June 10, 2017

Asset Pricing In The New Unreal World

A weekend topic starting with the Orange County Register. “Happy National Froth Day! Or, perhaps, my condolences! Twelve years ago today — June 9, 2005 — then-Federal Reserve Board chairman Alan Greenspan — the guy who was once seen as the ‘maestro’ of the economy — went to Capitol Hill and testified he saw ‘froth’ in housing but not a bubble.”

“His prepared testimony for the congressional Joint Economic Committee went like this: ‘There can be little doubt that exceptionally low-interest rates on 10-year Treasury notes, and hence on home mortgages, have been a major factor in the recent surge of homebuilding and home turnover, and especially in the steep climb in home prices. Although a ‘bubble’ in home prices for the nation as a whole does not appear likely, there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels.’”

“So today, we lift whatever froth you like — a coffee drink or something fizzy made with grains — as a toast to humanity’s inability to see a brewing bubble.”

From The Irish Times. “My partner and I began our house hunt fairly tentatively towards the end of last year, when talk of another property bubble was only starting. Now it’s on fire, and we’re at the centre of the blaze, competing with thousands of others searching for a property to call our own in Dublin. We knew that applying for a mortgage was going to be arduous, but we expected the delay to be at our end, as we completed the endless paperwork, not at the bank’s.”

“We’re out the door with all the applications at the moment,’ my bank’s mortgage adviser said when I went in for a chat in March. She told me it could take three or four weeks to get approval in principle, and that was after all the paperwork had been correctly submitted. ‘We can’t keep up.’ After a two-week wait our mortgage was approved, with a lower interest rate, by another provider in April, much to our relief.”

“There’s a distinct whiff of deja vu about what’s happening now. Having seen the devastating effects of the crash, we’re wary. But it’s hard not to get caught up in it when you’ve your heart set on buying a house. What’s another €10,000, you think, as the bidding climbs steadily higher.”

From Danielle DiMartino Booth. “Oh, but for the days the hawks had a hero in Sydney. Against the backdrop of a de facto currency war, the Reserve Bank of Australia stood as a steady pillar of strength. The Bank of Canada has taken a similar journey in recent years. How they’ve landed in their current predicaments is less easy to explain. Propelled by soaring home prices from Sydney to Toronto to Melbourne to Vancouver, Australia’s household debt-to-income has hit a record 190 percent, the highest among developed nations; it is trailed closely by Canada, which has a 167 percent ratio.”

“To put this in perspective, at the peak of the housing bubble, debt-to-income in the U.S. peaked at 130 percent. Then, economists took perverse pleasure in squelching the alarm these frightening figures elicited. ‘It’s not the level of debt that matters, it’s the cost to service that debt.’”

“That myopic mindset best captures the shackles that bind today’s global economy. Of course it’s acceptable to build infinitely high levels of debt — as long as rates never rise. But then there’s the inconvenient truth that when the price of the collateral backing those millions of subprime mortgages cratered, those irrelevant debt loads became relevant overnight. The same can be said of today’s delicate dynamic. Australia and Canada will be just fine so long as they don’t suffer a shock in any form to their respective economies.”

“Call it a global cultural tectonic shift. For close to a decade, the almighty Federal Reserve’s holding interest rates near the zero bound and its unconventional monetary maneuvers have bled into every nook and cranny of the global economy; it has altered the way investors of all stripes approach the very idea of debt. Asset pricing, the way it was taught in Finance 101 courses, has no place in the new unreal world.”

“Without the comforting embrace of such delusions we could hardly dismiss as hysterical hyperbole reports such as that recently released by the World Economic Forum, which said longevity and lackluster investment returns will viciously collude to create a $400 trillion retirement savings shortfall in 30 years’ time. That figure is five times global output.”

“At the very least, Australia’s Treasury Secretary John Fraser has an optimistic take on how far out the day of reckoning will be. Debt is, ‘all fine until it ain’t. When interest rates do, in the centuries to come, go up, it’s something to watch.’ Pray you aren’t the lucky soul with front-row seat tickets.”

From Harper’s Magazine. “Two years before the 2008 Wall Street crash that toppled the global economy into deep recession, Harper’s Magazine published a dark prophecy of what was to come. In ‘The New Road to Serfdom,’ economist Michael Hudson laid out how millions of Americans had taken on huge debts to buy houses on the presumption that they could later sell them at a profit. As the twenty million people who lost their homes discovered, Hudson got it entirely right.”

“Today, unemployment is at record lows, and the stock market is at record highs. Allegedly, we have recovered from the disaster. I talked to Hudson, Distinguished Professor of Economics at the University of Missouri-Kansas City and the author, most recently, of J is For Junk Economics, A Guide to Reality in an Age of Deception, about his pre-crash prediction, and what he now sees in our future.”

“At least you have the satisfaction, if that’s the word, of events proving you correct. But we’ve supposedly now recovered from that disaster. Have we?”

“No, we haven’t at all recovered. That’s why Hillary lost the election. She said, ‘Look at how much better you are since 2008. Obama has saved you.’ Trump said, ‘Wait a minute. Look at how bad you are. You’re not saved.’ Everybody thought, ‘Who are you going to believe, your eyes or Hillary?’ We haven’t recovered at all. Obama saved the banks and Wall Street, not the economy. From 2008 until today, the economy has grown by 2 percent, but the top 5 percent of the economy have got all of that growth. The economy isn’t recovering.”

“That’s why when the Department of Labor statistics gave the most recent employment figures, everybody commented, ‘It’s very interesting. Employment is up, but wages are continuing to fall.’ It’s all minimum wage work. The debt ratio for most families is rising, not falling, especially for student debt, for mortgage debt, for automobile debt. The default rate is continuing to rise.”

“So are we heading for another explosion comparable to 2008?”

“I’m not sure it’ll be an explosion. It’s more like a slow crash. It’s more like people are getting desperate. They’re having to live off their credit cards, not to buy luxuries but just simply to break even. They’re falling further and further behind, and as they fall behind the interest rate rises, the penalties rise, so people are getting more and more squeezed.”

“Is that your prediction for our future here in the United States? Greece?”

“Yes, a slow crash as more and more money is drained from the economy to pay the FIRE sector—finance, insurance, and real estate—not the goods and service producing sector.”