I have a thing about financial market quotes at the moment. Here are a couple of my favourite ones:
"Those who already own a house are only mildly concerned by the modest falls in the value of their homes, after all, the value of their property has practically doubled in the last six years. However many are already questioning whether this is the time to sell, and whether they shouldn't hang on until the market resumes its normal upward trend."
Grainne Gilmore, The Times economics correspondent
"The trend is no longer your friend"
Michael Turvey, INVESTools
Why would anyone buy the obligations of a shaky deficit-ridden political system in a currency that appears fundamentally unsound?
Martin Hutchinson, the Bear's Lair
“The repricing of risk…is not a process that we should try to reverse.”
Mervyn King, Governor of the Bank of England
"Up until this point in time, the market and the regulators have had to rely on the bond insurers and the rating agencies to calculate their own losses in what we deem a self-graded exam. Now the market will have the opportunity to do its own analysis.''
William Ackman, managing partner of Pershing Square Capital Management.
"Inflation is a regressive tax. Whether you earn less than $30,000 or more than $300,000, you spend about the same on gasoline, but at $30,000 a year an extra $375 is close to 2 percent of your entire after tax income."
FRED, iTulip Administrator
Am I Mr. Brightside? No, I believe that subprime's awful, even worse than the bears think.
Jim Cramer
Thursday 31 January 2008
How wrong can you be? Take a look at this article and you might get some idea.
Two years ago, Businessweek wrote article arguing that the US housing bubble will not burst. Well, we know what happened since then. The housing data has been just appalling; prices are falling in virtually every city, home starts are down, and sales volumes have tanked. However, the most shocking number must be the one for foreclosures; at the moment, one house in a hundred in the US is in some form of repossession process.
Of course, we find the same kind of deluded "the bubble can't burst" thinking here in the UK. Far too many people have too much faith in the property market. While the reality of an overpriced, over-inflated market is starting to impose itself, the majority of UK homedebtors are in denial.
Anyway, here is the article; read it and weep.
Why The Housing Bubble Won't Burst
Type the words "falling housing prices" into Google and more than 8 million citations pop up. Michael Youngblood's name won't be among them. Despite all the fear that single-family home prices will decline, the managing director of asset-backed securities research at Friedman Billings Ramsey & Co. (FBR ) in Arlington, Va., thinks residential real estate is a lot stronger than most people suspect. He bases this assessment on a new economic model he created that forecasts housing prices in 379 metropolitan statistical areas. Associate Editor Toddi Gutner spoke with Youngblood about his upbeat view and his surprising prediction that the greatest price appreciation will be coming in so-called bubble markets.
What makes you more optimistic than other housing experts?
I look at two economic indicators that I think drive the housing market: the growth in employment and the growth in personal income. Getting a job or a salary increase is what motivates people to buy their own home. This is different from the data the National Association of Realtors and other organizations rely on. They are more concerned with technical indicators such as the inventory-to-sales ratio and the number of months a house is on the market. These aren't leading indicators. Instead, they move with current changes in the market, rather than predict those changes.
Do you think the housing bubble argument is overblown?
Absolutely. It's overblown because there is no national housing market, so there can't be a national house-price bubble. However, there are bubbles in 75 of the 379 markets I studied. A bubble exists when the ratio of the median existing house price to per capita personal income exceeds 6.8 times. This definition is based on historical data of when other markets, like Houston and Boston, had bubbles.
Where are the bubbles?
Most of the bubbles exist on the East and West coasts in such markets as New York City, Los Angeles, Washington, Phoenix, Honolulu, and Tacoma, Wash. Only 12 of the 75 cities are located inland: Boulder, Colo., Coeur d'Alene, Idaho, Flagstaff, Ariz., and Las Vegas among them.
What markets are likely to show the biggest price gains and declines this year?
We expect the greatest gains in Bakersfield, Calif. (43%), Fort Myers, Fla. (42%), Stockton, Calif. (39%), and Punta Gorda, Fla. (35%); the biggest declines in Harrisburg, Pa. (8%), Odessa, Tex., Roanoke, Va., and Utica, N.Y. (all 6%).
But most people think that Florida and California are overpriced. Why would markets there show the greatest gains?
There is clearly speculation taking place in these areas. But bubbles can persist for very long periods of time, and it typically requires a downturn in the local economies to burst them. Then they can deflate for a long time, too. Given the expected gains in employment and income in both states, I don't expect the housing prices to fall in 2006.
How can investors play this information?
Investors should not necessarily fear homebuilders who are operating in bubble markets. House prices don't plunge immediately in economic downturns the way stock prices do. There is typically a one-year lag after the local economy sees a decline in average employment and income. Thus, the homebuilder stocks may continue to perform well for a while longer.
Of course, we find the same kind of deluded "the bubble can't burst" thinking here in the UK. Far too many people have too much faith in the property market. While the reality of an overpriced, over-inflated market is starting to impose itself, the majority of UK homedebtors are in denial.
Anyway, here is the article; read it and weep.
Why The Housing Bubble Won't Burst
Type the words "falling housing prices" into Google and more than 8 million citations pop up. Michael Youngblood's name won't be among them. Despite all the fear that single-family home prices will decline, the managing director of asset-backed securities research at Friedman Billings Ramsey & Co. (FBR ) in Arlington, Va., thinks residential real estate is a lot stronger than most people suspect. He bases this assessment on a new economic model he created that forecasts housing prices in 379 metropolitan statistical areas. Associate Editor Toddi Gutner spoke with Youngblood about his upbeat view and his surprising prediction that the greatest price appreciation will be coming in so-called bubble markets.
What makes you more optimistic than other housing experts?
I look at two economic indicators that I think drive the housing market: the growth in employment and the growth in personal income. Getting a job or a salary increase is what motivates people to buy their own home. This is different from the data the National Association of Realtors and other organizations rely on. They are more concerned with technical indicators such as the inventory-to-sales ratio and the number of months a house is on the market. These aren't leading indicators. Instead, they move with current changes in the market, rather than predict those changes.
Do you think the housing bubble argument is overblown?
Absolutely. It's overblown because there is no national housing market, so there can't be a national house-price bubble. However, there are bubbles in 75 of the 379 markets I studied. A bubble exists when the ratio of the median existing house price to per capita personal income exceeds 6.8 times. This definition is based on historical data of when other markets, like Houston and Boston, had bubbles.
Where are the bubbles?
Most of the bubbles exist on the East and West coasts in such markets as New York City, Los Angeles, Washington, Phoenix, Honolulu, and Tacoma, Wash. Only 12 of the 75 cities are located inland: Boulder, Colo., Coeur d'Alene, Idaho, Flagstaff, Ariz., and Las Vegas among them.
What markets are likely to show the biggest price gains and declines this year?
We expect the greatest gains in Bakersfield, Calif. (43%), Fort Myers, Fla. (42%), Stockton, Calif. (39%), and Punta Gorda, Fla. (35%); the biggest declines in Harrisburg, Pa. (8%), Odessa, Tex., Roanoke, Va., and Utica, N.Y. (all 6%).
But most people think that Florida and California are overpriced. Why would markets there show the greatest gains?
There is clearly speculation taking place in these areas. But bubbles can persist for very long periods of time, and it typically requires a downturn in the local economies to burst them. Then they can deflate for a long time, too. Given the expected gains in employment and income in both states, I don't expect the housing prices to fall in 2006.
How can investors play this information?
Investors should not necessarily fear homebuilders who are operating in bubble markets. House prices don't plunge immediately in economic downturns the way stock prices do. There is typically a one-year lag after the local economy sees a decline in average employment and income. Thus, the homebuilder stocks may continue to perform well for a while longer.
Wednesday 30 January 2008
Making sense out of the FSA
The Financial Services Agency has just published their Financial Risk Survey for 2008. As you would expect, the report is full of obtuse, convoluted phrases. Such reports leave the reader bewildered and confused about potential risks. The purpose is, afterall, not to enlighten but to obscure the dangers.
Today, I had too much time on my hands. I actually sat down and read this report. I have chosen my ten favourite lines and decoded them in the vain hope that we can all have a slightly better understanding of financial sector vulnerabilities going forward.
1. The recent tightening in financial conditions may have exposed some firms’ business models as being potentially unsuitable in more stressed financial conditions where, for example, access to liquidity is restricted.
The banks have taken on way too much risk. Now the banks are struggling to get cash.
2. The structured finance vehicles that some firms have chosen to use over the last few years have had a material impact on their financial performance during stressed financial market conditions.
The banks have been producing new financial products that we could not understand. It turns out that the banks didn’t understand them either.
3. Despite the more difficult economic and financial conditions, firms must not divert attention away from focusing on conduct-of-business requirements and our high-level principles.
The FSA better watch the banks more closely because they seriously starting to misbehave.
4. Market participants and consumers may lose confidence in financial institutions and in the authorities’ ability to safeguard the financial system.
The FSA can not afford to screw up like it did with Northern Rock.
5. Financial market conditions weakened considerably in 2007 as investors reassessed risks in their portfolios and risk premia began to rise.
The sub prime crap hit the fan in August, and now everyone is running for cover.
6. Tighter credit conditions are likely to add further risks to the growth outlook as consumers’ ability to spend and finance their house purchases comes under pressure.
The UK housing market is going to crash and it will take the economy down with it.
7. If consumers found it increasingly difficult to obtain credit, the number of property transactions would be likely to fall and the market for mortgages for own-house purchase would therefore become smaller. However, the demand for re-mortgaging and second charge lending could rise, particularly as consumers consolidate debt.
When it crashes, consumers are going to try to keep on borrowing, digging themselves into an even bigger hole. They are addicted to debt and there is nothing anyone can do to save them.
8. As commercial and residential property prices fall, financial firms with high concentrations in this type of lending could face losses which require an increase in provisions on both the residential and commercial property books, thus reducing profitability. This could put firms’ capital under pressure.
When the market crashes, the banks will be in serious difficulties. Some of them might go down the same hole that Northern Rock is now exploring.
9. Banks and other lending institutions might need to increase their provisions to account for consumers having difficulties in repaying their mortgages and unsecured loans due to a fall in their disposable and real incomes. However, changes in interest rates would give financial firms greater opportunities to widen margins to maintain profitability.
Please send a memo to the MPC begging them to cut rates. Many households are about to stop paying their debts. The banks are in trouble and if rates don’t come down, banks won’t be able to make enough money to cover the losses.
10. Over the course of 2007 there was a transition from a situation where there was overconfidence in the market to the current situation where confidence is low.
The FSA have failed miserably to prevent a financial crisis. While it may be our fault, we will push the blame onto overconfidence. As far as we know, overconfidence has absconded, and he won't be coming back any time soon.
Today, I had too much time on my hands. I actually sat down and read this report. I have chosen my ten favourite lines and decoded them in the vain hope that we can all have a slightly better understanding of financial sector vulnerabilities going forward.
1. The recent tightening in financial conditions may have exposed some firms’ business models as being potentially unsuitable in more stressed financial conditions where, for example, access to liquidity is restricted.
The banks have taken on way too much risk. Now the banks are struggling to get cash.
2. The structured finance vehicles that some firms have chosen to use over the last few years have had a material impact on their financial performance during stressed financial market conditions.
The banks have been producing new financial products that we could not understand. It turns out that the banks didn’t understand them either.
3. Despite the more difficult economic and financial conditions, firms must not divert attention away from focusing on conduct-of-business requirements and our high-level principles.
The FSA better watch the banks more closely because they seriously starting to misbehave.
4. Market participants and consumers may lose confidence in financial institutions and in the authorities’ ability to safeguard the financial system.
The FSA can not afford to screw up like it did with Northern Rock.
5. Financial market conditions weakened considerably in 2007 as investors reassessed risks in their portfolios and risk premia began to rise.
The sub prime crap hit the fan in August, and now everyone is running for cover.
6. Tighter credit conditions are likely to add further risks to the growth outlook as consumers’ ability to spend and finance their house purchases comes under pressure.
The UK housing market is going to crash and it will take the economy down with it.
7. If consumers found it increasingly difficult to obtain credit, the number of property transactions would be likely to fall and the market for mortgages for own-house purchase would therefore become smaller. However, the demand for re-mortgaging and second charge lending could rise, particularly as consumers consolidate debt.
When it crashes, consumers are going to try to keep on borrowing, digging themselves into an even bigger hole. They are addicted to debt and there is nothing anyone can do to save them.
8. As commercial and residential property prices fall, financial firms with high concentrations in this type of lending could face losses which require an increase in provisions on both the residential and commercial property books, thus reducing profitability. This could put firms’ capital under pressure.
When the market crashes, the banks will be in serious difficulties. Some of them might go down the same hole that Northern Rock is now exploring.
9. Banks and other lending institutions might need to increase their provisions to account for consumers having difficulties in repaying their mortgages and unsecured loans due to a fall in their disposable and real incomes. However, changes in interest rates would give financial firms greater opportunities to widen margins to maintain profitability.
Please send a memo to the MPC begging them to cut rates. Many households are about to stop paying their debts. The banks are in trouble and if rates don’t come down, banks won’t be able to make enough money to cover the losses.
10. Over the course of 2007 there was a transition from a situation where there was overconfidence in the market to the current situation where confidence is low.
The FSA have failed miserably to prevent a financial crisis. While it may be our fault, we will push the blame onto overconfidence. As far as we know, overconfidence has absconded, and he won't be coming back any time soon.
Mortgage approvals come crashing down.
UK mortgage approvals are crashing like a stone. In December, approvals fell to their lowest level since 1995.
According to the Bank of England, just 73,000 house purchase loans were approved. The average approval rate during the first half of 2007 was around 100,000 a month.
Let is repeat the golden rule of real estate:
"Credit availability determines house prices"
No credit growth, no house price growth.
According to the Bank of England, just 73,000 house purchase loans were approved. The average approval rate during the first half of 2007 was around 100,000 a month.
