4 ms·

But y does not get smaller. Only expected interest on y gets smaller. y is the same (actually a little larger because money today is worth more than money tomor

• roel_v 11y ago
  You're right, I didn't write it exactly enough. What gets smaller is (y + expected interest on y) because the expected interest goes to 0. The whole thing to realize here is that the 'cost' is not an actual loss as in 'less money comes in'; it's a cost in the sense of 'this portfolio will perform less than we anticipated'. And if the interest that people pay is based on a certain overall performance, but now all of a sudden the performance needs to be adjusted downwards, then one might argue 'we were shooting for a 0-operation, but in the end we will have to spend money to make up for the good borrowers leaving'. Here's another intuition that explains it: if the market is willing to finance the good borrowers at half the rate it takes to lend to everybody, regardless of their prospects of paying back; then only the bad borrowers will stay in the government-funded portfolio, reducing the performance that was originally estimated. Which is, if you've accounted for future earnings based on the original estimate, a loss when you have to write it down.