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Why The Banks Don’t Need To Lend Money

By Andy Shaw | January 26, 2010

Originally posted 19th October 12009

I have been watching the banks over here in Cyprus having Russian money literally poured into them and yet I have not seen a really significant change in the banks appetite for lending. So I decided to dig a little deeper to find out why the banks do not really need to lend this money out as we all assumed that they did.

So where do they put this cash reserve? Well, thanks to the banks being able to leverage this capital 10 to 1 they have a much more appealing proposition other than risking that money even at 70% loan to values.

They get given say £1,000 and pay very low rates for it of between 0 and 3.5%. Let’s say it costs them £35/year, they gear this £1,000 to make £10,000 and then they buy government debt with it that pays 2%, so they get £200. So even after paying out interest rates of 5%, they still make a 15% return on their investment of someone else’s money. That sure beats a 5% return on a mortgage lent to a buy-to-let investor! The banks do not need to lend the money and take any risk when they have risk free returns like that.

This cycle will only stop when the banks feel that the recession is over and the return they can safely get on lending to landlords and homeowners produces them a greater return than the 15% they can make risk free. Personally, I think that having had their fingers badly burnt means that they will wait longer than usual rather than being left without a chair when the music stops.

So the government is printing the money and the banks are taking it in, gearing it up and lending it back to the government. I couldn’t figure out for a while how the government was only printing as much as they were, but I hadn’t factored in the fact that the banks would legally gear it ten times and then lend it back to them. We are in the wrong business!!

We will see reserves at the Bank of England start to soar in a similar way to the reserves of the Fed. This is a neat trick. They print money, give it to banks, gear it to ten times its value and then give the cash back to the central banks. And with that cash the central banks will be able to rush in and save the day for literally hundreds of banks still expected to fail because of all the coming problems – What a con.

I started to see more signs this week that the government in waiting will start to raise taxes very quickly. This, of course is what they must do to try and stop the rot but in turn this will cripple the economy and will certainly return us to recession if and when complacency sets in.

Tax has a multiplier of 3, which means that a tax decrease increases GDP by 3 times the amount. Whereas a tax increase reduces GDP by 3 times the amount. Therefore, the tax increases that are coming in the near future will harm our GDP and at the very least suppress growth, even though unemployment is only now really getting going. We will probably see it slow its growth within a year then pause at some dizzy height for a while. Then, when the tax increases start unemployment will grow further still. This is a vicious cycle!

Still in the end we will figure out how to live and grow in this new terrain. Afterall, that is what free markets and entrepreneurs do. Things will sort themselves out and those with the right skillsets to deal with the new terrain will do well. But this will not happen until we have faced even more difficult choices.

Where this ends up for property investors is those that can borrow and invest should do very well, as there will be an ever increasing shortage of quality property in our target market and an increasingly hungry market of the unemployed and the people who cannot buy their own homes. But this will probably only happen after a lot of existing landlords have gone through a significantly difficult period, which we will have to endure first.

Best wishes

Andy

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