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Banks are not safe anymore

As we know, commercial banks are in the business of issuing promises. These promises are nothing else than debt (your debt to the bank) in exchange of a contribution towards your home purchase. Your debt is then immediately recycled into the economy as the previous owners receive real money in exchange of selling their home. They pay their own debt, tax, fees, and the rest becomes real money which got created by this ingenious system (and the invisible man 😉). Now, with each year going by, this business model is looking more and more dated and past century than ever.

What does this mean for us?

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OK, let's move on! we have a big topic this week.

We have to step back a bit to understand the magnitude of the problem. During the financial crisis which started in 2008, the world was engulfed in a vortex which swallowed all the money. Malinvestment, greed, and a list of bad policies and bad investments on the scale of the planet meant that suddenly, a debt which was initially worth 100 was now trading at 75, 50, or even 25. The banks were all going to go under, as they were the ones holding these worthless debts: country debts, commercial debts, and property debt. All of them!

As they probably had no other choice, the Central Banks saved them by doing one thing: printing enough money to buy back most of the bad debt (past and future). The commercial banks managed over the years to sell back the risky debt they were holding (think Greece, Italy, Portugal and the list goes on...) to their Central Bank masters at very close to face value. It took a decade but in a very large majority, they got saved. Well, I will always remember our client Fortis Bank, the largest bank in Belgium at the time, asking us a guarantee of continued business over 7 years whilst they ultimately did not make it past 2010...

So, what's the problem? They are saved, we move on, shall we?

Of course... not so fast... One thing I have been forced to learn in my 25 years of business is to always take more attention to the second effect of any decision. Or if I can foresee, even more attention to the third effect. In general, when the first effect (the obvious goal to achieve) is to move to the right at 100km/h, you can bet there is a boomerang second effect hiding somewhere which will move you and everybody else to the left at 200km/h when it wakes up.

To save the banks (and the world as they say...) the Central Banks had to print money like never before, and at the same time, push the interest rate close to zero. If you print money but it is costly, nobody will take it. So there was no choice: money must be free.

So here is the secondary effect: banks do not make money anymore on free money. Not only that, but as we saw recently, the Central Banks have gone so All-In that even a country like Greece is now entitled to borrow money and ask interest on the money they borrowed. First, not pay interest. Second, ask for interest! Greece!!! 😧 Hell, which bank will want to lend money to Greece and pay them for this privilege? And of course, if you take a very safe country, such as Germany for example, then banks have to pay them even more interest for the privilege of lending.

But that's not all. There is a third effect, also going in the wrong direction, at 300km/h! For you and me, the largest cost of living is always going to be your home (rented or acquired). Let's say that you can afford €2,000 repayment per month to buy your home. At 5% interest (in the pre-2008 world) over 20 years, it meant a €303,000 debt to be repaid. But in the post-2008 world, for buying a home, we take debt at around 1.25% over 25 years. For the same €2,000 repayment, you can now take a debt of €515,000. You can play with the simulator below to see for yourself.

So, the third effect is that people who used to buy a home (pre-2008) at 90% loan to value over 20 years could buy a house worth around €335,000. Post-2008, without earning too much more, the new rule is 25 years and a more conservative 80% loan to value, which gets you a house worth €643,000.

If you did not understand where the invisible man got the magic done, read again the lines above, and play with the simulator. Because houses doubling in value is nothing more than the boomerang third effect of zero percent interest rates.

Germany have not had a housing bubble in the last 40 years. They were the only Eurozone country without a housing bubble pre-2008. There are now reports that housing is overvalued by 15-30% in many cities. According to a Global Real Estate index, housing in Munich is now the most overpriced in the world. That is nothing else than the third effect in action for you.

The banks do not make money on 1% loan. And even less money on lending to a country which demands interest to be paid on taking up debt. The commercial banks operate in a model which worked in the 20th century, with branches in every street corner, and a good spread between money received and money lent. The world has moved beyond recognition. Soon, we will get Bank as a Service from Apple or Facebook.

Deutsche Bank stock is down more than 80 percent over the past 10 years. Commerzbank shares have lost nearly all its value over that period, with shares down nearly 90 percent. The ECB saved most of the commercial banks in Europe post crisis (well, not Fortis Bank, not RBS...) but the recipe to save them is the same one which is killing them.

I really think it is now time to load on cheap debt, because it will not be around for ever. Not that I think the interest rates will shoot up. They cannot afford to shoot up now, the next upcoming recession will drag them even lower into negative territory, so they will stay low for a loooonng time. No, I think that the commercial banks cannot continue to afford lending at so little return on capital. It is now a question of them surviving or joining Fortis Bank in the graveyard of history. The risk is that this will not get better during and after the upcoming recession. Better get into debt now than in 5 years!

To your journey!

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