The EMH (Efficient Market Hypothesis) is the cornerstone of the finance system capital distribution. It says that free and open markets for assets will reflect all available information, and the prices the market arrives at will be the most efficient and produce the most value for the least cost to satisfy both buyers and sellers.
A netlogo model has been written to model a simple free and open market that reflects all available information. It does not result in an efficient market. It lowers transaction rates, restricts participation and shows that free asset markets tend to move to monopolies or monopsonies.
A simple change to the model is suggested, and the model is rerun. The change is for the seller of an asset to return some of the asset's value to someone else at the next opportunity. The change suggested creates capital markets where assets can be exchanged for near zero cost, resulting in an efficient market. Capital markets operating at near-zero cost have different properties from capital markets where the objective of sellers is to maximise profits and production.
This article shows how sharing the profits from Bank Loans increases the returns to Banks and saves home buyers at least 30% of the cost of buying a house by reducing the cost of loans without lowering interest rates. Although not described here, we can eliminate another 30% in finance costs by removing the need for large housing markets. Most finance costs for existing housing can be eliminated. We replace traditional loans with the continuous incremental transfer of houses in small, self-contained, localised, permanent housing markets.
It is vital for governments that control the issuing of new money (capital) to trial the approach as it will help address many of the world's social, environmental, and international issues.
Model of a simple economy
NetLogo is used for modelling. It is free and can be found at https://netlogoweb.org/. The models used here derive from a simple economy model found in the textbook “Introduction to Agent-Based Modeling: Modeling Natural, Social and Engineered Complex Systems with NetLogo” by Uri Wilensky & William Rand.” The model “a simple economy” is changed to include the asset seller returning the profit from the sale to the buyer.
“A simple economy” is a mind experiment in which a fixed group randomly selects another person in the group and passes $1 to the person. This is a market with perfect information known by all participants. It is a free and open market, but it has constraints. The group members are fixed, and all the members start with a given amount of money. If they run out of money, they can only participate in the economy once another person randomly selects them and gives them a $1. After running for a while, the screen shows.
The dots on the screen represent a person, and the horizontal position of the dot represents the amount of money they have accumulated. As expected, some are “lucky” and are selected more frequently to receive money, so they might get several, while another person is “unlucky” and receives nothing.
When they run out of money, they do not have to give a dollar to anyone, but they still receive a dollar. After some more time, the distribution changes from a normal distribution to a Zipf.
This simple model reflects today’s economies, with fair and open capital markets. Unfortunately, these markets are inefficient and cost communities immense amounts of money.
It is counter-intuitive that people tend to stay poor when they get zero money, and they can receive money but not pay any out, but that is how the arithmetic works. Once you reach any level, you oscillate around that level—people who oscillate around zero stay at zero, but none go down. People who oscillate around 100 stay around 100, and some will keep going up. This dynamic results in the Zipf distribution, and the economic system with this type of distribution is not as efficient as a normal distribution of wealth because there is less activity and more stationary money.
The Efficient Market Hypothesis creates inefficiencies in the market and causes significant distortions in the wealth and income of market participants. It is imperative that we change the way markets operate. Attempting to fix the outcomes from markets that lead to these wealth distortions is futile because those who end up on the rich side by chance believe they deserve their fortune and, in practice, exclude underprivileged individuals from participating in the economy, exacerbating the problem. For instance, in Australia, you cannot normally purchase a house without a deposit even if you have the income to rent the same house.
Giving people one-off contributions — like first-home buyer deposits does not change the distributions. It temporarily moves some people off zero, but half will return to zero. Making homes cheaper to build helps but typically benefits the developers more than the buyers. Putting super profits on Banks does not help buyers. The solution lies in changing the operation of finance markets.
A Solution
A solution is to keep markets in goods and services but to keep capital in local communities. In the simple model, people give out a dollar and then get back an unknown number of dollars. Instead of getting back an unknown amount, the person who gave a dollar could be guaranteed to get it back if the person who gave it to them returned it. This is reciprocal capital where providing one party with a profit or more capital is reciprocated by the receiving party sharing the profit.
In a real economy, goods and services exchange hands when money exchanges. In our simple economy, we will introduce exchanging the same value of goods and services with the exchange of money.
A Modified Simple Economy Model
The simple economy model is close to the real-world model of wealth distribution. To make it more efficient, we can make the change of sharing the new wealth created with each transaction. New wealth is created when a transaction creates a profit. Instead of waiting for a random interaction, we can share the new wealth by transferring some back with the transaction. This is modelled with the slider in Figure 3 called “degree-of-reciprocation”. Zero is no sharing. 100% means all the new wealth is transferred back to the same person.
The value exchanged with each transaction is the value of goods transferred with a trade. In the model, it is set to the value of the asset.
In Figure 3, there is no sharing, and the simulation runs for 60 years and transfers 492 per month.
Figure 4 shows that the monthly wealth has increased from 496 to 900 per month, or about the same as the degree of sharing. If 80% represents the effort involved in generating the money for the profit by the buyer and seller, this will represent a fair exchange of trade.
Fair Banking
Bank Loans can use the insight shown above to reduce the cost of housing loans and increase the loans they can offer.
Figure 5 displays the results of the NetLogo model "FairBank Loans.netlogo". You can request the model for further analysis. The model compares the performance of Regular Bank Loans, where the Bank keeps all the interest as profit, with Fair Bank Loans, where the profit is shared between the Bank and borrower. In Fair Bank Loans, the sharing percentage represents the cost incurred by both parties in generating the interest.
The borrower must work hard to generate a profit to repay the loan and interest. Meanwhile, the bank must pay interest on deposits, and both parties must consider the possibility that the loan may not be paid back. The sharing of costs represents a fair distribution between both parties. In the case of home loans, the borrower's cost of generating interest is at least four times higher than the cost to the bank. Therefore, the sharing is set at 80% in favour of the borrower.
The same set of houses and occupants are modelled independently in the simulation. The triangular shapes represent regular loans, while the squares represent Fair Bank Loans.
The colours represent whether the loan can be repaid or no loan is made for some reason.
- Green is a loan that can be made.
- Cyan is a loan application that is rejected because of income.
- Violet's loan application was rejected because of the lack of deposit.
- Pink is rejected for both deposit and income.
- Yellow is a repaid loan.
All the sliders allow parameters to be changed, such as the maximum deposit and the cost of the house.
The amounts shown under averages mean the average for the loans.
For Figure 5, only 39% can get a regular loan, and 54% can get a fair loan.
The critical measure is the cost per $ of equity. This tells how efficient the loan is and measures how much profit a buyer has to make to buy $1 of equity. The figure in the first year is $6.38 for the regular loan and $1.24 for the Fair Loan. These numbers drop as the loan gets repaid as the interest component of a repayment drops as the loan is reduced, and the repayment stays the same.
Figure 6 shows that all the Fair Bank loans are repaid after 18 years. The cost per dollar of Bank Equity has dropped to $3.48.
Figure 7 shows that all the Regular Loans are repaid, and the average cost per dollar of house equity has dropped to $2.22
With Fair Bank loans, the house buyer has halved the loan cost, while the Bank has received about the same income but lower profits. For a Community Bank without shareholders but with members, it has benefited members and made more money available for more loans to benefit more members.
Members can group and become investors and buyers in the same organisation and remove the $1 cost of creating more money, saving members even more. How we can do that is outlined in Capital that Cares and Shares.
Summary
This approach applies to all types of assets. Further Reciprocal or Community Capital information is available at https://kevin-34708.medium.com/, or please contact the author.
