Posted on 09/27/2006 8:15:25 AM PDT by GodGunsGuts
No Shortage of Bubbles and Troubles By Jim Jubak MSN Money Markets Editor 9/27/2006
The stock and bond markets rallied after the Federal Reserve held short-term interest rates steady at its Sept. 20 meeting. Investors believe that the Fed has successfully steered the economy between too hot and too cold, and that we're headed for a just-right soft landing with inflation under control and the economy growing at a solid pace. The so-called "Goldilocks economy" will push both stock and bond prices higher.
But I think it's premature to slap the Fed on the back and say "mission accomplished." The truth is the Federal Reserve still hasn't pricked the financial bubble that it created with nearly a decade of easy-money policies.
Oh, the housing market bubble may be deflating, with or without the abrupt pop that ended the stock market bubble of 2000. But the Fed hasn't succeeded in sopping up the flood of cheap money it created when it drove short-term interest rates down to 1% in June 2003 and kept them at that level until June 2004. Now all of that cheap money is pushing up borrowing in the commercial real estate market fast enough to worry bank and savings and loan regulators. And that isn't the only sector in the midst of a bubble.
Washing Away a Curse
It might be better to name this the "Lady Macbeth economy." Cast Fed Chairman Ben Bernanke as Shakespeare's bloody queen who cried, "Out, out damn spot," as she vainly tried to wash the blood of a murdered king from her hands. In this economic version of the tragedy, however, Bernanke wanders the darkened halls of the Fed muttering, "Out, out damn bubble," as he tries to wash away the financial curse left to him by his predecessor, Alan Greenspan.
The Fed made three points in its Sept. 20 post-meeting statement:
**"The moderation in economic growth appears to be continuing, partly reflecting a cooling of the housing market."
**Moderating energy prices are likely to reduce inflation pressures over time.
**Some inflation risks remain, and additional interest rate increases may be necessary.
The bond market, however, seems to have heard only part of this message, the part about moderating growth and moderating inflationary pressures. Bond investors have been busy bidding up the price of 10-year Treasury notes ever since the last Fed meeting on June 29 in anticipation of exactly this mix of moderate growth and reduced inflationary pressures.
That's why the yield on the 10-year note has sunk to 4.78% at the close on Sept. 20 from 5.22% on June 30. That 8% drop in yield in less than three months is a very strong vote in favor of the success of the Federal Reserve's policies. Bond buyers are willing to accept a lower rate of interest on these long-term notes because they believe that inflation and interest rates will be lower than they are now.
Harder to Avoid Hikes
Of course, the bond market's belief in the Fed's conquest of inflation and in the likelihood of an interest rate cut next year makes it harder for the Fed to avoid raising interest rates. Even with 17 increases in short-term interest rates since June 2004, the Fed has had great difficulty in pushing up long-term rates and interest rates on mortgages that are so often linked to those rates.
Rates on the standard 30-year fixed-rate mortgage didn't climb above 6% to stay until October 2005 -- 15 months and 11 rate hikes after the Fed began to increase short-term rates. And despite all those rate increases from the Fed, the interest rate on a 30-year mortgage had actually climbed only as high as 6.8% by July 2006, shortly after Bernanke and company raised short-term rates for what is, so far, the last time in this cycle.
Since then, with the bond market increasingly convinced that the Fed is done, interest rates on a 30-year mortgage have actually dropped. The national average for a 30-year fixed-rate mortgage was just 6.33% on Sept. 21, according to the data from Informa Research Services. That's an effective rollback in mortgage rates to March 2006, when the national average stood at 6.31%.
Another Increase Likely
That drop in mortgage rates should be enough to raise a few worries at the Fed. After having fought so hard to raise mortgage rates to let some air out of the housing bubble, the Fed can't be happy to see the bond market so rapidly undo that work. Certainly somebody at the Fed has got to be asking, "Do we need to hit the bond market with another rate increase so that investors in long-term bonds and mortgage lenders don't forget the message?"
At the long end of the yield curve, the 10-year end, the bond market right now is pricing in a cut in interest rates by the Fed in 2007. By bidding long-term interest rates below 5%, however, bond investors are likely to force the Fed to move in exactly the opposite direction. If long-term interest rates drop lower or even just stay at this level, it's likely that the Federal Reserve will move to raise rates one more time, especially if current low rates on mortgages start to show up in an increase in housing sales or home prices.
But the strongest argument against the Federal Reserve moving quickly to cut interest rates comes in the continued -- maybe even accelerated -- growth in other kinds of financial bubbles. Some of the air may have gone out of the residential real estate bubble, but the evidence argues that all the Fed has accomplished with its interest rate increases so far is to trade one bubble for another.
Commercial Real Estate Takes Off
Take a look at what regulators fear is a growing bubble in commercial real estate. On the national level, commercial real estate loans climbed to $1.3 trillion in 2005, up 16% on the year. The Office of the Comptroller of the Currency has found that a third of nationally chartered banks have commercial real estate loans that amount to 300% or more of bank capital.
The Office of the Comptroller has said that banks with more than 100% of their capital in construction loans or more than 300% of that capital in commercial real estate generally need more thorough scrutiny from regulators.
On the local level, commercial real estate lending has taken up the slack left by a slowing residential mortgage market. In Florida's Manatee, Sarasota and Charlotte counties, 21 local community banks increased their real estate lending by 40% in the 12 months that ended in June 2006 from the prior 12-month period, according to the Federal Deposit Insurance Corp. -- even though residential real estate sales are down about 40% in the area in 2006. The biggest increase -- some 74% -- came in commercial construction and development loans.