Let is repeat the golden rule of real estate:
"Credit availability determines house prices"
No credit growth, no house price growth.
Losing big
Which bank will come top of the table of sub prime losers.
Today, UBS put down a very strong claim. Today, it announced a further $4 billion of losses, bringing its total sub prime losses to around $18 billion. This unprecedented losses should come as no surprise. At one point last year, the bank held about $40 billion of sub prime related debt.
With losses of this magnitude, the bank's capital is disappearing fast. The FT reported that UBS's "BIS Tier I capital ratio – a key measure of its financial strength – amounted to 8.8 per cent at the end of December." It went on to say that 8.8 per cent was "well below the 11-12 per cent ratio the bank has as its goal." If this capital ratio falls below 8 percent, then the bank would be in serious trouble with financial regulators.
With this in mind, UBS are frantically looking around for extra capital. Anyone out there interested in bailing out UBS?
Today, UBS put down a very strong claim. Today, it announced a further $4 billion of losses, bringing its total sub prime losses to around $18 billion. This unprecedented losses should come as no surprise. At one point last year, the bank held about $40 billion of sub prime related debt.
With losses of this magnitude, the bank's capital is disappearing fast. The FT reported that UBS's "BIS Tier I capital ratio – a key measure of its financial strength – amounted to 8.8 per cent at the end of December." It went on to say that 8.8 per cent was "well below the 11-12 per cent ratio the bank has as its goal." If this capital ratio falls below 8 percent, then the bank would be in serious trouble with financial regulators.
With this in mind, UBS are frantically looking around for extra capital. Anyone out there interested in bailing out UBS?
Tuesday 29 January 2008
It is different this time
Why did the UK housing prices reach the extraordinary levels we see today? There is no shortage of answers to this question, but whatever the explanation, it invariably begins with those five fatal words - "it is different this time".
Some pointed to demographics; the nuclear family was breaking down, creating an army of lonely single home buyers. As this army expanded, housing demand increased. Others suggested that the huge number of migrants coming into the country put unbearable pressure on the market, and likewise pushed up prices.
There was a variation on this theme, which pointed to the endless number of wealthy rootless cosmopolitans, who came to London and bought up huge swathes of property, with only a casual glance at the prices.
Structural factors was another favourite. The UK's archaic planning laws was a well-worn argument, while the peace dividend in Northern Ireland provided a regional flavour to the "it is different this time" mantra.
Whatever the explanation, the conclusion was always the same; conventional methods for determining home valuations no longer applied to the housing market. There was no point looking at affordability indicators or price-to-income ratios. The UK had "changed fundamentally" during the last ten years, and this "change" was reflected in property prices.
Superficially, the "it is different this time" claim must be correct. Obviously, when prices are racing ahead at 20 percent a year, something very strange and unusual must be happening somewhere. The curious thing, however, is why people prefer to accept a convoluted explanation, when a simple and convincing one is ignored. There was something wonderful and magical about how a grotty little terrace house in, say Fulham, could into multi-million pound money making machine. This magic needs a magical explanation.
Unfortunately, the answer to this transformation was obvious to anyone who wanted an honest explanation for the housing bubble. A casual visit to the Bank of England's online statistical database provided the answer. It has been credit that has driven the beast. The banks have gone on a lending binge. Households have met the banks halfway, happily absorbing the huge quantities of debt that have recklessly poured into the housing market.
The English language strains to provide a vocabulary that can describe this growth of credit. To say that lending standards were lax does not come close to describing the myopic decision-making process in banks. Describing the stock of outstanding debt as huge, somehow misses the intrinsic irresponsibility of piling on debt without any thought of how it would be repaid. However, let us give our limited vocabulary free rein; this huge outstanding debt stock arose from a voluminous, gargantuan, historically unprecedented borrowing binge that has endangered the financial well-being of the UK economy.
Whatever we may have thought in the past, today, the phrase "it is different this time" is taking on a new and frankly terrifying meaning. The UK, along with large parts of the industrialized world, now face a financial catastrophe. Disaster beckons, judgment day approaches and the UK economy must now answer for its transgressions.
To calibrate just how bad things are, go back 12 months to January 2007. Suppose somebody said that within the next 12 months there would be run on a major UK bank; that a rogue trader would lose a French bank some $7 billion; that virtually every major investment banks would own up to billions of dollars of losses, requiring them to run around the world, cap in hand, looking for new funds to recover their lost capital. Would you have believed any of this? As we all know, these few examples are but a sample of the financial shocks that are being uncovered almost daily.
Things are different today; and with this change, comes new darker consequences. Property prices are sliding, recent data has established this as a fact. As they slip, all those childish illusions about easy money evaporate. All that will be left will be those debt contracts, which were so easy to sign, but will yet prove to be so painful to honour.
Here, we find something constant and unchanging. Debts must be repaid, or the debtor must default and accept financial ruin. Today, UK households are beginning to appreciate this crushing stability of debt. Bubbles may come and go, and with them, our pathetic illusions, but the debts, they stay until they are repaid in full.
Some pointed to demographics; the nuclear family was breaking down, creating an army of lonely single home buyers. As this army expanded, housing demand increased. Others suggested that the huge number of migrants coming into the country put unbearable pressure on the market, and likewise pushed up prices.
There was a variation on this theme, which pointed to the endless number of wealthy rootless cosmopolitans, who came to London and bought up huge swathes of property, with only a casual glance at the prices.
Structural factors was another favourite. The UK's archaic planning laws was a well-worn argument, while the peace dividend in Northern Ireland provided a regional flavour to the "it is different this time" mantra.
Whatever the explanation, the conclusion was always the same; conventional methods for determining home valuations no longer applied to the housing market. There was no point looking at affordability indicators or price-to-income ratios. The UK had "changed fundamentally" during the last ten years, and this "change" was reflected in property prices.
Superficially, the "it is different this time" claim must be correct. Obviously, when prices are racing ahead at 20 percent a year, something very strange and unusual must be happening somewhere. The curious thing, however, is why people prefer to accept a convoluted explanation, when a simple and convincing one is ignored. There was something wonderful and magical about how a grotty little terrace house in, say Fulham, could into multi-million pound money making machine. This magic needs a magical explanation.
Unfortunately, the answer to this transformation was obvious to anyone who wanted an honest explanation for the housing bubble. A casual visit to the Bank of England's online statistical database provided the answer. It has been credit that has driven the beast. The banks have gone on a lending binge. Households have met the banks halfway, happily absorbing the huge quantities of debt that have recklessly poured into the housing market.
The English language strains to provide a vocabulary that can describe this growth of credit. To say that lending standards were lax does not come close to describing the myopic decision-making process in banks. Describing the stock of outstanding debt as huge, somehow misses the intrinsic irresponsibility of piling on debt without any thought of how it would be repaid. However, let us give our limited vocabulary free rein; this huge outstanding debt stock arose from a voluminous, gargantuan, historically unprecedented borrowing binge that has endangered the financial well-being of the UK economy.
Whatever we may have thought in the past, today, the phrase "it is different this time" is taking on a new and frankly terrifying meaning. The UK, along with large parts of the industrialized world, now face a financial catastrophe. Disaster beckons, judgment day approaches and the UK economy must now answer for its transgressions.
To calibrate just how bad things are, go back 12 months to January 2007. Suppose somebody said that within the next 12 months there would be run on a major UK bank; that a rogue trader would lose a French bank some $7 billion; that virtually every major investment banks would own up to billions of dollars of losses, requiring them to run around the world, cap in hand, looking for new funds to recover their lost capital. Would you have believed any of this? As we all know, these few examples are but a sample of the financial shocks that are being uncovered almost daily.
Things are different today; and with this change, comes new darker consequences. Property prices are sliding, recent data has established this as a fact. As they slip, all those childish illusions about easy money evaporate. All that will be left will be those debt contracts, which were so easy to sign, but will yet prove to be so painful to honour.
Here, we find something constant and unchanging. Debts must be repaid, or the debtor must default and accept financial ruin. Today, UK households are beginning to appreciate this crushing stability of debt. Bubbles may come and go, and with them, our pathetic illusions, but the debts, they stay until they are repaid in full.
Monday 28 January 2008
The debt industrial complex
Stop sending me credit card letters, man.....
For those with broadband....
The shakeout begins
It is never nice to hear about job losses. U.S. investment bank Goldman Sachs plans to fire about 5 percent of its global workforce in coming months after its annual staff evaluation.
The New York-based bank said those being dismissed will be the "worst-performing employees". However, what does that mean in an industry that has generated billions of pounds of losses?
A post bubble world
"We are living in a post-bubble world, following the stock market bubble of the 1990s and the real estate bubble of the 2000s. That is the backdrop for the current crisis. We need to restore confidence in the markets’ basic ability to function, not in their presumed tendency to make us all rich by always going up. "
Robert Shiller, professor of economics and finance at Yale
House prices - it is four in a row
The housing data is in for December, and prices are down for a fourth consecutive month. In many respects, the housing crash is a process of aclimatisation. Just as the bubble was marked by years of double digit growth, we must now learn to accept that prices will continue to fall for the foreseeable future.
So what happened in December? According to Hometrack, the average cost of a home in England and Wales fell by 0.3 percent. After 12 months of those kinds of monthly declines, prices would be down around 3.6 percent. Given that the RPI inflation rate is currently about 4.1 percent and rising, in real terms, we can, perhaps, expect house prices to fall somewhere between 7 to 8 percent this year.
This raises an interesting question; how long will the housing crash take? Suppose in rough terms, house prices are overvalued by 100 percent in terms of affordability and price to income ratios. Assuming that the combined nominal price fall and rate of inflation is around 8 percent, then it would take about 8 years for house prices to work off all that excess valuation.
So, homeowners, how do you feel about eight years of a "healthy price correction". Tough medicine, methinks.
So what happened in December? According to Hometrack, the average cost of a home in England and Wales fell by 0.3 percent. After 12 months of those kinds of monthly declines, prices would be down around 3.6 percent. Given that the RPI inflation rate is currently about 4.1 percent and rising, in real terms, we can, perhaps, expect house prices to fall somewhere between 7 to 8 percent this year.
This raises an interesting question; how long will the housing crash take? Suppose in rough terms, house prices are overvalued by 100 percent in terms of affordability and price to income ratios. Assuming that the combined nominal price fall and rate of inflation is around 8 percent, then it would take about 8 years for house prices to work off all that excess valuation.
So, homeowners, how do you feel about eight years of a "healthy price correction". Tough medicine, methinks.
Sunday 27 January 2008
Stability destabilises
"In finance, to borrow from the economist Hyman Minsky, nothing is so destabilizing as stability. The paradox is easily explained. Profit-seeking people will take more financial risk when they believe the coast is clear. By taking bigger chances, however, they unwittingly make the world unsafe all over again.
Anxious people don’t ordinarily get in over their heads; it’s the confident ones who do. And nothing builds confidence like the belief that a greater power has conquered the business cycle and laid inflation low. In such happy circumstances, a calculating human will take out a bigger mortgage, build a bigger hedge fund or attempt a gaudier corporate buyout. That is, he or she will borrow more money, or, as they say on Wall Street, lay on more leverage."
James Grant, editor of Grant’s Interest Rate Observer
Anxious people don’t ordinarily get in over their heads; it’s the confident ones who do. And nothing builds confidence like the belief that a greater power has conquered the business cycle and laid inflation low. In such happy circumstances, a calculating human will take out a bigger mortgage, build a bigger hedge fund or attempt a gaudier corporate buyout. That is, he or she will borrow more money, or, as they say on Wall Street, lay on more leverage."
James Grant, editor of Grant’s Interest Rate Observer
Saturday 26 January 2008
Deflation or inflation
In my most recent post which was on the possibility of major US investment bank failing, a reader - trader boy - left the following comment:
"do you read Mish?
if not, you should. it's becoming clear that DEFLATION is on the way. even the markets are telling you that, TIPS have not really done a lot for years, and long treasuries just hit all-time lows. that's not an inflationary sign."
On the first point, I will admit to reading Mish, but perhaps not as much as I should. I will, in future, rectify that failing.
However, trader boy has a second, more serious comment to make; whether the US, or the UK for that matter, will drift into a prolonged period of deflation rather than inflation.
His comments taps into a very difficult question, and I will admit to holding both opinions on different occasions. Nevertheless, I thought it might be useful to outline what I understand to be the two arguments, and why I think inflation, ongoing financial sector difficulties, and ultimately a recession are the most likely outcomes.
Deflation
Why would anyone think that after decades of inflation that prices might actually start to fall?
If inflation is due to an increase in the money supply, then deflation must be due to a decline. So why might Trader Boy and others think that the money supply might suddenly contract?
It is one of the great ironies of the modern world, but the vast majority of people do not have a clue how money is created. Of course, people understand that there are such things as central banks, and somewhere, the banks have printing presses that produce the notes they carry in their purses.
It is the role of commercial banks where the ignorance arises. It is the high street banks that generate the greater part of the money supply. The banks do this by creating loans while keeping only a small fraction of their assets in reserves as cash.
Central banks only determine short term interest rates, and in reality, have little control over commercial banks lending activities. In recent years, commercial banks made the most of their independence. They have created staggering amounts of money, largely through financing the real estate boom.
The commercial bank's money creating capacities are at the core of the deflationary argument, which in fact comes in two sizes; regular and supersize.
The regular deflation argument suggests that the banks, after years of feeding the housing frenzy are now chastened. Lending standards are tightening, and credit growth will be reduced. Without the performance enhancing flow of credit, the economy will slide into a recession, aggregate demand will fall, and inflation will abate. Banks may even become so cautious that credit growth grinds to a halt and with it, the money supply. This lack of monetary growth will eventually lead to prices falling.
The supersize version looks for a more dramatic and absolute decline in credit growth. Bank balance sheets, both in the UK and in the US, are fundamentally rotten. Those housing loans are about to go bad; defaults will rise, and when they do, banks will fail. The subsequent banking crisis will create a catastrophic collapse of balance sheets, credit will contract, and the money supply will fall. The consequences will be deflation and a depression very much along the lines of what happened in the United States in the 1930s.
