June 17, 2017

Moral Hazard, Easy Money And Cheap Credit

A weekend topic starting with the Star Tribune. “Prices for houses are generally back to where they were during the housing bubble that preceded the financial crisis a decade ago. What’s worse, flipping is back. That is the speculative practice of buying houses hoping to quickly sell for a gain. One report this spring said there hasn’t been this much flipping since 2006 — more or less the frenzied peak of the last housing boom. Neel Kashkari of the Minneapolis Federal Reserve seems oblivious to all this, at least according to critics knocking Kashkari’s recent essay about asset bubbles and what the Fed ought to do about them. Kashkari’s entirely sensible answer: not much.”

“And he made an even better point, that, even if the Fed did have something smart to do, it’s highly unlikely anyone at the Fed managed to correctly spot an asset bubble forming in the first place. As for the U.S. housing bubble alarmists of 2017, there’s far more to proving a case of irrationally overvalued housing prices than pointing out that the Case-Shiller housing price index has climbed above 2006 levels.”

“And it appears Kashkari agrees. ‘I appreciate [you] responding to my essay,’ he responded via Twitter to a blog arguing that spotting bubbles isn’t difficult at all. ‘If so easy to spot bubbles, why tell us? Launch [hedge fund] and short ’em. Make trillions. No? Just talk then.’”

From KCRA in California. “The average Sacramento County home is on the market for just eight days before selling, SAR’s Tony Vicari said. It’s really all about supply and demand, Kellie Swayne of Dunnigan Realtors said. ‘Right now, California’s real estate is hot, hot, hot,’ Swayne said. ‘With so little supply out there we’ve got lots of buyers in the market. We’ve got multiple offers most of the time.’”

“But with prices on the rise, some wonder if Sacramento’s housing bubble could one day crash as it did in 2008. Swayne said conditions are different now because inventories are so low. ‘For right now, there’s no end in sight in Sacramento, and frankly across the state, for relieving of more inventory on the market,’ Swayne said. ‘When that happens maybe we can start talking about a bubble.’”

The Business News Network in Canada. “In the almost 12 months since Finance Minister Bill Morneau announced his working group on housing, Ottawa has made it harder for Canadians to get an insured mortgage through more stringent stress tests. In the meantime, B.C. and Ontario have pulled policy levers – most notably taking aim at foreign investors with a 15 per cent tax.”

“BMO Capital Markets Senior Economist Sal Guatieri says the time for policy tinkering has passed. ‘Time to take out the heavy artillery: higher interest rates,’ Guatieri wrote in a note to clients. ‘The ball is now firmly in the Bank of Canada’s court.’”

The Border Mail in Australia. “It is almost exactly 10 years since the financial world began a wobble that would swing into what we now know as the global financial crisis. Today, the scars of the global financial crisis remain. There have been trillions of dollars in losses. And in a world of subpar economic growth, even optimists are downbeat about whether the economic medicine has been taken.”

“Let’s start with the question of debt. Lord Adair Turner, who chaired the UK Financial Services Authority between 2008 and 2013 and helped redesign global banking, says the world since has not addressed this root cause of the crisis and that means it’s at risk of another one. Lord Turner says the world is suffering from ‘irrational exuberance’ and ‘debt overhang.’”

“‘There’s been no deleveraging,’ Lord Turner says. ‘Once you’ve got too much debt in the economy … it’s incredibly difficult to get rid of it. If you say, ‘I’m going to write it off’, your banks go bankrupt … if you try get rid of it by people paying down that debt … the attempt to pay it back is what drives the economy into recession.’”

“To avoid that, interest rates then fall, and that simply encourages more borrowing, he says.”

“The team at LF Economics - a research firm founded by Lindsay David and Philip Soos - have also been sounding strong warnings of a crash. David says, ‘I don’t believe there is another mortgage market globally where a banking system leveraged their household sector as much as ours is without a systemic collapse.’ He says Australia’s debt profile has a strong resemblance to Ireland’s debt profile in the lead-up to the GFC, whereby public debt levels by global standards were relatively low but household debt is extremely high.”

