We thought we would kick off the week with some thoughts from the EconoMonitor community. Here is what’s on the minds of our esteemed group of EconoMonitor bloggers. We would love to hear your feedback and what’s on your mind.
Spain: It’s The Mortgage Book, Stupid!
-Edward Hugh (Don’t Shoot the Messenger)
I have spent the weekend worrying that I might be stupid. The application of more austerity in Spain without a serious attack on the competitiveness issue is simply going to weaken the economy, increase unemployment and send house prices down further. More problems in the Spanish bank mortgage book are thus inevitable, as a team of analysts at JPMorgan led by Roberto Henriques recently pointed out. Yet, Banco Santander CEO Alfredo Saenz simply responded by saying “Anyone raising this (the mortgage default) problem as one of the issues for the Spanish financial system is saying something stupid.”
Gee folks, that’s me he’s taking about. This is Spain’s metastasis moment, the point where what had been contained as a construction slump tied in with a set of bad developer loans, having suffered years of neglect as the patient refused to accept the diagnosis and pass through the operating theater, now spreads out and infects the whole bank loan book. If anyone has been doing something “stupid” here it is Spain’s leaders (aided and unwittingly abetted by the EU and the IMF) who have consistently refused to accept the magnitude and gravity of the problem that the arrival of the global financial crisis unleashed in Spain. Just make sure that you aren’t standing under the edifice when it falls.
Is Latvia the Austerity Exception?
-Ed Dolan (Ed Dolan’s Econ Blog)
What have I been reading this week? Undergraduate papers. They don’t usually contain research worth sharing with the world at large, but a bachelor’s thesis submitted by two of my star students at the Stockholm School of Economics in Riga is an exception. Using the latest data, it sheds new light on the issue of whether there is a Latvian exception to the general view that austerity-based “internal devaluations” are incapable of achieving real exchange rate realignment in fixed-rate countries like Europe’s so-called “PIIGS” and “BELLs.” The authors, Kaspar Daljajev and Emīls Kreislers, apply two standard methodologies, the Behavioral Equilibrium Exchange Rate (BEER) and Fundamental Equilibrium Exchange Rate (FEER) approaches. The FEER approach shows an estimated 3 to 5 percent undervaluation for the lats, and the BEER a small 1.1 percent overvaluation. Both measures show a strong recovery of competitiveness to an approximate medium-term equilibrium value of the real effective exchange rate since the start of the internal devaluation policy. I am not a big fan of austerity and internal devaluation, but the strategy does seem to be working a little better in Latvia than elsewhere. Of course, I don’t have to tell you that even with a properly aligned exchange rate, Latvia still faces some major problems—if you follow Ed Hugh, you already know that.
Why We Are Not on the Road to Recovery
-L. Randall Wray (Great Leap Forward)
The US has supposedly been in recovery since 2009, and in recent months even some naysayers have caught the sustainable recovery bug. I don’t believe it. And, apparently, neither does the Fed—which continues to worry about the US real estate markets. I thought I’d never utter the following: the Fed is right. Remarkably, the Fed has become just about the lone progressive voice in Washington—another claim I never expected to make, but a point made recently by both Bill Greider and Michael Greenberger. Yes, even a stopped clock gets it right twice daily—but in this case I think the Fed is looking at three important pieces of data. First, it has had ample time to assess the trashy mortgage assets that remain on the books of banks—and while the Fed has taken a lot off their balance sheets (and pushed much of the toxic waste onto the GSEs), it knows that we’ve still got a mountain of foreclosures coming. Second, the Fed has a growing awareness that households have plenty of other debts—about a trillion dollars each of credit card and student loans debts—that add to the burden, compounded by high energy prices and flat (at best) incomes while state and local governments ramp up taxes and fees to cover shortfalls. And if that were not enough, the global economy is slowing down. That poses two risks: US exports will face a difficult market environment while desperate foreign producers will cut costs to sell to America; and renewed financial crisis among big European banks could spread back to the US. As we know, it’s not over until the fat lady sings—and she hasn’t even made it to the stage yet.
U.S Housing and Mortgage Crisis: The Road Leads to a Cul-De-Sac
-Daniel Alpert (Daniel Alpert’s Two Cents)
Yes, the Euro-crisis is intractable and will resolve itself in a manner that is at or below the low range of expectations. Massive debt imbalances tend to do so. But beyond the boarder of the Eurozone lies another debt overhang that continues to threaten the world’s largest economy – the housing and mortgage crisis in the U.S.