Inflation
Given the events of the last six months, it is not hard to see why some people might think that deflation could be a possibility. The idea of a systemic banking crisis does not seem so far fetched; Northern Rock, sub prime, failing bond insurers, rising spreads and sporadic liquidity difficulties all attest to the growing weakness of the financial sector in both the UK and the US.
The problem, however, is that it is not just the US where we see a recent period of lax monetary policy. The world is full of money. From the tip of Africa to the top of Siberia, countries are loaded with unprecedented levels of foreign reserves, while their central banks have allowed very rapid monetary growth.
The cause of this worldwide explosion in monetary growth lies in an unspoken agreement between the US and emerging market economies. They agreed to supply cheap goods, and in return they accepted US dollars in exchange. Rather than spend these dollars on American goods, these dollars have been reinvested back into the US assets. This has kept US interest rates down, and allowed Americans to build up huge debts and keep on spending.
The deal has been good for emerging market economies, who have run up current account surpluses, and built up huge holdings of US assets, especially US treasury bills. Over the last ten years, these economies have enjoyed unprecedented growth and rising living standards.
These surpluses, if left to their own devices, should have prompted emerging market currencies to appreciate. However, emerging market central banks would not let that happen. They printed domestic money, in order to keep their exchange rates competitive. This kept the exports growing and allowed the US to keep their current account.
Unsurprisingly, these economies would like the deal to continue. Unfortunately, this implicit bargain was not sustainable, and today it is unwinding. It is inflation that is turning the screw. As emerging market economies have grown, commodity price inflation has increased; fuel and food inflation are rising rapidly, on account of higher living standards in places like China, Russia, India and the Middle East.
Inflation wins the day
Broadly speaking, there are three reasons why inflation and not deflation is the most likeliest outcome.
First, the Fed are again trying to use monetary policy to pump up demand. However, the recent interest rate reduction will serve to weaken the dollar, and as the dollar slides, import inflation will increase. Nor can we discount the possibility that all this excess liquidity might actually revive lending activity. It is unlikely, I agree, but Bernanke is a reckless inflator. He may bring rates down so far he could kick off another bubble somewhere.
Second, commodity price inflation is still rising. It is fueled by monetary growth in the rest of the world, which shows no signs of slowing. In many parts of the world, this monetary growth reflects a conscious decision to keep the US importing. Many key US trading partners, such as China and Japan, do not want to see a gradual reduction of the US current account. Although the dollar has fallen against the euro, the dollar has barely moved against Asian currencies. Many central banks continue to prevent their domestic currencies to appreciating against the dollar.
However, rising inflation will eventually prompt an adjustment, despite the best efforts of Asian central banks to prevent it. Furthermore, it will be our old friend, inflation, that will help the adjustment. Inflation in emerging markets is taking off, and as it does, real exchange rates will appreciate and this will eventually choke off export growth.
Finally, while recognizing the probability of a systemic banking crisis, it would need to be a truly massive one to generate deflation. Here, history is against the deflationary argument. The S&L crisis did not bring in its wake bring any deflation. The losses from sub prime have not yet reached the magnitude of that now almost forgotten crisis. While the sub prime crisis is big and nasty, it will need to get a whole lot bigger if it is to generate deflation.
So what are we looking at?
The situation today looks more like the 1970s than the 1930s. During the 1970s, the US ran up huge macroeconomic imbalances on account of the Vietnam war; it had a large current account deficit, an exploding fiscal deficit, and a weak and accommodating central bank, desperate to print money to avoid facing the consequences of a decade of bad policies. The dollar was tanking while the rest of the world had more dollars than they wanted. Does any of this sound familiar?
The US is looking at something very much in tune with the experiences of the 1970s - stagflation. It may have its very own 21st century flavour. For example, the growing banking sector difficulties may add a problem that was not evident back when Nixon was President. Nevertheless, the parallels are striking.
So I am with the inflation gang. Going forward, the US and UK economies will slow, but with inflationary pressures continuing. As unemployment increases, there will be some very limited downward pressure on domestic prices, but this will not be enough to counter the growing inflationary pressures coming world commodity prices. Moreover, those who remain in work will continue to push for higher wage increases.
As for deflation, the only market that will see falling prices will be real estate. In the case of the US, this has been going on for two years, while in the UK, prices have only just begun to slide. However, declining house prices can live quite happily with rapid inflation.
So, we are something of retro period in economics, but it is the 1970s and not the 1930s that are on the way back. Like Led Zeppelin, stagflation is on a comeback tour.
"do you read Mish?
if not, you should. it's becoming clear that DEFLATION is on the way. even the markets are telling you that, TIPS have not really done a lot for years, and long treasuries just hit all-time lows. that's not an inflationary sign."
On the first point, I will admit to reading Mish, but perhaps not as much as I should. I will, in future, rectify that failing.
However, trader boy has a second, more serious comment to make; whether the US, or the UK for that matter, will drift into a prolonged period of deflation rather than inflation.
His comments taps into a very difficult question, and I will admit to holding both opinions on different occasions. Nevertheless, I thought it might be useful to outline what I understand to be the two arguments, and why I think inflation, ongoing financial sector difficulties, and ultimately a recession are the most likely outcomes.
Deflation
Why would anyone think that after decades of inflation that prices might actually start to fall?
If inflation is due to an increase in the money supply, then deflation must be due to a decline. So why might Trader Boy and others think that the money supply might suddenly contract?
It is one of the great ironies of the modern world, but the vast majority of people do not have a clue how money is created. Of course, people understand that there are such things as central banks, and somewhere, the banks have printing presses that produce the notes they carry in their purses.
It is the role of commercial banks where the ignorance arises. It is the high street banks that generate the greater part of the money supply. The banks do this by creating loans while keeping only a small fraction of their assets in reserves as cash.
Central banks only determine short term interest rates, and in reality, have little control over commercial banks lending activities. In recent years, commercial banks made the most of their independence. They have created staggering amounts of money, largely through financing the real estate boom.
The commercial bank's money creating capacities are at the core of the deflationary argument, which in fact comes in two sizes; regular and supersize.
The regular deflation argument suggests that the banks, after years of feeding the housing frenzy are now chastened. Lending standards are tightening, and credit growth will be reduced. Without the performance enhancing flow of credit, the economy will slide into a recession, aggregate demand will fall, and inflation will abate. Banks may even become so cautious that credit growth grinds to a halt and with it, the money supply. This lack of monetary growth will eventually lead to prices falling.
The supersize version looks for a more dramatic and absolute decline in credit growth. Bank balance sheets, both in the UK and in the US, are fundamentally rotten. Those housing loans are about to go bad; defaults will rise, and when they do, banks will fail. The subsequent banking crisis will create a catastrophic collapse of balance sheets, credit will contract, and the money supply will fall. The consequences will be deflation and a depression very much along the lines of what happened in the United States in the 1930s.
Inflation
Given the events of the last six months, it is not hard to see why some people might think that deflation could be a possibility. The idea of a systemic banking crisis does not seem so far fetched; Northern Rock, sub prime, failing bond insurers, rising spreads and sporadic liquidity difficulties all attest to the growing weakness of the financial sector in both the UK and the US.
The problem, however, is that it is not just the US where we see a recent period of lax monetary policy. The world is full of money. From the tip of Africa to the top of Siberia, countries are loaded with unprecedented levels of foreign reserves, while their central banks have allowed very rapid monetary growth.
The cause of this worldwide explosion in monetary growth lies in an unspoken agreement between the US and emerging market economies. They agreed to supply cheap goods, and in return they accepted US dollars in exchange. Rather than spend these dollars on American goods, these dollars have been reinvested back into the US assets. This has kept US interest rates down, and allowed Americans to build up huge debts and keep on spending.
The deal has been good for emerging market economies, who have run up current account surpluses, and built up huge holdings of US assets, especially US treasury bills. Over the last ten years, these economies have enjoyed unprecedented growth and rising living standards.
These surpluses, if left to their own devices, should have prompted emerging market currencies to appreciate. However, emerging market central banks would not let that happen. They printed domestic money, in order to keep their exchange rates competitive. This kept the exports growing and allowed the US to keep their current account.
Unsurprisingly, these economies would like the deal to continue. Unfortunately, this implicit bargain was not sustainable, and today it is unwinding. It is inflation that is turning the screw. As emerging market economies have grown, commodity price inflation has increased; fuel and food inflation are rising rapidly, on account of higher living standards in places like China, Russia, India and the Middle East.
Inflation wins the day
Broadly speaking, there are three reasons why inflation and not deflation is the most likeliest outcome.
First, the Fed are again trying to use monetary policy to pump up demand. However, the recent interest rate reduction will serve to weaken the dollar, and as the dollar slides, import inflation will increase. Nor can we discount the possibility that all this excess liquidity might actually revive lending activity. It is unlikely, I agree, but Bernanke is a reckless inflator. He may bring rates down so far he could kick off another bubble somewhere.
Second, commodity price inflation is still rising. It is fueled by monetary growth in the rest of the world, which shows no signs of slowing. In many parts of the world, this monetary growth reflects a conscious decision to keep the US importing. Many key US trading partners, such as China and Japan, do not want to see a gradual reduction of the US current account. Although the dollar has fallen against the euro, the dollar has barely moved against Asian currencies. Many central banks continue to prevent their domestic currencies to appreciating against the dollar.
However, rising inflation will eventually prompt an adjustment, despite the best efforts of Asian central banks to prevent it. Furthermore, it will be our old friend, inflation, that will help the adjustment. Inflation in emerging markets is taking off, and as it does, real exchange rates will appreciate and this will eventually choke off export growth.
Finally, while recognizing the probability of a systemic banking crisis, it would need to be a truly massive one to generate deflation. Here, history is against the deflationary argument. The S&L crisis did not bring in its wake bring any deflation. The losses from sub prime have not yet reached the magnitude of that now almost forgotten crisis. While the sub prime crisis is big and nasty, it will need to get a whole lot bigger if it is to generate deflation.
So what are we looking at?
The situation today looks more like the 1970s than the 1930s. During the 1970s, the US ran up huge macroeconomic imbalances on account of the Vietnam war; it had a large current account deficit, an exploding fiscal deficit, and a weak and accommodating central bank, desperate to print money to avoid facing the consequences of a decade of bad policies. The dollar was tanking while the rest of the world had more dollars than they wanted. Does any of this sound familiar?
The US is looking at something very much in tune with the experiences of the 1970s - stagflation. It may have its very own 21st century flavour. For example, the growing banking sector difficulties may add a problem that was not evident back when Nixon was President. Nevertheless, the parallels are striking.
So I am with the inflation gang. Going forward, the US and UK economies will slow, but with inflationary pressures continuing. As unemployment increases, there will be some very limited downward pressure on domestic prices, but this will not be enough to counter the growing inflationary pressures coming world commodity prices. Moreover, those who remain in work will continue to push for higher wage increases.
As for deflation, the only market that will see falling prices will be real estate. In the case of the US, this has been going on for two years, while in the UK, prices have only just begun to slide. However, declining house prices can live quite happily with rapid inflation.
So, we are something of retro period in economics, but it is the 1970s and not the 1930s that are on the way back. Like Led Zeppelin, stagflation is on a comeback tour.
For the Fed, it is Merrill Lynch every time.
Over the last few weeks, a question has bugged me. Could the sub prime crisis bring down a major US investment bank? The crisis has already destroyed some 220 small financial institutions. It also forced Bank of America to bail out Countrywide, one of America's largest sub prime lenders. But what about a gorilla? Could it take down one of the big beasts roaming the financial jungle?
There are two badly wounded investment banks out there; Citigroup and Merrill Lynch. Out these two, Merrill looks the most vulnerable. In early January, the bank reported the worst quarter in its history, forcing the bank to write off $16 billion due to sub prime investments.
How much of a financial hit is $16 billion to a bank like Merrill? These days, balance sheets are available with a click of the mouse. Merrill started out in 2007 with assets amounting to $841 billion, and liabilities of $802 billion.
Subtracting assets from liabilities gives the bank's capital, which is the loss-making shock absorber. So long as the bank has a sufficiently large stock of capital, the bank can ride calamitous decisions like investing in sub prime assets. Simple arithmetic tells us that at the end of 2006, Merrill had capital amounting to around $39 billion.
The Merrill website has a couple of further, more interesting numbers for capital. During the first quarter, bank capital increased by around $2 billion, to around $41 billion. By the end of 2007, the bank had owned up to the losses. As a consequence, bank capital fell to $32 billion. In simple terms, sub prime investments burned up around 24 percent of Merrill's capital.
Looked from the perspective of bank capital, these losses are mighty. While subprime has not put the bank in any immediate danger of insolvency, neither is the bank in any shape to absorb any further shocks.
So when Bernanke met with the rest of the FOMC on Monday, he almost certainly had Merrill foremost in his mind. With the stock market crashing on monday, he had a vision of a further financial shock ripping through the banking system, zapping bank capital, much like the sub prime crisis did in 2007. He may be worried about a recession, but he is petrified of a major bank sinking into bankruptcy.
There is only one way he can help; reduce rates. This will allow banks like Merrill to increase their spreads between borrowing and lending money. Over time, bank profitability will improve and gradually bank capital will recover.
However, the rate cut comes at a time when inflationary pressure in the US is at a 17 year high. The CPI is now over 4 percent and will almost certainly rise further. After several years of relentless dollar weakness, import prices are rising.
However, when it comes to choice between Merrill or inflation, the Fed knows what to choose. It will be Merrill every time. This leads us to a profound conclusion. Whatever the Fed may say, monetary policy is there to serve Wall Street.
There are two badly wounded investment banks out there; Citigroup and Merrill Lynch. Out these two, Merrill looks the most vulnerable. In early January, the bank reported the worst quarter in its history, forcing the bank to write off $16 billion due to sub prime investments.
