Reserve Bank seeks laws supporting covered bonds as it moves to allow banks to issue billions of dollars worth

By Gareth Vaughan

The Reserve Bank wants to introduce legislation that enshrines the rights of foreign covered bond investors to mortgages written by New Zealand banks ahead of local bank depositors and give the banks carte blanche to issue covered bonds worth more than NZ$32 billion.

In a consultation paper on covered bonds, the Reserve Bank says it would now be happy for banks to issue covered bonds worth up to 10% of their total assets, based on the value of assets securitised. This is up from its previous guideline of 5%. The central bank says it will review this limit within two years. The Reserve Bank also says it wants laws passed to enable banks to issue bonds backed by legislation to help attract overseas investors.

Based on the total assets of ASB, ANZ, BNZ, Westpac and Kiwibank at June 30, the five banks would be allowed to issue covered bonds worth up to NZ$32.1 billion of their combined NZ$321.05 billion of assets. That’s just half a billion dollars less than New Zealand’s NZ$32.6 billion of exports for the nine months to August and it’s equivalent to 59% of the sharemarket’s total capitalisation, which stood at about NZ$54 billion at the close of Friday’s trading.

Banned in Australia

Covered bonds are senior debt instruments issued by a bank, usually of five-to-ten year durations, and backed by a dedicated group of home loans known as a “cover pool.” If the issuing bank becomes insolvent, the assets in the cover pool are carved off from the issuer’s other assets solely for the benefit of the covered bondholders. This ring fencing of a chunk of a bank’s balance sheet is why covered bonds are banned by the Australian Prudential Regulation Authority as, in the event of a default by the bank issuer, depositors’ claims are diluted. 

Overseas banks can, however, issue Australian dollar denominated covered bonds.

There’s nothing in the Reserve Bank’s prudential requirements or New Zealand law prohibiting or limiting the issue of covered bonds. With the Reserve Bank’s consent, the BNZ became the first New Zealand bank to issue covered bonds, issuing NZ$425 million worth to domestic institutional investors in June. Westpac’s chief financial officer Richard Jamieson told interest.co.nz in June that his bank also hoped to get a covered bond issue away during 2010.

At that stage the central bank had indicated it was comfortable with banks issuing covered bonds worth up to 5% of their total asset bases, but Jamieson said Westpac would like to see this lifted to 10%. On Friday a Westpac spokeswoman would only say the bank supported the active development of a covered bond market in New Zealand and the consultation document was an important step in this process.

Both ASB and ANZ have indicated they are also considering issuing covered bonds. And the recently departed CEO of Kiwibank, Sam Knowles said the state owned bank would also look at covered bonds. A spokesman said on Friday Kiwibank was supportive of the Reserve Bank advocating and encouraging development of covered bonds.

“We expect to make a submission on this subject but we will not be issuing this product in the near term,” the Kiwibank spokesman said.

Funding benefits to bank issuers

The Reserve Bank notes that covered bonds have significant benefits for issuers by lengthening the term structures of their funding, diversifying funding by providing access to new investors and enhancing domestic capital markets.

“This benefits the financial system by reducing the likelihood of liquidity problems affecting an issuer, and promoting the sound and efficient operation of the system.”

The central bank says the primary attraction for banks in issuing covered bonds is the chance to access relatively cheap long-term funding and that it has been concerned for a number of years about New Zealand bank’s over reliance on short term funding. This is something the banks are striving to overcome following the introduction of the Reserve Bank’s core funding ratio (CFR) on April 1. The CFR requires banks to source 65% of their funding from either retail deposits or long-term wholesale funding with maturities of more than one year.

The central bank aims to lift the CFR to 75% by mid-2012.

The Reserve Bank says the potential negative consequences that could arise from covered bonds don’t represent “a compelling argument” for prohibiting the issuance of covered bonds, so long as covered bond issuance is restricted to a conservative level. It notes that recent overseas experience shows an issuer with a AA credit rating could expect to save up to 50 basis points by developing a triple-A rated covered bond. 

Covered bonds generally attract AAA credit ratings, giving them a higher credit rating than any of the AA rated ANZ, ASB, BNZ or National Bank and AA- rated Westpac.

They are generally issued at 50-60% of whatever the standard senior bond spread is. For example, if a bank issues five-year senior vanilla AA rated bonds at 100 basis points over the swap rate, it should be able to issue AAA covered bonds at 50-60 basis points over that swap rate. However, BNZ’s issue, comprising a five-year bond and seven-year bond, was priced at 98 basis points over the swap rate for the five-year and 112 basis points over the swap rate for the seven-year.

Legislation sought

The consultation document notes there are two types of covered bonds; - legislatively backed ones and structured ones, such as those issued by BNZ. The latter, rely on contractual arrangements to protect bondholders’ rights, whereas legislatively backed bonds enshrine bondholders' interests in legislation. The Reserve Bank says that whilst discussions with market participants suggest some overseas investors would be willing to hold structured covered bonds issued by New Zealand banks, others were only willing to invest in legislatively backed bonds.

Furthermore, overseas benchmarks suggest a robust legislative framework could result in additional savings of 5 to 10 basis points compared to structured bonds with the same credit rating.

“The Reserve Bank’s initial view is that a legislative framework should be developed,” it says.

The central bank hopes to introduce a covered bonds register and for legislation to be introduced during 2011.

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148 Comments

 ".....now be happy for banks to issue covered bonds worth up to 10% of their total assets, based on the value of assets securitised."

Anyone else still puzzled as to why this is called Noddyland?

So let's say that my own mortgage is assigned to the pool to be covered. Don't I have to be asked or at least told, that my defacto lender is now an offshore entity of some non descript nature? Isn't this what has gotten the States into the foreclosure mess it's now in? ie: who owns the mortgage, and how is the paperwork tracked from borrwer to lender, if or when things go bad.

'the rights of foreign covered bond investors to mortgages written by New Zealand banks ahead of local bank depositors'

Hmm, I may need a bit more interest as it appears my security isn't quite as good, especially if house prices keep falling. heck ,why dont hey let us know their Loan to deposit ratio so we can make and informed decision.

from money morning

Remember how people swarmed the banks in the UK and the US to withdraw their deposits as soon as there was a whiff of trouble at the banks. Well, take a look at the latest Commonwealth Bank annual report.

The CBA records in its balance sheet that it holds $374 billion of "deposits and other public borrowings."

Yet, if you look in the Assets column you'll see the bank holds just $10.1 billion of cash and liquid assets. And if you drill down further you'll see that the CBA holds just $3.09 billion in "Notes, coins and cash at banks" in its Australian vaults.

In other words, it tells its customers that their cash is available when they want it, yet less than one cent on the dollar is sitting in the CBA's vaults.

So, run it past me again. If Australia's property market collapses by 40%, according to Fitch, this will only have a negligible impact on the banking system.

Yeah right.

It certainly looks ominous. 

Banks have very little need to hold cash,  so little cash does not worry me too much.

Liquid assets is more of a concern since these are held at other banks as deposits and might not be available in the event of a systemic crisis.   

But at the end of the day, if one of the big 4 was in trouble the whole banking sector would be in trouble, it would be deflationary, and the RBA would supply whatever cash or cash equivalent  was needed to the system by taking whatever collateral was available.   The RBA can write up billion dollar banknotes if necessary just by getting the governor and secretary to the treasuries signature on a piece of paper.

And ultimately if people are scared away from banks then deposits will circulate rapidly and rapid inflation will result, so a deflationary collapse via a banking collapse seems next to impossible.

"And ultimately if people are scared away from banks then deposits will circulate rapidly and rapid inflation will result"

This depends on the actions of the central bank.

Andrew - have a look at this http://www.youtube.com/user/cedec0#p/u/3/t4uVqRt2eV0

There the Federal reserve, after their first round of bailouts, has paid above market value for banking system securities which has resulted in "excess" reserves being held.

If there was no central bank, due to the effect of interest (and yes sure the banks spend some of that interest back into circulation) the sum of the deposits will tend to be less than the sum of the banks assets, over time.  If, because they were spooked, all the depositers of a bank rocked up on a particular day and wanted their money out.  Then, if there is a central bank and it was prepared to buy the banks assets, then sure you will get your inflation, but understand why, it's a debasement of the currency due to the central banks ability to print money for nothing and liquidate "assets" quickly, and no bank (with access to the central bank) ever has to go under.  If there was no central bank, the bank would go under and there there would be true market price discovery of the banks assets and depositers would get their money back over time, at so many cents in the dollar, as the borrowers paid their loans off (and the bank's shareholders would be wiped out).

CTNZ and Fred

if you spend your money on gold then somebody else has your money  and presumably if people do not feel comfortable with a bank deposit or banks or fiat that money will be spent very quickly on something tangible - stocks of food or property or whatever they feel is a good store of value for them.

Only if people value fiat can they  cause a deflationary collapse by putting fiat in their mattress if they dont trust banks and how likely is that when the government will always lean against that possibilitiy by devaluing the money??

Fred we do have central banks and we do have governments who will act against deflation.

heck ,why dont hey let us know their Loan to deposit ratio so we can make an informed decision.

They already do, in their General Disclosure Statements.

