“I was in bed last night with Alan Greenspan,” your editor told a colleague this morning.
“Wait. It’s not what you think. I’ll explain in the DR today.” The explanation is below. But first, what will today bring for stocks?
On Wall Street the Dow fell by 1.7% and is back below 8,000 again. It looks like traders took advantage of yesterday’s earnings surprise from Goldman Sachs (NYSE:GS) to sell bank stocks. That sounds like the old, “buy the rumour, sell the news,” theory at work. And it tells you there’s not a lot of confidence that bank stocks have truly recovered and can lend the world economy into newfound glory.
By the way, a follow up to the Goldman earnings announcement. The Financial Times reports that Goldman’s performance was calendar aided. The FT says that Goldman’s “Fourth quarter ended in November 2008, but after converting to a bank holding company last year, Goldman adopted a calendar-year earnings period starting in 2009. As a result, the company did not have to include December in its first-quarter earnings, a month in which it sustained $1.3 billion in pretax losses.”
If you include the pretax losses from December, Goldman made $500 million in the first quarter, which is a lot less than $1.88 billion (but a profit nonetheless). Goldman’s Chief Financial Officer David Viniar also told analysts the Goldman’s first quarter profit was not boosted by profits from the $14 billion in U.S. taxpayer money it received, via the bailout of AIG. Viniar said that the profits from AIG “rounded to zero” once Goldman’s hedges to its AIG exposure were included.
What we wonder is why Goldman needed to be made whole at all if its exposure to AIG was hedged? And why did Goldman get paid US$14 billion for its securities when the market value was around $8 billion?
Questions and more questions. Goldman’s fixed income, commodities, and currency trading division (FICC) generated 70% of its net revenues for the quarter (US$6.56 of US$9.42 billion). While the former investment banking giant made just $823 million as an investment banker, it generated $7.1 billion in revenues trading and investing, although it’s not really clear from its financial filing just how that $6.5 billion was made by the boys at FICC.
Our point? This isn’t the sort of report that gives you confidence that credit market losses are behind us. More on that below, as we delve into yesterday’s numbers on commercial finance in Australia.
Speaking of Australia, the S&P ASX/200 is now 21% up from its low point on the year of 3,120. Yesterday’s close at 3,753 leaves it just below its high for the year of set in the first week of January. Will it matter if the index makes a new closing high today?
“No. I don’t think so,” said Swarm Trader Gabriel Andre on the phone today. “To be important, it needs to close above 3,820,” he added.
We’d love to unleash Gabriel and his technical analysis to produce short-sell recommendations. But the regulators are making it really hard to make money selling stocks short. So instead, we’ve begun looking at the top 50 ASX stocks on a daily basis, identifying long-term support and resistance levels for each of Australia’s top 50 largest companies. The goal is to alert readers to when they are overbought or oversold. We’ll keep you posted on the progress.
And the rest of the market? It’s meandering. Qantas announced its worst half-year result in 14 years yesterday. It’s also firing 1,750 people. But is this actually good news for the economy?
Unemployment is said to be a lagging indicator because it tells you where the economy has been, not where it’s going. That is, Qantas is firing people because the last half-year was bad, not because it expects the next half-year to be worse. At least, that is one way of looking at it.
But there is a deeper back story, too. In a routine recession, businesses reduce payrolls to match reduced demand in the economy. But this is not a routine recession. We would argue that businesses are reducing payrolls now because the entire economy has been built for an illusory demand propped up by credit.
With the credit depression, households and businesses are cutting back on spending and investment, respectively. What this means is much higher unemployment than anyone is currently figuring. And it means that because the entire structure of global labour markets has been based on a demand that’s clearly not sustainable without massive new levels of credit.
For Australia, that means fewer people hopping on Qantas jets to holiday in Thailand or Europe. It means fewer cars being built in Australia for consumers buying those cars on credit (the ABS reports a 24.6% fall in personal finance commitments for new cars in the last year). And by the way, for China, it means a lot fewer jobs in urban factories for rural workers who’ve come to make the stuff that Americans buy.
Do you think we’re just making this all up? Au contraire mon frère!
The ABS reported yesterday that total finance commitments to business fell by 14.7% in February to a 42-month low. Translation? Either the banks aren’t lending or businesses aren’t borrowing. Or both!
The numbers are actually worse when you stretch them out over time. Over the course of the last year, the seasonally adjusted commercial finance figures show a 43% decline from $44.3 billion in February of last year to $25 billion in February 2009. If your eyes aren’t bleeding yet, stick with us for just a few more pieces of data.
In a worrying trend for businesses, the big month-to-month decline in finance commitments came not in fixed loan finance but in revolving credit. The fixed loan finance figures show commitments declining from $29.6 billion in February ’08 to just $16.3 billion in February ’09. That’s a 45% decline, year-over-year.
That’s surely the sign of a credit depression. The only reassuring news is that the month-over-month fall in fixed loan commitments was just 7.3% (from $17.6 billion in January to $16.3 billion in February). But in the revolving credit sector (shorter-term, higher-interest borrowing) the month-to-month numbers are pretty alarming.
Revolving credit finance commitments to business fell about 6% year-over year, from $14.6 billion in February of 2008 to $8.7 billion in February 2009. But in the last month? They’ve fallen from $11.6 billion in January to $8.7 billion February. That’s a decline of 25%.
What does all this mean? Well its statistical confirmation of what you’re hearing on the street. Banks are getting tight and businesses are getting terrified. We have a modern economy that lives and breathes and bleeds on credit. The supply of that credit is shrinking. What do you think happens to the economy then?
