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"Trust me", says the Fed
I wish to trust Richard Fisher, the Dallas Fed President, because he is a well-known inflation hawk. But I am not convinced the Fed knows when is the exact right time to rein in the massive liquidity (we know monetary policy works with more than 12 months lag), and whether they could be able to do it given the almost certain prospect of double digit unemployment rate, and the political pressure they are about to face.
Watch this interview of Richard Fisher on inflation and the Fed.
College towns are recession proof: the Euro version
College towns are relatively recession-proof in the United States. This recent Deutsche Bank research says this is true also in Europe:
The recession is also affecting the European real estate sector. True, many German housing markets are regarded as relatively stable. However, differentiation is called for, since regional differences, as in other countries, are considerable in Germany as well. Two simple criteria are good indications of price dynamics of housing investments: for one thing, the share of students in a city, and for another, the share of the manufacturing sector.
The economic crisis has unsettled many investors. Currently, they are looking less for risky products with high yield potential but rather for low-risk investments with a stable return. This is precisely why many people are turning to residential property: they are interested either in owner-occupied housing or in buying rented property. Is this a sound assumption? Although no housing bubble for residential markets has occurred in Germany yet, the low financing rates currently also make residential property an interesting investment. Thus, an investment in German residential property currently offers potential.
It should be kept in mind, however, that investments in residential property per se are not risk-free. In particular, investors should always be aware of the location risk of housing investments. But what makes a good location in housing? No doubt, good utility connections and the proximity to infrastructure systems are among the key criteria. In particular, such micro factors require a case-by-case examination of properties, i.e. very good market knowledge, though. Before starting the selection, the quality of a region, that is its macroeconomic factors, should be checked. What are the prospects for the economic structure? How good is the location with regard to transport links? For these factors have a decisive influence on the future demographic and income situation and thus the development of house prices.
In a thorough location analysis, forecasts have to be made of a very large number of macro factors. This is a very demanding task, especially as various factors have reciprocal effects, and some variables can change quickly, e.g. the registered office of a major company. Thus, factors subject to only minor fluctuations are particularly useful indicators for risk-averse real-estate investors. This can be illustrated by two selected factors: the share of students and the share of employees in the manufacturing sector. To show the influence of these two factors, the average price development of new owner-occupied housing units in over 100 German cities over the last ten years has been analysed.
This shows the 20 cities which post the best gains do not only include the usual suspects like Munich and Hamburg but also smaller cities such as Marburg, Heidelberg, Trier, Wuerzburg and Muenster. These five cities are marked by a very high share of students in the residential population. The value development in typical university towns was more favourable all in all than in towns without a sizeable share of college students. In the last ten years, the average value increase of new condominium apartments in university cities, i.e. towns with a share of college students of at least 15% in the population, rose by roughly 0.75 percentage points more than the increase in house prices in towns with very few students or no students, respectively – annualised, that is. This applies to both east and west Germany. At first glance it may come as a surprise that the value of residential property – and even more so, condominiums – in university towns has increased disproportionately well, for the disposable incomes of college students are of course by no means above average. The correlation is plausible, though: first, universities serve as large employers, and many jobs in university towns are not influenced by the economic cycle. Second, many college students stay in their college town after graduation as they still find their university town so attractive. The incomes of these graduates usually exceed that of people without a college degree. University towns therefore – also in times of crisis – are a safe haven for housing investments.
Risk-conscious investors should currently act cautiously with regard to typical industry locations. Average house prices in highly industrialized towns (with a share of employees in manufacturing of over 30%) were about 0.50 percentage point per year below price levels in towns with very small industrial bases. Even though the number of manufacturing employees increased strongly in the latest upswing, the gap reflects Germany’s continuing structural change towards a service society, especially wage moderation in many segments of manufacturing. As in the current recession manufacturing is severely battered by the decline in exports, it is plausible that towns with a strong industrial base in this crisis will be hit even harder than in the last ten years. Thus, investors considering towns such as Ludwigshafen, Schweinfurt, Ingolstadt and Salzgitter as locations for an investment will probably have to pay a higher risk premium at present.
Investors should be aware of the fact that these two correlations are stable and statistically verified. It should be kept in mind, however, that these are only two individual criteria. Not every university town can guarantee value, and the risks among industrial towns do vary. In particular, the microeconomic factors mentioned above always play a major role. What is more, attention must also be paid to the change in value retention and the yield. For example, Wolfsburg and Ludwigshafen are the beneficiaries of a relatively favourable multiplier while the ratios for Freiburg and Bamberg are rather unfavourable.
Milton Friedman: Don’t rely on the ‘right man’
Who said Friedman’s ideas were out of date? Watch this video you will know exactly why his ideas are as refreshing as it was 30-40 years ago.
One lesson to take away: don’t rely too much on the Fed’s exit strategy and its promise to get inflation under control. Smart investors should protect themselves ahead of the curve. There is probably 80% chance that inflation will NOT get out of control if the right man, Ben Bernanke, acts wisely; but if the 20% chance prevails, you want to make sure you have inflation-hedge in your portfolio.
