"Yesterday's home runs don't win today's game"-Babe Ruth
Welcome to The Golden Sense! Babe Ruth was right when he made the statement above. However, banking is not baseball. Currently it is yesterday's strategy that is hitting the home run for banks today. The strategy that bankers play in the bond market is not something to celebrate but it's a strategy that's been played for quite some time. This strategy is unique to the banks and individual investors can't get in on the play. To understand the strategy you have to break it out in simple terms.
Banks are often misunderstood and seen as complicated establishments. This is simply not true. The banking business model is easy to understand and extremely profitable.
The bank gets money through customer deposits. The public put their money in the bank because the banks promise to keep the money "safe" and available. After receiving that money they then use that money to make loans. This is the profit engine of the bank. Today, banks lend out the money and receive 5-6% return on that money. This money goes to pay for the services the bank provides and to pay employees that run the bank.
The bank typically uses 80-90% of the deposit liquidity (customer deposits) to make loans. So what do they do with the rest of the money?
Answer: They invest it in the bond market.
This money is given to boys and girls in the finance department. They make use of every depositor's penny and still have money to dish out on more lucrative loans and deposit withdrawals as needed.
Wait-if every dollar is used then how is there more left over for making new loans and to cover the withdrawals?
The banks have the ability to borrow money from the Federal Home Loan Bank or the Federal Reserve. The banks can borrow millions of dollars and only have to pay 0.30% or 0.25% on the borrowed money. That's right, that is less than a third of a percentage point annually. This is super cheap money! Meanwhile the boys and girls in the finance department can earn an average return of 0.45% on short term bonds.
Do you see how that works? The bank can borrow money for 0.30% and then invest it the same day for 0.45%. The bank pockets the difference (a free 0.15%).
When the bank borrows money (from the FED or FHLB) the bank can use that money to buy additional bonds or make a loan to an individual. When the bank needs to repay the FHLB or the FED it can use new depositor money, sell a short term bond, or use money from a matured loan to pay the FED or FHLB back. By employing this method the bank always has access to free money. It can use this borrowed or "free money" to earn easy returns in the bond market. You see, the bank always has money "working" for them and earning profits.
You might say that those rates are so low it hardly makes a difference. However, when you are using millions of dollars... it does make a difference and the cash rolls in.
It's the arbitrage of all arbitrages! And the bond guys call it "playin the yield curve".
Signing off,
T. Norman
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Can grown-up Justin Bieber still sway the masses? Believe it. The pop sensation, which turned 18 in March, tops the Billboard chart for the fourth time after selling 374000 copies of “Believe,” the year's biggest debut. I must confess I have never listened to an entire Bieber album but I have to say he sure can draw a crowd.
Census data finds that while most people in this country have moved to a new community at least once in their lives, about 40% never leave the city or town where they were born. There are many factors that come into play when you look closely at who moves and who doesn’t that I find interesting. For instance, did you know the affluent are the most likely to move (by income group), while those with a college degree will move about 33% more often than those with a high school diploma (by education level). In addition, those who live in the Midwest are about 25% more likely to stay in their hometown than those who live in the West (by geography).
The City of Stockton, CA (with 300,000 people) is expected to formally file for bankruptcy, after 90 days of negotiations with 18 creditors failed to reach a deal. The city would become the largest city ever to file.
A sign of the times...
