A weekend topic starting with the Real Deal. “For years, venture capitalists and tech firms from California descended on South Florida. But the industry’s foothold on the market began to falter last year. And now, in the aftermath of the collapses of banks with large tech lending arms, South Florida’s future as a tech mecca is on even shakier ground. South Florida ‘wanted California investors,’ said Peter Zalewski, a longtime local real estate market analyst. ‘Well, you got them. But you also got Silicon Valley Bank exposure.… So you live by the sword, you die by the sword.’”
“Others expect trouble in residential real estate to be longer lasting. As tech firms leased South Florida offices, executives scooped up condos and single-family homes here. ‘I would also expect there might be some residential foreclosures, related to mortgages provided for recent transplants who may not be able to make their payments, given the issues that are transpiring,’ said Josh Migdal, a Miami-based attorney.”
Yahoo Finance. “Last week, Silicon Valley Bank shuttered, prompting alarm nationwide. Reality TV star and business mogul Kevin O’Leary blames the bank’s management for the crisis. ‘Basically, they took 90% of the depositors’ money and bet it long on 10-year Treasuries right when the Fed was raising rates. Yes, only an idiot banker would do that. But that’s what they did, massive risk,’ said O’Leary. O’Leary also argued that the intervention could set a bad precedent going forward. ‘I can be running a bank and just spend all of my day worrying about the stock price because I don’t have to worry about the deposits anymore…. I can swing for the fences,’ O’Leary said. ‘I have to stay within the rules of banking, but I can take inordinate risk to move that stock price and never worry about what I do with the depositors’ money. Does that sound like a good idea to you?’”
From Mises.org. “How should Congress assess the Federal Reserve’s track record as an investor in residential mortgage-backed securities (MBS)? Regardless of Fed spin, it merits a failing grade. From 1913 until 2008, the Fed owned precisely zero mortgage-backed securities. In a radical ‘temporary’ policy response to the 2008 financial crisis, the Fed began intervening directly in the mortgage market. Through a series of MBS purchases, the Fed’s MBS portfolio ballooned from $0 to $1.77 trillion by August 2017. The Fed subsequently altered policy and slowly reduced its MBS holdings. By March 2020, it held about $1.4 trillion in MBS.”
“When the COVID crisis hit in March 2020, the Fed decided to reinstate its 2008 financial crisis rescue plan. It resumed purchasing MBS as well as Treasury notes and bonds. By the time it stopped its purchases in the spring of 2022, it owned $2.7 trillion in MBS. The Fed had become the largest investor in MBS in the world. By spring 2022, it owned nearly 22 percent of all 1-to-4 family residential mortgages in the U.S. By Sept. 30, the date of the last available quarterly Fed consolidated financial statement, the Fed had lost $438 billion on its MBS investments.”
“Government statistics report that, from January 2018 to this January, the median new home price in the United States rose from $331,800 to $467,700—an increase of 41 percent. Interestingly, from January 2018 through March 2020, before the Fed renewed its MBS purchases, the median price of a new house actually declined to $322,600. From April onwards, the national median house price rose steadily, reaching a peak of $468,700 by the end of June 2022.”
“In 2018, purchasing a new median-price home with 20 percent down and the then prevailing average 30-year mortgage rate of 3.95 percent required $1,259 in monthly principal and interest payments. In January, purchasing the $467,700 median-priced new home with 20 percent down required monthly payments of $2,360 given the 6.48 percent rate on a 30-year mortgage. In only 5 years, because of house price inflation and higher mortgage interest rates, the monthly principal and interest payment needed to purchase a median-priced new house increased by 87 percent!”
The Globe and Mail. “February’s housing report from the Canadian Real Estate Association cemented this as the steepest house price correction at the national level in decades. According to CREA data, the typical home in Canada has fallen by $132,000, or 15.7 per cent since February, 2022. As bad as that sounds, the drop is actually worse once the corrosive effect of high inflation on purchasing power is factored in. In real, or inflation-adjusted terms, national house prices have fallen nearly $168,000, a more-than-19-per-cent decline.”
“Even though real prices are now just 5.5 per cent higher than in April, 2017, bigger mortgages and higher interest rates mean ownership costs eat up 60 per cent of average household incomes now, compared with 44 per cent then, according to RBC Economics.”