(video haptip: TMGM)
No need to say Friedman’s idea also has important implications to different political systems we are living in. Think China vs. the US —with the former relying too much on the ‘right man’ to make the right decisions.
How serious is America’s budget deficit?
Charlie Rose —A conversation about the growing fiscal deficit with Alan Blinder, Professor of Economics at Princeton University and Director of Princeton’s Center for Economic Policy Studies, David Leonhardt of “The New York Times” and Alan J. Auerbach, Professor of Economics and Law, Director of the Burch Center for Tax Policy and Public Finance, University of California, Berkeley.
A fun talk on whether Americans should start saving
Peter Schiff on Daily Show:
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Update: Has housing reached the bottom?
The short answer is NO. Here is another interview of Susan Watcher of Wharton Business School following my previous post on predicting the housing bottom. (source: Bloomberg)
Larry Summers on the current state of the economy
Larry Summers speaks to the Council of Foreign Relations. He explains government’s intervention was out of ‘necessity’ not ‘choices’.
Can banks grow without removing toxic assets?
David Wessel discusses whether banks can lend and grow without removing toxic asset on their books. (Source: WSJ)
Eight months ago, in the worst moments of the Great Panic of ’08, then-Treasury Secretary Henry Paulson persuaded Congress to provide $700 billion for what he said was the crucial task of buying lousy real-estate loans and securities, the “toxic assets,” from the nation’s banks.
Four months ago, Treasury Secretary Timothy Geithner proposed to leverage some of that money with private money to buy as much as $1 trillion in what he delicately dubbed “legacy assets” from the banks to repair their balance sheets and get them lending again.
The government has yet to buy any of these assets. Instead, it bought about $200 billion worth of shares in the banks, and this week it allowed 10 big banks to repay $68.3 billion of that taxpayer money. The key: Big banks have raised about $65 billion in private capital in the past several weeks, an accomplishment that seemed unimaginable just a few months ago.
So is it no longer necessary for the government to get toxic assets off banks’ books to get credit flowing again? Is bolstering banks’ capital a substitute for ridding them of smelly loans and securities?
We’re about to find out. Until this historic episode, the internationally accepted recipe for fixing a banking crisis had three ingredients: take bad assets off bank books, temporarily guarantee their debts and deposits, recapitalize the banks. The notion was that removing toxic assets usually was necessary before a bank could attract new capital or a buyer and get on with the business of making loans.
Banks need capital to absorb losses when borrowers don’t repay their loans. If a bank’s capital cushion is large enough, it can absorb all the losses it faces and remain solvent. (Say a bank is carrying a loan at 80 cents on the dollar, but it’s really worth 50 cents. Investors don’t want to lend that bank money or, if they do, they charge a lot. That makes it hard for the bank to lend readily. With a fat enough capital cushion, the bank’s solvency is assured even if it has to mark the loan down to 50 cents.)
The very stressful stress tests conducted by the regulators were intended to calibrate how much capital the big banks needed in a terrible, though not worst-case, economy. Arithmetically, if banks raise enough capital, then there’s no need for the government to buy the toxic assets. And we all live happily ever after.
Perhaps. But ridding toxic assets accomplishes two other things. First, it removes any doubt about looming undisclosed losses. As long as toxic assets remain on bank books, there’s uncertainty about whether they’ve been marked down enough to reflect reality. If they’re gone, it doesn’t matter.
Second, it removes a huge distraction for management, which may be prerequisite to focusing on making new loans, the objective of all these efforts.
Michael Bleier, a banking lawyer at Reed Smith in Pittsburgh who spent 14 years as general counsel at Mellon Bank, says this is a big deal. In 1988, Mellon created a “bad bank” to hold and sell $1.4 billion worth of bad real-estate and energy loans that were then worth 47 cents on the dollar. “One of the key reasons we did this was that management’s time and attention was being taken up with questions like: What are you going to do with this stuff?” Mr. Bleier said. “By not getting rid of the assets, management attention is somewhat diverted.”
The bad bank was a success at its sole mission: It sold the assets and closed its doors in 1995. And the good bank, Mellon, was healthy enough to be making acquisitions in late 1989 (and was later acquired by Bank of New York.)
Mr. Geithner’s Public Private Investment Program to buy toxic loans is going nowhere; the PPIP to buy securities may yet materialize. If markets and banks deem all this no longer necessary because the financial system has pulled back from the abyss and banks have raised more capital than expected, that’s good.
That’s not the only possible explanation. Bankers always will be reluctant to sell if they have to mark down loans; they’d rather wait and hope for better times. But the Treasury offered investors a sweet deal here — and found few takers amid much anxiety about whether participating would subject investors to congressional scrutiny and limits on executive pay. If the lack of appetite for these deals instead reflects Wall Street worries about the political risk of doing business with the U.S. government, that’s not so good.
At a Senate hearing this week, Mr. Geithner said lack of interest in toxic-asset sales reflects elements of both explanations. And he isn’t ready to abandon the effort. If the economy takes a bad turn, or attitudes toward banks change — particularly toward banks that weren’t deemed healthy enough to give back taxpayer capital — a mechanism for removing toxic assets may yet prove essential to reaching a happy ending.