Lenders ban old risky practices, only to come up with new ones | Hacker News Reader

Lenders ban old risky practices, only to come up with new ones

businessweek.com

8 pointscwan13 comments

This article is flawed. Here's why:

CDS-linked credit lines are just another way to manage risk. If the risk of the loan goes up, the interest rate rises. What this actually means is that the bank can offer a lower initial interest rate, knowing that their risk is hedged.

Payday loans: if someone living paycheck-to-paycheck has their car break down, should it cost them their job? Payday loans are a very effective solution to short-term cash flow crises, and it's often much easier to pay back 10% more money a week later than to, e.g., spend a week without a phone (and with a black mark on your credit).

"Derivatives for small investors." Okay, YCers, let's get hypothetical: what if instead of referring to malicious code as a "virus," people started calling it "code." And then you read an article about how, e.g., "Apple is knowingly shipping a new kind of computer which is full of code. Every application available on the new computer uses code, and users will be forced to send code to anyone they send an email to." That would be incredibly frustrating; this is how the word "derivatives" feels to anyone involved in finance. Derivatives are just contracts whose value is based on the something that varies. You can use derivatives to reduce your risk, or to take on risk. In the case of "structured notes," the derivatives are generally designed to reduce risk -- e.g. you'll get the S&P's return, less two percentage points, but with a maximum loss of 10%.

Is it just me, or is there just plain too much money? Having made all the safe loans the market can take, these banks are left sitting on a still-giant pile of money, which they can't just sit on. Combine that with the fundamental inability of any single human to understand the effects of some of these loans and it just doesn't matter what regulations you throw at the market; the banks will find a way to make loans that are as risky as necessary to avoid the alternative of... well, not making loans. That's just not thinkable.

Somehow, we've got to address the roots of the problem, not keep trying to regulate the second- and third-order effects away.

You've got it exactly right. There's even a term for such "excess liquidity" that everybody knows: inflation. The Fed Funds Rate is supposed to rein in this kind of behavior, but I wouldn't hold my breath for the next couple months.

I've discovered a great hedge against inflation: consumption.

Right now is the perfect time to blow your savings on a great vacation. I just returned from Egypt, India is next.

A bank doesn't sit on a large pile of money, it facilitates the flow of money from lenders to borrowers. Eg. if Microsoft makes $1bn in profits and wants to invest the money it calls up Morgan Stanley, who in turn sells them these "structured investments" --- which means Morgan Stanley passes the money on to borrowers at an interest. If all goes well, Joe Sixpack doesn't starve 'til his paycheck comes, so he "happily" pays the interest. Morgan Stanley keeps some of the interest and pockets the premium, and at the end of the year Microsoft has $1.1bn. Now, if Joe Sixpack defaults it's no big deal, because there are many Joe Sixpacks. If too many of them default, then Morgan Stanley would be in trouble and MS would loose their investment --- but what are the chances of that happening...

For the purposes of my post, lenders having money when the banks are unable to provide borrowers is "sitting on a pile of money". The money may not "belong" to the banks, but the effect is the same: Too much supply.

Explaining the banking system in precise terms was beyond the scope of my post.

>> If the economy keeps moving toward recovery, as many measures suggest, then the new products might well work out for buyers and sellers alike.

Isn't this exactly what they were saying when encouraging people to take out ridiculous mortgages to buy homes? "As long as the market keeps rising, which it will of course do, your value will keep rising and you can just refinance!"

And we all know how well tha-- oh, wait...

If banks are too big to fail, they should be prevented from pulling this kind of stuff. If it's a truly profitable venture, spin off a startup to do it. If the startup goes belly-up, bankruptcy can work its magic.

I don't see why the financial world can't do innovation like the technology world, so long as I don't have to bail them out every April 15th.

Risk is fine. What's not fine, is the obfuscation of risk to the point of fraud.

And my problem with pay-day loans stems solely from the fact that the vast majority of pay-day loan 'customers' are already functionally bankrupt when they start using these services.

They're just delaying the inevitable with these loans and the banks are only too happy to eat the cost of the inevitable default if it means they can collect 100-400% interest a dozen times before that.

Cap the rates and this loan-sharking will end.

So instead of giving poor people a few months to get back on their feet, you want to bankrupt them immediately?

Isn't the point of bankruptcy to wipe out all debts after they took too much risk and/or just got unlucky? In theory that sounds better than giving people a few more months to keep going with their too-much-risk-taking approach now loaded with a new debt. I don't know if that's the way it works in practice, but hell we're just all armchair economists anyway. ;-)

Reminds me of the Batman line: "Why do we fall, sir? So that we might better learn to pick ourselves up."

Difference being, it's the Joker who's getting up.

Something needs to be done to stop banks from taking advantage of people who don't do their research or people who are going through a crisis and need money.

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