The New York Times. “Over the past week, an observation by Matt Klein, a financial journalist, has gotten passed around quite a bit. ‘This was more a case of a ‘bank-run by idiots’ rather than a ‘bank run by idiots, he wrote, referring to the collapse of Silicon Valley Bank. I don’t think all these people – many of whom performed quite well before in crises and amid uncertainty – are, or suddenly became, idiots. Here’s a more generous interpretation: change makes fools of us all, and we are living through an era of change. Three changes, in particular, are worth thinking about right now.”
“In his 2020 letter to investors, Seth Klarman, the CEO of the Baupost Group, a hedge fund, wrote, ‘The idea of persistent low rates has wormed its way into everything: investor thinking, market forecasts, inflation expectations, valuation models, leverage ratios, debt ratings, affordability metrics, housing prices and corporate behavior.’ He went on to say that ‘by truncating downside volatility, forestalling business failures and postponing the day of reckoning, such policies have persuaded investors that risk has gone into hibernation or simply vanished.’”
“Point for Klarman. Silicon Valley Bank’s collapse is inseparable from the long era of low interest rates. Silicon Valley specialised in providing banking to startups that had little or no revenue but were nevertheless flush with cash – much of it coming, indirectly, from the Fed’s huge increase in the money supply. In April 2021, Richard Clarida, who was then the vice chair of the Federal Reserve, said the conditions keeping rates low were ‘a global phenomenon that is widely expected by forecasters and financial markets to persist for years to come.’”
“Less than a year later, the Fed would embark on one of its fastest rate-hiking campaigns in history. As it did, all manner of assets that had levitated toward eye-popping valuations in recent years – stocks, cryptocurrencies, NFTs, Swiss watches – began to tumble. As Edward Chancellor writes in ‘The Price of Time,’ ‘A disconnect between finance and the real world lies at the heart of all great bubbles.’”
From Market Watch. “The failure of Silicon Valley Bank (SVB) is a failure of federal supervision as well as regulation. The two terms are used interchangeably, but are different concepts: regulation is about creating rules, supervision enforces them. Initial reactions to SVB’s failure focused on debating whether the Trump-era deregulation caused the failure, but this ignores the fundamental question of whether the rules that existed were being properly enforced. The answer is that they weren’t, and the Federal Reserve failed as a bank supervisor.”
“The Fed supervised SVB from head to toe, with the San Francisco Federal Reserve Bank in charge of both the bank and its larger parent holding company, SVB Financial Group. SVB was the largest bank the SF Fed supervised. SVB’s CEO even sat on the SF Fed’s Board of Directors up until the day the bank failed. As SVB needed cash, it used the arcane Federal Home Loan Bank system to borrow heavily — becoming the San Francisco FHLB’s top borrower at $20 billion.”
“To understand how significant this is, know that the FHLB is called the lender of next-to-last-resort. When a bank fails, the FHLB is the only entity that gets paid out ahead of the FDIC. The more indebted a bank is to the FHLB, the greater the losses born by the taxpayer if the bank fails. An oft-forgotten fact is that Senator Christopher Dodd’s original proposal, in the law that became Dodd-Frank, envisioned taking supervision of banks like SVB away from the Fed. That idea was voted down 91-9. Dodd-Frank ultimately expanded the Fed’s authority and power over the nation’s banking system. In SVB’s case, that has been a failure.”
From Richard A. Werner. “Central bank decision-makers led by the Fed were largely responsible for the Great Inflation of the 1970s. They adopted “easy money” policies in order to finance massive national budget deficits. Yet this inflationary behaviour went unnoticed by most observers. Most worryingly, despite these failings, the world’s central banks were able to continue unchecked on a path towards the unprecedented powers they now hold. Indeed, the painful 1970s and subsequent financial crises have been repeatedly used as arguments for even greater independence, and less oversight, of the world’s central banking activities.”
“All the while, central bank leaders have repeated the mantra that their ‘number one job’ is to achieve price stability by keeping inflation low and stable. Unfortunately, as we continue to experience both punishing inflation rates and high interest rates, the evidence is all around us that they have failed in this job.”
