Showing posts with label credit bubbles. Show all posts
Showing posts with label credit bubbles. Show all posts

Thursday 10 December 2020

The health of the credit system is crucial

Periods of healthy credit growth bear no psychological resemblance to the extreme exuberance of manias or the extreme caution or fear of debts (debtophobia).


The health of the credit system in 2008

When the global financial crisis hit in 2008, countries like the United States were vulnerable because they had been running up debt too fast.

In Southeast Asia, however, the opposite story was unfolding.  Indonesia, Thailand, Malaysia and the Philippines had manageable debt burdens and strong banks ready to lend, with total loans less than 89% of deposits.

Over the next 5 years, post 2008, the health of the credit system would prove crucial:

  • nations such as Spain and Greece, which had seen the sharpest increase in debt before 2008, would post the slowest growth after the crisis;
  • nations such as the Philippines and Thailand, which had seen the smallest increase in debt during the boom, would fare the best.


How the credit cycle works in brief

Rising debt can be a sign of health growth, unless debt is growing much faster than the economy for too long.

The size of the debt matters, but the pace of increase is the most important sign of change for the better or the worse.

The first signs of trouble often appear in the private sector, where credit manias tend to originate.

The psychology of a debt binge encourages lending mistakes and borrowing excesses that will retard growth and possibly lead to a financial crisis.

The crisis can inspire a healthy new caution, or a paralyzing fear of debt (debtophobia).

Either way, the period of retrenchment usually lasts only a few years (usually 4 to 5 years). #  

The country emerges with lower debts, bankers ready to lend, and an economy poised to grow rapidly.



Additional notes:

# On average, credit and economic growth remained weak for about four to five years.

In Asia, credit fell in the five years after 1997 by at least 40 percentage points as a share of the GDP in Indonesia, Thailand and Malaysia.  But within about four years, the gloom had started to lift as debts fell, government deficits declined, and global prices for the region's commodity exports rose.  Credit growth picked up, and the average GDP growth rate in these three Southeast Asian economies rose from around 4% between 1999 and 2002 to nearly 6% between 2003 and 2006.

The 4 basic signs of a stock bubble

 There are four basic signs of a stock bubble:

1.  high levels of borrowing for stock purchases;

2.  prices rising at a pace that can't be justified by the underlying rate of economic growth;

3.  overtrading by retail investors; and

4.  exorbitant valuation.


In 2015, the Shanghai market had reached the extreme end of all four bubble metrics which is rare.  

The amount that Chinese investors borrowed to buy stock had set a world record, equal to 9% of the total value of tradable stocks.

Stock prices were up 70% in just 6 months, despite slowing growth in the economy.

On some days, more stock was changing hands in China than in all other stock markets combined.


In April 2015, the state-run People's Daily crowed that the good times were "just beginning."

In June 2015 the Shanghai market started to crash, and it continued to crash despite government orders to investors not to sell.




Friday 19 October 2018

Definition of a Stock Bubble

Definition of a stock bubble


A bubble occurs in a stock when:

1.  Implausible assumptions are applied to justify its present price using normal valuation (e.g.  DCF) models.

2.  There are people buying at these prices ignoring these implausible assumptions.


Based on this defintition, Tesla is a bubble while Apple and Microsoft are not at current prices.  

Tuesday 14 February 2012

Australia is caught in a credit crunch and the banks just made it worse, not better.

