Arnold Kling  

What Banks are (not) Doing

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Eric Falkenstein writes,


A friend shares with me the following anecdote. He thinks real estate is cheap, and wants to buy houses, and make money renting them. Ultimately, he would sell out of the homes when they recover in value. He has been doing it for a couple years with good results. He went to a bank, to see if he could leverage this idea, say by getting loans for 50% of the purchase price. They said, only if you hold this in a 'compensating balance.' These are cash balances held by the borrower at the bank, and add fees and some safety to the bank. In this case, the bank wants the borrower to keep the entire balance as a cushion, borrow money for a potential liquidity event, that would be rather futile because once the borrower used said compensating balances to rectify a funding problem, it would then have a liquidity problem with the bank. So, in practice, the compensating balance would not be a cushion for tough times, nor would it earn interest for the borrower. My friend decided not to get the loan.

Take the deal to me. I keep looking for ways to get in on this sort of investment.


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COMMENTS (2 to date)
Eric Morey writes:

I think Eric Falkenstein is being a bit coy. He reveals in the comments scetion that his friend is looking to buy a total of $200 Million of real estate. On an individual basis, rental homes are not so hard to finance. It seems that a he might be better off with a correspondent lender (or creating one) to sell the loans into MBS pools. Or issuing bonds to finance this venture.

PrometheeFeu writes:

That's basically the problem with reserve requirements. It's a safety net, but if you ever fall and need the net to be there, somebody runs over and hits you with a baseball bat. Not useful.

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