“To understand the real roots of our current inflation crisis, we must instead address another widely-held misconception: how money is created. This perceptive insight by the American economist J.K. Galbraith in 1975 was supported some 35 years later when, along with my Goethe University students, I conducted a survey of more than 1,000 passers-by in central Frankfurt. We found that more than 80% of those interviewed believed that most of the world’s money is created and allocated by either governments or central banks. An understandable view, but wrong.”
“In fact, my empirical studies of our global monetary system have demonstrated that it is high-street or retail banks that produce the vast majority – around 97% – of the world’s money supply. Every time a bank grants a loan, it is creating new money that is added to the economy’s overall money supply. In contrast, governments don’t create any money these days. The last time the US government issued money was in 1963, until President John F Kennedy’s assassination that year. The UK government stopped issuing money in 1927 and Germany even earlier, around 1910. Central banks, meanwhile, only create around 3% of the world’s money supply.”
“For growth to occur, more transactions need to take place this year than last. This can only happen if the supply of money available for these transactions increases – in other words, if retail banks issue more loans. If used correctly, it can be a powerful tool for increasing growth and productivity. This was the basis of my proposal to help Japan’s flatlining economy in the 1990s, which would later become widely known as “quantitative easing”, or QE.”
“However, QE’s subsequent depiction as a form of “magic money tree” is misplaced. In my 1997 paper and subsequent book, I stressed the difference between newly-created money when it is used for productive purposes – in other words, for business investment that creates new goods and services or increases productivity – and when it is used for unproductive purposes such as financial asset and real estate transactions. These merely transfer ownership from one party to another without adding to the nation’s income.”
“Unfortunately, in the UK and many other countries – especially those with only a few, very large retail banks – there has been a significant shift of bank credit away from lending for productive business investment to lending for asset purchases. As big banks want to do big deals, bank lending for asset purchases now accounts for the vast majority of lending (75% or more, according to my analysis of Bank of England data).”
“In contrast, just before the first world war, when there were many more small banks in the UK, more than 80% of bank lending was for productive business investment. This decline in bank lending for business investment has had many consequences, including falling economic growth and lower productivity in the UK. Nonetheless, over the two decades since, QE has become a monetary policy beloved of central banks across the world as they have sought to keep their economies looking strong in the face of serious economic challenges.”
“In May 2020, as I conducted my latest monthly analysis of the quantity of credit creation across 40 countries, I was startled to find that something extraordinary had been happening since March that year. The major central banks across the globe were boosting the money supply dramatically through a coordinated programme of QE.”
“Apparently agreeing with my critique that pure fiscal policy does not result in economic growth unless it is backed by credit creation, Blackrock had argued at Jackson Hole that the “next downturn” would require central banks to create new money and find ‘ways to get central bank money directly in the hands of public and private sector spenders’ – what they called ‘going direct,’ bypassing the retail banks. The Fed knew this would create inflation, as Blackrock later confirmed in a paper which stated that ‘the Fed is now committing to push inflation above target for some time.’”
“Many banking and economic experts thought the Fed’s and other central banks’ similarly aggressive credit creation policy in 2020 would not be inflationary, again. However, this time the economic conditions were very different – there had been no recent slump in the supply of money via retail bank loans. Also, the policy differed in a crucial aspect: by ‘going direct’ the Fed was itself now massively expanding credit creation, the money supply and new spending.”
“Meanwhile the COVID measures imposed by governments also focused on bank credit creation. In parallel with unprecedented societal and business lockdowns, retail banks were instructed to increase lending to businesses with governments guaranteeing these loans. Stimulus checks were paid out to furloughed workers, and both central banks and retail banks also stepped up purchases of government bonds. So both central and commercial banks added to the supply of money, with much of it being used for general consumption rather than productive purposes (loans to businesses).”
“As a result, the money supply ballooned by record amounts. The US’s “broad” money supply metric, M3, increased by 19.1% in 2020, the highest annual rise on record. In the eurozone, money supply M1 grew by 15.6% in December 2020. It was a perfect recipe for inflation – and significant consumer price inflation duly followed around 18 months later, in late 2021 and 2022. While it was certainly exacerbated by the COVID restrictions, it had nothing to do with Russian military actions or sanctions on Russian energy – and a lot to do with the central banks’ misuse of QE.”