BNZ kicked off with borrowing $425 million...this they will cook up until it amounts to nearly 4 billion in new credit to be sold to fools to chase price bloated property in the Noddy ponzi scheme....WHY?...because the bank wants to protect it's previous loans made on price bloated property...the bubble must be saved! Oh there are enough mindless morons out there willing to be the host to this parasite...and the value of the new loans will be nearly 4 billion...which means the BNZ can then print off some more securitised filth to be swapped for more hot toilet paper out of the US or the UK or Japan...take your pick....then it's back to Noddy to flog off another round of cheap nasty credit...round and round we go...deeper and deeper into debt..isn't this fun!

You can sit back and watch as the economy is driven deeper into the hole by these people..or just watch the Alice in Wonderland sky movie....there is no difference.

I would be really interested to know how these things are priced.  Are they like a standard bond? ie, the coupon payment divided by the interest rate.  In which case there's a huge capital gain to be made out of the difference in the interest rates between the retail and the wholesale.

I also see that one of the reasons given in the paper are to "reduce dependance on short term deposits for funding".  Aren't these the opposite, you sell a bunch of mortgages, packages them up, pocket the capital gain by making them appear less risky than the sum of the parts, and the difference in interst rates.  Move your assets (loans) into a trust away from your balance sheet (the risky part from the RB perspective) but you then end up with cash of at least the face value of the bond, ready for fresh lending.

What these do is monetise debt, take a future cash flow and turn it into it's net present value.  If you have a mortgage which is a stream of payments at a discount rate of 8% (= the retail rate) the NPV is the value of your loan (say $100,000).  Discount the same series of payments at 2.5% and the NPV is quite a bit more (stick the figures into a spreadsheet), and there's your capital gain right there.

Of course this is of relevance to the borrower, because what this does is change the cost of varying the loan.  What is the real cost in a securitised situation?  Well that would depend on what provisions are made, and it would also depend on the price they sold the bond for (back to my first question).  You could well find that the "cost" of early termination is as good percentage of the total interest that they are expecting to earn from the loan.

Of course the banks want to do this, while overseas interest rates are next to nothing (again based on my assumption about how they are priced) and our RB promotes a high interest rate policy.

The discussion paper doesn't say a thing about the current issues with title over in the USA.  Are they ignoring this, or is this because there is no issue?

As a wholesale investor, issuance of covered bonds bothers me for a couple of reasons. My concern relates to existing senior bonds, which are not 'covered'. Theoretically, if a bank came under serious stress, a wholesale investor in senior-ranking bonds would be subordinate to covered bond holders and feasibly subordinate to retail depositors, depending on whatever govt guarantee arrangement panned out. If I want to accept the additional risk in a world where covered bonds exist, then surely I need a larger spread to compensate me. The markets don't usually offer a free lunch. The RBNZ would understand this and the covered bond idea is therefore a technique to make it easier for banks to extend the maturity profile of their debt. That's a good thing and improves solvency at the margin. But it does not outweigh the effect of subordination and I am not convinced the bank treasurers will concede that they should pay more for their vanilla senior debt. Investors would need to argue for this.

The second thing that bothers me is the idea that changing the covered bond maximums moves the goalposts. Say I buy a senior 3 or 5 year bond and next month the RBNZ increase the covered bond max level. That means I just bought a bond that is now likely to become more subordinate. Tough. So, to make the market credible, the RBNZ needs to make every effort to set policy and stick to it. This news looks like the RBNZ are catering to the banks and their own financial stability goals at the expense of investors. If the RBNZ proceed, I'd argue for a long lead time and plenty of notification. Banks need to be open about their planned issuance and if they aren't investors might want to ask for coupon step-ups linked to covered bond issuance to protect them from unanticipated subordination risk. I'd guess the chances of success here are low.

Very interesting points onestepahead

cheers

Bernard

This news looks like the RBNZ are catering to the banks and their own financial stability goals at the expense of investors.  

But then bank stability is the 'greater good' - according to neoliberal political theory, that is.

I had no idea covered bond holders claims,  which are popular in Europe, are senior to depositors.  It might though explain why house prices here in Finland are so high and still going higher.. 

Ok consultation over....did you get the message there Bolly....the covered bond securitised mortgage cash raising ponzi scheme investment rort is not the way to ensure Noddy's financial future remains free of massive cock ups.

Now you settle in for a long hard recession Bolly because that's the cost of the cheap credit partytime. The skilled labour is heading for Jewleya's shindig and that is about the only bit of luck Noddy will get. But it will not last as you know.

Iain

I have pointed out to you several times before i do not work for a bank or have anything to do with banking.   Neither do i work for government or anything like it.

If you want to be successful you need to win hearts and minds rather than alienating people who are already interested in financial reform.

"about Northern Trust

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"affluent individuals" need access to good assets.

Has Bill English answered the question "why don't we just monetise our debt"?  Is the answer that this is illegal/fobidden under the international banking accords we are party to?

Thanks for your insights Fred, and yes I was wondering  "why don't we just monetise our debt" as well. Wouldn't this have been a choice question to throw at AB?

The lawyers in the States are in party mode...the banks are being sued by the hedge funds who want billions in damages and surprise surprise the DOW is toast...Aymereekans are telling the banks to take a hike.."show me the paper"..is the new song in the suburbs....now who put their life savings into US bank shares yesterday....didya well didya!

I work in Sweden for a bank that specialises in mortgages (no retail account banking, just phone and internet mortgage applications), and we source the bulk of our finance from "covered bonds".

As the remarkabley tolerant Andrew from Finalnd says, covered bonds are a well establish method of mortgage financing in Europe. The bonds are principally sold in the wholesale markets, from terms of 3 months to 10 years, and are just like "normal" bonds, differing only in their security.

In our bank, a run is done every night through every loan on the books and if a loan is deemed "qualifying" (basically a high quality loan with a good loan to value ratio) it is put into the qualifying pool, and this pool forms the secured "cover" for the covered bonds - all the various tenors of covered bonds have security over the pool, and the pool value is typically slightly larger than the total amount of the covered bonds. In the event of default or insolvency of the bank, the loans in the pool and their underlying assets will be dedicated to redeeming the covered bonds, anything left over goes into the next ranking debt. The pool is constantly adjusted daily. Additionally a detailed analysis of the bonds and covered pool is sent to Moody's and S and P every 3 months.

Note that the loans in the pool still belong to the bank, and haven't been assigned, and never will be. The loans of excellent quality (trust me, no lo/no doc loans, borrowers have good credit ratings ...) the loan to value ratios are typically below 75-80% and often much less.

This means that the rates the banks can borrow on the wholesale market can be very low, as they genuinely deserve a high AA or better rating, and of course, in theory this can get passed onto our clients; well it does happen sometimes.

The bonds out rank normal senior debt, in that they are secured against a specific pool of loans, and of course this does have implications for the interest rates that lower rated bonds further down the food chain might require. Our bank does not have an account holders in the normal sense, so this is not really an issue for us, but if the big four banks in NZ did issue covered bonds to any great extent, this would be an issue. 5 to 10% of assets doesn't seem to be particularly bothersome though.

Properly managed they are a very sensible way to raise mortgage finance and diversify funding sources.

And let's take an extreme, teabagger. Let's say your boss comes down to your office, and asks you to  re-allocate the pool to 'bad risk mortgages". He may know something you don't, maybe not. But what would you do? My point being; it's all very well and good to allocate 'the good loans' to the pool during goods times. But as we have all seen, during stressed times; the bad times; all sorts of misallocation goes on. And it can be a suprise to the covered bond holder, in that case, as to what is actually 'in their pool'.

Do you lend on residential property, what percentage is your lending to business?

 ".... "......a bank that specialises in mortgages (no retail account banking, just phone and internet mortgage applications), and we source the bulk of our finance from "covered bonds".....]

So this bank just started out being given the nod to dream up a few billion in credit and kick the mortgage ball rolling did it?...no deposits were required!

Well that certainly reduces the risk for depositors when the shite hit the fan ...there are none!

Check it out Teabaggger...find out how deeply involved in the bank the pollys are...follow the money.........

Wolly

The covered bond holders are effectively term wholesale depositors who dont get paid a high rate of interest compared to the other wholesale depositors who get a higher rate of interest.

What could possibly go wrong? (I was going to double check that the lending was on residential mortgages)

Nothing and everything.  You think you are investing in real assets and you are, but what you are doing is monetising the future income of the person that's living in the house (assuming you sell real estate loans secured against property).  This is fine, but you haven't contributed any funding towards the jobs that would assist in paying off the loans someone else has to take that risk.

If you lend more more money than it cost to build that house, or even if you lend to a second person to buy the house (and the first has paid it off and walks away with the money) you are creating debt and there has been no corresponding economic good created to pay that debt off.  The house was there before you extended the loan and it's still there afterwards, unchanged.  The earning capacity of the economy has not been improved as a result of the loan being extended.

These actions are ponzi like.  The economy can withstand a few lenders doing this, but if everyone is doing it, it ends up being a misallocation of savers' money and they won't get their money back.

As you were, never mind me, carry on, cos it pays the bills.

And by the way it's all above board isn't it, because this "is different" to that http://www.zerohedge.com/article/whistleblower-speaks-fraudclosure

Iain Parker

I am still not sure what your real grievance is with private banking or the RBNZ.  But on your blog you say this:

9- Could you please tell me if, in New Zealand, a “new” mortgage at issuance, before it becomes tradable, is loaned to a borrower by a registered bank, is that mortgage created as a debt book entry account, not anyones existing savings, but an electronic debt book entry creating “new” money?