How much of a financial hit is $16 billion to a bank like Merrill? These days, balance sheets are available with a click of the mouse. Merrill started out in 2007 with assets amounting to $841 billion, and liabilities of $802 billion.
Subtracting assets from liabilities gives the bank's capital, which is the loss-making shock absorber. So long as the bank has a sufficiently large stock of capital, the bank can ride calamitous decisions like investing in sub prime assets. Simple arithmetic tells us that at the end of 2006, Merrill had capital amounting to around $39 billion.
The Merrill website has a couple of further, more interesting numbers for capital. During the first quarter, bank capital increased by around $2 billion, to around $41 billion. By the end of 2007, the bank had owned up to the losses. As a consequence, bank capital fell to $32 billion. In simple terms, sub prime investments burned up around 24 percent of Merrill's capital.
Looked from the perspective of bank capital, these losses are mighty. While subprime has not put the bank in any immediate danger of insolvency, neither is the bank in any shape to absorb any further shocks.
So when Bernanke met with the rest of the FOMC on Monday, he almost certainly had Merrill foremost in his mind. With the stock market crashing on monday, he had a vision of a further financial shock ripping through the banking system, zapping bank capital, much like the sub prime crisis did in 2007. He may be worried about a recession, but he is petrified of a major bank sinking into bankruptcy.
There is only one way he can help; reduce rates. This will allow banks like Merrill to increase their spreads between borrowing and lending money. Over time, bank profitability will improve and gradually bank capital will recover.
However, the rate cut comes at a time when inflationary pressure in the US is at a 17 year high. The CPI is now over 4 percent and will almost certainly rise further. After several years of relentless dollar weakness, import prices are rising.
However, when it comes to choice between Merrill or inflation, the Fed knows what to choose. It will be Merrill every time. This leads us to a profound conclusion. Whatever the Fed may say, monetary policy is there to serve Wall Street.
Quote of the day
"An annual review by Income Data Services showed that the median total earnings of the chief executives of the FTSE 100 companies - the UK's 100 largest quoted companies - in the financial year 2005/06 was £2m, up 20pc on the previous year.
By contrast, the gross median pay for full-time British employees in April 2006 was £23,600, up a mere 3pc on the previous year. So the typical FTSE 100 boss earned 75.2 times what the typical employee was paid - and just one year's pay rise for that typical boss was £400,000, equivalent to 17 times the total pay of the typical employee."
Robert Peston, Daily Telegraph
By contrast, the gross median pay for full-time British employees in April 2006 was £23,600, up a mere 3pc on the previous year. So the typical FTSE 100 boss earned 75.2 times what the typical employee was paid - and just one year's pay rise for that typical boss was £400,000, equivalent to 17 times the total pay of the typical employee."
Robert Peston, Daily Telegraph
Friday 25 January 2008
Buy To Let heads south
"Buy to let investors will keep the South East the most prosperous area."
When I saw this title, I had to check the date. How could anyone write anything like this on the same day that also saw mortgage approvals fall almost 40 percent. However, the date was there - Thursday, January 24, 2008.
However, the article was even scarier than the title. According to a Homebuyer and Property investor survey, 70 percent of investors believe that the South east and London will be the top performing market this year. Furthermore, the article identified the "growth in buy-to-let interest in London and the South East" as the primary factor that "will help to buoy the UK property market."
The disconnect with reality didn't stop there. Around "40 per cent of investors" still considered new-built flats as "the most profitable buy-to-let investment."
So what accounts for all this unjustified optimism? "Supply and demand, improved transport links, wealth, foreign buyers and regeneration across the area".
Unfortunately for buy-to-let investors, none of their optimism is reflected in rental yields, which have in real terms, been flat for at least ten years.
When I saw this title, I had to check the date. How could anyone write anything like this on the same day that also saw mortgage approvals fall almost 40 percent. However, the date was there - Thursday, January 24, 2008.
However, the article was even scarier than the title. According to a Homebuyer and Property investor survey, 70 percent of investors believe that the South east and London will be the top performing market this year. Furthermore, the article identified the "growth in buy-to-let interest in London and the South East" as the primary factor that "will help to buoy the UK property market."
The disconnect with reality didn't stop there. Around "40 per cent of investors" still considered new-built flats as "the most profitable buy-to-let investment."
So what accounts for all this unjustified optimism? "Supply and demand, improved transport links, wealth, foreign buyers and regeneration across the area".
Unfortunately for buy-to-let investors, none of their optimism is reflected in rental yields, which have in real terms, been flat for at least ten years.
Quote of the day
"If it wasn't so strange, it wouldn't be true. So this guy, unbeknownst to Societe Generale, his employer, made £60 billion in bets on the Footsie and other indexes out there. Then this weekend he was found out, and the bank quickly sold off his positions, causing the markets to tank.
And like the planes hitting the towers gave Cheney what he needed, this charade was the perfect excuse for Bank Bailout Ben to hop into action, dropping rates a historical 3/4 point in an emergency cut."
Keith, Housing Panic
And like the planes hitting the towers gave Cheney what he needed, this charade was the perfect excuse for Bank Bailout Ben to hop into action, dropping rates a historical 3/4 point in an emergency cut."
Keith, Housing Panic
Reduce rates in haste; repent at your leisure
This week proved, if any proof were needed, that the Federal Reserve is run by clowns.
The week starts with a public holiday in America. But while Americans were honouring the memory of Martin Luther King, stock markets around the world were engaged in a major sell-off.
Coco Bernanke gets into the office early on Tuesday morning, he switches on his bloomberg terminal and sees a tidal wave of selling. Overcome by panic, he calls his fellow FOMC members and tells them that the US is on the brink of the greatest recession since the war. Only decisive action will do. So, the FOMC announces the biggest interest rate cut in 25 years.
Back over at the markets, the news of a 0.75 percent cut is greeted by a mixture of shock and incomprehension. In an efforts to explain the Fed's action, a consensus gradually emerges; perhaps the Fed knows more about a rapidly approaching recession. Perhaps, the FOMC had some advance warning of some shocking US macro data, pointing to the inevitability of a slowdown.
Shift forward two days and that interpretation of events looks extremely generous. France's second largest bank announces a $7 billion "fraud". Eventually, it emerged that this fraud is rather more like a huge trading loss than a criminal conspiracy.
As more details emerge, we find out that Societe Generale knew about the problem on Saturday, while on Monday, the beleaguered bank tried to unwind their exposure.
Suddenly, an entirely new explanation emerges. The sell off on Monday was almost certainly provoked by Societe Generale's desperate attempts to establish the extent of their losses before they announced their difficulties to the rest of the world. As Societe Generale were offloading their positions, others jumped in and started to sell.
Back over at the fed, it knew nothing of Societe Generale's difficulties. Instead, the Fed reacted with a mad and totally unjustified rate cut without any clue about that was actually happening within the world's financial markets.
The Fed is now trapped. It can not reverse this rate decision, since that would be an admission that it over-reacted on Tuesday. It is now stuck with an excessively expansionary monetary policy. It all goes to prove the Fed simply does not know what it is doing.
Thursday 24 January 2008
I almost forgot to mention it; the UK housing market is crashing
With all this crazy stuff about rogue traders, sub-prime losses and manic interest rate cuts, the UK housing crash has drifted into the background. It is time to bring it out of the shadow; buried beneath today's shocking financial news, the British Bankers Association issued the latest data on mortgage approvals.
Now what is the right word to describe the latest data? The numbers were miles beyond "bad". They were well south of "appalling". In fact, there were found within the vicinity of catastrophic.
December mortgage approvals are down about 38 percent compared to 2006. Moreover, the actual number of approvals were the lowest since records began. Yes, that is right. Let us repeat that; mortgage approvals were the lowest since records began.
This brings us nicely to the golden rule of real estate; credit availability determines house price inflation. As today's data amply illustrates, credit availability has collapsed. As credit disappears, so does housing demand.
However, in one crucial respect the housing market is different from other markets. Normally, when demand falls, prices adjust downwards. With housing, people are notoriously reluctant to cut prices. Instead, volumes collapse. Don't look for the housing crash in estate agent's windows. It will take years before prices come down.
Instead, the crash will hit the financial services sector; no mortgages means a recession for building societies. Many estate agents will quickly downsize and disappear. While all that lovely lolly generated by stamp duty will evaporate. Yes, the chancellor will find slim pickings from housing.
As for home owners, they will suffer from an epidemic of denialitis. People may love their homes, but they love those inflated valuations even more. It will be hard to let go and recognize that house prices reached a high watermark in the early summer of 2007 and that those valuations will not return again for a generation.
Now what is the right word to describe the latest data? The numbers were miles beyond "bad". They were well south of "appalling". In fact, there were found within the vicinity of catastrophic.
December mortgage approvals are down about 38 percent compared to 2006. Moreover, the actual number of approvals were the lowest since records began. Yes, that is right. Let us repeat that; mortgage approvals were the lowest since records began.
This brings us nicely to the golden rule of real estate; credit availability determines house price inflation. As today's data amply illustrates, credit availability has collapsed. As credit disappears, so does housing demand.
However, in one crucial respect the housing market is different from other markets. Normally, when demand falls, prices adjust downwards. With housing, people are notoriously reluctant to cut prices. Instead, volumes collapse. Don't look for the housing crash in estate agent's windows. It will take years before prices come down.
Instead, the crash will hit the financial services sector; no mortgages means a recession for building societies. Many estate agents will quickly downsize and disappear. While all that lovely lolly generated by stamp duty will evaporate. Yes, the chancellor will find slim pickings from housing.
As for home owners, they will suffer from an epidemic of denialitis. People may love their homes, but they love those inflated valuations even more. It will be hard to let go and recognize that house prices reached a high watermark in the early summer of 2007 and that those valuations will not return again for a generation.
One more unemployed rogue trader
Société Générale €5bn trading loss finally answered a question that has bothered me for some time. What do you have to do to get fired from a bank without a big money pay-off? Jérome Kerviel - the rogue trader behind today's extraordinary losses, answered that question today. After nearly destroying the second largest bank in France, he has been "suspended pending a dismissal procedure".
Although subprime losses are in the tens of billions, surprisingly few people have been held to account. A handful of CEOs have been eased out, typically with massive golden handshakes, but apart from the hapless Mr "evil" Kerviel, I know of no cases of summary dismissals without compensation.
Therein lies are large part of the reason why we are in such a mess. This is rogue capitalism; huge rewards for reckless speculation; no consequences when things go wrong.
Although subprime losses are in the tens of billions, surprisingly few people have been held to account. A handful of CEOs have been eased out, typically with massive golden handshakes, but apart from the hapless Mr "evil" Kerviel, I know of no cases of summary dismissals without compensation.
Therein lies are large part of the reason why we are in such a mess. This is rogue capitalism; huge rewards for reckless speculation; no consequences when things go wrong.
Coco the clown
If the suit fits, wear it.Picture is courtesy of Adrian, who first posted it on the house price crash message board.
Quote of the day
"Nobody knows how big the losses are likely to be when the bottom is finally reached. And precisely because nobody knows, nobody wants to lend any more money. A rate cut won't change this. It's like offering a 10-pound lobster to someone so constipated he can't take in another mouthful."
Robert Reich, Former US Secretary of Labor and professor at the University of California at Berkeley.
Robert Reich, Former US Secretary of Labor and professor at the University of California at Berkeley.
Wednesday 23 January 2008
Bernanke - you are on your own, mate
A day after the big fed cut, and the message from other central banks has been as clear as crystal - Bernanke is on his own.
No other central bank is likely to follow with a headline hitting uber-cut. While other banks might be contemplating a rate reduction, moderation will be the order of the day. Inflation may be only a marginal issue for the Fed, but other central banks continue to be concerned about rising price pressures.
Here in the UK, King went to Bristol where he gave his own account of recent developments. The speech is well worth a read. Although it has a rather dubious sea-faring theme running through it, the message is stark; "this year we (i.e. the UK) are probably facing a period of above-target inflation and a marked slowing in growth”. No talk of avoiding recessions for the Bank of England.
In contrast to Bernanke, King does not claim to have any Harry Potter-like magic potion hiding up his cape. "We (the Bank of England) have little control over the strength of the economic winds buffeting our economy. We cannot avoid some volatility in the short run and it is important that everyone understands the limits to the ability of central banks to smooth the economy."
Over at the ECB, one finds a similar realism about the limits of central banks. Earlier this week, Jürgen Stark, a member of the Executive Board of the ECB provided a straight talking assessment about how far central banks can influence economic growth. His assessment is worth quoting at length.
"Any attempt by central banks to systematically stimulate output and employment is ultimately doomed to failure, the only certain outcome being inflation. The perceived trade-off between inflation and growth will, sooner or later, reveal its true nature. Although it is tempting to believe that such a trade-off exists, it is in fact a mirage.
New empirical evidence and new insights in monetary theory have shown that even moderate levels of inflation have considerable negative repercussions for long-term economic performance, and maintaining price stability is therefore the best contribution that monetary policy can make to economic welfare, growth and employment."
Unfortunately, Bernanke and his fellow inflationist friends on the FOMC believe that a dramatic gesture and easy money will somehow save the day. However, the US macroeconomic imbalances are simply large. A further round of easy money will not reduce the burgeoning current account deficit, it will only exacerbate inflation, and it will not improve bank lending standards.
Although the Bank of England and the ECB have in the past made some terrible mistakes, neither central bank are quite so stupid as to believe that the answer to today's problem is a massive interest rate cut. Nor do they believe that the answer to a credit-induced asset bubble is yet more easy credit.
No other central bank is likely to follow with a headline hitting uber-cut. While other banks might be contemplating a rate reduction, moderation will be the order of the day. Inflation may be only a marginal issue for the Fed, but other central banks continue to be concerned about rising price pressures.
