Monday, June 1, 2009

The problems with mortgages

Economics is a fascinating science (physical scientists often look down upon the social sciences, however, social sciences are simply areas of scientific study that are affected by human behaviour – a fascinating challenge for the researcher).

Present law in Canada and the United States says that a banking institution can issue a mortgage while only actually having 10% of the amount of funds needed for the mortgage. The bank borrows the rest of the money from the central bank (a government agency: the Bank of Canada or the Federal Reserve in the USA). The banks are charged a remarkably low interest rate from the central bank and in turn charge YOU a higher interest rate on money they never even had!

The banks get to charge interest on money they never even had, which is almost like a license to behave like a mint (a money printer). When the subprime mortgage crisis hit the United States an interesting question could/should have arisen: “Why would a financial institution sell mortgages at such low interest rates (subprime)?”. The answer in hindsight is obvious: as a mortgage issuer the financial institution gets to charge you interest on money that they never even had! The bank's policies could be summed up as such: Who cares if you give some customer a low interest rate – we're charging interest on money we don't even have! Any mortgage is a profitable mortgage! But then people started defaulting on their mortgages, house prices dropped and the banks were left with houses they can't sell (hence the collapse of so many banking institutions). To make matters even more ridiculous many hundreds of billions of government dollars have been used to prop up banks that were failing due to their own greed (a lot more has been spent here than on the General Motors bailout – see post below).

I have money borrowed on a line of credit (secured by my house), and recently my bank (simultaneously with a host of other Canadian banks) decided to increase their interest rates by 1% (sounds like collusion to me). Now, 1% may not sound like much but when you consider that my interest rate went from 2.5 to 3.5%, that represents a 40% increase in my debt servicing charges. Times are tough economically and a lot of people (like me) are struggling to make ends meet. It is awfully hard to swallow paying more to the banks just because their profits are looking a little meagre this year (the Canadian banks have been praised as being among the most economically healthy in the world – surely this is part of the reason). Interestingly, when the economy started to tank the central banks (government agencies) started lowering interest rates so that borrowing money became cheaper. This was an attempt to assist citizens who were having a hard time economically. I really appreciated the reductions in interest rates – but so did the banks. On at least one occasion since the economic crisis hit, the banks (at least in Canada) did not match the lowering of interest rates that was provided by the government. This amounts to stealing (by increasing the amount of interest charged on money they never even had) and happened before the more recent 1% interest rate increase. This practise should be banned.

I found this appropriate message on the internet:

(I prefer to think of this as a revolution in banking - nothing violent ;)

Now the federal reserve (or the bank of Canada) provides an amazing service: they will provide a super low-interest loan for a mortgage. Unfortunately, this government service is provided only to the banking institutions: the rich get richer. If any citizen wants a mortgage they have to go through the commercial banks which charges the citizen a huge overhead in order to hand them government money.