That is a horribly worded sentence!    A mortgage is a debt.  It is not loaned to the borrower.    The mortgage is the borrowers promise to repay the bank.   When the borrower promises to repay the bank, the bank creates a promise to the borrower or creates a line of credit to be used to buy a specified house in the future..   This is the same thing as being issued with a credit card with no debt and a limit for a house worth of purchases.

Once you use 'the card' the bank then has the ability to transfer the liability it created to pay you a house worth of money to either an existing customer (where they effectively now have a credit card with a limit for a house worth of purchases) as a liability to pay them or the bank has to have to pay another bank central bank money or get an interbank loan etc.

The bank is not creating something for nothing as you seem to believe.

Hi Teabagger

Thats a great comment thanks.  The mechanics of the process are now very clear, but I am majorly resisting the idea that a deposit taking bank can divert deposits into mortgages and then enable other investors in the bank to be senior to the investing depositors, no matter how small the percentage involved.   

Even if the bonds were issued by entities not apparently connected to the banks I would also wonder who would be investing in the covered bonds and protected from losses and to what degree they are connected to the ownership of the banks.   

Obviously if some of the banks can be in a position to allow the depositors to take the losses and still own the assets they are going to try that on if they can.

And as we know in Sweden/Norway when the banks were calling in all of the loans as the economy imploded in the 1990's the governments severely haircutted the bondholders, wiped out shareholders, installed new managers and recapitalised the banks.    Politically i doubt NZ could do that to Australian banks and still be able to trade with Australia their biggest trading partner

Covered bonds might therefore reflect the unique social parterships that apparently still exist in scandanavia and in Germany?

@Nicholas A
The rules governing what's in and what's out of the pool are very strict and highly regulated. It's just not possible to casually allocate or deallocate them.
The state's financial inspectorate also takes a keen interest; we have to provide regular reports about the probability of default and likely loss in the event of a default for our loans.

But in essence, there is a strong culture of integrity, supported by vigorous regulation. As Andrew of F mentioned, the Nordic/Germanic culture is better suited to this, but there is no reason NZ cannot make it work with proper supervision.

Covered bonds do not really affect the banks depositors in the sense that they are subordinated, unsecured debtors at the bottom of the chain, and remain so. The bonds in essence re-arrange the senior portion of the bank's debt, splitting it into two tiers. The now lower ranked senior debt has some cause for concern.

@Fred
We have three roughly equal divisions, mortgages to home and individual apartment owners (residential), mortgages to apartment owners associations and loans to property developers.

@Wolly
The bank, SBAB have been going for over 20 years, initially set (capitalised) up by the Swedish government to provide mortgage competion. They are basically run as an SOE (and return around 9-10% ROE), The government indicated some years ago that it wished to sell it off, beautifully timed just at the start of the Financial crisis, so things are on hold for a wee while.

The prime web site of SBAB (in Swedish)
http://www.sbab.se

Current residential rates in English (read it and weep)
http://www.sbab.se/2.135/2.234/2.257

More info on their covered bonds in english
http://investor.sbab.se/sbab/jsp/polopoly.jsp?d=1538&selDep=1531

No doubt yoy are right, teabagger. But on a day when our news encompasses a Seroius Faud Office investigation around 'what was declared to the Government' or not, to allow SCF to enter the Government Guarrantee, I can only add that 'what should happen, doesn't always'; As the contributors to Robert Maxwell's superannuation fund or Bernie Madoffs fund, found out; and they were 'overseen' as well.

@Nicholas
Yes, fraud and sleaze will regularly appear in new and devious ways (and old familar ones too).
I suppose what I am trying to say is that covered bonds are really quite a prosaic and established mortgage financing method and should be treated like any other form of existing senior debt. They are no golden financial instrument immune from malfeasance (though they do tend to be more highly and more effectively supervised), but they shouldn't be feared either.

 ".. but there is no reason NZ cannot make it work with proper supervision.".

ahahaaaaaaaaaaahaha....oh that is priceless Teabagger....you clearly have a poor understanding of Noddyland...."proper supervision"....oh jeez I love it.....what a friggin laugh.

Oh Wolly wolly wolly you are a hardened cynic in these matters.

Actually, I think the general standard of supervision in Noddyland is quite good.  Certainly the standards of integrity and resistance to corruption are excellent.

But people have too high expectations;  it is fundamentally just very difficult to detect and prevent bad behaviour in a timely manner. Well thought out regulation can definitely have a strong positive impact, but it can never be enough.

In the specific matter of covered bonds, two points.
1: They are wholesale market instruments, and the participants in these markets are normally reasonably clued up and knowledgeable and can fend for themselves.

2: They are better suited to formulaic supervision than most.

  "...the participants in these markets are normally reasonably clued up and knowledgeable and can fend for themselves"........doh

Where have you been hiding Teabagger.....do some research on the financial shite going down in the USA...and then tell us who is clued up...and you might also ponder the fact that it is the US taxpayers who are bailing out all these 'clued up" entities you speak of.

My opinion....your covered bonds stuff is about as nice as a dog turd on the footpath....people with eyes and noses stay well clear.

@Wolly
There are no covered bonds issued in the USA Wolly, they are basically a European practice, and have been one of the principal methods of funding mortgages in Europe for decades. The market to date has been little affected by the Financial crisis, as in practice the quality of the covering pools has been up to standard, and there is little indication that this will change in the immediate future.

Though the American practice of slicing and dicing into collateralised debt obligations and mortgage backed securities looks superficially similar, there are significant differences.

1: The loans supporting the covered bonds are never assigned to another party, they always remain with the issuing bank, which severely reduces the incentive to cheat.

2: The quality of the underlying mortgages is far, far higher. Most European banks have been and still are quite conservative in their lending requirements, requiring substantial deposits, well documented ability to support the interest payments (including supporting future interest hikes), thorough credit checks, independent valuations. Default rates are still low (ish).

3: Supervision and regulation of general practice is more thorough. There is a more hands on approach to supervision.

Those European banks in trouble are not in trouble because of covered bonds.

"1: The loans supporting the covered bonds are never assigned to another party, they always remain with the issuing bank, which severely reduces the incentive to cheat."

Cheating these days takes the form of paying yourself a massive bonus for issuing billions of quality loans to great credit customers on the assumption that house prices can only go up and the central bank will protect you and there is no possibility that fannie and freddie or or the bank of new york are going to bust you to buggery by requiring you to buy back every single one of those loans you produced via an inadequate tool that has left your investors clueless to which houses they are entitled to go and possess to have a chance of getting their money back.

We can only hope that covered bonds can enable house prices to go up where other methods have failed! :-))

Teabagger

"In the specific matter of covered bonds, two points.
1: They are wholesale market instruments, and the participants in these markets are normally reasonably clued up and knowledgeable and can fend for themselves.

2: They are better suited to formulaic supervision than most."

As others are pointing out the clued up knowledgeable wholesale depositor can get protection and the regulator allows this, and rather than this sophisticated investor fending for themselves they rely on the system to obfuscate what is going on to privatise gains and socialise losses.

It amounts so far to a fraud in the telling so far of this story.

Teabagger

"Covered bonds do not really affect the banks depositors in the sense that they are subordinated, unsecured debtors at the bottom of the chain, and remain so. The bonds in essence re-arrange the senior portion of the bank's debt, splitting it into two tiers. The now lower ranked senior debt has some cause for concern."

The problem i see is that bank ABC can get an agreement to receive interest from bank AAA and be in a later possession of bank AAAs covered bond to a value of 1B and then when bank AAA wants to create mortgages that pay ABC then ABC can then tick this off versus the 1B until the 1B is "consumed". No money however gets transfered and the effect is that ABC has protected wholesale deposits that are senior to ordinary depositors who you say are not impacted because they are at the bottom of the chain. How can a regulator know this is happening? Either way, whatever the actual mechanics, the process enables banks to be protected ahead of ordinary depositors where you are even taking the trouble to ensure they get the best assets. A feature of scandanavian realities is that everything is a cartel. Even the plumbers have cartels.

@Andrew of F
Hi Andrew, I was confused by your example, could you expand a little?

What I meant by the normal depositors not being impacted is that their returns in the event of insolvency and liquidation will not be much different. They will of course be impacted.

For example, say a banks total liabilties of 100m are made up of 10m capital, 20m senior debt and 70m deposits and they replace 10m of that senior debt with covered bonds - 10m capital, 10m covered bonds, 10m senior debt, 70m deposits.

In the event of insolvency the covered bond owners will get the 10m of assets (loans) from the covered bond pool, then the senior holders will get 10m and finally the depositors will get the balance, and if everyone is paid up the shareholders might get something back.

If the actual realisable assets are less than 20m, then the covevered bonds holders will get their 10m (assuming the pool is still worth this much under such a catastrophic loss) and the senior debt the balance, the depositors will get nothing, the same as they would have got under the original debt distribution.

If the assets realise more than 20m but less than 90m, the depositors get that amount, less 20m, again out of pocket by the same amount under both scenarios.
 

Teabagger

What i am getting at is there are two classes of depositors:

mums and dads so to speak

wholesale depositors.

In theory they are treated equally although the wholesalers might be out quicker than mum and dad if there was trouble.

But a covered bond holder is effectively a term wholesale depositor. Covered bonds enable the other banks to have secured cross lending between each other to ensure they have fully lent out their excess reserves where the risk is carried by mum and dad or the tax payer generally.