Too Much Money
That's not exactly what the Fed was hoping for when it raised interest rates 17 times. Raising interest rates is supposed to make borrowers more reluctant to borrow and make it more expensive for lenders to raise the capital that they use to make loans.
The amount of money available for lending is supposed to shrink, but that doesn't seem to have happened so far in the market for commercial real estate loans. If anything, too much money is chasing too few good loan opportunities, according to regulators.
They fear that exactly the same situation is developing in the commercial real estate market as developed in the market for residential mortgages, when banks with more than enough money to lend chased after borrowers by lowering their credit quality standards.
Is this the only place in the economy where too much loan money may be chasing too few good borrowers? Not by a long shot. One place to look is the runaway market for mergers and acquisitions and private buyouts of public companies.
The volume of leveraged buyouts, for example, tripled in the 12 months that ended in August from the same period a year earlier. Every private buyout that is announced is larger than the one that closed just the week before.
Still Some Gas Left
And I'm pretty sure that mortgage lenders have yet a few more tricks up their sleeves to rope in a few more borrowers. American Express (AXP) recently announced that buyers of condominiums at some projects in Manhattan will be able to charge their down payment on their green, gold or platinum cards. Borrowers will get reward points good for airline miles, of course.
Sounds like the residential real estate bubble may still have some gas left in it. And that the commercial real estate and corporate mergers and acquisitions markets may be more than able to put any excess cash to work in pumping up their own bubbles.
The Fed's Bernanke has argued that long-term interest rates have been so low for so long -- and so resistant to moving upward under pressure from climbing short-term rates -- because we are in the middle of a global savings glut. There is simply too much cash in the world and too few good investment opportunities for that cash. The result is low rates for lenders and rising asset prices as all that money chases a limited supply of things, be they homes or commercial buildings or corporate buyout candidates.
Until the underlying excess liquidity is removed from the system, deflating one bubble will just produce another bubble somewhere else. So far, the world's central banks and sovereign governments have shown little ability -- and in many cases, no real inclination -- to slow the growth in the supply of global capital, let alone actually reduce it.
So the Federal Reserve is left with a dangerous brew like that boiled up by the witches at the beginning of "Macbeth." Remember what they chant: "Double, double, toil and trouble/Fire burn and cauldron bubble."
At the time of publication, Jubak did not own or control any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
Jim Jubak is senior markets editor for MSN Money. He is a former senior financial editor at Worth magazine and editor of Venture magazine. Jubak was a Bagehot Business Journalism Fellow at Columbia University and has written two books: "The Worth Guide to Electronic Investing" and "In the Image of the Brain: Breaking the Barrier Between the Human Mind and Intelligent Machines." As an investor, he says he believes the conventional wisdom is always wrong -- but that he will nonetheless go with the herd if he believes there's a profit to be made. He lives in New York. While Jubak cannot provide personalized investment advice or recommendations, he appreciates your feedback; click here to send him an email.
ping
This is pathetic.
People have for years said that inflation is the primary factor in what the Fed does.
I agree it is a factor, but I think the most important factor is what happens at the auctions.
If the furriner investment dries up, the only way to boost it is to raise rates.
I agree. The FED mostly just plays catch-up with long rates.
LOL. Yeah, he manipulated the those rates so low just so you could get a 5% interest rate. Evil bastard.
Exactly.
What is pathetic? Jim Jubak is in the business to make money on his picks and analysis...he lays it all on the line with his purchases and sales, unlike Cramer.
Yep, and obviously he's not too bright. There is no housing bubble to burst. A correction to the overheated demand of the last few years is a natural reaction, not a bubble burst. The tech sector had a bubble burst 7 years ago. Housing will experience no such thing.
What's a temporary recovery? And how does someone leverage one?
He didn't call it a housing bubble...he called it a lending bubble, which is exactly what it is.
I liked that lending bubble. Bought in 200 on an ARM. Converted it later to a 30 year fixed at a great rate. Helluva bubble to me.
Exactly. Many people borrowed more money at those low rates. Now, the doom and gloomers point to the higher levels of mortgage debt as proof of a disaster.
I don't know about them, but I prefer to borrow more when rates are low and save more when rates are high.
"I prefer to borrow more when rates are low and save more when rates are high."
No, no, no, you've got it all wrong ... it's a horrible debt bubble when people buy because rates are low, and it's a sign of impending collapse when mortgage applications deline with rising rates. And, on a related note, a decline in savings when rates are low is a sign that consumers are cash strapped, and an increase in savings when rates increase means that people are turning pessimistic.
The temporary recovery? How is that different from the other kind of recovery?
by encouraging his fellow American's to go into debt
Did he encourage this debt the same way as he encouraged ARMs? You know, by not actually encouraging it but just hinting?
thus postponing the previous recession
Wow, time travel even.
So no matter which way you look at it, this is a debt-driven economy.
So debt rose above your preferred level? What is the perfect level? What is the current level?
And when it comes time to pay the piper, the recovery will be over.
Unless Alan does that time travel thing again.
Exactly, Now is the time to buy GOLD!
Now it all make sense. Thanks.
If government can protect one, just one, individual from themselves then it is worth whatever the cost in terms of expanding its control over the rest of us.
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.