April 5, 2015

A Grand Experiment In Promoting Risk Taking

A weekend started by comments in Saturday’s Bits Bucket. “Is it a safe bet that the dollar will weaken and Wall Street will party Monday on the realization that no Fed rate hikes are imminent?” “Was it ever imminent?”

From Forbes. “The world has been on a debt binge, increasing total global debt more in the last seven years following the financial crisis than in the remarkable global boom of the previous seven years (2000-2007)! This explosion of debt has occurred in all 22 ‘advanced’ economies, often increasing the debt level by more than 50% of GDP. Alarmingly, China’s debt has quadrupled since 2007. The recent report from the McKinsey Institute, cited above, says that six countries have reached levels of unsustainable debt that will require nonconventional methods to reduce it (methods otherwise known as defaulting, monetization; whatever you want to call those measures, they amount to real pain for the debtors, who are in many cases those least able to bear that pain). It’s not just Greece anymore.”

“Quoting from the report: ‘Seven years after the bursting of a global credit bubble resulted in the worst financial crisis since the Great Depression, debt continues to grow. In fact, rather than reducing indebtedness, or deleveraging, all major economies today have higher levels of borrowing relative to GDP than they did in 2007. Global debt in these years has grown by $57 trillion, raising the ratio of debt to GDP by 17 percentage points.’”

The Independent Record. “Risk taking is the life blood of a free market economy. However, free market economies have ups and downs, and are in fact prone to speculative bubbles. Success does not travel in a straight line. There will be failures and excesses, and money will be lost. It is the free market’s way of ensuring that in the long-term money and resources are allocated efficiently. In economic terms it is called ‘creative destruction.’”

“If you believe in the free market’s ability to effectively allocate resources and the forces of creative destruction, you might find some concern with the current state of things. In 2009, the Federal Reserve came up with a grand plan to turn the economy around by encouraging risk taking and putting a floor under home prices. As announced in 2009 by Ben Bernanke, the Chairman of the Federal Reserve at the time, it is called the portfolio balance channel strategy. This official strategy was to drive the returns on relatively safe assets such as U.S. Treasury bonds so low that yield seeking investors were forced into other higher yielding, but riskier assets.”

“It was a grand experiment, and it is still ongoing. Given the current level of stock markets globally versus their levels when the Federal Reserve implemented their strategy, one might say it has been successful in promoting risk taking. One might also consider other places money has flowed such as commodity production. The world is now awash in raw materials as the price of everything from oil to lumber is falling.”

“Bonds themselves might also be a bubble as yields and interest rates remain at historical lows in the United States, and are actually negative in many European countries. The problem with bubbles is that markets are never convinced it’s a bubble until it pops. The question is; can risk taking be induced by central bank policy? Or have the policies of the Federal Reserve and their counterpart central banks around the world lead to mal-investment, the inefficient allocation of money and resources, and asset price bubbles?”

The Houstonia Magazine. “‘From 1981 to 1984, we lost 210,000 people who moved away from the city of Houston,’ said Marvy Finger, CEO of the Finger Companies, the developer responsible for the construction of nearly 60 apartment complexes and rental communities in Houston since 1958. ‘It’s indelible in my mind, because my occupancy went from 95 percent to 65 overnight, and it wasn’t because of rent price,’ he recalled, sitting just to our left. ‘We were giving them away—we just didn’t have anybody to give it to. There just weren’t any people.’”

“‘Those were disaster times,’ intoned a man sitting to our right, part of a coterie of real estate experts who had met for lunch at a Galleria-area restaurant. He was Robert Bland, founder of Pelican Builders, which has developed some of Houston’s most sought-after high-rises, mid-rises, and single-family home communities over the last four decades.”

“‘There’s still a lot of uncertainty,’ Finger continued. Then Bland cut to the chase, asking the question that’s on every Houstonian’s mind these days: ‘Is this going to be the 1980s again?’ The table looked again to Finger, who sat quietly for a moment. ‘I’m not comparing this to the Confederacy just before the opening volley,’ he said, as the table erupted in laughter. ‘Everything’s gonna be okay.’”

“If there was a theme for the afternoon, it was this: everything is gonna be okay.”

“Martha Turner’s real estate firm was acquired by Sotheby’s in early 2014, after a banner year in which she sold $2 billion worth of properties in Houston alone. After last year, in which million-dollar home prices became the norm and sales rose nearly 13 percent, the luxury real estate market will also be cooling its heels in 2015. And before you ask, no, this doesn’t concern the legends of real estate either. ‘The bread and butter [of our industry] is $300,000 to $500,000 houses,’ said Tom Anderson, Turner’s longtime business partner. ‘It’s the bread and butter.’ Will the market correction mean lower home prices down the road, we wondered? Nope.”

“‘I don’t think you’re going to see prices go down,’ Anderson said, as the table nodded in agreement. ‘I think they’ll stabilize.’ What’s also definitely not going down is the price of land, which is the chief reason—along with a booming job market that brought in lots of out-of-towners with big paychecks—that real estate became so pricey over the last several years.”

“‘We’re all very optimistic about the future,’ said Finger as lunch came to a close, in case anyone still doubted it. The rest of the party murmured their agreement. And even if being bullish is their job—after all, building and selling homes is how they make their livelihood—perhaps we should all be optimistic. After all, even if inventory is low right now (read: prepare for a bidding war), at least prices have plateaued—for the moment.”

“‘We’re all very positive about Houston,’ Bland said, driving the point home. ‘It might moderate a little bit, but we’re not headed for disaster.’ What we are headed for is still a bit fuzzy, but expect a future of—at a minimum—more mid-rises and shiny new residential towers, all of them changing Houston’s landscape as indelibly as the oil boom did in the 1970s. ‘I think Houston could be the next Los Angeles or New York City,’ smiled Bland, an optimist to the end.”

Bits Bucket for April 5, 2015

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