What the Reserve Bank fails to point out is that the cornerstone of its regulatory regime is market discipline, and currently all banks (apart from BNZ now) funding is equal or subordinated to depositors.

With this structure in place, it means the people who have the most capability to exert market discipline are incentivised to do so, and thereby protect the retail depositors as well.

What this proposal does is that it creates an upper teir of funding, that all other funding, including depositors will be subordinate to, thereby increasing the overall riskiness of the deposit base.

If the Reserve Bank does not at the same time increase its regulatory discipline, say through higher capital ratios, and prefundied deposit insurance etc, then all that is happening is that the banks will be able to increase their funding profile at a lower cost, therby increasing profits to their shareholders, but at the same time increasing risk to the rest of the market.  We all know that, even though the Reserve Bank denies this, the government will bail out depositors - and increase the costs to the taxpayer.

Banks can increase the term of their funding right now - just at a cost which they want to avoid by passing the risk on to the taxpayer.

Is the old story of privatisation of profit, and socilisation of losses.

 

This consulation just shows how captured the Reserve Bank has become.

It has a statutory obligation to avoid damage to the financial system on the failure of a registered bank - it is ignoring that responsibility and should be taken to task about it.

If they want to go down this route, then banks should be required to hold much higher levels of capital, and should be made to contribute to a prefunded deposit insruance scheme, with rates being calculated on the risk to the Crown, and not overall risk.

This is the thin end of the wedge, and should be challanged - especially the drive to get legislative backing, because wihtout that backing, a statutory manager could challange the preferential security under the current Reserve Bank Act.

I wonder who got paid off at the RB?

It will also knobble the effectiveness of the core funding ratio as a macro-prudential tool

If the RB doesn't include covered bonds in its core ratio requirement, then yes there is an out for banks.

I just assumed that the covered bonds would be included amongst the normal senior debt, and that it would replace other senior as a source of funds.

AAA, has the RB given an indication that this would not be the case?
If the CBs are included, then the status and risk profile of depositors doesn't change, there is just a re-alignment amongst the senior debt holders.

Teabagger

A deposit is a debt.  How does a bank have a senior debt that ranks higher than a deposit?

  Are you saying this is the debt the bank starts with which means it has less equity than the available working capital and bank owned assets?

Are you saying a covered bond can only be used to replace an existing senior debt created before the bank began taking deposits?   The impression i get is that issuing a covered bond simply enables the bank to offer secured wholesale lending for a wholesale depositor investing in the bank who is now mysteriously ahead of the other depositors.

Have i got my wires crossed here?

@Andrew

Banks can issue senior debt, typically unsubordinated bonds, that rank ahead of depositors. All our big four issue such bonds (and various hybrids that may rank with deposits, or may not). For example, the ANZ has an unsecured, unsubordinated bond (ANB030) for 150m at 6.8% expiring this coming 17 Feb 2011. This bond will rank ahead of depositors in the event of insolvency.

A Covered Bond doesn't have to replace other senior debt, I had assumed that if the Reserve Bank set the ratio say of senior debt to total liabilities, that it would include covered bonds as part of the senior debt. This would mean that if they reached their ceiling and wanted to issue more CBs, they would have to replace it with existing senior debt, if they hadn't reached their limit they wouldn't of course.

But Anon annoy anono has raised the possibility that CBs may be outside of this control, which does alter things somewhat. But I don't know what the RBs position is on this. Does anyone?
 

Teabagger

Thanks for your help.

Some interesting comments here. I am enjoying the debate Cheers.

Therefore the valuation(s) becomes ever more critical? i.e. over valuation of assets potentially allows a greater than the maximum 10% of issuance to be shelled out from total recoveries in the event of default (as a percentage).

Over valuation quite topical given some recent failures in N.Z. such as Feltex and Hanover.

The evidence is mountaing that the RBNZ is out to protect the bubble...to protect the banks....to protect a system that is distorted thanks to the bubble...at some point somebody has to stand up and tell the bloody truth....property in Noddyland is seriously unaffordable because the market is a ponzi scheme inside a bubble blown on cheap easy credit....throwing more cheap easy credit at the mess will not help....but that is what the RBNZ is setting out to get the fools in the Beehive to accept as a wise move...hence the covered bond bullshit....

Why is all this so hard for so many to see?

And that brings us to Noddyland's very own QE programme...which is clearly going to involve the banks being given some form of Govt Guarantee over their covered bond poo...and the end result will be..wait for it...a mountain of newly created credit that you, the stupid peasant will be told is a must have for every Kiwi...get your slice of the Elephant of debt...just try not to be in the wrong place when it sits down.

The spin is being crafted in wgtn...the dumb media lined up to push it...You are going to be blamed for the fact that the economy is in the shite...it's going to be Your fault because You have stopped splurging with the cheaper for longer credit...all your doing!

That brings us to the day of reckoning...somewhere out there in the future just when you think things are improving..along comes the inflation riding on the back of the covered bond poo and all the other money 'printing schemes in Noddy'...guess what will happen to your interest rates on that day...yup..the Elephant is sitting down....splat.

Wolly the QE wont get far past covering the losses the banks are facing. Inflation-not yet

 

Greg Pytel  on the problem

 

Liquidity v money supply/demand

 

On 7 October 2010 The Economist published an article "The costs of repair". Its author wrote:

"So far the current recovery is following this post-crisis script. Output is sluggish and credit is growing weakly or shrinking across much of the rich world. But is this because over-leveraged households and firms have become less willing to borrow or because banks have become less willing to lend? In other words, is the credit problem one of demand or supply?"

Then the author concluded: "Both supply and demand probably play a role."

The question is wrong and the answer is wrong too. The problem is neither of supply nor demand but of liquidity: i.e. too high money multiplier makes it too risky to lend and to borrow. Banks do not have money to lend without fear of losing liquidity and money is too hard to come by to repay loans which is putting off prospective borrowers. In terms of statistical analysis (correlation) such situation will show up on both: supply and demand as causes, as both are causally subsequent to an underlying (and overriding) cause which is too high money multiplier (i.e. liquidity shortage). Here you can read more on liquidity shortage caused by high money multiplier.

Hopefully such money multiplier based analysis of the current financial crisis finds its way into the mainstream.

Incidentally it appears that the mainstream economists put too much weight, without understanding, on statistics and real analysis (in mathematics) and too little (practically nothing) on other branches of maths such as topology (that allow to determine relationships between phenomena which are the subject of an analysis). And The Economistand the mainstream media and the politicians are just confused. Little wonder, over 2 years after the Lehman Bros collapse the financial world remains in a mess and the taxpayers keep paying for it: after stimuli, spending cuts. What's next since the end is not in sight

http://gregpytel.blogspot.com/2010/10/liquidity-v-money-supplydemand.html

"This ring fencing of a chunk of a bank’s balance sheet is why covered bonds are banned by the Australian Prudential Regulation Authority as, in the event of a default by the bank issuer, depositors’ claims are diluted."

Why are the Australians different?   

Here's why Les:

Australia’s Banking Act requires that, if an authorised deposit-taking institution (ADI) becomes unable to meet its obligations or suspends payment, the assets of the ADI in Australia are to be available to meet that ADI’s deposit liabilities in Australia prior to all its other liabilities.

“In substance, covered bond structures subordinate the interests of depositors of ADIs to the interests of the covered bond holders. For this reason, APRA has an in principle objection to such structures.”

For more see here - http://www.interest.co.nz/news/aussie-regulator-unlike-rbnz-still-oppose...

Thanks Gareth. Am no whizz on this, but I had a basic understanding of that from what I've read before on Int.co. My question was really about why we have different principles that mean, "APRA has an in principle objection to such structures," but we don't. Don't we give a toss about savers?

Is it because they are less keen to follow ortho'box norms and look after themselves? Methinks they do, hence my comparison to the way they support private sector R&D. Maybe there is a similar comparison between fin.secs - them better regulated to promote legitimacy and trust cf. us, the wild west?  I don't know on that one, as am not as aware of their fin.sec problems as I am ours, which are as obvious as balls on a dog. (Our regulators need to get their eyes tested, or something ...)

Cheers, Les.

Gareth?les

So what are these about then.  If these aren't covered bonds or RMBS what are they?

http://www.commbank.com.au/about-us/securitisation/pdf/medallion-trust-r...

Hi Fred - the bounders! Am saying that after reading just reading page 1 of the 276. However, I guess they'd be subordinate to deposits, not 'tother way around as over here, which is the difference in the principles behind the two different frameworks? Thoughts?

Cheers, Les.

Well all the terms are there;

The loans are "sold" into a pool and there is a servicer etc etc.  The structures look exactly the same, so it's a moot point to argue that they are different, they are all complex documents so it would be possible to delve into them and come up with something and say aha this is different.  In the end tho, the loans are sold into the pool so they are off the balance sheet . . . by definition.

"The information in Appendix A, attached to this prospectus supplement, sets
forth in tabular format various details relating to the housing loans proposed to be
sold to the trust on the closing date"

There is a statement that says;

"The Class A notes will not
constitute ‘‘mortgage-related securities’’
for the purposes of the Secondary
Mortgage Market Enhancement Act of
1984 under United States federal law."

There are some words in there about what happens when there is a default in terms of the trust deed see below.  But it's very clear that there is a trust that holds a pool of loans that have been sold to the trust, and surely this means that anyone buying the securities has equitable ownership of them.