Here in the UK, King went to Bristol where he gave his own account of recent developments. The speech is well worth a read. Although it has a rather dubious sea-faring theme running through it, the message is stark; "this year we (i.e. the UK) are probably facing a period of above-target inflation and a marked slowing in growth”. No talk of avoiding recessions for the Bank of England.
In contrast to Bernanke, King does not claim to have any Harry Potter-like magic potion hiding up his cape. "We (the Bank of England) have little control over the strength of the economic winds buffeting our economy. We cannot avoid some volatility in the short run and it is important that everyone understands the limits to the ability of central banks to smooth the economy."
Over at the ECB, one finds a similar realism about the limits of central banks. Earlier this week, Jürgen Stark, a member of the Executive Board of the ECB provided a straight talking assessment about how far central banks can influence economic growth. His assessment is worth quoting at length.
"Any attempt by central banks to systematically stimulate output and employment is ultimately doomed to failure, the only certain outcome being inflation. The perceived trade-off between inflation and growth will, sooner or later, reveal its true nature. Although it is tempting to believe that such a trade-off exists, it is in fact a mirage.
New empirical evidence and new insights in monetary theory have shown that even moderate levels of inflation have considerable negative repercussions for long-term economic performance, and maintaining price stability is therefore the best contribution that monetary policy can make to economic welfare, growth and employment."
Unfortunately, Bernanke and his fellow inflationist friends on the FOMC believe that a dramatic gesture and easy money will somehow save the day. However, the US macroeconomic imbalances are simply large. A further round of easy money will not reduce the burgeoning current account deficit, it will only exacerbate inflation, and it will not improve bank lending standards.
Although the Bank of England and the ECB have in the past made some terrible mistakes, neither central bank are quite so stupid as to believe that the answer to today's problem is a massive interest rate cut. Nor do they believe that the answer to a credit-induced asset bubble is yet more easy credit.
Quote of the day
I picked this quote up from the big picture blog:
"It's a sad testament to think the Fed has to cut interest rates eight days in front of a meeting to salvage the equity markets. The U.S. economy is in a rather sad state of affairs in that it depends on housing and stock prices to keep going."
Bill Gross, founder and chief investment officer, Pacific Investment Management Co. (PIMCO)
The quote does have a certain sad logic.
"It's a sad testament to think the Fed has to cut interest rates eight days in front of a meeting to salvage the equity markets. The U.S. economy is in a rather sad state of affairs in that it depends on housing and stock prices to keep going."
Bill Gross, founder and chief investment officer, Pacific Investment Management Co. (PIMCO)
The quote does have a certain sad logic.
Tuesday 22 January 2008
clowning around
It is highly doubtful whether anything good can come from Bernanke acting like a clown at a children's party, jumping out of a wardrobe waving his surprise 75 basis point interest rate cut.
The initial reaction will almost certainly be shock "What??? They cut by how much??" However, after a few minutes of reflection, a second more dangerous thought takes hold. Perhaps, the US economy is diving into a deeper recession than originally thought. After all, why does the Fed feel the need to cut so aggressively? Shock will be quickly replaced by concern.
Looking beyond a 24 hour horizon, it is hard to see how this cut could help much. Adjusted for inflation, fed rates are now negative. US inflation is accelerating, and reducing rates can only weaken the dollar, which is not exactly a recipe from price stability
The Fed appears to be, for all practical purposes, unconcerned about inflation. This will ultimately begin to affect inflationary expectations. Over the longer term, the Fed could be reviving the reputation it had from the 1970s. When it come to inflation, the Fed is a weak and accommodating central bank.
Although the Fed's amateur dramatics will grab headlines, the US housing market is extremely unlikely to benefit much from this cut. According to bankrate.com, the 30 fixed rate jumbo mortgage interest rate is 6.5 percent, which is approximately the same level it was at in mid-2007. After record sub-prime losses, US banks have significantly tightened their lending criteria. The days of easy mortgage credit are gone and will not return any time soon.
Likewise, consumer credit is unlikely become cheaper either. This largely reflects a growing concern about the capacity of US consumers to repay their loans. Banks are anxious to reduce exposure, while Wall Street isn't in any shape to repackage this debt and lift it from bank balance sheets. Currently, credit card rates average between 10-14 percent. These are not the type of rates that would encourage a recession-avoiding spending spree.
This recession was booked and paid for three years ago. The US housing bubble created massive macroeconomic imbalances that could only be resolved by an economic slowdown. Rising inflation has eroded the incentive to save. Personal household balance sheets are overloaded with debt. The current account deficit is unsustainable. Lending standards have been too lax, and pushed the financial sector to the brink of crisis. Another round of easy fed money does nothing to solve these problems.
It would have been better if the clown had remained in the wardrobe.
The initial reaction will almost certainly be shock "What??? They cut by how much??" However, after a few minutes of reflection, a second more dangerous thought takes hold. Perhaps, the US economy is diving into a deeper recession than originally thought. After all, why does the Fed feel the need to cut so aggressively? Shock will be quickly replaced by concern.
Looking beyond a 24 hour horizon, it is hard to see how this cut could help much. Adjusted for inflation, fed rates are now negative. US inflation is accelerating, and reducing rates can only weaken the dollar, which is not exactly a recipe from price stability
The Fed appears to be, for all practical purposes, unconcerned about inflation. This will ultimately begin to affect inflationary expectations. Over the longer term, the Fed could be reviving the reputation it had from the 1970s. When it come to inflation, the Fed is a weak and accommodating central bank.
Although the Fed's amateur dramatics will grab headlines, the US housing market is extremely unlikely to benefit much from this cut. According to bankrate.com, the 30 fixed rate jumbo mortgage interest rate is 6.5 percent, which is approximately the same level it was at in mid-2007. After record sub-prime losses, US banks have significantly tightened their lending criteria. The days of easy mortgage credit are gone and will not return any time soon.
Likewise, consumer credit is unlikely become cheaper either. This largely reflects a growing concern about the capacity of US consumers to repay their loans. Banks are anxious to reduce exposure, while Wall Street isn't in any shape to repackage this debt and lift it from bank balance sheets. Currently, credit card rates average between 10-14 percent. These are not the type of rates that would encourage a recession-avoiding spending spree.
This recession was booked and paid for three years ago. The US housing bubble created massive macroeconomic imbalances that could only be resolved by an economic slowdown. Rising inflation has eroded the incentive to save. Personal household balance sheets are overloaded with debt. The current account deficit is unsustainable. Lending standards have been too lax, and pushed the financial sector to the brink of crisis. Another round of easy fed money does nothing to solve these problems.
It would have been better if the clown had remained in the wardrobe.
Monday 21 January 2008
The impossible triangle
Consider these three headlines; all of them taken from the same edition of the Times:Mortgage lending hits a new record in 2007
Half a million homeowners miss mortgage payments
Bargain hunters reignite UK housing market
Despite the seeming contradictions in the headlines, taken together the three articles provide an almost complete narrative about today's housing market.
The first article tells us of a bumper year of household debt accumulation "Gross mortgage lending rose to its highest level last year. Figures from the Council of Mortgage Lenders (CML) show that banks lent a total of £362 billion to homeowners last year, up 5 per cent on 2006 and the highest level since records began in 1999."
To be fair, the mood of the article quickly sours when it acknowledges the recent mortgage slowdown: "lending in December was £22.6 billion, down 25 per cent on November and the lowest level in any month since May 2005."
The second article is much more unpleasant; it is about debt despair and desperation. It tells of "almost half a million cash-strapped homeowners" who have "missed a monthly repayment on their mortgage in the past six months." Since there are almost 12 million mortgages in the UK, this means that about 4 percent of borrowers are in deep trouble. Should these repayment difficulties turn into repossessions, then the UK would have financial crisis every bit as bad as the sub-prime crisis over in the US.
So far, the story is clear; too much housing debt pushing far too many households into payment difficulties. But what about the third article? How does that fit into the reality of a rapidly deteriorating property market. Can the housing market really be reigniting?
The third article is about denial. The housing crash may be upon us, but there are still plenty of people ready to drop a quote that distorts reality. The market is not crashing, it is reigniting because "bargain hunters" have appeared to save the day.
It acknowledges that "the average price of a house has fallen for a third month", but despite declining prices "activity is growing as cheap deals draw out buyers ". Miles Shipside, from Rightmove, gleefully informs us: “Some home buyers are now able to find properties that have fallen into their affordability zone, and are bagging what they see as bargains against previous prices."
So there we have it, the three corners of the UK property market triangle; debt accumulation, debtors drowning in debt, and denial that anything is wrong.
A seven point plan to save housing
When I saw the title of this article from the Scottish Herald, I cringed; a seven point plan to saving housing? There is nothing that can save the housing market. However, I was pleasantly surprised. The article contained much that I could agree with.
Here is the plan:
1. Restore the old building-society benchmarks limiting loans to three or three-and-a-half times income, with deposits of 15%.
2. Interest-only mortgages should be outlawed, as should "suicide" loans which are higher than the value of the property.
3. End self-certification. It is unacceptable for brokers to connive with mortgage-seekers in misrepresenting the borrower's earnings so that the banks can give them loans they cannot afford.
4. End the securitisation of mortgage debt.
5. Make housing an economic objective of the planning laws. At present you can build any number of out-of-town shopping centres, because they create jobs, but you can't build houses.
6. End right-to-buy and restore council housing.
7. End tax breaks for buy-to-let landlords. Why should people who buy houses as investments be allowed to set their mortgages against tax, while people who buy to live can't?
The article ends with a promise:
"Introduce these measures and, within five years, house prices would be stable and affordable. People would no longer have to live in fear of their debts and would be able to turn their attention to more productive activities than house-price speculation."
Seems reasonable to me.
Here is the plan:
1. Restore the old building-society benchmarks limiting loans to three or three-and-a-half times income, with deposits of 15%.
2. Interest-only mortgages should be outlawed, as should "suicide" loans which are higher than the value of the property.
3. End self-certification. It is unacceptable for brokers to connive with mortgage-seekers in misrepresenting the borrower's earnings so that the banks can give them loans they cannot afford.
4. End the securitisation of mortgage debt.
5. Make housing an economic objective of the planning laws. At present you can build any number of out-of-town shopping centres, because they create jobs, but you can't build houses.
6. End right-to-buy and restore council housing.
7. End tax breaks for buy-to-let landlords. Why should people who buy houses as investments be allowed to set their mortgages against tax, while people who buy to live can't?
The article ends with a promise:
"Introduce these measures and, within five years, house prices would be stable and affordable. People would no longer have to live in fear of their debts and would be able to turn their attention to more productive activities than house-price speculation."
Seems reasonable to me.
Sunday 20 January 2008
Don't worry about house prices, worry about the banks
"Husband and wife magnates Fergus and Judith Wilson have just signed a deal to buy their 700th house. If things go to plan, they will become the country's first buy-to-let billionaires. Every week they buy another house - and on one day alone spent £10m buying 40 properties off a distressed developer.
In the early 1990s the Wilsons were marking maths homework and writing school reports at a Blackheath comprehensive. Today their property empire is worth £240m - almost all of it within commuting distance of the Eurostar terminal in Ashford, Kent. They put their personal wealth at £180m - leaving them on a par with Anita Roddick and singer Phil Collins in the Sunday Times Rich List. And with property prices climbing at £40 a day, their personal wealth rises by £28,000 every time they get out of bed."
There is only one way that Fergus and Judith could have ended up with a "property empire worth £240 million". Some foolish bank lent them the money. Which must mean that Fergus and Judith owe millions to some deluded financial institution.
Just think about that for a moment; a pair of school teachers managed to buy hundreds of houses on credit. Whatever wealth they may have accumulated was due to a self-replicating bubble. Easy credit created the demand that pushed property prices higher. This pushed people like Fergus and Judith to take out more credit to buy more houses, pushing demand even higher.
It would not be such a problem if Fergus and Judith were the only ones leveraging nothing into a multi-million pound portfolio. There are now close to a million buy-to-let mortgages in the UK; which is about one in eleven of all mortgages. In reality, that number understates the true extent of buy-to-let speculation. Many investors misled banks and took out loans posing as owner-occupiers when they were actually buying rental properties.
For the typical buy-to-let investor, there is an unshakable optimism in the future. In that happy hereafter, house prices rise perpetually, whipping up an infinity of wealth for those owning property. It is a faith buttressed by higher divorce rates, stringent planning procedures, and low interest rates. The UK will be eternally short of houses, and packed out with people desperately looking for homes. It all means one thing, prices can never go down.
However, the past tells a different story. Back in 1989, house prices crashed, and kept on falling until 1996. Moreover, the decline was significant; in real terms prices fell 35 percent. For the buy-to-let generation, it provokes a dark nagging thought; perhaps, prices could slide again. Over the last couple of months, those nagging thoughts have morphed into reality. Prices are falling.
Over time, buy-to-let investors will lose money. Even Fergus and Judith can expect their net wealth to take a hit. Declining rental yields and falling prices will force a fire sale of buy-to-let properties. Many properties will be sold at a loss. Many investors will default, creating a huge cesspit of bad loans.
Alas, buy-to-let losses will not remain a private matter. Burgeoning banking sector problems will transform buy-to-let into a matter of public policy. It was banks that made Fergus and Judith possible. It was banks that put out a million buy-to-let mortgages and when it all turns ghastly, it will be the banks that will see their balance sheets deteriorate.
There may be some people who think that this will not happen, or who think that the UK financial system is simply too strong and too well supervised. Think again, the crisis is already here; Northern Rock is already down; Paragon is about to go, while the Derbyshire Building Society is facing a ratings downgrade. Meanwhile the remaining banks are urgently trying to exit the market. Unsurprisingly, mortgage lending volumes are down 43 percent compared to last year.
The housing crash is now gathering momentum. However, property market losses is really only a marginal issue. The real concern is the banks. Banking crises are horrible; they undermine the payments system, generate extremely persistent credit contractions, and spark recessions. This might be the ultimate legacy of the buy-to-let bubble.
