Since the "LTCM crisis" of 1998 and the start of the meltdown of global stock markets in March 2000, central banks around the world geared up their money printing machines to postpone a systemic collapse. Within two years, starting in January 2001, Federal Reserve chairman Alan Greenspan pushed down short-term interest rates from 6.0% to 1.0%, with European central banks following. And while Fed governor Ben S. Bernanke repeatedly refers to the use of "helicopter money" as the next possible escalation, the Bank of Japan, with its zero-interest-rate regime, tries to assure the markets every day that it can print money even faster than its U.S. or European counterparts.
As a result, we are witnessing the biggest explosion in consumer and mortgage debt in history. The average American household's debt grew by 11% in the last year, for example, while its wage income grew by only 1.6%. The generation of trillions of dollars in new debt every year-about $2 trillions in the U.S. economy alone-helped to build up new bubbles which now pose an even larger threat to the financial system and the world economy, than the "new economy" stock market hype a few years ago.
In the center of these new bubbles is the global housing boom. Representing a combined financial asset value of roughly $50 trillion in the OECD countries-for the moment holding up a private debt mountain of similar dimensions-the housing market certainly has the potential to bring down the whole system. And everybody knows it might happen soon.
Following an unmistakable warning in the Bank for International Settlements (BIS) quarterly review for March 2004, on the systemic threat posed by global housing markets, a series of alarming statements on the same matter have been issued by financial officials and experts in Britain. On March 17, economics editor Pam Woodall of London's *Economist* magazine appeared at a conference organized by the Investment Property Databank, and declared that the global housing boom is teetering on the edge of a crash. "House prices look seriously overvalued in Australia, Ireland, Netherlands, Spain, the UKand U.S., and will fall by at least 20% in many economies over the next four years."
This time, Woodall emphasized, it wouldn't require large interest rate hikes, as in the late 1980s, to trigger a sharp fall in house prices. This is because the ratio of house prices to average income is now at record highs in the United States, Australia, and Britain. America in particular has just seen the biggest housing boom in its history, but "the U.S. has very little fiscal or monetary ammunition left to support its economy if house prices collapse. If the U.S. falls, it would be the first global property bust in history."
The “Economist” ran a March 13 feature headlined "Homing In on Trouble-Sell, Sell, Sell," emphasizing that "house prices are at record levels in relation to average income in America, Australia, Britain, Ireland, the Netherlands, and Spain." The prices of British, Irish and Dutch homes, relative to incomes, are now 50% above their 30-year average, according to the * Economist* survey, while property is thus overvalued "by 23% in America, by 33% in Australia, and by 68% in Spain."
The Bank of England (BoE) is ringing the alarm bells as well. In its latest Quarterly Bulletin, BoE economist Olaf Weeken warns that British housing prices have risen too much since 1995 to remain at current levels. The average house price was about 25 times income from rental property in 2003.
That's up from less than 15 in 1995, and far above the average of about 18 over the last 37 years. It's "a situation that in the past has often been followed by periods in which real house prices have fallen," stated Tucker.
He added that British house prices increased 15% last year and 25% the year before: "There is little doubt that such rates of increase are unsustainable."
Fannie/Freddie Fiascos Debated
Once the global housing boom runs into trouble, we will not just see trillions of dollars of financial asset value disappearing-though that would suffice to bankrupt millions of private households, which have expanded their mortgage and consumer debts rapidly since 2000 in the belief in ever-rising house prices. It could also sink some of the world's largest banking institutions, followed by a domino-like collapse of smaller banks.
The two U.S. mortgage-finance giants, known as Fannie Mae and Freddie Mac, are of particular concern in this respect. Multi-trillion-dollar-asset institutions known as government-sponsored enterprises (GSEs), with only a few tens of billions in core capital, they are in fact not explicitly government-sponsored. They buy up most of the U.S. mortgage debt from banks, keep some of these obligations on their books, and sell the larger part in the form of traditional bonds or asset-backed securities to investors around the globe. To "hedge" against sudden shifts in interest rates, which could lead to enormous losses on their holdings, Fannie and Freddie furthermore have become top players in the worldwide casino of financial derivatives contracts.
A debate has erupted in the United States about the "systemic risk" posed by the high concentration of the mortgage-debt balloon, and related derivatives bets, at these two mortgage-financing entities. The question has been raised whether the government should explicitly renounce any public guarantee for Fannie and Freddie's debt operations; the neo-conservative American Enterprise Institute, claiming Fed Chairman Alan Greenspan's support, has even called for a full privatization. The reasoning is that the widespread assumption of a public bail-out of the GSEs in the case of default is the primary cause of the incredible rise of their obligations; remove this cause, and the systemic threats just go away. Unfortunately, this isn't going to work, because for Fannie's and Freddie's problems, it's "too late to correct."