It looks like a duck, quacks like a duck, so it must be

Perpetual Trustee Company
Limited, as issuer trustee, will grant a
floating charge over all of the assets of
the trust under the security trust deed in
favor of P.T. Limited, as security trustee,
to secure the trust’s payment obligations
on the notes and the redraw bonds and
to its other creditors. The floating charge
is a first ranking charge over the assets of
the trust subject only to a prior interest
in favor of the issuer trustee to secure
payment of certain expenses of the trust.
A floating charge is a security interest on
a class of assets, but does not attach to
specific assets unless and until it
crystallizes, which means it becomes a
fixed charge. The charge will crystallize if
an event of default occurs under the
security trust deed (but in some cases
will crystallize only over the assets
affected by the event of default). While
the charge is a floating charge, the issuer
trustee may deal with the assets of the
trust in accordance with the transaction
documents and, if it acts contrary to its
duties, may be able to deal with the
assets of the trust in such a way as to
prejudice the security trustee’s interest in
the assets in breach of the transaction
documents. Once the floating charge
crystallizes, the issuer trustee will no
longer be able to dispose of or create
interests in the assets of the trust affected
by the crystallization except in
accordance with the transaction
documents. For a description of floating
charges and crystallization see
‘‘Description of the Transaction
Documents—The Security Trust
Deed—Nature of the Charge’’ in the
accompanying prospectus.
Payments of interest and principal
on the notes and the redraw bonds will
come only from the housing loans and
other assets of the trust. The assets of
the parties to the transaction are not
available to meet the payments of
interest and principal on the notes and
the redraw bonds. If there are losses on
the housing loans, the trust may not have

Fred

Covered bonds are secured by quality mortgages on the banks books.  In the event the economy goes bad the bank is required to keep the best mortgages in the covered pool which dilutes the final payout for depositors if the bank fails. 

if the mortgages are sold and the economy goes bad the investors just eat the losses and only have recource to the bank if there was fraud.   These investors cannot easily impact the depositors unless they can prove there was fraud.

Iain, hypotheticated or sold?  Going by RBNZ consultation paper they say in Para 47 "Within these two broad options, we believe that there is a spectrum of approaches that could be implemented. These are outlined in figure 1 below." and they range from saying to banks, "do what you like under current legislative framework" (which allows these things anyway), to "we will provide a legislative framework".  I see that they still talk about the creation of a special purpose vehicle which is bankruptcy remote and that a "true sale" needs to occur.

Therefore the assets are completely removed from the balance sheet of the originating bank, and the SPV is just that in the event of insolvency of the banks, the assets in the pool can't be touched.

In the other direction, the bond holders have "dual recourse to both the assets in the pool and to the issuer".  If the mortgages have been sold as a true sale, then there can't be anything left owing, but maybe as a separate transaction the SPV has a claim on the issuer, so how can it be bankruptcy remote?  A classic case of having your cake and eating it too.

Thanks Iain.

But why have the Auzzies decided not to do this?

I often ask why the Auzzies decided not to repeal their R&D tax credit when NACT repealed ours?

Perhaps similar reasoning behind both decsions?

Cheers, Les.

www.mea.org.nz

Iain Parker

I am still not sure what your real grievance is with private banking or the RBNZ.  But on your blog you say this:

9- Could you please tell me if, in New Zealand, a “new” mortgage at issuance, before it becomes tradable, is loaned to a borrower by a registered bank, is that mortgage created as a debt book entry account, not anyones existing savings, but an electronic debt book entry creating “new” money?

That is a horribly worded sentence!    A mortgage is a debt.  It is not loaned to the borrower.    The mortgage is the borrowers promise to repay the bank.   When the borrower promises to repay the bank, the bank creates a promise to the borrower or creates a line of credit to be used to buy a specified house in the future..   This is the same thing as being issued with a credit card with no debt and a limit for a house worth of purchases.

Then when you are going to use the 'the card' the bank might have the opportunity to transfer the liability it created to pay you, for a house worth of money, to either an existing customer (where they effectively now have a credit card with a limit for a house worth of purchases) as a liability to pay that customer, or the bank has to have to pay another bank central bank money or get an interbank loan etc.

The bank is not creating something for nothing as you seem to believe.

Iain

You are making it too complicated and just getting confused as far as i can understand.

The bank can only create credit if it has a saver who is happy to save.   I just explained this:

The bank gives you a credit card with 0 debt and a limit on it.   At the time of purchase the bank notes the amount of your purchase and credits the seller with the proceeds of the sale.

That is all there is to it.

Gosh ! Even a " bumper-sticker-boy " can understand that .

Crikey Iain , wot say you ?

Andrew : Iain truely believes that banks create credit out of thin air . He ponders at some length ........ ye Gods the length ....... that he ought pay no interest on his mortgage 'cos the banker made the munny , " ka-poof " , as if by magic .

You cannot rationalize with a conspiracy theorist , nor with a Gummy Bear .

Enjoyed reading your postings today : Cheers !

Roger/Andrew

Actually Iain's right.  I can't believe that you are still saying what you are saying Andrew.  It's explained in the federal reserve booklet here http://www.archive.org/details/ModernMoneyMechanics and Steve Keen's post roving cavaliers of debt. 

The saver comes after the debt creation, without the debt creation there is nothing available to save.  Are you thinking about the very first deposit that has to be saved to start the bank?  Even then the very first loan would have to come first.  The money that comes into circulation is the debt of the borrower.

Andrew, if you are locked into your way of thinking it can't be changed.  But here's another question.  Look at the federal reserve money supply figures, noting that it has increased exponentially, and answer this.  Was it saved into existence or was it borrowed into existence.  Or even just simply "where did it all come from"?

The real reason why the money is created out of thin air by the borrower is because the money is being borrowed from a legal person, not a real person.  A real person would have to hand over real money to the borrower, whereas when it is a fictional legal person then it's fictional money (made real by the borrowers determination to pay it back).  The lender still has the borrowers note that could be traded.

 

 

 

Fred

Modern money mechanics entirely agrees with me.      Unless you want to have money in your current account that the private bank owes to you that  you are not spending, the private bank can only create the money that you spend by owing another customer for the purchase.   This owed money is called commercial bank money or deposit money or cheque book money.

If you name a forum i can go thru modern money mechanics in precise detail to show you where you are mistaken.    For example Steve Keens forum http://www.talkfinance.net/

First you have to understand how a private bank works without central banking then you can begin to understand how private banking and central banking work together. Of course the central bank can just print up the notes by devaluing existing money if it wants to. The situation is different with private banks. Private banks can only do what you and I do. We can create a private money for our customers use that is exchangeable for central bank money (that we are required to provide if asked by our customers) but our private money is useless to us and is simply the means of exchange for our customers where one customer is effectively owed by the other customer and we guarantee the seller gets paid and for the service to buyers we receive a fee. You and Iain and others are entirely misunderstanding the whole process. Banks however still need effective regulation and control by the society they operate in.

Andrew, I'll have a think about this today.

Unless you want to have money in your current account that the private bank owes to you that  you are not spending, the private bank can only create the money that you spend by owing another customer for the purchase. 

But it seems to me that this sounds more complicated than it is.

Catch you tonight.

Fred

This might help?

http://maxkeiser.com/watch/the-keiser-report/keiser-report-77-14-september-2010-guest-steve-keen/

11:30 Max begins talking to Steve Keen

Kaiser gives his version.....

Keen responds

14:22 a bit over the top mate, ill bring you back a bit
14:40 creating a loan creates a matching deposit at the same time and then if the banks need the reserves they go looking for them later.

So the bank can only create 'out of nothing money' by owing somebody this money. By definition a deposit is called cheque book money. It is money because if you transfer a deposit from one person to another then you are creating 'the means of exchange'. So if you owe a person central bank money and move your liability to another person who you now owe this central bank money you enabled 'the means of exchange'. So by definition you have useable 'deposit money'.

So a bank 'creates a loan' and you spend the money and the bank owes somebody this money. A bank regulated by a requirement to hold an amount of central bank money to back deposits must have this fraction of the deposit so it has to go to the money market to borrow this cb money. But the CB keeps interest rates in the money market to target by either providing or taking away CB money. If the act of creating a deposit requires a bank to get more CB money than is available in the money market interest rates rise and the CB has to provide this money to get rates lower again. So deposits lead CB money where CB money is by definition called Reserves.

That is what Steve is saying.

Andrew,

So we agree.  This is useful also http://econviz.com/balance-sheet-visualizer.html  Writing a loan creates money out of thin air.  Somone else's savings are not a pre-requisite.  The act of writing the loan creates the money.  The deposit balance of the person borrowing the money goes up by exactly the amount of the loan, the banks liabilities go up by the same amount of the banks assets.  The amount of money in circulation goes up by the amount of the loan.

When you say

"Modern money mechanics entirely agrees with me.      Unless you want to have money in your current account that the private bank owes to you that  you are not spending, the private bank can only create the money that you spend by owing another customer for the purchase.   This owed money is called commercial bank money or deposit money or cheque book money."

Makes no sense at all.  There's too may double negatives.

Fred

the loan account entry places a promise of central bank  money in your account if you do not spend it.

Most people do not do that.

Most people get a loan so that the promise of central bank money is in somebody elses account.

As i said before the only way the bank can create cheque book money is if it owes somebody central bank money. There is no other way. Nothing particularly dodgy is happening here. If you get a mortgage loan to buy property the money is always placed in somebody elses account before it is ever available as cleared funds for you to spend - the banks lawyer ensures that. And the other side does not release the ownership paper until cleared funds are received. If credit is created the bank is always only owing somebody the money via a deposit entry or IOU.