“‘The mistake we have made in Australia’s is that we essentially copied Ireland’s pre-GFC paper wealth creation model by allowing banks to over-lend and engage in Ponzi finance,’ Mr David says. ‘That is, lending ever-larger amounts of mortgage debt to owner-occupiers and investors to increase leverage and outbid other speculators.’”

From Bloomberg. “The architects of U.S. monetary policy at the Federal Reserve should be happy. They’ve succeeded beyond their own expectations in bringing down the unemployment rate without triggering an outburst of inflation. Stock indexes are near record highs, and interest rates remain low. On June 14, the Federal Open Market Committee voted as expected to raise the federal funds rate a quarter point, to a range of 1 percent to 1.25 percent. It said it expects inflation to rise to its 2 percent target ‘over the medium term.’”

“For Fed Chair Janet Yellen and company, the central mystery continues to be why ­inflation remains below 2 percent despite unemployment having dropped to just 4.3 percent in May. Those who set interest rates are in the awkward position of not understanding how things got so good—and are therefore confused about what to do next.”

“The risks could simply be hidden. If rates get much higher, borrowers who took on too much debt during the long period of abundant credit may have trouble making payments or refinancing, says Christopher Whalen, chairman of Whalen Global Advisors Inc. He says the Fed should have begun tightening credit several years ago but can’t do so now without triggering a wave of defaults. ‘I think they’re stuck,’ he says. ‘They’ve boxed themselves in.’”

The Real Deal. “In May, commercial real estate mortgage borrowers paid off maturing loans at a slower rate, according to Morningstar Credit Ratings LLC. In 2007, borrowers took out 10-year loans that were repackaged into commercial mortgage backed securities. This partially explains the uptick in the number of unpaid and delinquent loans, the Wall Street Journal reported. About $9.4 billion was unpaid from about 790 loans that came due last month.”

“The real estate market has been preparing to deal with a wall of 10-year maturities, and last month there was an increase in borrowers that either failed to repay their debts or defaulted on monthly payments. ‘It’s all because of the riskier nature of the loans originated 10 years ago,’ Steve Jellinek, a Morningstar vice president told the newspaper. ‘Today, with more conservative lending standards, they can’t get refinancing.’”

“Nearly 18 percent of commercial mortgage securities loans that reached maturity in the past 12 months were delinquent. From June 2015 to April 2016, the average was about 10 percent.”

From the Independent Institute by Alvaro Vargas Llosa. “Moral hazard, easy money and cheap credit have never produced good results. History is littered with examples of financial disaster brought about by monetary manipulation originating in central banks and then spreading to other parts of the system. One would think that the 2007/08 credit crisis, whose effects have not quite withered away, would teach politicians, central bankers, corporations and consumers something about the causes of credit crunches and meltdowns.”

“Think again. The world’s four largest central banks have pumped more than $9 trillion into the system since the last financial crisis and brought about a world of absurdly low and even negative interest rates. The incentives generated by these policies and their effects—moral hazard, easy money, cheap credit—will lead, at some point, to the bursting of new bubbles.”

“However, those consumer credit markets are the ones already signaling distress, so we better pay some attention. These symptoms point to risks not dissimilar in nature to what was happening before the housing-related financial meltdown. Banks are beginning to reduce outstanding corporate lending for the first time since that crisis, a very significant reversing of the trend. Standard and Poor’s downgraded 1,088 companies in the United States last year, and analysts are predicting a wave of junk-debt defaults, perhaps encompassing one in every four high-yield debt issuing companies.”

“One can never tell exactly when a bubble will burst or which corner of the financial system will be the epicenter of the earthquake. But if and when these looming bubbles explode, the main culprit will be the irresponsible policies that were supposed to prevent future bubbles and that created the perfect storm of moral hazard, easy money, and cheap credit once again.”