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Inverting the Time Value of Money Business Model

Submitted by John Beasley…

The general consensus is that banking institutions like the Federal Reserve Bank cannot charge standard interest rates for the use of capital. The reason lenders cannot charge ten percent interest in the USA is that debt is so pervasive that the US Federal Government and private borrowers cannot support any more debt when interest rates are high. This theory holds that interest rates have fallen to one percent or two percent, and could go to zero or negative percentage rates to sustain economic growth.

I would like to argue exactly the opposite case. All the interest, minus a small loan- servicing fee, is now being collected at the beginning of the loan period rather than over the life of the loan. The selling price of residential and commercial real estate is being doubled and even tripled in value. (The same thing is being done with automobiles, trucks and consumer goods).

A $100,000 dollar home loan at ten percent interest for thirty years would have a payment of about $877 a month. The interest paid over the life of that $100,000 loan would be $215,925. At two percent interest the same $100,000 dollar home loan would have a payment of only $370 a month. The interest paid over the life of that loan would be about $33,200 dollars. At two percent interest that same monthly payment of $877 would support a retail home value of $237, 400 dollars. This entire $237,400 would go into the economy when the house is built and sold rather than over the thirty-year life of the home loan.

This business model using a high selling price and a low interest rate pushes more money into the economy faster. This can be seen as an inversion of the “Time Value of Money” business equation. The “Time Value of Money” business model takes an investment and discounts the rate of return to compensate for the timing of the cash flows, discounts for all forms of identifiable risks, discounts for various forms of inflation, and subtracts a risk free return, such as treasury bills, from the actual cash flows to arrive at what is called the “Net Present Value” of the cash flows for this investment.

What if an investor could do away with those risk factors and those discounts that the “Time Value of Money” equation identifies? What if an investor could take all the equity and interest out of a project as soon as possible, in the first or second year of the investment, rather than over the thirty-year life of the loan? If the cost to build the $100,000 dollar home is about $75,000 and if at two percent interest that home could be sold for $237,400 dollars then the Internal Rate of Return on that investment would be about 216%. That is much better return than a ten percent return on capital.

My read on the American housing boom in the early 2000’s as well as the current residential and commercial building boom, is that the Federal Reserve Bank has lowered interest rates that allowed for the doubling or tripling in the selling price of buildings to maintain the same affordable payment schedules.

The oligarchs, for lack of a better term, own the banking cartels. The banking cartels are calculated to hold a controlling investment in seventy-five percent of the publicly traded corporate stocks worldwide. The oligarchs and banking cartel that controls Wall Street also owns an estimated ninety percent of the construction materials and the construction manufacturing industry. This provides an opportunity to take the profit in this investment at a different point in the investment “supply chain.” What we learned in the 1980’s and 1990’s from “supply chain management business modeling” is that a profit can be taken at any point in the development process. A profit does not have to be taken where it is earned and it can be taken before it is earned.

These low interest rates allow companies to pull equity out of projects at the earliest possible date. I would argue the economy is not running on a one percent to three percent margin. Many sectors of the economy are running on a twenty-five or thirty- five percent annual return on investment. The investment return is being taken in the first or second year of a projects existence rather than over the life of the investment. Of course, this inverted business model that pulls the majority of the cash out of an investment at the beginning of the investment requires constant construction to sustain these higher than average cash flows.

One question that comes to mind is who would benefit from pumping large amounts of cash into the economy to create “inventories” of tangible real assets? Why would an investment cartel be more interested in converting cash into tangible assets rather than prudently holding onto their cash reserves and waiting for a market correction to invest? Could this possibly be a calculated hedge against hyperinflation or dollar devaluation?

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The statements, views and opinions expressed in this column are solely those of the author and do not necessarily represent those of The Duran.

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July 22, 2019

This theory collapses at the fact that there are no 1.5 to 2% loans to buy RE. Banks approve mortgages on which they frontload interest over half the loan period, not the first two years. While they do sell mortgages as securities to increase profit, that will still not reach such high margins in residential construction though it does in commercial RE where the risks are way higher. Generally, the higher the risks, the higher the profits – and losses when the economy tanks. It certainly makes sense for large lenders to own building material trade, which gives them control… Read more »

John Beasley
John Beasley
Reply to  Regula
July 28, 2019

My home loan was 2.99%, I paid no discount points. I paid the house off in 5 years. I had to work 2 jobs as a property manager- building contractor and work on tugboats to qualify for the loan. If I had been thinking more clearly I would have paid all the interest on the loan in advance. This “theory” is more interesting in the commercial real estate markets of apartment complexes, chain restaurants, community development of houses, hotels, and strip plaza’s. The lower the interest rate, the more money they can pull out of these projects. They are building… Read more »

John Beasley
John Beasley
Reply to  Regula
July 28, 2019

As per your valued comment, probably the most expensive place to borrow money is at the local bank. There are national lending companies like “Rocket Mortgage” that make reasonable priced loans. They explained to my wife and I every good reason not to buy the house we chose to buy. During the Real Estate Boom our house was sold for +-$250,000. We bought in the BUST for $104,000 and paid too much. We bought the house for the neighborhood it was in. As for how much house a person can afford, 25% of their disposable income. It is more cost… Read more »

John Beasley
John Beasley
Reply to  Regula
July 28, 2019

The theory is based on a person paying PITI of $1,000 a month with a $4,000 dollar or more total income. PI payment of $877 monthly. at 10% 30 years the house can command $100,000 (the old standard) at 2% 30 years the house can command $237,425 at 3% 30 years the house can command $208,150 at 4% 30 years the house can command $183,817 at 5% 30 years the house can command $163,475 at 6% 30 years the house can command $146,371 at 7% 30 years the house can command $131,905 The home loan business is like the Wizard… Read more »

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