Financial Versus Real
I wrote the following this morning for Finacorp clients:
“One of the keys to understanding the current environment is that there is a lot of financial liquidity, which obscures a lack of demand for products that are not staples. With unemployment so high, and perhaps worsening, it is difficult to invest in new plant and equipment, but easy to build up excess liquid assets as protection against further decay. It is also then easier to refinance debts, or buy high yielding debt, and clip a spread, hoping things don’t blow up again.”
Let me phrase it another way. So the Fed comes in and offers cheap liquidity to financial institutions. Does that mean the financial institutions will now offer loans to industrial corporations? More of the loans will go to those that are buying “cheap” high yield debt, until the yields make no sense versus the bad default climate for companies that have issued high yield debt.
Most of what the Fed has done has been to raise the prices of financial assets for now. Unfortunately, the the Fed is not big enough to do that for most residential housing in America. For those that have mortgages, sorry, half of you are under water, where under water is defined as higher than a 90% LTV. Once sale costs are counted in, a 90% LTV is a close to a breakeven.
For the US government, together with the semi-independent Fed, it is relatively easy to lower interest rates, which percolates through the lowest risk sectors of the economy, so long as the dollar does not fall apart.
The Fed can manufacture financial speculation easily, but has a harder time encouraging investment in plant and equipment. Much of that depends on the rest of the world. There are no strong economies now, and most countries need to pay down debts. Debt-based financial systems are more fragile than equity based systems. Things may be weak for a while as we head back to an equity-based system.
October 2nd, 200912:32 pm at
good point David. We need a new bubble and liquid assets it is.
October 2nd, 20091:52 pm at
TraderMark, nice to have you visit. Come back again.
October 2nd, 20092:02 pm at
>Unfortunately, the the Fed is not big enough to
>do that for most residential housing in America.
1. You mean fortunately, not unfortunately, right?
Housing prices are too high compared to income, and it is desirable for the economy as a whole house prices fall.
In my city, the median house price is still 10x the median household income. The bubble has only deflated 15% from peak here, and houses are still outrageously priced.
With the Fed buying 100% of mortgage backed securities, they have propped up prices a lot. Now that is unfortunate.
October 2nd, 20092:17 pm at
Fu — you’re right. When I said “unfortunately” it is for those who are inverted on their mortgages, not those who don’t own homes.