Banks' rate moves reveal system cracks

David Llewellyn-Smith
February 13, 2012

The media reaction to the banks' Friday rate hikes has been dominated by a schoolyard binary construction of the problem: the banks versus the government.
Some have taken the side of the government, that the banks are a greedy bunch of so and sos. Most have taken the side of the banks, that the government has no right to interfere in private business decisions.
Laudable sentiments if the banks are private. Which they are not. But let that pass.
This columnist has already written that what's really at stake here is the political economy of banking and the government's failure to openly address that fact is now coming back to haunt it.
Instead this column will argue a much simpler point: Australia is caught in a credit crunch and the banks just made it worse, not better.
How so? To understand you have to have a handle on the basic tenets of banking. Like all businesses, banks have a balance sheet. There are two halves to the balance sheet: assets and liabilities.
For banks it's a little confusing because outgoing loans - for houses, cars etc. - are in fact assets. They are the stuff from which banks draw an income.
The bank's liabilities are also loans, but those taken from others, like deposits or bonds. The difference between these two is the bank's equity or capital base.
The ratio between the amount of capital and total assets is called the leverage. It's the number of times against which the bank's capital has been multiplied in its outgoing lending book.
That's it, not so hard.
Trouble triggers
There are two ways in which a bank can find itself in trouble. The first and most common is when its assets - the loans it has given to its clients - deteriorate in quality.
This problem happens when the folks who borrowed the money struggle to repay it. They might have lost their job, or the asset they offered as collateral against the loan - say, a house - may have lost value and their own balance sheet is under pressure.
If they sell, they can't repay the whole loan amount. You can see how this process can feed upon itself as distressed sales leads to more falling prices.
At a certain stage the banks themselves get into trouble as enough assets are impaired and their capital begins to decline. They must then restrict lending and the problem gets worse again. This is called a credit crunch.
This is what happened in the US. Australia is also in the early stages of such a process with falling house prices, rising unemployment and rising impaired loans at the banks. It's difficult to judge how far into this we are and whether it can be reversed.
The jobs generated by the mining boom offer the hope that it is possible to arrest the decline and instead of a credit crunch we get a stall in housing and a redistribution of capital elsewhere.
The primary protection against the process getting out of control is monetary policy, or interest rates, which can be lowered to alleviate the borrower stress at the heart of the problem.
Nervous creditors
The second way in which a bank can find itself in trouble is on the other side of the balance sheet: the liabilities. This happens when the people lending money to the bank - depositors or investors - get nervous and want a higher interest rate to give the bank their money.
In the past this was not much of a problem for Australian banks as they relied upon steady deposits. However, after the new millennium began, the banks went a bit nuts borrowing less stable money from investors here and abroad and loaned that money largely to punters betting on houses.
Now, through a combination of the troubles in Europe, the fact that the process of deteriorating assets is under way, and through their own incompetence in the mishandling of covered bonds, investors want much higher interest rates to lend our banks money.
So yes, they need to raise interest rates to extract more money from the other side of the balance sheet to compensate. If they don't then they'll not be able to lend money on unprofitable loans and the credit crunch still transpires as the banks limit the supply of credit.
In short, whichever way the banks turn right now, whether they pass on their borrowing costs to mortgagors and put downward pressure on their assets, or they absorb the higher funding costs and stop making unprofitable loans, we edge further into a credit crunch. And indeed, as you can see, the two halves of the balance sheet aren't at all separate.
Credit crunch
As risk builds in one then it has a deleterious effect on the other and so another feedback loop threatens. This is systemic stress and is exactly where we are now, whether you want to blame the government or the banks (or, in this writer's case, the politico-housing complex).
So, the only question that matters right now is this: can the RBA arrest this developing feedback loop by cutting interest rates?
To my mind it is now clear that the central bank, which handled its actions flawlessly last year, erred dramatically last week in staying on hold.
By pushing the banks to hike unilaterally, the first time in history, the banks have shaken the foundation of the one commonly (and sensibly enough) held truth in Australian asset markets, that when asset prices decline, unemployment or other economic adversity threatens, the RBA will save us by cutting interest rates.
The insurance is still there but a nasty crack now runs through its base and this commentator can only see this making asset markets worse.
We're into a credit crunch all right.
David Llewellyn-Smith is the editor of MacroBusiness and co-author of the Great Crash of 2008 with Ross Garnaut. This is an edited version of a longer article available free at MacroBusiness.


Read more: http://www.smh.com.au/business/banks-rate-moves-reveal-system-cracks-20120213-1t0ce.html#ixzz1mIsQMilO





