moving the 800+ FICO people to floating rate....

Given what I've been reading about the circle jerk of LIBOR, it will be interesting to see if Prime makes a comeback as a benchmark.

Any others? Thoughts?

Part of the conundrum of the FIRE-driven economy is that banks lend at fixed rates (esp. mortgages), which exposes them to inflation risks and therefore forces them into speculative investments. Perhaps if lending was done at rates adjusted for inflation (as it is in Europe, etc.) banks would have less incentive to engage in potentially ruinous speculation. Or put another way, perhaps it would be politically more possible to outlaw certain forms of speculation in such a framework.

[cindykimlisa]

Re: Systemic shift to floating rates...

Banks are not forced into speculative investments.

Banks have been enbled to make speculative investments by congress, etal,

Reckless greed and lack of underwriter supervision and little Exectutive Supervision account for the risky speculation.

[Chomsky]

Re: Systemic shift to floating rates...

Banks are not forced into speculative investments.

Banks have been enbled to make speculative investments by congress, etal,

Reckless greed and lack of underwriter supervision and little Exectutive Supervision account for the risky speculation.

Is there unrisky speculation?

I have little sympathy for the banks, but really, lending at fixed rates in the face of inflation -- it's so obvious what banks would choose to do in such an environment.

I think a new paradigm of floating rates for mortgages is virtually a guarantee.

[ricket]

Re: Systemic shift to floating rates...

Part of the conundrum of the FIRE-driven economy is that banks lend at fixed rates (esp. mortgages), which exposes them to inflation risks and therefore forces them into speculative investments. Perhaps if lending was done at rates adjusted for inflation (as it is in Europe, etc.) banks would have less incentive to engage in potentially ruinous speculation. Or put another way, perhaps it would be politically more possible to outlaw certain forms of speculation in such a framework.

Inflation is a guarantee whenever you have a system that, in the very design itself, requires more money to be created in the future simply to service the debt that was created in the past (since the interest is never created).

Lending by banks at fixed rates does not "expose them to inflation risks" since charging interest, but never creating it, is what actually causes the future need for inflation in the first place.

I think it would be more beneficial to outlaw charging interest (as the Christians did for quite some time --see Jesus and usury) in the closed monetary system that we practice. Until that day comes, I no longer participate in such a system unless absolutely necessary.

[MarkL]

Re: Systemic shift to floating rates...

A major defect of FICO is that it doesn't reflect ability to pay, only willingness to pay. It doesn't reflect whether you own a home (mortgage free) or rent. Nor does it reflect whether you are employed or have a savings account with a large balance. If you have paid off all your debts and use only a debit card you may not even have a credit score.

Been there done that. One good feature is no one will steal your identity.

Quite amazing.

You seemed quite informed about FICO. A few years ago I tried to ferret out exactly how the score was calculated, and although I did find that

"The breakdown of the calculation is– past payment history worth 35 percent, outstanding debt is 30 percent, length of credit for 15 percent, new credit for 10 percent, and type of credit is 10 per cent"

I was also told by Fair Isaac that their are other considerations in their calculations and that the additional specifics were proprietary. The best I could come up with beyond that were some half-baked blog theories.

How do you know these "facts" about FICO??

[newnewthing]

Re: Systemic shift to floating rates...

You seemed quite informed about FICO. A few years ago I tried to ferret out exactly how the score was calculated, and although I did find that

"The breakdown of the calculation is– past payment history worth 35 percent, outstanding debt is 30 percent, length of credit for 15 percent, new credit for 10 percent, and type of credit is 10 per cent"

I was also told by Fair Isaac that their are other considerations in their calculations and that the additional specifics were proprietary. The best I could come up with beyond that were some half-baked blog theories.

How do you know these "facts" about FICO??

The specific formulas are proprietary but the information in the credit reporting agencies is not. Out of curiosity, probably by seeing too many "selling fish to tourists in t-shirts" ads, I decided to check out my credit report. I was shocked.

Here's my situation. I retired some 6 years ago. I paid off my last mortgage 15 years ago. I stopped using CC's 10 years ago and just used a bank debit/visa card. I own two homes outright. I hold a first mortgage on another property. I have banked at the same place for 30 years and currently have a couple 7 figure bank accounts, A brokerage account, PMs, and own about 10% of a nicely growing private company.

Well, due to my switch to debit cards and away from CCs, I had no, nada, credit history except one bank that I'd parked $250k in that apparently opened up a $1,000 overdraft thingie. That had been reporting for only 6 months so I didn't even rate a Credit Score (FICO). Ya gotta have two reporting creditors. My main bank and broker account have nothing in the credit report. No record at all. Since I haven't had a mortgage in over a decade it doesn't even have me down as a homeowner.

Someone looking at my credit report would have a hard distinguishing me from a just graduated high school student at a new job with no credit history.

So, after being suitably impressed with just how useless FICO scores are, I made a point of trying to understand exactly what info was collected and what wasn't.

On the good side, I haven't gotten junk mail "you have been preapproved" letters from CC vendors for many years and no-one is going to steal my identity.

[newnewthing]

Re: Systemic shift to floating rates...

To clarify:

The $1,000 overdraft thingie shows up as having a high limit of $1,000 with 0 utilization. Were I to have had a mortgage I would have been marked as a homeowner. Had I applied for credit in the not too distant past, my employment at the time would have shown up. So basically, I just look like some shmuck that can borrow a Grand.

Obviously, home ownership is a public record, but they don't collect that info directly.

So FICO reflects a record of paying loans. Ability to pay? Not a chance. Any wonder why securitized CC debt is wilting in this economy? No wonder at all.

ETOA:
Check out the credit card fora on credit.com and myfico.com et al. The CC issuers are being gamed big time.

[WildspitzE]

Re: Systemic shift to floating rates...

I think a new paradigm of floating rates for mortgages is virtually a guarantee.

In the emerging markets, the mortgage markets stayed pretty thin until fixed rates joined the party. The variables are more manageable, in order to create a secondary market which is what eventually drives demand. Just as AIG's unlimited risk appetite for guaranteeing MBS drove investor demand for MBS which in turn drove demand for the underlying mortgages.

As rates rise, and if wages don't keep up with the rates increase, probabilities of defaults increase. This relationship has a host of other speculative ramifications for those in the casino. Mexico tried indexing mortgages to minimum wage. That idea was an unhedgeable political risk clusterfuck.

[WildspitzE]

Re: Systemic shift to floating rates...

Lending by banks at fixed rates does not "expose them to inflation risks" since charging interest, but never creating it, is what actually causes the future need for inflation in the first place.

On a systemic basis (in the game of musical chairs), it exposes those holding the bag to inflation, which may or may not be the banks. It does so by making it more difficult for those with the bag to trade out of it (in essence getting a chair as the music winds down) before defaults start to roll in and eat into equity.