You seem to be confusing the nature of deposit money?   It is just a promise of money.  That promise of money is the means of exchange between customers and is therefore by definition it is money.   But the bank is only doing something you can do amongst your own customers who can buy and sell and save and borrow  via you and be owed by you unitl they require CB money.   The loan account entry is simply two promises.   But the bank is now contractually  liable  to give you central bank money and has to have the ability to be able to do that if necessary.

Andrew

"the loan account entry places a promise of central bank  money in your account if you do not spend it."

Unless it's a personal loan the loan is secured against an asset that the borrower has agreed to buy.  There's no discretion.  On the other hand a personal loan is secured against the assets of the bank's shareholders, so the sum of the personal loans should be limited to the bank's shareholders funds - see related party loans.

As i said before the only way the bank can create cheque book money is if it owes somebody central bank money. There is no other way. Nothing particularly dodgy is happening here. If you get a mortgage loan to buy property the money is always placed in somebody elses account before it is ever available as cleared funds for you to spend - the banks lawyer ensures that. And the other side does not release the ownership paper until cleared funds are received. If credit is created the bank is always only owing somebody the money via a deposit entry or IOU.

No, all that is required is shareholders "funds", reserves that have been long since monetised by a central bank.  Once the interest starts coming in the reserves are substituted with bank credit money backed by the loans that have been sold.

You seem to be confusing the nature of deposit money?   It is just a promise of money.  That promise of money is the means of exchange between customers and is therefore by definition it is money.   But the bank is only doing something you can do amongst your own customers who can buy and sell and save and borrow  via you and be owed by you unitl they require CB money.   The loan account entry is simply two promises.   But the bank is now contractually  liable  to give you central bank money and has to have the ability to be able to do that if necessary.

Now this is where we depart.  Deposit money has to be fairly earned by the depositer.  If you want to draw a distincton between the different types of money in circulation.

  • Bank credit  money = money pushed into circulation by bank loans.  Quality dependant on the assets used as collateral.  New assetts = yet to be tested investments.  Existing assets = inflation (of the bubble).
  • Govt deficit money = money yet to be taxed (if not taxed = inflation), if investment it can pay for itself otherwise it needs to be taxed back.
  • Deposit money = money backed by inventory, commodities, accumulated wealth (eg Bill Gates' wealth.)

Touble is, money is fungible, we don't know what's good what's bad.  The good is mixed with bad if every country monetised their debt then we would find out.  The tide goes out . .

A bank that is party to the central bank will always have access to the fiat notes the central bank will take whatever paper is given to them.

 

Fred I cannnot follow what you are saying.

When you get a bank loan, effectively you or the seller get a bank cheque. The holder of the cheque then has several options. Most people go to the bank and ask the bank to clear the cheque.

Bank credit money is always a deposit or a bank cheque (your deposit is debited first) . If cash is required then the deposit is destroyed and cash is provided. Unless a deposit still exists inside the same bank then the deposit is destroyed and the bank has to provide the equivalent of cash.

Bank credit money cannot be forced into circulation outside the banks own customers where it exists as a deposit, unless the bank issues a bank cheque which then does exit the banks doors. If you write a cheque out then you have just created money since this is the means of exchange for your transaction.

I am not sure what you are saying but you seem to think something else is happening.

By the way this is an exstremely clumsy medium to be having such a complex discussion.    It would be better to continue this on especially written forum software.  Like for example http://www.bustbubbles.com

We're just splitting hairs.  In my view there's really only three ways money enters an  economy one is via a govt deficit, two exports and three as bank credit.  Bank credit is created out of nothing, it's backed by the strength of the signature of the borrower and their determination to pay it back.  It doesn't need savers to allow bank credit to be created.

The system is deeply flawed, and unfair, because of interest (but it is the only one we have and it works ish).  Interest is charged on the bank credit which cost the bank nothing to write up, if the interest is to be paid in bank credit money, then other bank credit money needs to be continuially created (out of nothing using other borrowers signatures).  This stands to reason and it's quite simple to work out.  The interest flows into the bank and due to the nature of the table mortgage (where the first half of the payments are predominantly interest) whan a bank grows it's asset base it quickly builds up reserves and it soon has money to meet it's reserve requirements.  So the system is inherently unstable, the need for growth is baked in, and growth is sought at ALL costs.  All the politicians and banking economists EVER talk about is growth.

Don't get me wrong, interest is needed, some of the loans written out might go bad so interest needs to be charged to cover bad loans, and the cost of running the bank needs to be covered, but for a stable system the natural rate of interest is zero.

The other deep flaw in the system is central banks.  Central banks can print money to infinity and they then think they should set an interest rate which the banks then use as some sort of fake "well this is what it costs for the money that we are going to lend to you", when the reality is that it actually costs nothing for the actual credit (until someone defaults on a loan).  It would be far better if we didn't have fiat money, or central banks, then each bank would have to issue it's own notes/customer cheques.  But even then there would probably be this boom and bust cycle depending on the amount of securitisation that was allowed.

But, as you point out, we have fiat money and central banks.  But Governments still behaves as they don't have a printing press at it's disposal (and if it uses it it is both wrong and right).  It issues bonds to cover any deficits it incurs when it doesn't have to.  If it ever uses it's printing press it's regarded as theft on the international scene so there's all sorts of pressure applied to stop this from happening.  Of course the biggest culprit is the US.  Every US$ that's in circulation outside of the US represents something that they have bought but have no intention of actually paying for.

In the end what you and I think is not going to make one jot of difference, clumsy medium or not.

Thank you Fred. Your posts are superb, keep'em coming.

We are miles apart in our understanding.       You said you would think about what i said overnight but instead you have just come back and said i am wrong, have too many negatives, make it unnecessarily complicated and you are right.

A private bank that 'creates money out of thin air' can do nothing different to what you and I can do. All we need is some customers who will save with us and the ability to borrow money. But evidently you think that all you need is the borrowers signature to create money and have no need for your own customer savers who are to receive this IOU.

We are not splitting hairs.  We see things totally differently. 

Yes that's part of the scam, they have been conditioned to think they are "savers", exchanging real assets for IOU's.  It will only last for a while.

Whether we call them "savers", savers or creditors, they are still absolutely needed to enable the loan IOU's the bank creates to remain as IOU's.   Otherwise, whatever the loan begins as, it quickly converts to a hard money loan unless a customer just wants an unsecured personal loan paying interest as a line of credit,   and is unable to get a line of credit via a Home Equity Line Of Credit that pays no interest.  Unused HELOC amounts can however be withdrawn at the banks descretion before they are used.

Anyone who has bothered to chug through the annual report of a listed bank ( try ANZ or Westpac for one , in NZ ) will clearly see from the profit and loss account , that a bank cannot create credit out of thin air , as Iain believes .

Even here in the Philippines , where many privately ( family ) banks exist . On Wednesday I sat in the Rural Landbank ( Maig-ao ) and there plastered upon the wall were two large posters showing the bank's P&L accounts , and balance sheet , for the previous 12 month year . 280 million pesos of deposits / 220 million pesos of loans . A prudently run enterprise . The owner is a kindly old ex-corporal of the Philippine army . And his bank is run exactly as those in NZ / Australia / anywhere else .

Seems to back up Andrew in F's argument  all the way .

Hey Gummy Bear..see if you can catch the cnbc chitchat with the Bank of America ceo....it's the best quality bullshit for sure mate...never has a ceo danced so round the truth...this prick made sure the message went out that it was all the fault of the borrower...those who failed to pay the mortgage ...not a single mention of the word fraud...not one little peep about criminal behaviour by banking bosses....and then this piece of #### went on to say how the BoA was doing everything it could to help the homeowners....

I wonder how many security guards this creep has protecting his arse.

We cannot download videos or live streaming here , at the beach . But I can listen to any NZ radio station !

Agree that those bosses of big Yankee bankys are shonky sods ........ And ought to have been left to face the wrath of the public ...... Instead of being bailed out at the tax-payers' expense .

Thankfully Kiwi politicians aren't as idiotic as those in America ............. Yessssss ?

[ the argument above is Andrew Finland attempting to knock some sense into Parksy .......... and failing of course ........ If you attempt to correct a conspiracy theorist , then it's clear for all to see , that you must be a part of the " cartel " too ]

I can but I don't because it eats megs of money....tried to spot your dive on GE but your directions aint up to it...

An American friend here says that we're not on Googlie Earth yet . But he scanned his former  neighbourhood in Chicago , and found that the guy he sold his house to , still has the same old car ........... The power  of the internet , huh !

GBH Maate.

Get yourself over to Steve Keen's website and read his Roving Cavaliers of Debt post

You can brush up on the model economic texts teach.  Then have a look at the empirical evidence put forward by Keen that contradicts that model.

To make it easy for you try reading the section titled

"The Data versus the Money Multiplier Model"

The empirical data supports Iain.

The trouble with Empirical data is that it points out the lack of clothes in your argument.

The Land Bank in the Philipines you may be referring to might be more in line with a credit union than a bank....

Roger,

What you say is absolutely true for each individual player in the economy, each balance sheet has to balance.  So the "create money out thin argument" has a couple of caveats.

It definitely applies at a macro level. 

There's a couple of ways to show that it's true, but they use hypothetical examples.  The question is are the hypothetical examples applicable to reality.

