The sky isn’t falling…
US share prices are stable and the housing scare possibly overdone
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.