All the Big Banks lift Rates


Eric Johnston
February 13, 2012 - 5:46PM

ANZ won't rule out more job cuts

Despite slashing 1000 jobs and raising mortgage rates to protect profit margins, ANZ Australia CEO Philip Chronican says there could be more pain.
The Commonwealth Bank and National Australia Bank have become the latest banks to raise their variable lending rates outside the Reserve Bank's regular monthly cycle.
National Australia Bank this evening said it would lift its standard variable home loan interest rate by 9 basis points to 7.31 per cent.
Earlier, the Commonwealth Bank, Australia's biggest mortgage bank, announced that its standard variable mortgage rate will rise 10 basis points to 7.41 per cent from February 20.
CBA AFR 090827 MELB PIC BY JESSICA SHAPIRO...GENERIC commonwealth bank, banker, interest rates, big four, four pillars, pedestrians, customers.AFR FIRST USE ONLY PLEASE!!! DIGICAM 112727
Commonwealth Bank and regional lender Bendigo and Adelaide Bank become the latest banks to break ranks with the RBA. Photo: Jessica Shapiro
The moves round out the out-of-cycle rate rises among the big four banks.
Also today, Bendigo and Adelaide Bank increased its standard variable mortgage rate 15 basis points to 7.45 per cent.
Westpac and the ANZ defied Treasurer Wayne Swan and lifted variable rates 0.10 and 0.06 percentage points respectively, on Friday, despite a decision by the Reserve Bank to hold its cash rate steady. The ANZ bank today announced it would cut 1000 jobs by September 30 to cope with weaker demand for banking services.
Rising costs
As with other banks, CBA blamed today's rate increase on rising funding costs, adding that greater uncertainty emanating from Europe was exacerbating the situation.
“In making this decision, we have been cognisant of our total funding costs, of which the official cash rate is only one factor,’’ said CBA group executive of retail banking Ross McEwan.
‘‘The Commonwealth Bank believes Australian banks should continue to price sensibly, taking into account factors both on and offshore, rather than experience similar problems to those that many banks overseas have experienced,’’ Mr McEwan said.
"Whilst we understand that any increase in interest rates is not favourable to borrowers, our millions of deposit customers are favoured and since the commencement of the GFC we have seen significant competition in retail deposits pricing," he said.
CBA said it would raise the interest rate on its six-month term deposit account by 20 basis points, also effective February 20.
National Australia Bank, the last of the four big banks to announce its interest rate stance, said it is reviewing its rates.
Commonwealth Bank shares rose 41 cents, or 0.8 per cent, to $50.29, slightly less than the overall market's gain. Bendigo and Adelaide Bank shares rose 6 cents, or 0.7 per cent, to $8.19.
Bendigo move
Bendigo, like ANZ, has also said it would review interest rates independently of the Reserve Bank. Westpac's new variable mortgage rate is 7.46 per cent and ANZ's is 7.36 per cent.
Bendigo managing director Mike Hirst said current banking margins are not sustainable and adjustments to interest rates must be made.
“This is not a popular move, we know that, but it is the right thing to do to restore a proper balance between depositors, borrowers, the Bank’s shareholders and our community partners. At current funding cost levels that balance is out,” he said.
At current pricing levels banks were “subsidising mortgages,” Mr Hirst said.
“If you look at the traditional role of a bank this makes no sense and is unsustainable,” he added.
Mr Hirst said banks had a fundamental choice to make: adjust the pricing on loans or restrict lending. He added the latter option would have significant implications for the economy and would not be the right thing to do at this point in time.
He also said many staff at Bendigo have taken unpaid leave to help reduce costs, while no new back office staff are being hired.
Bendigo’s new mortgage rate will apply from February 21.
ejohnston@theage.com.au, with Chris Zappone


Read more: http://www.smh.com.au/business/all-the-big-banks-lift-rates-20120213-1t1ae.html#ixzz1mIuF0oCu

Thursday 26 November 2009

One possible cause of bubbles is excessive monetary liquidity in the financial system

Liquidity

One possible cause of bubbles is excessive monetary liquidity in the financial system, inducing lax or inappropriate lending standards by the banks, which asset markets are then caused to be vulnerable to volatile hyperinflation caused by short-term, leveraged speculation. For example, Axel A. Weber, the president of the Deutsche Bundesbank, has argued that "The past has shown that an overly generous provision of liquidity in global financial markets in connection with a very low level of interest rates promotes the formation of asset-price bubbles."  According to the explanation, excessive monetary liquidity (easy credit, large disposable incomes) potentially occurs while fractional reserve banks are implementing expansionary monetary policy (i.e. lowering of interest rates and flushing the financial system with money supply). When interest rates are going down, investors tend to avoid putting their capital into savings accounts. Instead, investors tend to leverage their capital by borrowing from banks and invest the leveraged capital in financial assets such as equities and real estate.

Simply put, economic bubbles often occur when too much money is chasing too few assets, causing both good assets and bad assets to appreciate excessively beyond their fundamentals to an unsustainable level. Once the bubble bursts the central bank will be forced to reverse its monetary accommodation policy and soak up the liquidity in the financial system or risk a collapse of its currency. The removal of monetary accommodation policy is commonly known as a contractionary monetary policy. When the central bank raises interest rates, investors tend to become risk averse and thus avoid leveraged capital because the costs of borrowing may become too expensive.

Advocates of this perspective refer to (such) bubbles as "credit bubbles," and look at such measures of financial leverage as debt to GDP ratios to identify bubbles.

http://en.wikipedia.org/wiki/Economic_bubble