In your real life bank, when you lend the money out the borrower and the person the borrower gives the money to has a number of choices, so there are no guarantees that the loaned money will return as a deposit.  Depending on how much cash is used, it has to end up as a deposit somewhere so the amount of money in circulation goes up by the amount of money created by the loan.  Exactly to the cent.

The clincher. for me anyway, is simply to look at the US Federal reserve figures, and just ask the question where did it all come from.  What exactly is it? it's a number.  A number where? numbers in a whole bunch of spreadsheets/computer systems.  What do the numbers represent? someone's or a corporation's promise to pay, each and every cent of it is a promise to pay someone else.  It's a big number.  Something is wrong very wrong.

Still not convinced?

Have a read of the Lawrence RBNZ paper I'll quote a bit of it;

"In a modern economy, money can be created either by the
central bank (the Reserve Bank, in New Zealand’s case) or
by private sector institutions – in practice, mostly registered
banks.3 Section 25 of the Reserve Bank of New Zealand
Act 1989 gives the Reserve Bank the monopoly right to
issue physical money (notes and coins), which enters public
circulation through the private sector institutions to which
it is issued.
A private sector institution can also create money by
issuing claims on itself (ie, by accepting deposits) that
may be transferred between, and are generally accepted
by, members of the public as a means of payment. For
that matter, any institution that can maintain the public’s
confidence that its liabilities will be generally accepted as
means of payment, can create money"

And the other paper/booklet from the Federal Reserve "modern money mechanics".

"Who Creates Money?
Changes in the quantity of money may originate with actions of the Federal Reserve System (the central bank), depository institutions (principally commercial banks), or the public. The major control, however, rests with the central bank.
The actual process of money creation takes place primarily in banks.(1) As noted earlier, checkable liabilities of banks are money. These liabilities are customers' accounts. They increase when customers deposit currency and checks and when the proceeds of loans made by the banks are credited to borrowers' accounts.
In the absence of legal reserve requirements, banks can build up deposits by increasing loans and investments so long as they keep enough currency on hand to redeem whatever amounts the holders of deposits want to convert into currency. This unique attribute of the banking business was discovered many centuries ago."

And Andrew in F agrees with this as well.

...not very bright thinkers here.

I just dry to make me smaller.

I'm dry really wow ! All my big ideas gone ! Hickey !

That's it from me goodbye, can't see you.

Hey Walter : Why did the lads John Walley and Les Rudd not get back , and answer any of your questions . I was awaiting their response . Good questions , Kunzie . Keep the buggers honest , buddy !

Rogie you look slim today too ! I'm wonder how Wolly looks ?

 Are we under attack from the NZMEA

No , not we , just you Walter ........... That Rudd's too scarey a critter for me to tangle with ! But be heartened as he mauls you mercilously , that I'll be behind you with the first aid pack . ................ meebee an ambulance and paramedics would be of more use !

Yes ! The daily Gummy waddle up the beach has lost me a few kilos ! Down to a svelte 145 kg , at nearly Hickey's weight . ........... Mind you , at 6'5" he carries it better than I do at 4'9" !

Good help - they are pushing us over the cliff !

"Tis 'like sailing ships of olde , we be on the edge of the world , land lubber .......... Prepare to drop into the void ( something 'like a weekend at  the Labour Party conference ) .

Guys is this a reflection of our economy ? A long word

Pneumonoultramicroscopicsilicovolcanoconiosis t

...and all of a sudden the economy looks a lot brighter.

" It's all about Phil now " , Walter . Feel better ? Labour will do it all to / ah sorry / FOR you !

We'll get Wolly onto it . He's trying to find something intelligible from the Labour Party conference ............ I fear that it is a lost cause ............ But the long words , although unparliamentarism , fill in for the faff from Phil's "family" for freeing voters' fears of fleecing in the future .

Before we call Phil & Wooly for help - and make our economy working - I try another word:

floccinaucinihilipilification

I give up - China obviously already pushed us over the sideline – as everyone can see with this chart – it only goes down fast – hardly understandable  - economically we are in free fall situation – Amen !

Maybe Kiwidave or Andrew in Finland can help us ??????

Meebee the NZMEA will surprise all and save us . We appear to be on the cusp of disaster . Could Less Rude and Johhny Whale bail us out of this pickle , Walter ?

Oooooh you buggers have done it now. Alice will be here with the Madhatter any minute.

The "Madhatter" : Didya mean that Iain Parker's back in town ! Holy McFudgeknuckles , Batman , I'm gitting oota here lickety splick .

WTF you guys, I come back after a day away and you've wrecked the site. Bernard's gonna be pissed off, BTW where is Bernard and what's happened to the top ten?

Seen a big pasty looking lad strolling down Panay Bay with a bevy of barely clothed and nearly of age , nubile nymphets ............. Has Hickey been holding out on us , the scallywag !

Bloody hell - there isn’t much space left until the cliff. Goodbye my friends I miss you so much, especially the NZMEA – manufafuckturing sooo much for the good of our country.

You have gone and done it now, you've buggered the bloddy site, shit bernard going to be pissed with you guys, this is going to cost someone.. Bernard when he's angry is not something you want to see, remember when he had a bit of biffo with one of Crafars managers, you gona get it

T'was the moderator , Brian Sponde , wot crashed his head viciously into the closed & swinging fist of Crafarm Public Relations Officer , Sam Webb ............. Bernard sat in the car , re-applying his mascara !

Strolling up and down is actually quite fun

You sure that it isn't "scrolling" up and down, Walter ?

ahh……Rogie after a number of glasses of fruity Marlboro it doesn’t matter.

Please scroll sidewise – well done !

Lucky you , to have some slurps ! I'm off the plonk for 6 weeks , due to me rabies shots , silly Gummy got caught  in the middle of a dog-fight !!!

Silly people...

Some humour for the long weekend then?

http://www.youtube.com/watch?v=y1yxDWxUIM0

If you buggers keep this up Bernard's server will turn inside out. Get you on the bum did he Gummy...so was it a long needle into the guts...was it blunt Gummy?...you wouldn't have that problem in China Gummy....the dogs would have been in the pot in a blink.

Next time Gummy you just grab him by the throat - until sophisticated.

On the bright side of things , I am meeting some super cute little nurses ( wish I could needle them ! )

Luckily some of these comments are hidden and not easy to read.

Got bit on the knee , Wolly .  ............... Had time to read all the posters in the clinics . Alot to know about rabies ............ Bloody good thing it's not in NZ nor in Oz.

Thanks to you it probably is in NZ now. Dont go biting those nurses.

Oh no it isn't ! I'm  here in the Phils . And as the dogs involved are both still alive , I suspect that it was a false alarm .

Yeah we know better Gummy...you been chasing the nurses again?

Yup ! I was in the clinic , leering at the loverlies , when I got this searing pain in the ribs . But I kept my focus , happily leering at the nurses ...... After a few minutes , the pain in my ribs grew so intense that I had to look ...... And there was wifey , jabbing me with her sharpened elbow  ........... Back to reality , bugger !

Like the two gay's in the bar- One say's tot he other, "you had Aids","na" is the reply, great said the first one wouldn't want to catch that again

First debt then savings,100% agree Fred.

Here's the link to Keen's Roving Cavaliers: http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/

For further confirmation see the trend of total debt, it's been rising at more than double the GDP increase for forty years.  Unfortunately i's impossible to reduce the worldwide debt to GDP other than by default or debt forgiveness. So on we go, interest rates at four hundred year lows and still the developed economies are on the mat, the debt ratios are all still high or climbing from Government borrowing while the GDP is weak or falling.

The increasing debt is not causing the GDP to increase, now why would that be?

Fakete: "the marginal productivity of debt"

http://www.financialsensearchive.com/editorials/fekete/2009/0330.html

In most situation it is more true to say first a purchase and then savings and then a debt.

Steve Kean, the governors of the RBA and BOE agree with me.   Money multiplier theory is simplistic and naive and does not properly reflect the realities of credit creation where demand for  central bank money follows from deposit creation rather than the other way around. 

But you guys are taking that all out of context.

"we cant simply monetise our debt and neutralise or vapourise the foreign banksters monetised debt because as much as it sounds good, replacing one unsound system with another will most certainly lead to global anarchy."

Yes we can, it all depends on what the debt that is being monetised has been spent on.  By monetising it you will find out whether it is worth anything or not.  It's price discovery.

Using your example of monetising the cost of building a state house, that you always quote.  What backs the money in circulation is the state house but the money in circulation is still a claim on the state house, and is backed by the rental income that it produces for the owner.

The "anarchy" is the result of savers realising that they have been ripped off.

And we are about to see our govt shove through new laws which give the OK to the covered bonds scam with a govt guarantee so the private banks can chase the hot money, which has been pulled out of the air...so that the banks can bulk up the new debt times ten and lend this new credit out at special low rates to pork the property bubble and generate even fatter bonuses for themselves and keep this economy under their total control.

Bollard is talking "orthodox" measures while encouraging a scam to benefit the banks.

If Key and Co dance to the banker's tune, it will be a clear statement that the govt has decided to blow compressed credit into the ponzi scheme to fake the growth to stay in office come the election.

Can someone explian how this works?

