You won’t be surprised to hear that Cyprus’ banks passed a stress test in 2011. They were tested to see if they could survive a bit of economic turmoil, and they passed. Now they’re failing anyway. Clearly, bank stress tests are about as reliable as Lululemon’s quality testing.
You see, Lululemon makes tights. The kind you would wear to a yoga or flying trapeze class. Unless you’re a 12-14 year old girl, in which case wearing tights is fashionable generally.
Apparently, wearing slightly sheer tights is also fashionable. But Lululemon’s quality testing and design team made an error. Their tights are just a bit too sheer, triggering a product recall. ‘The truth of the matter is the only way you can actually test for the issue is to put the pants on and bend over,’ Chief Executive Officer Christine Day said in a conference call. The mistake is set to cost the company up to 27 cents per share.
Now, given the whole point of wearing these tights (yoga), you’d think that people might want to test them by…bending over. That’s what people do when they do yoga. It’s also why we don’t do yoga.
It’s the same story with the banks’ stress tests. So if Cyprus’ banks passed stress tests, but find themselves in need of a bailout, what did the stress testers miss? You guessed it, a sovereign debt crisis – the kind that Europe is going through.
Just like Lululemon’s quality testing team, the stress testers didn’t test for the one thing that really matters: What happens when your biggest and best asset is at its most vulnerable.
All this should sound familiar. In America, houses and mortgages were the biggest and best asset of the financial system.
When Ben Bernanke was asked what would happen to the financial system if house prices on a nationwide basis fell, he replied ‘I guess I don’t buy your premise’. He wasn’t even willing to consider it. Australians are suffering from the same delusion. But before we get to Australia, let’s take a global property tour to see what’s going on.
The whole world is going on another property binge. Politicians and central bankers are adding ‘eye of newt and toe of frog’ to try and pump their economies the way they know how. Yes, governments are struggling financially because of the last housing bubble they inflated, so they’ve decided to inflate another one.
Are they really that dumb? You betcha!
In America, government backed mortgage behemoths like Freddie Mac and Fannie Mae are buying up the overwhelming majority of new mortgages. Without them, who would be willing to lend the money?
The other source of property buyers are hedge funds, also supported by government in the form of the central bank. Spurred on by stupidly low interest rates from the Federal Reserve, they buy vast bundles of houses and rent them out, pocketing the difference.
‘Last year, institutional investors made up 19% of all sales in Las Vegas, 21% in Charlotte, 23% in Phoenix, and 30% in Miami,’ writes ZeroHedge. The problem is, they’re flooding the rental market, which is pushing down rents.
There’s a crisis in the making here. If interest rates rise and rents stay low because of oversupply, the hedge funds will be in trouble. Michael Krieger of Liberty Blitzkrieg calls this ‘one of the biggest disasters waiting to happen in the US economy.’ If the hedge funds try to escape en masse, house prices could fall just as interest rates rise.
The story would be the same as sub-prime, but with hedge funds on the receiving end instead of poor borrowers. Of course, a fall in house prices ends up affecting anyone who own as house, which is why the sub-prime mess went viral.
In the UK, the government has come up with a plan to engineer a ‘housing boom’ by subsidising the mortgages of people who buy a new construction. To be clear, taxpayers will be explicitly guaranteeing loans. The Telegraph explains the details:
‘…the Government would offer five-year interest-free loans worth up to 20 per cent of the value of new-build homes costing less than £600,000. From January, another scheme will see taxpayers underwrite mortgages to those with small deposits, including more than a million people trapped with so-called “zombie” loans, whe
re the fall in the value of their homes has left them unable to move.
‘The Government will offer £12?billion of guarantees covering mortgages worth more than £120?billion. They are intended to help 644,000 people over the next three years.’
This is known as an ‘epic facepalm’. That’s when you slap your hand over your face in a display of dismay and incredulousness. We know how this ends – in a housing bubble and crash. But hey, the election cycle is only so long. Some other politician will have to deal with the aftermath.
Here in Australia, the story only gets more absurd. The TV show The Block is back spruiking the benefits of property investing. And it’s just the most beautiful little microcosm of Australia’s housing obsession.
According to News.com.au, the Blocksters made a combined profit of $815,000. That’s impressive until you realise what’s meant by ‘profit’. You see, the Block calculates ‘profit’ based on the difference between the sale price and the auction reserve price.
In case you missed it, the difference between the sale price and the RESERVE PRICE. Never mind the prices the houses were actually purchased at before the teams were let loose with sledge hammers.
As the article explains, there was ‘no real world profit’. But it gets worse. Take out the costs of renovation and even their fake profit disappears.
According to one ‘Block Head’ (fan of the show), after the 2011 campaign exposed the underperforming property market the producers changed the rules. Now they don’t keep track of the purchase price and just under-quote a reserve price to make the whole effort look profitable.
At some point, Australians will realise that property just isn’t affordable in Australia. The only thing making it affordable for now is rising house prices – once you own a house you become more wealthy.
But they can only keep rising for as long as people are willing to go into debt. And signs of stress are already emerging. Banks have had to target people who can’t afford loans to keep the lending machine going. That’s what caused all the problems in America.
But the biggest and best property bubble award goes to China. All sorts of cracks are appearing in that country’s property boom. And without construction in China, who will buy Australian resources?
We’ll leave that for another day.
Much more interesting is a new study showing that German median net wealth is less than a third of Spanish and Italian median net worth! And less than half the French equivalent. The Germans are being asked to support countries that are wealthier than them. That’s not going to go down well.
By the way, if you’d like to see your editor in non-sheer tights, come on down to the Flying Trapeze Centre Melbourne’s show ‘Fall’. (That’s ‘Fall’ as in ‘Autumn’, not ‘fall’ as in house prices.)
Markets and Money Weekend Edition
BHP The Old Warrior
By Dan Denning
Here in Australia, the leadership of the index is being fought over by the Commonwealth Banks and BHP Billiton. This is a subplot in the global story, but a compelling one nonetheless. The banks and the miners generally work together to drive the index and the economy. At least, that’s been the case for most of the last ten years. But could their paths diverge now?
For the first time in modern history, the light of day is being cast on the great vampire squids from depths of Mordor. Maybe (but I doubt it) the world can begin to see the noose that banks have around our necks. And that we will hang ourselves if we don’t break up all the big banks and the central banks that use government power to back the true usurpers of humankind.
War Criminals Still at Large
By Bill Bonner
Calling it a ‘calamity’ or a ‘catastrophe’ makes it sound like an accident…or a natural disaster. This was no accident…not even a case of manslaughter; it was pre-meditated murder. But the journalists, moralists, and geo-political illusionists – each striving to find words to describe what one called America’s biggest blunder ever – keep at it.
The Mining Shuffle
By Nick Hubble
Diggers and Drillers editor Dr. Alex Cowie has been busy telling a Hong Kong audience about one of those two sectors…. His main argument is simple. Things could hardly get much worse and people could hardly be more pessimistic. The details involve factors like downgraded institutional forecasts, record short positions, record ETF liquidation and much more. It takes guts to call out ‘buy’ in the midst of all that.