Are Negative Interest Rates in America’s Future?

Negative Interest Rates

“ “Risk-free return” is the standard tag attached to the government’s solemn obligations. An investor I know, repulsed by prevailing government yields, has a timelier description – “return-free risk”.”    – Jim Grant

How absurd are negative interest rates?

Two weeks ago in Denmark, news spread about the first person to get a business loan and get paid by the bank to do so. Eva Christiansen, and entrepreneur, earns about 1$ a month from a business loan she took out to grow her business. Let that sink in for a few minutes. She took out a loan, and instead of paying interest to the bank, gets paid interest each month just for taking the bank’s money.  What a great deal. Where do I sign up for one of these loans? If you are interested in what type of business she is running, that makes the story even better.

If you are asking the question of why would the bank pay this woman money each month to take their money, you wouldn’t be alone. I’m fairly certain that it has nothing to do with the type of business she runs, but it is mind-boggling to understand why a bank would pay someone to borrow money. Unless of course you understood what was happening in Europe with interest rates.

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My Uncle Samuel’s Solution to the Moral Hazard Problem

What is moral hazard?

moral hazard definitionLet’s say that you have a gambling problem. You like to bet on football, baseball, basketball, and hockey. Professional, college, or high school — it doesn’t matter. You visit your local casino to bet on cards. You bet on the coin flip at the start of a football game. You will bet on anything.

Now generally people like this will end up in trouble at some point or another if they cannot control their vice. I have seen friends of mine get into this sort of trouble. It isn’t pretty. At some point they hit a losing streak and end up owing a “bookie”, more than they have. At some point after this happens, their debts get called. If the debt is called and you don’t have the money, “something bad” will happen.

However, lucky for you your Uncle Samuel is wealthy. When you get into trouble, you call Uncle Samuel to “bail” you out of this mess. Being a loving uncle, he gives you money to keep you from being the victim of “something bad”. Now maybe this scares you straight and you give up your gambling vice and you never gamble again. More likely than not, this “bail out” will only fuel your appetite for gambling (risk taking). Since you didn’t have to experience the pain of “something bad”, you will feel free to engage in the same destructive behavior as before. This time you might take greater risks with your bets. Why not? Your wealthy Uncle Samuel can come to your aid, and he has a lot more money than you do. So the pattern continues.

As your behavior continues, the pattern repeats itself. As you keep getting bailed out and your appetite for risk increases. This is an example of moral hazard. Moral hazard is a lack of incentive to protect against risks because someone else is bearing the risk for you. The best example of moral hazard is the treatment of large financial institutions in 2008 by the US government and related government entities.

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