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Stock markets around the world have bounced strongly this week, following the turmoil earlier this month.
In no small part, this was down to the Federal Reserve changing the wording on its latest interest rate statement on Wednesday. It left the key US interest rate exactly where it was, but indicated it was slightly more worried about growth, and a little less concerned about inflation.
Why do the markets think that’s good news? Because it means the chances of an interest rate cut have risen. Now given that inflation has a tendency to surprise on the upside at the moment, we’re not so sure that a rate cut will appear as quickly as the market hopes.
But in any case, it’s ironic that the prospect of easier lending criteria is getting the market excited. After all, it’s slack lending that got everyone into trouble in the first place…
While the Fed was getting the markets excited with the prospect of the ‘Bernanke put’ (the ‘Greenspan put’ refers to Ben Bernanke’s predecessor’s habit of always cutting interest rates every time the US economy was threatened with the tiniest bit of discomfort), a group of Senators was berating both the Fed and the lending industry over the sub-prime mortgage debacle.
The Washington Times reports that the Senate Banking Committee argued that the practice of doling out home loans to people who couldn’t afford them – particularly mortgages with an initial low rate, which then surges, rendering it seriously unaffordable – should not have been allowed to continue for so long.
Senators from both sides of the political divide feigned outrage and disbelief at the lack of responsibility on the behalf of lenders. ‘It just seems to me that you were asleep at the switch,’ said Senator Robert Menendez.
The lenders tried to defend themselves. Sandor Samuels of Countrywide warned that stricter standards would have meant that about half of the subprime loans made during the housing boom would not have been made.
‘An appropriate balance must be struck between maintaining affordability and lessening payment shock. Wherever you draw the line, someone will be shut out of the market.’ And that of course, could ‘materially reduce housing demand’, which as everyone, including the Senators, knew, has been the main thing keeping the US economy afloat for the past few years.
But last time we looked, that’s the point of having credit standards – to stop people who can’t or won’t pay from getting access to loans. That of course means that affordability puts a natural ceiling on just how far prices can rise – but then, prices can’t go up forever, not even property prices.
Meanwhile, it wasn’t just the lenders coming in for flack – Senators criticised both the Fed and the state regulators for not being stricter with the lenders. Joseph Smith, North Carolina’s commissioner of banks, tried to cover his back by arguing that they simply couldn’t believe just how irresponsible lenders and investors had been.
“What has been stunning to me is: Where is the market discipline? We did naively assume that up the line, lenders and securitisers were doing due diligence.”
It’s the naivety of all these high-ranking officials that we find stunning – we have to hope that it’s a straightforward backside-covering exercise, because to believe that they are genuinely this bad at grasping how markets work, is just frightening.
You want to know what happened to the due diligence, Joe? This is roughly how it went. The hedge funds said “Wow, look at the size of the yield we can get from investing in mortgage-backed securities (MBSs)- we want more! The riskier the better – after all, we’re hedge funds, we know what we’re doing!’
The securitisers – the investment banks who parcel the loans up into MBSs in the first place – said “Wow, look at all the money we can make by selling MBSs to hedge funds – we want more loans to parcel up! Who wants credit? After all, we’re selling these things in packs of 100 at a time – they can’t ALL go bad!”
The sub-prime lenders – who were extended lines of credit by the securitisers in order to offer mortgages – said “Wow! Look at all the money we can make by selling these loans to securitisers – they’ll buy anything! Who wants a house? ”
And at the end of the chain, Mr Sub-prime, who thought his lack of income, assets or sound credit history would forever disqualify him from getting on board the housing gravy train, found himself being offered a dirt-cheap housing loan, no questions asked. His due diligence, on which this Ponzi scheme relied, stretched as far as saying “Where do I sign?”
It’s called a credit bubble. And now the markets are getting all excited that Mr Bernanke is going to try the same trick yet again to prop up the US as the housing fall-out gets worse.
The trouble is, it won’t work this time. Because even if the Fed relaxes its lending criteria, the lenders are now in a position where they have to tighten up their lending standards, like it or not. The same thing happened in Japan – the main rate might have hit zero, but by then the banks were far too indebted and scared to lend money to the man in the street.
Japan’s only just now, warily and unsteadily, coming out of its near two-decade slump – we wonder how long it will take the US to recover from the current credit implosion.
Turning to the stock markets…
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In London, retailer Next led the FTSE 100 61 points higher to a close of 6,318 yesterday, although the index failed to regain an opening high of 6,342. Mining stocks including Antogasta and Lonmin rallied on the stronger gold price. For a full market report, see: London market close.
Across the Channel, the Paris CAC-40 closed at 5,598, a 96-point gain, and the DAX-30 ended the day 114 points higher, at 6,856.
On Wall Street, stocks closed mixed yesterday. The Dow Jones finished 13 points higher, at 12,463. However, a profit warning from Motorola weighed on the technology and telecoms shares, sending the Nasdaq down 4 points to a close of 2,451. The S&P 500 closed a fraction of a point lower at 1,434.
In Asia, the Nikkei closed 61 points firmer today, at 17,480.
Crude oil had fallen back slightly today following yesterday’s gains, and was trading at $61.56 a barrel this morning. In London, Brent spot was at $62.10.
Spot gold hit an intra-day high of $664.20 in Asia trading, but had fallen back to $661.65 this morning. Silver had slipped to $13.37/oz from $13.41 in New York late yesterday.
And in London this morning, BP‘s Russian arm, TNK-BP, announced plans to bid for bankrupt Yukos Oil’s 9.4% stake in state oil company Rosneft. In a statement, TNK-BP said that the move was intended to help ‘develop [their] strategic relationship’ with Rosneft. BP CEO John Browne and successor Anthony Hayward are set to meet with President Putin at the Kremlin today.
And our two recommended articles for today…
Invest in low-inflation gold
– As central banks around the world increase the supply of ready money, fuelling bubbles in assets such as property and fine art, the production of gold is slowing down. And the yellow metal’s relatively low rate of inflation is good news for gold investors. For more on why bubbles elsewhere are good for gold, click here: Invest in low-inflation gold
How subprime became today’s dot-com
– Subprime could – like internet stocks earlier in the decade – be the pin that pricks a much larger bubble, says Stephen Roach. To find out what form will the spillover from the US housing market to the wider economy is likely to take, read: How subprime became today’s dot-com