In the early 1990s the Wilsons were marking maths homework and writing school reports at a Blackheath comprehensive. Today their property empire is worth £240m - almost all of it within commuting distance of the Eurostar terminal in Ashford, Kent. They put their personal wealth at £180m - leaving them on a par with Anita Roddick and singer Phil Collins in the Sunday Times Rich List. And with property prices climbing at £40 a day, their personal wealth rises by £28,000 every time they get out of bed."
There is only one way that Fergus and Judith could have ended up with a "property empire worth £240 million". Some foolish bank lent them the money. Which must mean that Fergus and Judith owe millions to some deluded financial institution.
Just think about that for a moment; a pair of school teachers managed to buy hundreds of houses on credit. Whatever wealth they may have accumulated was due to a self-replicating bubble. Easy credit created the demand that pushed property prices higher. This pushed people like Fergus and Judith to take out more credit to buy more houses, pushing demand even higher.
It would not be such a problem if Fergus and Judith were the only ones leveraging nothing into a multi-million pound portfolio. There are now close to a million buy-to-let mortgages in the UK; which is about one in eleven of all mortgages. In reality, that number understates the true extent of buy-to-let speculation. Many investors misled banks and took out loans posing as owner-occupiers when they were actually buying rental properties.
For the typical buy-to-let investor, there is an unshakable optimism in the future. In that happy hereafter, house prices rise perpetually, whipping up an infinity of wealth for those owning property. It is a faith buttressed by higher divorce rates, stringent planning procedures, and low interest rates. The UK will be eternally short of houses, and packed out with people desperately looking for homes. It all means one thing, prices can never go down.
However, the past tells a different story. Back in 1989, house prices crashed, and kept on falling until 1996. Moreover, the decline was significant; in real terms prices fell 35 percent. For the buy-to-let generation, it provokes a dark nagging thought; perhaps, prices could slide again. Over the last couple of months, those nagging thoughts have morphed into reality. Prices are falling.
Over time, buy-to-let investors will lose money. Even Fergus and Judith can expect their net wealth to take a hit. Declining rental yields and falling prices will force a fire sale of buy-to-let properties. Many properties will be sold at a loss. Many investors will default, creating a huge cesspit of bad loans.
Alas, buy-to-let losses will not remain a private matter. Burgeoning banking sector problems will transform buy-to-let into a matter of public policy. It was banks that made Fergus and Judith possible. It was banks that put out a million buy-to-let mortgages and when it all turns ghastly, it will be the banks that will see their balance sheets deteriorate.
There may be some people who think that this will not happen, or who think that the UK financial system is simply too strong and too well supervised. Think again, the crisis is already here; Northern Rock is already down; Paragon is about to go, while the Derbyshire Building Society is facing a ratings downgrade. Meanwhile the remaining banks are urgently trying to exit the market. Unsurprisingly, mortgage lending volumes are down 43 percent compared to last year.
The housing crash is now gathering momentum. However, property market losses is really only a marginal issue. The real concern is the banks. Banking crises are horrible; they undermine the payments system, generate extremely persistent credit contractions, and spark recessions. This might be the ultimate legacy of the buy-to-let bubble.
Saturday 19 January 2008
Fold your arms Justin, we need you to look mean for the publicity shot
Does anyone remember this pair of shockers? Yes, it is Justin Ryan and Colin McAllister - the property millionaires. They had a ridiculous TV programme "Million Pound Property Experiment". They were the original property developer fantasists and inspired a generation of would-be small time property developers.The show first aired on BBC 2 during 2003-4. It was a pernicious idea; take out a £100,000 loan from the BBC and then transform it into a million pound profit from buying, renovating and selling properties. Of course, Justin and Colin tarted up this concept with charity - any profits would go to the BBC's "Children in Need" campaign.
What pearls of wisdom did the programme offer? Find areas on the up, buy the shabbiest house in the best street, find out what kind of people buy in the area and aim your development squarely at them.
However, the true attraction was not educating people how to make money from property. Rather, it was to show how easy it would be to make money from buying houses on credit, doing some painting and decorating and flogging it off three months later. If Justin and Colin were doing anything sophisticated or difficult, the program would have lost its appeal.
Four million viewers tuned in to watch these jokers flip houses across the UK, and I was one of them. Oh, how I wanted them to fail. However, that was never going to happen. After seven nauseous programmes, the pair ended up with a net profit of £290,000.
The program created a myth. In around two years, Justin and Colin had taken £100,000 loan and generated a 290 percent return. It all looked too easy; a £100,000 was definitely within the reach of most homeowners, buying property is just a matter of visiting an estate agent and any fool can paint and buy furniture. The end result was a surge in small-property development. It helped fuel demand, which pushed up prices.
So, Justin and Colin, you did your bit to create the bubble. You fed the lie, and now the lie is being exposed. I hated the pair of you back then, and time has not healed the wound.
What a week
Few weeks have been so loaded with bad financial news. Here is just a selection:
Monday, January 14th
As inflation fears increaed, gold prices reached $900.
IVA.com reported a 67% surge in enquiries for individual voluntary arrangements this January compared to December.
UK house prices fell by 0.8 percent in November according to latest government figures
Tuesday, January 15th,
Citibank wrote off $18 billion in subprime losses.
Taylor Wimpey, the U.K.'s largest homebuilder, said its order book was 19 percent lower on Dec. 31 compared with the same date a year earlier.
The Alliance & Leicester and Britannia building society, doubled the minimum deposit demanded from first-time buyers.
Wednesday, January 16th
For the third month in a row, inflation was above the Bank of England's target.
Thursday, January 17th
Over the US, the housing crash accelerated. The latest data showed that California home prices drop nearly 15 percent.
Moodys put Derbyshire Building Society on review for possible downgrade.
Merrill Lynch posts $7.8bn loss on account of subprime.
Barratt order book for new homes fell for the first time in almost four years.
US housing starts fall to 16-Year low
Friday, January 18th
Fitch credit rating agencies downgraded the bond insurer Ambac Financial Group, pushing the company to the verge of bankruptcy.
Over on Wall Street, bonuses fell by 5 percent.
In a frantic effort to save face, the chancellor was preparing to issue billions of pounds of government debt to cover the financing hole in Northern Rock.
Over in Germany, newspapers report that troubled regional bank, WestLB, needs a capital increase of euro 2 billion; not quite yet a Northern Rock, but still big.
Paragon announced that it will cease lending from February, so farewell, buy-to-let.
Scottish Equitable, - one of Britain's biggest property funds - shut its doors to withdrawals form small investors due to the slump in commercial prices triggered panic selling by small investors
Saturday, January 19th
New Star Asset management crashed after it issued a profit warning and cut its dividend. UK retail investors panicked as millions were wiped off the value of commercial property funds.
Bond guarantor, ACA Financial Guaranty, was facing a midnight deadline to restructure its insurance contracts with investment banks or face a bankruptcy filing.
Did I leave anything out? If so, post a comment.
Monday, January 14th
As inflation fears increaed, gold prices reached $900.
IVA.com reported a 67% surge in enquiries for individual voluntary arrangements this January compared to December.
UK house prices fell by 0.8 percent in November according to latest government figures
Tuesday, January 15th,
Citibank wrote off $18 billion in subprime losses.
Taylor Wimpey, the U.K.'s largest homebuilder, said its order book was 19 percent lower on Dec. 31 compared with the same date a year earlier.
The Alliance & Leicester and Britannia building society, doubled the minimum deposit demanded from first-time buyers.
Wednesday, January 16th
For the third month in a row, inflation was above the Bank of England's target.
Thursday, January 17th
Over the US, the housing crash accelerated. The latest data showed that California home prices drop nearly 15 percent.
Moodys put Derbyshire Building Society on review for possible downgrade.
Merrill Lynch posts $7.8bn loss on account of subprime.
Barratt order book for new homes fell for the first time in almost four years.
US housing starts fall to 16-Year low
Friday, January 18th
Fitch credit rating agencies downgraded the bond insurer Ambac Financial Group, pushing the company to the verge of bankruptcy.
Over on Wall Street, bonuses fell by 5 percent.
In a frantic effort to save face, the chancellor was preparing to issue billions of pounds of government debt to cover the financing hole in Northern Rock.
Over in Germany, newspapers report that troubled regional bank, WestLB, needs a capital increase of euro 2 billion; not quite yet a Northern Rock, but still big.
Paragon announced that it will cease lending from February, so farewell, buy-to-let.
Scottish Equitable, - one of Britain's biggest property funds - shut its doors to withdrawals form small investors due to the slump in commercial prices triggered panic selling by small investors
Saturday, January 19th
New Star Asset management crashed after it issued a profit warning and cut its dividend. UK retail investors panicked as millions were wiped off the value of commercial property funds.
Bond guarantor, ACA Financial Guaranty, was facing a midnight deadline to restructure its insurance contracts with investment banks or face a bankruptcy filing.
Did I leave anything out? If so, post a comment.
Need some reassurance.....
...there are plenty of soothing words about the UK housing market out there. Here are a few choice comments for those who would prefer to sit back and take a relaxed view about the ailing market.
"House prices for the UK as a whole are expected to be flat during 2008 but there are likely to be regional variations. Small price rises are expected in Scotland whilst modest falls are predicted in northern England and the Midlands. These falls should however be viewed in context with the substantial house price rises over the past few years."
Martin Ellis, chief economist at Halifax.
"I don't think we will see house price falls. I just see no reason for it."
Andrew Weir, Foxtons
"Don't panic. You are not going to see all your equity disappear. We expect the market to be steady,"
Martin Ellis, chief economist at Halifax.
“First time buyers, whilst likely to be nervous from recent press comment, have a golden opportunity over the next few months to pick up a bargain from a developer or vendor looking to sell quickly. I would recommend they move quickly to take advantage of reducing interest rates over coming months whilst getting a great property price. The massive shortage of property in the UK will not go away for many years or even decades to come, and prices will strengthen again in due course as a result."
Stuart Law, Chief Executive of Assetz
"There's no doubt that a lot of agents are having a tough time at the moment,"
Peter Bolton King, head of the National Association of Estate Agents.
"House prices for the UK as a whole are expected to be flat during 2008 but there are likely to be regional variations. Small price rises are expected in Scotland whilst modest falls are predicted in northern England and the Midlands. These falls should however be viewed in context with the substantial house price rises over the past few years."
Martin Ellis, chief economist at Halifax.
"I don't think we will see house price falls. I just see no reason for it."
Andrew Weir, Foxtons
"Don't panic. You are not going to see all your equity disappear. We expect the market to be steady,"
Martin Ellis, chief economist at Halifax.
“First time buyers, whilst likely to be nervous from recent press comment, have a golden opportunity over the next few months to pick up a bargain from a developer or vendor looking to sell quickly. I would recommend they move quickly to take advantage of reducing interest rates over coming months whilst getting a great property price. The massive shortage of property in the UK will not go away for many years or even decades to come, and prices will strengthen again in due course as a result."
Stuart Law, Chief Executive of Assetz
"There's no doubt that a lot of agents are having a tough time at the moment,"
Peter Bolton King, head of the National Association of Estate Agents.
Friday 18 January 2008
Time to wind up the FSA
What a surprise; more financial failure in the UK. A second property fund has frozen withdrawals, trapping over 129,000 small savers into a rapidly disintegrating investment. Scottish Equitable, one of Britains biggest funds, said it no longer had sufficient cash to meet the demands of panicked investors.
Property fund investors have plenty of reasons to panic. The UK commercial property market is in an unprecedented crisis. Property values, especially in London, are falling rapidly, and investors are desperate to cash out.
As investors are on the verge of losing billions, what is the Financial Services Agency doing? It is "monitoring the situation closely". Monitoring, schmonitoring, that means it is doing nothing.
Like the Northern Rock crisis demonstrated, the FSA have no capacity to monitor, identify and assess financial sector vulnerabilities. When financial panics occur, the FSA are incapable of action. It is an institution hard-wired for failure.
The FSA is a defective, inadequate and malfunctioning institution. It is time that it was wound up, with the Bank of England regaining its traditional responsibilities for supervising the financial system. It is too late to save Northern Rock or the Scottish Equitable property fund, but liquidating the FSA might avoid similar failures in the future.
Property fund investors have plenty of reasons to panic. The UK commercial property market is in an unprecedented crisis. Property values, especially in London, are falling rapidly, and investors are desperate to cash out.
As investors are on the verge of losing billions, what is the Financial Services Agency doing? It is "monitoring the situation closely". Monitoring, schmonitoring, that means it is doing nothing.
Like the Northern Rock crisis demonstrated, the FSA have no capacity to monitor, identify and assess financial sector vulnerabilities. When financial panics occur, the FSA are incapable of action. It is an institution hard-wired for failure.
The FSA is a defective, inadequate and malfunctioning institution. It is time that it was wound up, with the Bank of England regaining its traditional responsibilities for supervising the financial system. It is too late to save Northern Rock or the Scottish Equitable property fund, but liquidating the FSA might avoid similar failures in the future.
The things people say......
"With the benign economic backdrop and unique nature of the housing market, we do not envisage forced sales and repossessions spiralling. Instead, we expect a thin market in 2008 with lower levels of transactions."
Jennet Siebrits, head of residential research at CB Richard Ellis.
“You don't want to upset the seller by offering too low."
Kevin Shaw, the national operations director of Spicerhaart estate agents
“Buyers looking at £1million-plus homes do not mess about.”
Cliff Gardiner, Buying Solutions
"It is encouraging to see landlords taking a measured, long-term approach to their buy-to-let investments."
Stephen Leonard, director of mortgages at Alliance & Leicester
"I have £10,000 to invest and am thinking of buy-to-let, but warnings of a property crash are putting me off. Is it too late to invest in property?"
JD, Essex
Jennet Siebrits, head of residential research at CB Richard Ellis.
“You don't want to upset the seller by offering too low."
