Thru the Looking Glass

Imagine a place where the bank pays you interest after you borrow money from them to buy a home.   Could such a place exist?

Yes! Denmark is that place!

Why you should care:   This is a serious, unanticipated problem.   Remember, banks make money off interest rate spreads – the difference between what they pay depositors and what borrowers pay the bank on their loans.    Sure, banks really don’t pay depositors anything today, so this cost is zero.  But what could happen if banks no longer receive interest from borrowers – and instead, are obligated to pay borrowers interest?   That’s crazy talk right?   Well…keep on reading.

Additionally, while there’s little chance of this happening here in the US (at least, not yet), depositors in Wonderland may soon find themselves paying the bank to keep their money.

Taking action:  If the majority of bank profit is the result of interest spread, banks in Denmark, Sweden, Spain and Portugal are in dire shape.  In each of these countries is one or more ‘G-SIB’ or ‘globally systemically important bank.’  There are two in Spain (including Banco Santander) and one in Sweden (Nordea).  A year ago, Banco Santander traded around $7.   Today is close to $4.60.    A year ago, Nordea was at $111; today, $79.   Both will probably go lower.   If you’re a risk taker, short these stocks.   If you’re a value buyer, wait until rates reverse, the problem unwinds, and then buy them.

Either way, there’s plenty of risk here … so better yet, sit on the sidelines and let’s see how the whole thing shakes out.   That’s what I’m doing.

THE BLOG:  Instead of paying mortgage interest to the bank on a variable rate home loan he received about 10 year prior, Hans Christensen received 249 Danish kroner from his bank in April.  Per his mortgage statement, his interest rate was a negative .0562% and the bank paid him $38 in interest for the 1st quarter.  Sweet!

Is Mr. Christensen unique?   It turns out he is not.   Per the WSJ:  “Banks in Denmark are paying thousands of borrowers interest on their home loans, nearly four years after the central bank introduced negative interest rates.   Danish banks have increased some fees to compensate but never mounted serious legal objections.”

We have truly passed thru the looking glass into Wonderland.   Has anybody seen Alice?

Denmark and Sweden, grappling with weak GDP growth and foreign exchange issues, have both had ‘official’ negative rates for quite some time now:

Banks in Spain and Portugal are worried.   Both countries are now led by socialist governments, and consumer groups are demanding banks stick to the terms of the variable-rate loans. If rates fall far enough below zero, these groups said, the banks should make interest payments to borrowers.

So banks in both countries are rewriting new mortgage agreements to prevent the bank from ever paying a home loan borrower anything.  In both countries bank executives have been quoted as saying “they would pay borrowers interest when pigs fly.”

And we all know how much they love pigs in Spain.

Here in Wonderland, even countries can issue debt – and get paid for doing so!   Yes, here in Wonderland, the investors pay the country interest!

Earlier today Japan sold 2-year notes.   The investors are paying Japan for the privilege of owing those notes.    Yesterday, investors in Japan paid 100.45 yen to the Deposit Insurance Corp of Japan in exchange to received 100 yen back 2 years hence.   Right now, 70% of Japan’s debt requires investors pay Japan.   For a country with debt equaling about 250% of their GDP, this is a really good thing.  For Japan.  For now.

Frankly, I’m surprised mattress sales haven’t skyrocketed in Europe and Japan.   It seems to me both banks and sovereign bond buyers should be stashing their money in a nice thick Simmons ‘Beauty Sleep’, not making loans.

And yet here in the US, the FED is talking about increasing rates?   I’m still looking for Alice.  She’s got to be here somewhere!

• Terry Liebman