Shortly after I moved to Zurich with my family, we went to visit my wife’s sister that also lives in Switzerland. While chilling on the couch on a rainy Saturday, I started to rant to my brother-in-law about the fact that I had to stash more than 11k in a bank account as a deposit for our rent.
11.280 CHF
Sitting on an account doing nothing. That’s probably why Swiss banks have combined liabilities that are 10x the Swiss GDP: Nazis’ money and rent deposits (61% of people living in Switzerland are tenants).
My brother-in-law calmly told me that there is a new tool available: Swiss Caution. You pay them a fee, they release a guarantee in your name and done, no need for any deposit no more. That’s, I thought, what happens when entrepreneurial spirits are left free to express themselves: identify a need and offer a solution. Or…given that money is involved, exploit poorly financially literate folks.
Enters Swiss Caution
Swiss Caution is, as I expected, an insurance company. It is even regulated as such. The fee that the client pays is an insurance premium and SC steps in if the client has a financial need, i.e. their landlord makes a claim on some damage/lost rent payment. So far so good. The small print, something that not even my brother-in-law was aware of, is that the client is on the hook to then pay back SC…nice deal bro!
It is like if your health insurance would cover your hospital bill only to re-charge you a few days later. The only way I can remotely make sense of this is that the client is (supposed to be) in control here: even if I take care of my health the best that I can, I might still have cancer; aside from what you consider normal wear and tear, I should be 99% in control of anything that happens in the place where I live (or the rent I fail to pay). But then you can make the same point about car insurance: you do not see many individuals crashing into other people’s cars just because they would not have to bear the related financial consequences. The way I see it, SC designed its policy to “force” an alignment between its clients’ interests with its own…only to factually demonstrate again that the only insurance worth paying is the one that covers risks you cannot auto-insure.
In the remote case you are based in Switzerland as well and are still interested in SC, here are two additional ways it takes advantage of its clients:
- the premium is paid annually, not monthly: if the client leaves the place mid-year, the residual premium is lost
- the landlord is the only one that can formally cancel the client’s annual subscription to SC: if the client decides to leave close to the SC policy renewal and the landlord does not communicate with SC in a timely manner, the client is still legally obliged to cover the next year payment. Swiss Real Estate agencies are not exactly famous for giving a shit…that’s why this risk is not as tiny as someone might think.
There are a few, financially related, interesting points to highlight out of this short, mostly sad, story.
Different country, same NIMBY-sm
As in many other places in the world, rents (and ancillary costs) are so high in Switzerland because there are not enough houses. If you want to build something, you need a permit, and the only person who can give you that permit is elected by someone that already lives in Switzerland. And that person has no interest in a change in the status quo. Even worst, if they own their house, their incentive is the opposite: the fewer houses, the higher the value of theirs.
As a bonus, you get an effective form of immigration control. In order to afford the exorbitant rent, you need a high salary. And to get a high salary, you have to bring skills that cannot be found otherwise in-house. “Now, we are happy YOU came“.
Do you remember the struggle to put together that 20% downpayment for first-time buyers? Let’s run the same trick again…for renters.
It is a racist policy because it is not mandatory by law to request such a high deposit. In the end, this deposit is just a guarantee for the landlord that if something bad happens, they have it covered. (What can I do to cause 11k of damages in an empty place, blow up a wall?!? Well, they have another insurance for that…) If you rent from your uncle, your parent’s friend, or…someone that is part of your community, they might not want a monetary proxy of trust…because they already know you.
[The majority of Swiss landlords are pension funds and insurance companies. It is more likely that the high deposit is a way for Real Estate agencies to keep their clients (and keep them happy) in case something bad happens; it is a guarantee on their tenants’ screening process. Still, if you know the RE agent, they might be willing to cut the deposit]
Desperate…or stupid
SC has two types of clients:
- those that need to live somewhere but do not happen to have such spare change in their pocket (folks that came to Switzerland to work and…surprise, surprise)
- those that never manage to save a dime in their life and see this service as a ‘bargain’
While doing some research on when the company was launched, I found many competitors. Which means there must be a real demand for this service. Which, in my deranged mind, turned immediately into a great example of why p2p loans have, at least, a rational basis to exist.
If you are new to this blog, a quick recap. I invest in p2p loans for more than a decade and I started this blog also to write about them. I do not touch the topic that much lately but it is something that I hold in the back of my mind.
One of the reasons I invest in the product is because I think there are many people that make stupid financial decisions. And the preponderance of them are Lannisters: they pay their debt. Or better, they borrow with at least the genuine intention to pay back the loan.
A valid argument against p2p loans is that they attract only borrowers that plan to “take the money and run”. But this would mean the existence of a big population that is able to discern between good and bad financial decisions.
The Swiss system is built so that no person can default on a financial obligation (unless the person leaves the country and never comes back). So it is very hard to envision someone that decides to engage with SC thinking they can get an ILLEGITIMATE financial gain. They must think that paying a 5% annual fee is cheaper than the alternative.
Obviously the simple existence of a group of people that makes poor financial decisions does not make the p2p business intrinsically viable. It is a necessary but not sufficient condition, as my former Engineering professor would put it.
Leverage & Collateral
All considered, the SC 5% fee is currently lower than a USD margin loan on Interactive Brokers (IB charges FED rate + 1.5%). Wouldn’t it be better for me to do the SC guarantee and invest the 11k? Am I stupid that I accept to pay 6.5% to IB but I avoid SC?
This is the main reason why I wanted to write about SC, because it offers a nice opportunity to discuss all the aspects related to the use of leverage from an angle that might be more familiar to the general public.
There is no way to “arbitrage” this, i.e. invest the 11k in a CHF asset that pays 5%+ in a secure (or secur-ish) way. The Swiss National Bank policy rate currently sits at 1.5%: bonds that pay more than 5%, if exist, must be issued by companies with a very crappy credit rating (not sure how to check this now that I do not have Bloomberg but a quick Google search returned a perpetual callable subordinated bond issued by Hero, the Swiss food company…if “perpetual callable subordinated” sounds scary to you, you are on the right path to understand the risk-level of this instrument).
5% in CHF is a high hurdle rate but by no means an impossible target to achieve. The iShares MSCI World CHF hedged UCITS ETF returned 7.53% annualised in the last 10years and 8.6% since inception. But under that ‘average’ sits this kind of volatility:
Here, the problem in matching assets and liabilities is that I need years for my assets to generate the type of return I am aiming at (in a somehow consistent fashion) but I am not in control on the liability side. What if I my wife wants to change apartment while the stock market is down and the Real Estate agent decides I have ruined the floor? In fairness, I cannot think (again) what damage I can cause in the range of thousands of CHF but I hope you get the point. I might finds myself not only liable for an unreasonable bill but also having to sell stocks at the wrong time.
There is also no guarantee that the SC fee, my funding cost, will stay at 5%. It is reasonable to think that, with the SNB rate negative, SC had a good profit margin charging 5%; what about when rates are at 1.5%? What if rates go higher? What if the fee becomes 7% and I have to unwind the structure, cancel the SC guarantee and put up a standard deposit, when the stock market is down?
How do you price this risk? Another way of seeing this, might be that is actually good to diversify my funding sources away from IB. But I do not think this is such a clever way to achieve that goal, despite how bargan-ish it might look at the moment. I would rather bet that SC will increase its fee soon.
I hope this post will give you an idea on how to apply financial reasoning to seemingly unrelated or mundane decisions. At least, you can leverage a bit all that time wasted thinking about…leverage.
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