As a flood of central bank liquidity in December and February enabled zonal banks to delay the inevitable for a few more months, so did the trillions of dollars in cash injected by the U.S. Fed into the reserves of the banking system, and the economy at large, (and let’s not forget TARP money) permit the can to be kicked down the road here. But the road—particularly in housing—is leading to a cul-de-sac. Someone eventually needs to hold the “sac”.
There is an ongoing debate as to whether price-to-rent ratios in housing are truly signaling a bottom to the U.S. housing market. Bob Shiller’s long term pricing trend line would indicate we’ve still got a ways to go. And the much more pessimistic supply and demand view that is based on (i) the overhang of both excess unutilized vacant homes (the lesser problem) and the shadow inventory of unresolved homes with defaulted or seriously delinquent mortgages (the far larger problem, let’s default to the numbers of Amherst Securities’ Laurie Goodman on the latter score) and (ii) the notion that much of so-called “affordability” in U.S. housing is merely obtained through catastrophically low interest rates.
The answer, I believe, lies in the impact of the following insight:
(a) The upward effect on prevailing rents of both (x) millions of units that are neither paying debt service nor are available for rental; and (y) a heavily constrained market for mortgage financing that is forcing a higher number of households into the rental market.
(b) The likely offset to part of the foregoing that will occur with any meaningful degree of macroeconomic recovery through the release of “pent up” household formation (multigenerational unbundling).
I would conclude that the reversal of the conditions (a)(i) above will have a more acute impact on prices than the offsetting factors in (b) or more open mortgage markets (which are years down the road, in any event); the reason being merely numbers. A major uptick in household formation would be counted in hundreds of thousands of more homes per year, while the overhang numbers in the many millions. Accordingly, I view prevailing rents as artificially elevated (N.B. consider the impact thereof on other data such as core CPI) and home prices as not having fully resolved themselves to trend (and one might also consider that if recent inflation is overstated by temporarily elevated rents, there would be knock-on effects as this ceases to be the case). The data to illustrate the above will soon follow.
Turkey: More Than Meets the Eye in the Latest Inflation Report
-Emre Deliveli (The Kapalı Çarşı: Emre Deliveli’s blog on the Turkish economy)
At first glance, there isn’t much new in the Central Bank of Turkey’s latest Inflation Report: The Bank is happy with the unconventional framework I summarized several times, most recently in last week’s Hürriyet Daily News column, because they argue it provides them with flexibility.
But that flexibility has come at a cost: According to data from the Istanbul Stock Exchange, trading volume in the bond market is at the lowest levels since 2009. A Bloomberg story a few weeks ago reported that a similar tale holds in the FX market as well.
It could also be that markets expect additional tightening and would like to stay on the sidelines until that materializes. With inflation in double-digit territory, the Bank has been emphasizing of late that its main priority is disinflation. It has chosen to keep the 6.5 percent year-end inflation forecast despite higher import prices, as it is planning to offset that with additional monetary tightening – which would mean more extraordinary days ahead, when markets won’t be funded at the one-week repo and the effective funding rate will go even higher.
But the inactivity in the bond markets and the heavy Treasury redemption schedule ahead could mean that the Bank does not have much room to go. Besides, the current account deficit and the government’s bias for high growth/low interest rates are further constraints on higher rates.
The Return of Investment Policy – The U.S. Is Back in the Game
-Efraim Chalamish (Efraim Chalamish’s Economic Development and Security Blog)
Recent developments in the U.S. foreign investment policy arena have been on my mind this past week and will continue to be an important part of the current administration’s economic policies in the coming days and weeks. As we all know, foreign investment policy hasn’t been the U.S. government’s main focus in recent years. Yet, as I explained in my recent piece on the Return of of Investment Policy,the administration’s conclusion of the review process of the model investment treaty will revive old negotiations and kickstart new ones. It has already triggered some political pressure to tie the ongoing strategic dialogue with China to foreign investment policy and to initiate new regulatory economic dialogue with Brazil. The new ‘resource nationalism’ cases are also on the minds of American CEOs and policy makers as they examine various strategies to protect their economic interests abroad.