MSE News: Interest rates could hit 8%, says economist

RenovationMan

brit1234 wrote: »

Rates are too low, the sooner they rise the better. Remember it was too low interest rates that caused the credit crunch in the first place.

For a healthy economy we need savers. With a level layer of savers lenders can give out loans and every one is happy. At the moment savers are being punished for the recklessness of borrowers.

Then we end up with deflation, which is far worse than inflation.

"Deflation is generally regarded negatively, as it causes a transfer of wealth from borrowers and holders of illiquid assets, to the benefit of savers and of holders of liquid assets and currency. In this sense it is the opposite of inflation, which is similar to taxing currency holders and lenders (savers) and using the proceeds to subsidize borrowers. Thus inflation may encourage short term consumption. In modern economies, deflation is usually caused by a drop in aggregate demand, and is associated with recession and (more rarely) long term economic depressions."

Pincher

The banks should be forced to introduce interest rate hedging insurance, or equivalent products.

For example, I buy a £1000 face value interest rate bond, which pays BOE-2.5%. At BOE = 0.5%, it's -2%, so I pay the issuer 2% of £1,000, which is £20 a year, so each month I pay £1.67 .
If I had a mortgage of £100,000, I would buy 100 bonds, and I would pay £167 a month. The idea is that when BOE rises to 8%, the bank would be paying me 8 - 2.5 = 5.5%, which is £5,500 or £458 a month.

If my mortgage rate is BOE+1.5%, it's equivalent to my paying 4% on a £100,000 mortgage, fixed, until I sell this bond. The cost of the bond now should be very low, since the buyer actually loses money currently. When the BOE is 8%, and the holder gets 5.5% income, the bond should be worth quite a lot.

Because the monthly pay out is interest, I would be taxed on it,
but if it was an insurance product, with the payout direct to the mortgage lender, maybe there would be no tax.

No remortgage costs, no mortgage approvals. You can choose to do a partial hedge, e.g. I buy 60 bonds instead of 100. The only losers are the lenders, who don't get the remortgage fees any more. The brokers can sell the bonds to pick up some commission.

You can even sell the bonds if you think the BOE is about to drop,
but of course if everyone else think the same, the price of the bond will drop as well.

For the issuer, if they can sell the bond for £100, and then receive £1.67 a month, it could be money for old rope. Remember that the bank can enter into long term interest rate swaps for millions of pounds, so they can easily hedge away the interest rate risk. If they want to. It's an indirect way of stealing other lenders fixed rate business without all the admin.

samizdat

Pincher wrote: »

The banks should be forced to introduce interest rate hedging insurance, or equivalent products.

For example, I buy a £1000 face value interest rate bond, which pays BOE-2.5%. At BOE = 0.5%, it's -2%, so I pay the issuer 2% of £1,000, which is £20 a year, so each month I pay £1.67 .
If I had a mortgage of £100,000, I would buy 100 bonds, and I would pay £167 a month. The idea is that when BOE rises to 8%, the bank would be paying me 8 - 2.5 = 5.5%, which is £5,500 or £458 a month.

The problem is credit risk. The bank that lends you the mortgage money has the security of a fixed charge against your property, whereas the "bond issuer" you mention would have unsecured exposure to the risk of interest rates moving against you. Your own mortgage bank could sell you the insurance, but they are probably happier to extract fees from you to remortgage, and wouldn't have much of an incentive to offer you keen pricing.

Pincher

samizdat wrote: »

The problem is credit risk. The bank that lends you the mortgage money has the security of a fixed charge against your property, whereas the "bond issuer" you mention would have unsecured exposure to the risk of interest rates moving against you. Your own mortgage bank could sell you the insurance, but they are probably happier to extract fees from you to remortgage, and wouldn't have much of an incentive to offer you keen pricing.

The idea is that the BOE rate couldn't go against you,
because the mortgage payments go down when the bond payments go up.

If a bond buyer reneges on the monthly payment, the bond, which has value itself, is sold on, and a penalty deducted. The most the issuer has lost is £167 from a buyer who holds 100 bonds.

owitemisermusa

Whatever the rate, we will survive!

owitemisermusa

BTW, I guess it's a good idea to fix all the 'fixables' if you believe rates will rise in the short to medium term.

FTB-FTW

brit1234 wrote: »

For a healthy economy we need savers. With a level layer of savers lenders can give out loans and every one is happy. At the moment savers are being punished for the recklessness of borrowers.

What about us poor mugs who saved for 10+ years for our 25% deposit, borrowed a reasonable amount and are now going to get stung for it? Don't assume that the only people who are going to get hit by this are idiots - some of us were just born at the wrong time!

Pincher

It's all screwed up. People who can cope with 5% but not 8% WANT to fix, but they are rejected due to income or LTV. So the rate shoots up, and the lender repossesses. If they had allowed a fix at 5%, then nothing would happen, everyone is happy.

temporary1

Next time we have a recession, can we not prolong this indefinitely destructive monetary experiment with sudden knee-jerk interest rates, bloating up banks, wiping out investors, inflating costs and destroying the incentives for growth, but instead, go back to the previously proven Conservative answer of chucking up interest rates, making the banks more competetive for funds to stimulate lending and investment, leading to rapid growth, new production, job oportunities and a rich stimulated moving economy - at the expense of a few unfortunate debters - in a very short time period, so the majority of hard-saving people can get their lives back on track again?
It worked for the 80's and 90's recessions.