The only positive way of looking at yesterday’s news is that it represents a “liquidation” of labour. This is not exactly good news for the liquidated employees of Qantas. But one the admonitions of the Austrian school of economics is that you can’t move to a recovery and new growth (new production possibilities frontiers) until the bad investments from the previous credit boom have been liquidated.
The trouble is, there is still a lot of liquidating to do. And we are not just talking about labour markets where, after all, Qantas expansion was the result of low fuel prices and globalisation for many years. No. We’re talking commercial and residential real estate.
That’s where Australia’s banks have the most exposure on their loan books. And that’s where you’ll see write downs and losses on commercial property portfolios. We suspect that’s why the banks are getting tight. They are preparing for much tougher times. Are you?
Well you wouldn’t be if you were just listening to the good folks at the Reserve Bank of Australia. Luci Ellis, the head of the RBA’s financial stability department, said that lending standards never delved too low into subprime territory in Australia to lead to a mortgage lending bubble.
In comments she delivered in Melbourne, she added that the inability of Australians to deduct the interest on their mortgage from taxes gave them a financial buffer against falling prices. She said that Aussies tended to pay off their mortgages more quickly because of this, whereas in America, the interest deduction presumably encourages people to maintain high balances on their mortgage.
And what defence of bubblicious Aussie house prices would be complete without trotting out that old canard, the housing supply gap! “Unlike in the United States,” Ms. Ellis said, “housing supply [in Australia] had not boomed in the same way for the past five years. There simply has not been an overhang of supply built up that would subsequently weigh on prices.”
We’ll get to the supply bogey in a moment. But we’re certain Ms. Ellis knows that the supply of homes is just one part of the pricing equation. The other part is, of course, demand. And the demand for housing is clearly influenced by the price of money (mortgage rates plus the first home buyer grants). Everywhere else in the world, plunging interest rates led to a huge mortgage lending boom that inflated house prices at historic multiples of household income.
Nowhere else in the world, in fact, has housing become as expensive as it is today in Australia, when measured against household income. Two things make this possible. First is the availability of mortgage financing to lever up and get on the property ladder. Second, and more importantly, is the deep seated belief-encouraged and repeated by those in government and banking and real estate-that property prices always go up.
The Great Australian Property Price Crash is coming people. You can’t have a depression in credit and expect inflated housing values to magically levitate. The latest figures on housing and commercial finance show a few things. They show that first-home buyers are propping up the market while investors flee (as was the case in the U.S. in 2006). And they show that bank-lending to the private sector (both fixed loans and revolving credit) is retrenching.
But what about the great supply deficit? Ms. Ellis cites a report by the National Housing Supply Council. This “State of Supply” report is prepared by a committee of insiders from the building, banking, and real estate industries. You’d naturally expect them to conclude that the supply gap is large and growing.
Yet this is not exactly what they’ve done. They’ve confessed that their estimates of housing demand are based on statistical models. To quote directly, “The Council estimates that a minimum of around 85,000 dwellings is the gap (unmet need) in the supply of housing in 2008. This is based on the incidence of homelessness and the low level of vacancy rates in the private rental market.”
And you thought we were joking about the homeless. We’ve always said if there was really a supply problem, you’d see more homeless people. The estimate the Council comes up with for the gap assumes, we assume, that the homeless are homeless because there aren’t enough houses. This is nonsense. Studies show that a fair portion of the homeless choose to be homeless, or would be homeless regardless of historically low mortgage rates.
But that point aside, low rental vacancy rates are also cited as evidence of a gap. This is nonsense too. Couldn’t this also be the fact that so many Australians live in capital cities? And so many of them want to live in the same place? It’s not that there aren’t places to live. It’s that everyone wants to live in the same place, which violates the laws of physics, of social propriety, and also drives up rents).
In other words, maybe the two factors the Council cites in fabricating a housing gap have other, better explanations that a fictional shortage of housing. But maybe that narrative doesn’t suit the needs of people who make money selling houses.
Ah! A caveat arrives on cue!
“The Council acknowledges the crudeness of this [housing supply gap] estimate and also points out that there were some 830,000 vacant dwellings in Australia at the time of the 2006 Census. The Council has assumed that most of these were probably second homes, homes in the process of sale or homes awaiting redevelopment and that there is likely to be limited capacity for absorbing growth in underlying demand within the present level of housing supply.”
Baffling. Or just deliberate chicanery?
There are 830,000 vacant dwellings. But that, according to the Council, is not enough to meet the housing supply gap of just 85,000 dwellings? Math was never our strong suit. But this smells fishy.
Could it be that property investors, let’s say boomers sitting on property as a retirement income, are not prepared to sell those investments at these prices? There’s no urgency, after all. Do they expect to sell these properties to pay for their retirement? Or are they just taking advantage of the tax benefits of negative gearing?
Who knows, dear reader? But we’d humbly suggest there is no housing supply gap at all. You could bring some of those 830,000 vacant dwellings on the market by changing the negative gearing laws. And the elimination of the first home buyers grant would prevent so much future demand from being “brought forward” merely to prop up values for existing homeowners who want to sell now to the sucker first home buyers.
But we reckon none of that is going to happen. While the stock market wades through earnings information and employers batten the hatches and throw men overboard, Australia’s property market is headed towards an epic fall. More on the fall tomorrow. Oh! And we almost forgot, more on our dream with Alan Greenspan too. We promise!
for The Daily Reckoning Australia