Kevin Shaw, the national operations director of Spicerhaart estate agents
“Buyers looking at £1million-plus homes do not mess about.”
Cliff Gardiner, Buying Solutions
"It is encouraging to see landlords taking a measured, long-term approach to their buy-to-let investments."
Stephen Leonard, director of mortgages at Alliance & Leicester
"I have £10,000 to invest and am thinking of buy-to-let, but warnings of a property crash are putting me off. Is it too late to invest in property?"
JD, Essex
Thursday 17 January 2008
Those losses just keep piling up
Take a look at this list:
Merrill Lynch: $22.1bn
Citigroup: $18bn
UBS: $13.5bn
Morgan Stanley $9.4bn
HSBC: $3.4bn
Bear Stearns: $3.2bn
Deutsche Bank: $3.2bn
Bank of America: $3bn
Barclays: $2.6bn
Royal Bank of Scotland: $2.6bn
Freddie Mac: $2bn
JP Morgan Chase: $3.2bn
Credit Suisse: $1bn
Wachovia: $1.1bn
IKB: $2.6bn
Paribas: $439m
Over the last ten years, banks across Europe and North America have run up mountain of losses, stupidly lending to households who now can not pay the debts back. This list is just a selection; there are literally hundreds of financial institutions now their booking sub-prime losses.
The scary thing is that the US banks are ahead of the curve. The housing market over there began collapsing two years ago. The losses are on the balance sheets of the banks, and the write-offs have started.
In Europe, we are still listening to the prelude. The fat lady hasn't even walked onto the stage to start act one. Over here, our housing sector losses are still hidden, tucked away, waiting to jump out and frighten the living daylights out of us. The same is true over in Ireland. It is the same in Spain. As those Eastern European hotspots; Bulgaria, Croatia and Albania - oh boy, dark days will soon be upon us.
What can be done? The first thing to do is to stop pouring money at the property markets. Banks should severely tighten credit standards. There is no point making a bad situation worse. Second, separate the seriously ill from the corpses. Save what you can, bury what is dead. For example, start with Northern Rock.
Closing down a bank is actually very easy. Close the offices at 5pm. Send in some accountants as soon as you have sent the staff home with their photocopied good-bye letter from the director of human resources. Then add up the assets and subtract the liabilities. See what you have left. Sell the assets, pay off as much of the liabilities as you can with the proceeds.
Then send the outstanding bill to a man down in Whitehall called Mr. Darling. Tell him to pay up by return of post. Bob's your uncle, its all over, and wait until the next bank drops dead, and start all over again.
Merrill Lynch: $22.1bn
Citigroup: $18bn
UBS: $13.5bn
Morgan Stanley $9.4bn
HSBC: $3.4bn
Bear Stearns: $3.2bn
Deutsche Bank: $3.2bn
Bank of America: $3bn
Barclays: $2.6bn
Royal Bank of Scotland: $2.6bn
Freddie Mac: $2bn
JP Morgan Chase: $3.2bn
Credit Suisse: $1bn
Wachovia: $1.1bn
IKB: $2.6bn
Paribas: $439m
Over the last ten years, banks across Europe and North America have run up mountain of losses, stupidly lending to households who now can not pay the debts back. This list is just a selection; there are literally hundreds of financial institutions now their booking sub-prime losses.
The scary thing is that the US banks are ahead of the curve. The housing market over there began collapsing two years ago. The losses are on the balance sheets of the banks, and the write-offs have started.
In Europe, we are still listening to the prelude. The fat lady hasn't even walked onto the stage to start act one. Over here, our housing sector losses are still hidden, tucked away, waiting to jump out and frighten the living daylights out of us. The same is true over in Ireland. It is the same in Spain. As those Eastern European hotspots; Bulgaria, Croatia and Albania - oh boy, dark days will soon be upon us.
What can be done? The first thing to do is to stop pouring money at the property markets. Banks should severely tighten credit standards. There is no point making a bad situation worse. Second, separate the seriously ill from the corpses. Save what you can, bury what is dead. For example, start with Northern Rock.
Closing down a bank is actually very easy. Close the offices at 5pm. Send in some accountants as soon as you have sent the staff home with their photocopied good-bye letter from the director of human resources. Then add up the assets and subtract the liabilities. See what you have left. Sell the assets, pay off as much of the liabilities as you can with the proceeds.
Then send the outstanding bill to a man down in Whitehall called Mr. Darling. Tell him to pay up by return of post. Bob's your uncle, its all over, and wait until the next bank drops dead, and start all over again.
I need an ERO
The government have finally woken up to the fact that UK consumers are overloaded with debts. So they have put on their collective "thinking hats" and come up with a solution - "why not have an interest payment holiday for anyone who can not pay their debts".
The plans, prepared by those financial geniuses over at the Ministry of Justice, would allow consumers who slide into financial difficulties through a change of circumstance, such as losing their job or divorce, to stop making repayments their personal loans, credit cards and other debts. All they have to do is apply for “enforcement restriction order”. This scam even has a ill-starred name; it will be called an ERO.
How is this for a classic example of double-speak -. Bridget Prentice, the Civil Justice Minister, said: “We want to ensure that people who run up debts are given every opportunity to pay them off.” How do you ensure that people are given "every opportunity to pay"? You give them a way of evading payment.
If ever there was an idea designed to undermine the financial system, then this is it. What bank would give a loan knowing that the borrower has the right to turn around at some point in the future and say "sorry, I can't pay and I won't pay".
What is the point of trying to save?
The plans, prepared by those financial geniuses over at the Ministry of Justice, would allow consumers who slide into financial difficulties through a change of circumstance, such as losing their job or divorce, to stop making repayments their personal loans, credit cards and other debts. All they have to do is apply for “enforcement restriction order”. This scam even has a ill-starred name; it will be called an ERO.
How is this for a classic example of double-speak -. Bridget Prentice, the Civil Justice Minister, said: “We want to ensure that people who run up debts are given every opportunity to pay them off.” How do you ensure that people are given "every opportunity to pay"? You give them a way of evading payment.
If ever there was an idea designed to undermine the financial system, then this is it. What bank would give a loan knowing that the borrower has the right to turn around at some point in the future and say "sorry, I can't pay and I won't pay".
What is the point of trying to save?
Wednesday 16 January 2008
When will it end?
Recently, I've resisted the temptation to post anything on Northern Rock. The reluctance stems from a mixture of boredom and anger. I just wish that someone would put the old nag out of its misery.
Today's news that the share price fell another 20 percent forced me sign in and write something. It must now be obvious that there is no "private sector" solution. It is time to wind the thing up.
Nationalization is a bad idea. Should the government take it over, the shareholders might have an opportunity to take legal action. Nationalization also sets a dangerous precedent. Before this housing bust is over, other banks will probably go under. Will they be nationalized too?
There is, thankfully, a very simple solution available that would put an end to all this nonsense. The Bank of England is a creditor. It should call its emergency loan, and put Northern Rock into bankruptcy. It should cease operations immediately and an administrator should be appointed rescue whatever value remains. As solutions go, it would be merciful; it would be all over in a day.
The newly appointed administrator should sell the assets, make redundancy payments to Northern Rock staff, clear off any outstanding tax bills, and use the rest to pay off depositors. If there is anything left, it should go to the Bank of England. If the remaining assets are insufficient to clear the Bank of England's loan, then Mervyn should send the invoice to the Treasury.
Hopefully, the shareholders will get nothing. As the owners of the bank, they took the profits when times were good. Now that the company has failed, it only seems reasonable that they should accept their losses with good grace.
Northern Rock would then do something useful. It would demonstrate to all other banks that failure has consequences. It would show that stupidity and excessive risk-taking has a price. Although, the tax payer could well end up paying out, if it prevents some of the banking sector excesses of the last ten years, it may well be money well spent.
Where is the recession?
While everyone might be expecting a recession, there is surprisingly few sign of one in recent economic data. Today, three numbers came out; all indicating that the UK labour market was in fine shape.
First item; unemployment. The number of people out of work was just 1.65 million. It is now at a 32 year low That is genuinely great news, since there is nothing sadder or more painful than unemployment.
Item two; employment numbers; the numbers are strong. The number of people in work increased by 175,000 in the laste quarter to 29.3 million. It is at the highest figure since 1971.
Finally, wage growth - average earnings growth, including bonuses, are chugging along at 4 per cent. No sign of a slowdown there.
These numbers, along with other recent numbers, like the rather perky third quarter GDP numbers, and dreadful recent inflation numbers, all suggest that the economy has not yet slipped significantly. In fact, the only numbers that looks weak are those from the housing market.
There is a danger here for the MPC. Aggressive interest rate reductions while the labour market remains tight might only fuel inflation. It won't however, do much to save the housing market. That wreck is beyond saving; house prices have drifted so far from fundamentals that that only way is down.
First item; unemployment. The number of people out of work was just 1.65 million. It is now at a 32 year low That is genuinely great news, since there is nothing sadder or more painful than unemployment.
Item two; employment numbers; the numbers are strong. The number of people in work increased by 175,000 in the laste quarter to 29.3 million. It is at the highest figure since 1971.
Finally, wage growth - average earnings growth, including bonuses, are chugging along at 4 per cent. No sign of a slowdown there.
These numbers, along with other recent numbers, like the rather perky third quarter GDP numbers, and dreadful recent inflation numbers, all suggest that the economy has not yet slipped significantly. In fact, the only numbers that looks weak are those from the housing market.
There is a danger here for the MPC. Aggressive interest rate reductions while the labour market remains tight might only fuel inflation. It won't however, do much to save the housing market. That wreck is beyond saving; house prices have drifted so far from fundamentals that that only way is down.
Monday 14 January 2008
Central banks - hoping for the best, fearing the worst
Inflation is back with a vengeance. Today, UK factory gate price growth reached 5 percent, giving a 16 year high. The retail price index is stuck above 4 percent while the Bank of England has missed its inflation target in 23 out of the last 24 months. The story is much the same in the US. Import prices are exploding while consumer price inflation is above 4 percent. Understandably, gold prices today cruised passed the $900 barrier.Meanwhile, over in the US, Bernanke is promising more interest rate cuts, while over here the MPC look ready to knock 0.25 percent off the cost of borrowing next month. In principle, central banks are supposed to worry about price stability, but these days, central banks seem more interested in avoiding recessions. Why have they ignored the recent surge in inflation? Why do they fear an economic slowdown so much?
The answer in two words - household debt. Central banks - both in the UK and in the US - fear that an economic slowdown will increase default rates and weaken bank balance sheets. Central banks know that there is enough dubious debt out there - mortgages, unsecured loans, credit cards - to sink the financial system. If default rates increase enough it could lead to some banks drifting toward bankruptcy. Nothwithstanding all their brave words about price stability, central banks fear household debt more than inflation.
In their more optimistic moments, central bankers think that the current round of interest rate cuts will not actually be inflationary. Cuts will improve liquidity and allow banks to borrow to each other. It may also help banks to reduce their rates on teaser loans and therefore limit default rates. Central bankers hope that commercial banks have learnt some hard lessons in 2007 and that lower rates will not prompt a renewed burst of irresponsible lending. In this happy scenario, credit growth will be sufficient to avoid a recession but slow enough to prevent stoking up inflation.
Unfortunately, inflation doesn't respond to wishful thinking by central bankers. The cause of inflation is well understood, it is excessive monetary growth. However, monetary growth does not generate inflation in the same way that turning on a tap generates running water. Inflation works its mischief slowly, it takes its time when it decides to accelerate.
The inflation we have today is the consequences of poor central bank decisions taken two years ago. Lest we forget, two years ago, was early 2006, when the housing bubble had regained momentum and banks showered anyone who could fill in an application form with a cheap loan. At the time, the UK money supply was growing at double digit rates. As a consequence, the UK has a growing inflationary problem today.
Central banks must also come to terms with a second limitation of monetary policy. They can only control short term rates. Long term interest rates are determined by markets. Once inflation picks up, long term rates follow. This was why the 1970s were marked by stagflation, when the UK and the US had slow growth and rising inflation. Higher long term interest rates killed growth. It was only when central banks started to tackle inflation that long term rates fell and economies began to grow on a sustained basis.
The Fed and the Bank of England are cornered. Cutting rates might give some temporary relief to banks. However, higher inflation will push up long term interest rates and will bring on a recession. Both central banks know that a recession is inevitable, but both institutions hope that by the time an eocnomic slowdown arrives, commercial banks will have made sufficient preparations for a wave of personal sector defaults.
What does this mean for the UK housing market. Ultimately, house prices are driven by one thing - the availability of credit. Despite any future interest rate cuts that might appear in February, UK banks will not start lending again. Now is the time to repair balance sheets not feed the get-rich-quick-on-real-estate illusions of UK households.
The UK bubble is over and a quarter point rate cut in February will not make a difference. House prices are about to take a long awaited trip back to earth.
Sunday 13 January 2008
The ghost of housing equity
Over the last few days, newspapers have been full of happy talk about the huge appreciation of house values. Supposedly, over the last ten years home owners accumulated £4.0 trillion worth of equity in their homes.
However, the most idiotic comment came from firstrung.com. It claimed that due to rising house prices "UK household balance sheets strengthened again in 2007". So despite that huge increase in personal indebtedness, rising inflation and stagnant incomes, UK household became wealthier last year. And not just a little more wealthier; household net wealth went up a tasty 9 percent.
Lets start with an obvious point; for the vast majority of households, there is just one asset in their balance sheet - their home. Portfolios with just one asset are not exactly diversified. This makes their portfolios vulnerable to sudden changes in price of this one asset. This is not what an accountant would call a position of financial strength.
But what of the household income statement? Households invariably one source of income - their job. Apart from the BTL brigade (and we will come to them in a moment), people are living in their sole asset. Therefore, it is not earning an income stream. On the liabilities side, however, there is debt. This needs to be paid off. Despite their huge price appreciation, from an income perspective, homes are simply an expense. In balance sheet terms, homes are non-performing assets. Houses certainly provide a flow of services, but unless they are sold, houses don't pay off debts. Only jobs do that.
