Juggling Dynamite

In explaining why highly levered, speculative cycles are so damaging to balance sheets and financial stability, I often reference the reality that when asset bubbles burst, prices drop and debt level rise, evaporating net worth rapidly and intensifying selling pressure.

The graphic below captures the point within the context of housing.  Of course, the same applies to leveraged participants in security markets when prices tumble and margin and other debt borrowed to buy them does not.  Margin calls and demand loan payments then force the borrower to add more cash or sell falling assets to raise it,  accelerating the downward pressure on prices.

ABC Australia reports on the defaults mounting as home prices in many parts of the country are continuing to fall in 2019, even while unemployment rates remain historically low.  See Mortgage delinquencies mount as more borrowers find their home is worth less than their mortgage.

Chinese stimulus spending and commodity stockpiling, along with incoming Asian money looking for land banks, helped drive a debt-fueled rebound in the economy and property markets into 2011-12 (Canada too). However, renewed commodity weakness in 2016, prompted the Australian central bank (RBA) to cut its bank lending rate to 1.5% from 1.75% where it has languished since.  Today, the RBA cut its rate to a new historic low at 1.25% to try and increase record indebtedness further and put a bid under falling property prices.  Australian households are already the world debt champions with 200% debt to disposable income.

As shown in the chart below, even with low mortgage rates, home prices have continued to slide in several major areas since 2017.  Sydney and Perth markets are down about 20% from their peak, and further weakness is expected through 2019, as mortgage delinquencies rise.

Price declines are already greater than those experienced in Australia during the 2008 financial crisis.   This is causing optimists to predict that a price rebound is due next year.   Historically, that would be a very short, shallow correction given the extremity of the overshoot in the last decade.

As explained in New Study of old real estate bubbles (1582-1810) finds two surprising similarities with modern bubbles, the correction phase after a housing bubble, commonly lasts many years.  Researchers offer the chart below showing 200 years of Amsterdam home prices, incomes and rent.  Note that price spikes (in blue) which wildly disconnected from wages (in green)–came back down for years to restore affordability.  At the same time, income yields (dotted line) leapt for investors who bought low from the owners and lenders liquidating at fire-sale prices.

There are always slightly different factors driving property boom and bust cycles, but price behavior has remained remarkably consistent in the aftermath.  It is doubtful that this time will be different.

Building Wealth in a Challenging World – Debt Free In 30 _ A Personal Finance Podcast – Ep. 248. The rate at which Canadians are saving has dipped to the lowest in more than 10 years. A lack of money saved means more Canadians are relying on debt for events like retirement or an emergency expense. In today’s challenging economy, how can someone build a better financial cushion? Our podcast guest, portfolio manager and finance author, Danielle Park, explains that to keep up, one needs to have more balance between income and investments. Here is a direct video link.

I just finished Michael Lewis’s latest book, The Fifth Risk: Undoing Democracy.

Lewis examines key US government departments like Agriculture, Commerce (which should be called the ministry of data on things like weather and food production), and Energy. He describes the many vital duties these departments are responsible for, and what happened when the Trump administration took over.  Full of his famous character studies,  this material becomes a page-turner.  It also sheds light on the strategy of many in positions of power to not delve in and understand the issues in detail so that they can skirt responsibility and cling to preconceived narratives.  Some insight for those of us trying to comprehend what we are witnessing in many government and big business leaders today.  Here’s a taste:

“Willful ignorance plays a role in these looming disasters. If your ambition is to maximize short-term gains without regard to the long-term cost, you are better off not knowing those costs. If you want to preserve your personal immunity to the hard problems, it’s better never to really understand those problems. There is upside to ignorance, and downside to knowledge. Knowledge makes life messier. It makes it a bit more difficult for a person who wishes to shrink the world to a worldview.”