The sky isn’t fall­ing…

US share prices are stable and the hous­ing scare pos­si­bly over­done

Finweek English Edition - - Economic trends & analysis - BY HOWARD PREECE howardp@fin­week.co.za

JOHN BERRY HAS IT RIGHT. The Bloomberg colum­nist likens many cur­rent eco­nomic com­men­ta­tors to Chicken Lit­tle. That car­toon char­ac­ter reg­u­larly had a burst of hys­te­ria and rushed here and there scream­ing: “The sky is fall­ing! The sky is fall­ing!” All that ac­tu­ally hap­pened was that an acorn had fallen on Lit­tle’s head. The sim­ple gift of an um­brella, to pre­vent any re­cur­rence, brought an end to that par­tic­u­lar non­sense.

But so many con­tem­po­rary al­leged fi­nan­cial and eco­nomic an­a­lysts clearly need a lot more than a para­sol to keep their per­spec­tive. It seem­ingly needs no more than any mod­er­ate eco­nomic up­set – above all, in the United States – to pro­voke a great burst of cluck­ing. “The sky is fall­ing! The sky is fall­ing!”

Two par­tic­u­lar de­vel­op­ments have trig­gered yet an­other squawk­ing ren­di­tion of that cry:

Share prices in the US and ma­jor mar­kets gen­er­ally lurched south this month. On 27 Fe­bru­ary the Dow Jones share in­dex fell 416 points. A host of dun­der­heads, not least in sup­pos­edly rep­utable publi­ca­tions and fi­nan­cial in­sti­tu­tions, at once started talk­ing “melt­down”. That was ab­surd, as the ac­com­pa­ny­ing graph shows. Fur­ther, as Robert Sa­muel­son, eco­nomic colum­nist at The Wash­ing­ton Post and for Newsweek, notes, price:earn­ings ra­tios on Wall Street’s S&P share in­dex are now around 16 to 17 – very much the av­er­age range of the past 60 years, less than the av­er­age be­tween 1987 and 2006 (22) and way be­low the 2001 peak (47). There’s also great con­cern (not matched by sim­i­lar knowl­edge) with re­gard to the “cri­sis” from “sub-prime” house mort­gages in the US. Those loans are cru­cially aimed at peo­ple with low in­comes and min­i­mal sav­ings as­sets who want to get into the home­own­er­ship game. As prop­erty prices went up and up in the US, peo­ple in­creas­ingly wanted to be­come part of that “easy ride to riches”. That, of course, boosted prices even more.

How­ever, for decades there was a big tra­di­tional pru­den­tial ob­sta­cle – mort­gage ap­pli­cants had to prove they had suf­fi­cient cap­i­tal and a salary base to af­ford the loan com­mit- ment. How­ever, there had long been an­gry com­plaints that that “dis­crim­i­nated” against, es­pe­cially, the rel­a­tively poor, par­tic­u­larly black peo­ple. So there was a wide wel­come for the up­surge in “no ques­tions asked” mort­gage fi­nance. Sound familiar in SA? It cer­tainly does to SA Re­serve Bank Gov­er­nor Tito Mboweni. He’s re­peat­edly warned South Africans – and newly em­pow­ered blacks in par­tic­u­lar – against the dan­gers of tak­ing on ex­ces­sive credit and then “some­thing hap­pens, the 4X4 has gone, the lux­ury house has gone and it’s back to the town­ships”.

But the wider truth is that what’s oc­curred in hous­ing in the US is the story of al­most ev­ery long-run­ning, over­done bull run. Some peo­ple al­ways get hurt – and most usu­ally they in­clude a high pro­por­tion of as­set buy­ers who came last and who shouldn’t re­ally have got in­volved at all. That’s mag­ni­fied by the way sub-prime deals work. In­ter­est rates are well above par, to com­pen­sate for greater risk. But to get the pun­ters play­ing, they’re of­fered spe­cial low rates for, say, the first two years of the loan. The lenders – just as dumb as the bor­row­ers, even if they num­ber such in­sti­tu­tional bank­ing heavy­weights as HSBC and Morgan Stan­ley – thought it ex­cel­lent busi­ness. That would pro­mote turnover, earn fat rates – and have the “pro­tec­tion” of the prop­erty as­sets to cover de­fault­ers. It’s that kind of sce­nario that the In­ter­na­tional Mone­tary Fund strongly warned SA against in 2000. The IMF said that ideas fer­ment­ing in the ANC to com­pel banks to lend money to the “dis­ad­van­taged” could, if ap­pre­cia­bly acted on, pose a se­ri­ous risk to the health of an ex­cep­tion­ally sound bank­ing sys­tem. Hap­pily, Mboweni and Fi­nance Min­is­ter Trevor Manuel have en­sured that the IMF’s cau­tions have largely been heeded.

In the US, though, the sub-prime story has borne out Polo­nius: “Nei­ther a bor­rower nor a lender be.” Ris­ing US in­ter­est rates over­all, the pro­gres­sive fall­ing away of the cheap money “teaser” pe­riod and the end of the home price boom will end in in­evitable tears – much as Mboweni fears the in­sa­tiable de­mand for con­sumer credit could yet do in SA. Sub-prime bor­row­ers are in­creas­ingly los­ing all; and so too are lenders who have as­sets worth less than the loans.

But will that bring the whole US hous­ing mar­ket crash­ing? It’s pos­si­ble, and the “sky is fall­ing” cho­rus is glee­fully claim­ing it def­i­nitely will. How­ever, more sober-minded ob­servers think the great scare has been over­done. For ex­am­ple, Cit­i­group econ­o­mist Steven Wi­etin says: “Mort­gage de­faults are more sig­nif­i­cant for af­fected in­sti­tu­tions than for the econ­omy. In all like­li­hood, credit prob­lems for low-net-worth con­sumers are not a sub­stan­tial is­sue for the over­all pace of con­sump­tion.

“The mod­est share of the pop­u­la­tion and the low share of na­tional in­come as­so­ci­ated with ad­justable rate sub-prime loans sug­gest lit­tle con­sumer de­mand im­pact.”

We shall see. Mean­while, the sky re­mains in­tact.

SO THIS IS MELT­DOWN?

Source: I-Net Bridge

HARDLY A RE­CES­SION

Source: US Bureau of Eco­nomic Anal­y­sis

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