The BTL brigade understand this point better than most. These jokers are out there trying to make a return on their houses via rents. However, all too often, these rents do not cover the mortgage costs. On a cash flow basis, many BTL investments offer extremely low and sometimes negative returns.
This pernicious idea that rising home values generates real wealth has encouraged people to take out more debt, to over consume and under save. It has also encouraged many speculate in the BTL scam. It has served to underpin the housing bubble and offered false hope that debt accumulation has no long term financial consequences.
This year, it is coming to an end. House prices will fall, and as they do, that phantom home equity will disappear. However, those debts taken out on the housing upswing are real. They need to be paid off. Then households will understand the true wealth generating capacity of housing equity.
Saturday 12 January 2008
UK cash shortage crisis
I love the nonsense the Daily Express produces. Today's edition was a classic. It announced that the value of UK housing was now £4 trillion. But that wasn't all; the Express also told us that in ten short years wealth in the UK has doubled on account of increased house prices.
Someone help me out here. I am just too simple for this high-falootin' Daily Express thinking. In 1997, the country had some houses; ten years later, we had basically the same houses, but now we are twice as rich? I don't see it. What am I missing here? I thought being rich meant you had more stuff.
This is what I think being twice as wealthy means. Yesterday, I had one house, but today, I have two houses, therefore I am twice as rich. Here is another one. Yesterday, I had ten quid in my purse, but today, I have twenty quid there. Oh I don't know, all this talk of money just leaves me confused.
However, after I read the Express article, I was gripped with panic. What if there isn't enough money in the country to buy up all this housing wealth? After all, you can not go down to the corner shop and offer your house as payment for your copy of the Daily Express. In my world, you need cash to pay for things. So I quickly ran to my computer, signed on, and logged onto the Bank of England's website, wanting to know how much actual cash we have in the country.
Prepare yourself for some bad news. If everyone wanted to sell their house today, there isn't enough money in the economy to pay the sellers. According to the Bank of England website, there are only £51 billion worth of notes and coins in the country. This is barely a fraction of what is needed if homeowners are going to get that £4 trillion that the Daily Express promised.
The conclusion is obvious. The Bank of England hasn't produced enough money. The wealth is there but the money isn't. There is a cash shortage in the UK today. I, for one, demand that the Mervyn and his MPC mates get cracking and start producing the lolly. Homeowners of Britain need that money, and they need it today.
Anyone fancy pointing the cash shortage out to the Bank of England? Perhaps, the Daily Express should follow up with another outraged headline "Mervyn starves UK of money".
Someone help me out here. I am just too simple for this high-falootin' Daily Express thinking. In 1997, the country had some houses; ten years later, we had basically the same houses, but now we are twice as rich? I don't see it. What am I missing here? I thought being rich meant you had more stuff.
This is what I think being twice as wealthy means. Yesterday, I had one house, but today, I have two houses, therefore I am twice as rich. Here is another one. Yesterday, I had ten quid in my purse, but today, I have twenty quid there. Oh I don't know, all this talk of money just leaves me confused.
However, after I read the Express article, I was gripped with panic. What if there isn't enough money in the country to buy up all this housing wealth? After all, you can not go down to the corner shop and offer your house as payment for your copy of the Daily Express. In my world, you need cash to pay for things. So I quickly ran to my computer, signed on, and logged onto the Bank of England's website, wanting to know how much actual cash we have in the country.
Prepare yourself for some bad news. If everyone wanted to sell their house today, there isn't enough money in the economy to pay the sellers. According to the Bank of England website, there are only £51 billion worth of notes and coins in the country. This is barely a fraction of what is needed if homeowners are going to get that £4 trillion that the Daily Express promised.
The conclusion is obvious. The Bank of England hasn't produced enough money. The wealth is there but the money isn't. There is a cash shortage in the UK today. I, for one, demand that the Mervyn and his MPC mates get cracking and start producing the lolly. Homeowners of Britain need that money, and they need it today.
Anyone fancy pointing the cash shortage out to the Bank of England? Perhaps, the Daily Express should follow up with another outraged headline "Mervyn starves UK of money".
Friday 11 January 2008
Give me Mervyn over Ben any day
Mervyn and the MPC do not inspire much confidence, but I would rather those jokers running monetary policy than Bernanke and the Fed.
US monetary policy is in a mess. Since August, US interest rates have been foolishly chasing after growth. At the same time, the Fed poured out huge amounts of liquidity as it vainly tried to prevent troubled banks from facing up to the consequences of years of bad lending policies. In the process, the Fed has disregarded the growing dangers of inflation.
Unfortunately, the Fed is on the fast track to failureville; the economy is moving decisively into recession, the banks are still posting huge losses, while inflation continues to pick up.
Events over the last couple of days have highlighted the Fed's difficulties. As concerns about a slowdown have increased, the Fed chairman promised Wall Street that he would rates aggressively should the US economy moves into recession.
Wall Street were happy to hear about this relaxed attitude about future rate policy. Nevertheless, large investment banks are still posting massive losses. Merrill Lynch is about to write down $15 billion, Citigroup and Merrill Lynch are set to report losses of as much as $26 billion. The magnitude of the losses are so great that US investment banks have been obliged to go "cap in hand" to various sovereign wealth funds for a bail-out. This frantic overseas search for cash is a humiliation for the once proud US investment banking community.
Today, the US commerce department added to the Fed's troubles. It reminded Bernanke and the FOMC that US inflation is rising at an uncomfortable rate. In 2007, import prices increased at their fastest pace for 25 years. The commerce department then followed up with another another grim statistic. Higher import prices data pushed the November US trade deficit to its highest level in 14 months.
This latter news must have been hard to swallow for the Fed, who had allowed the dollar to crash in the hope that the US external deficit might improve. Like so many of the America's economic difficulties, the root of the US external deficit problem lay in the housing market. On the back of record house price growth, the US consumer went on a massive import spendfest. The crashing dollar has only served to increase import prices, but done little to improve the deficit. US households just kept on buying imports despite the falling dollar.
The immediate future looks rather bleak. Inflation is above 4 percent and rising. Any further interest rate reductions will weaken the dollar and add to inflationary pressures. The housing market is still sliding and pushing the economy into a recession. The current account deficit remains huge despite a massive dollar depreciation.
A modest slowdown in growth might help resolve some of these difficulties, particularly the huge US current account deficit and rising inflation. Lower growth would reduce import demand, while a slightly higher unemployment might help curb prices. However, the Fed wants to sustain growth and seems prepared to let inflation go where it likes.
It is a very short sighted strategy. Once inflation picks up, it does not fall quickly or without a significant tightening of interest rates. US inflation is already over 4 percent, with the dollar remaining weak, and rates falling fast, it wouldn't take much for inflation to climb to 6 percent. Once it is at 6 percent, a 10 percent rate doesn't seem so far away.
Back here on the other side of the Atlantic, the MPC have not yet adopted this irresponsible approach to monetary policy. So far, we have had just one interest rate cut, while the level of rates remains significantly higher than in the US.
I would like to think that the MPC could look at the Fed's difficulties and revolve to avoid the simple mistakes that Benanke and the Fed have made. Those lessons would include don't get carried away with loose monetary policy; don't let the exchange rate crash, and don't be too afraid of a modest slowdown in economic growth since a few lost points of GDP today might prevent stagflation a year from now.
Ben or Mervyn, it is not much of a choice, I admit, but I know which one I would choose.
US monetary policy is in a mess. Since August, US interest rates have been foolishly chasing after growth. At the same time, the Fed poured out huge amounts of liquidity as it vainly tried to prevent troubled banks from facing up to the consequences of years of bad lending policies. In the process, the Fed has disregarded the growing dangers of inflation.
Unfortunately, the Fed is on the fast track to failureville; the economy is moving decisively into recession, the banks are still posting huge losses, while inflation continues to pick up.
Events over the last couple of days have highlighted the Fed's difficulties. As concerns about a slowdown have increased, the Fed chairman promised Wall Street that he would rates aggressively should the US economy moves into recession.
Wall Street were happy to hear about this relaxed attitude about future rate policy. Nevertheless, large investment banks are still posting massive losses. Merrill Lynch is about to write down $15 billion, Citigroup and Merrill Lynch are set to report losses of as much as $26 billion. The magnitude of the losses are so great that US investment banks have been obliged to go "cap in hand" to various sovereign wealth funds for a bail-out. This frantic overseas search for cash is a humiliation for the once proud US investment banking community.
Today, the US commerce department added to the Fed's troubles. It reminded Bernanke and the FOMC that US inflation is rising at an uncomfortable rate. In 2007, import prices increased at their fastest pace for 25 years. The commerce department then followed up with another another grim statistic. Higher import prices data pushed the November US trade deficit to its highest level in 14 months.
This latter news must have been hard to swallow for the Fed, who had allowed the dollar to crash in the hope that the US external deficit might improve. Like so many of the America's economic difficulties, the root of the US external deficit problem lay in the housing market. On the back of record house price growth, the US consumer went on a massive import spendfest. The crashing dollar has only served to increase import prices, but done little to improve the deficit. US households just kept on buying imports despite the falling dollar.
The immediate future looks rather bleak. Inflation is above 4 percent and rising. Any further interest rate reductions will weaken the dollar and add to inflationary pressures. The housing market is still sliding and pushing the economy into a recession. The current account deficit remains huge despite a massive dollar depreciation.
A modest slowdown in growth might help resolve some of these difficulties, particularly the huge US current account deficit and rising inflation. Lower growth would reduce import demand, while a slightly higher unemployment might help curb prices. However, the Fed wants to sustain growth and seems prepared to let inflation go where it likes.
It is a very short sighted strategy. Once inflation picks up, it does not fall quickly or without a significant tightening of interest rates. US inflation is already over 4 percent, with the dollar remaining weak, and rates falling fast, it wouldn't take much for inflation to climb to 6 percent. Once it is at 6 percent, a 10 percent rate doesn't seem so far away.
Back here on the other side of the Atlantic, the MPC have not yet adopted this irresponsible approach to monetary policy. So far, we have had just one interest rate cut, while the level of rates remains significantly higher than in the US.
I would like to think that the MPC could look at the Fed's difficulties and revolve to avoid the simple mistakes that Benanke and the Fed have made. Those lessons would include don't get carried away with loose monetary policy; don't let the exchange rate crash, and don't be too afraid of a modest slowdown in economic growth since a few lost points of GDP today might prevent stagflation a year from now.
Ben or Mervyn, it is not much of a choice, I admit, but I know which one I would choose.
Paragon - digging deep
Can Paragon survive after February 27? The prospects look poor. The buy-to-let mortgage provider needs to come up with a hefty £280 million to cover a maturing loan. If it does not find the cash, then Paragon will follow Northern Rock into the abyss.
Today, Paragon scraped the bottom of the financing barrel. In a forlorn attempt to find cash, it offered investors additional shares at a breathtaking 90 percent discount. Paragon hopes that this frantic gesture will stave off bankruptcy.
Today, Paragon scraped the bottom of the financing barrel. In a forlorn attempt to find cash, it offered investors additional shares at a breathtaking 90 percent discount. Paragon hopes that this frantic gesture will stave off bankruptcy.
The news wiped out a fair chunk of existing shareholder value. Once the news got out, Paragon's share price fell 38 per cent, bringing the decline for the year as a whole down to a eye watering 78 per cent.
However, would any sensible investor take up Paragon's offer of these new cheap shares? The company is financing a sector that is just about ready to fall off a cliff. Mortgage volumes are down sharply, and apart from a few self interested estate agents, everyone expects a sizable decline in house prices.
The company itself admits that its strategy amounts to waiting and hoping that things turn out alright. Or as Robert Dench, the chairman of Paragon put it: "The board believes the rights issue will provide Paragon with a platform from which it can pursue further funding, so the company can return to writing significant volumes of profitable business when credit markets reopen".
If Paragon does go down, it will heighten concerns that the UK is heading for a systematic banking crisis. Other banks look just as vulnerable. There is nothing unique about Paragon and its business model. Like Northern Rock, it was gambling that house prices would just keep on rising. It poured out loans on people who had little idea of the financial risks of property speculation. In the wake of Paragon's slack attitude to risk, there are now too many over-extended buy-to-let amateurs with mortgages that can not be repaid.
It is an obvious point, but banks should only give out loans to those who can repay. Unfortunately for Paragon, the corporate banking sector suddenly remembered the virtue of this simple principle and applied it ruthlessly to the failing mortgage company. If only Paragon had remembered the same principle when that army of uninformed small time speculators came looking for financing.
However, would any sensible investor take up Paragon's offer of these new cheap shares? The company is financing a sector that is just about ready to fall off a cliff. Mortgage volumes are down sharply, and apart from a few self interested estate agents, everyone expects a sizable decline in house prices.
The company itself admits that its strategy amounts to waiting and hoping that things turn out alright. Or as Robert Dench, the chairman of Paragon put it: "The board believes the rights issue will provide Paragon with a platform from which it can pursue further funding, so the company can return to writing significant volumes of profitable business when credit markets reopen".
If Paragon does go down, it will heighten concerns that the UK is heading for a systematic banking crisis. Other banks look just as vulnerable. There is nothing unique about Paragon and its business model. Like Northern Rock, it was gambling that house prices would just keep on rising. It poured out loans on people who had little idea of the financial risks of property speculation. In the wake of Paragon's slack attitude to risk, there are now too many over-extended buy-to-let amateurs with mortgages that can not be repaid.
It is an obvious point, but banks should only give out loans to those who can repay. Unfortunately for Paragon, the corporate banking sector suddenly remembered the virtue of this simple principle and applied it ruthlessly to the failing mortgage company. If only Paragon had remembered the same principle when that army of uninformed small time speculators came looking for financing.
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