So we have a cover pool, presumably for arguments sake say its $1million and has 3 houses in it...each worth $333,000.....but we have a properrty bubble with a ratio of 7:1....so that bubble bursts and we fall back to 3:1   Those three houses are now worth $165K each....so my Q is does the pool get topped up?  What if a house owner defaults as well, so that pool is now worth 1/3rd of what it was....

So 6 houses have to be moved into that pool for it to retain its "value".......

The housing portfolio outside the pool in the meantime has also lost 50% of its value and has some mortgage defaults....so that could be down to 45% of its worth before the pool above takes a %....

Arnt depositors being really hammered? or with a guarantee scheme that the banks are not paying for, the Govn?

For me this sounds like the CDS debacle....just in a different format with the potential for depositors and/or the Govn to carry the can.

regards

Iain You will never win hearts and minds while you describe people like me as rats. That is pretty disgusting behaviour on your part.

As Bernard will tell you, banks operate as margin banks. Credit can only be created if there are creditors involved when the 'money' is created. The exception being an unspent loan that exists as a cleared funds line of credit.  But this is still a promise of central bank money only, but the liability is even so real for the bank.

Reserves are only supplied to maintain the inflation target or they are removed.   Todays conditions are exceptional because of poor regulation rather than basic banking being incorrect.    There is no free lunch here for the people via government spending

Your video link is just another person on the internet who talks about money creation but totally refuses to see that creditors are required. http://www.youtube.com/user/councilonsper#p/u/11/3uWCOvnOtTI

Even if the bank goes straight to the CB it can only do so by selling an asset on a temporary basis   -  except in exstremely exceptional circumstances.   The world cannot exist like this as a normal way of operating because it would be massively inflationary..

You said:

Any debt, which is a liability to the person who owes the money, is an asset to the person to whom the money is owed.

Yes but what is your point?  It is also true that when the debt is created, money that is given to the person with the debt is an asset for them and a liability for the lender.

Why do you social credit people endlessly focus on one part of the equation to create your argument of fraud and so forth???

How can you possibly celibrate these videos were somebody creates an argument from half of the facts and makes out he has found something machevelian???

 

 

 

 

 

 

 

Iain

I am a new zealand citizen.  You have no legal rights to continually abuse me.      And i do not have the financial resources to waste to shut you up.

And in any case it is not my style to get somebody else to deal with my problems.

How about you focus on a discussion and for once you stop dragging my good name thru the mud?

Who the hell do you think you are?

I have presented a reasoned argument as to why i think you are wrong.    I do not deserve to be continually kicked in the nuts by you or anybody else while you totally avoid dealing with the argument i have presented to you!

.

Iain

To be honest i am not so young, have a bit of arthritus and i have no idea of what you are capable of.     Evidently you fancy your chances so since i have a family i will have to remove my nuts for you and allow you to gloat at my expense

So congratulations sonny.

You got what you want.   Thugs like you can rule the world.  Reality can be created by you and there is little i can do about it.

Such is life.

 

Iain

OK i admit it.

I had a senior position at the BOE and prior to that I was a major in the British Army.    I went to Eaton and i personally know the royal family.   Now that i am retired i am doing part time work in the psy ops department of the Federal Reserve Bank of New York.

Is that sufficient?

Tell me what to write.

Andrew, I admire your stamina (and interesting links), but

  Do not feed the bear,  do not feed the bear

:-)

Andrew : You're most welcome to keep feeding this bear ! Over the years of seeing Iain's posts I have been amazed at his confusing & convoluted arguments , and his downright rudeness to fellow bloggers . But your posts are straightforward , easy to follow ........ and for me , an educational experience . Bravo , buddy !

Andrew old boy air hair lair welcome to Eton, meet you in the club afterwards and we can chat about the good old days.  Wonder what the poor people are doing today? oh well never mind them.

We agreed that the credit was created by the borrower and the saver came second, and that you were wrong, sorry.  The financial system is about allocating savers' capital to true investment.  Sure you can give me you stone money and we can swap it for my shell money and it's not until either of us can convince someone else that they are worth saving, that our stones and shells are worth anything.  They only become worth something when they are backed by someone's promise.  The borrowers promise to the banker and the bankers promise to what? . . . . . Answer that.   It's the promise itself that backs the money into circulation, nothing more.  And the promise comes first.  The saver is being duped when the money promised into circulation is not backed new, true productive investment.  And that is the question.  Can we trust trillions of dollars worth of promises that exist.  The numbers don't lie, are there that many promises available in the world.  Can you smell a rat?  I can.

Teabagger, you run a sausage factory pumping out credit.  Some of what you do may be true productive investment (because people need houses to live in so they can work in a job) but in the end it's the promise that backs the credit.  And when you package that promise up and sell it many times over (read the naked short) you are ripping someone off.  How so?  Because it's a pyramid scheme, pure and simple, but it's OK because everyone is doing it.

I don't think that there is any question that the verdict is out.  A housing bubble has been blown, globally, and there has been systemic misallocation of capital with a wealth transfer to the shareholders and elites behind the banking system.

Here's a link

http://www.newyorkfed.org/research/staff_reports/sr458.pdf

Also Warren Mosler Seven deadly innocent frauds is a good read.

Fred

Anybody can create credit to enable a customer to buy something from another customer if the selling customer is happy to be owed money.

For example here is 1000 NZD to enable you to buy something which my wife is selling for 1000 NZD.  It is there right now in your account.   She is just waiting for you to buy something from her.   Once you agree the sale i will owe her the 1000 NZD.  

Amazingly i did not need any money to create the 1000 NZD.   Out of thin air i could create 1000 NZD to enable you to make that purchase from my customer.

Anybody ought to be able to see that my created 1000 NZD is pretty useless to you unless I agreed that you can ask me for 1000 NZD cash, unless i have a customer who is willing to be owed 1000 NZD who wants to sell something to you that you want to buy.

It cannot me made clearer than that.

 

 

 

 

 

 

 

Yes, agreed.  Did I say that this couldn't happen?  You could pay her a real $1,000 (less an agreed cost) in which case you would be acting as a debt factoring company.  You could then write a note saying good for $1,000 from Fred and spend that into circulation, and you are now square.  This note is accepted because people trust the debt factoring company to not print more than it's assets, the loans outstanding, not only that if they know that you have the power to enforce the debt, it's even better.  Your created $1,000 is good for me because I have $1,000 in value of goods for my use. The note ends up with someone who decides that they want "real" money.  The note is presented to me, I pay the $1,000 clear the debt and rip the note up.  If you add up the total amount of "money" in circulation before the credit is created by your wife willing to extend it, and with your assistance it was monetised and the amount of money in circulation goes up by exactly $1,000 and when I rip up the note with a smile it goes down by the exact amount of $1,000.  It goes back to where it came from, into thin air.

I think I see the point you are pulling me up on.  The fact that a third party needs to be involved.  The difference between a line of credit and actually spending the money.  Sure you can sign up for a loan, but that alone isn't money in circulation, it has to be spent first.

Hey I'm only trying to understand it.  Did you have a look at this link, it's quite useful.

http://econviz.com/balance-sheet-visualizer.html

Other interesting reading is at the Daily Bell, Webster Tarpley, Michael Hudson, Gonzalo Lira FOA and FOFOA.  I'm sure you've seen those.  Iain has a lot of links as well.

Fred

Yes.   A creditor always has to be involved for it to be spendable money or it is just the same as a promise of a hard money loan, agreed at time A and and honoured at time B.  

Banks are indeed margin banks and can only do what we can do in our private buisinesses if we have customers who want to  buy and sell across our books where we take a fee or interest for that where we need to encourage the sellers to remain invested with us with sufficient interest or a convenient money spending system.

Will these covered Bonds be restricted to NZ Banks only? Most of our big banks are Australia owned where CB are not allowed so it will only be Kiwibank, TSB etc that can issue them?

Oh no no no Valentina...the big 4 over here in Noddy get to rort their way to fatter profits with the help of the RBNZ and the fools in the Beehive...in other words they can do what they bloody well want. The covered bond scam being cooked up involves the RBNZ getting the Beehive idiots to pass laws to provide taxpayer guarantee behind the bond sales....for the single reason that this reduces the cost of the bonds to the banks....so they can then advertise the credit at even lower prices and suck in a larger number of Kiwi peasants.....all this to protect the earlier funding by the banks of the residential and rural land bubbles.

These bubbles remain the foundation of the Noddy economy...that's it.

So we have the RBNZ and the Beehive idiots selling the BS that Noddy will emerge from the debt hole on the back of an expanding export sector and and and.....it's all pure spin. Westpac's BS about 4.2% GDP in 2011 is a wee part of the programme to convince the peasants of a light at the end of the tunnel.....haaaaaahahaha.

Get yourself as far from debt as you can Valentina....avoid the banks for they carry the debt virus and they want you to share it with them.

This turd of an economy is sinking into a deflation downturn and the RBNZ is rushing to plug the hole with it's own version of QE....Brownlee's $200m dyke in Christchurch is not about trying to beat the faultlines with a sunken stone wall round a suburb...it's part of the QE effort...the loot will be biffed at any and every scheme and scam going. 'The Great Gerry Stimulus!.......it follows on from The Great Key Stimulus...also known as the SCF rort. Hey what's a couple of billion when it's taxpayer's money...haaaahahaha.

Hi Wolly, I am more worried about the money that I have deposited in the bank, it seems that the covered bonds have preference over depositers money!

FYI, the Aussies are now considering allowing covered bonds - http://www.theaustralian.com.au/business/industry-sectors/new-bank-bonds...