Exposed: Why We Boom and Bust

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Now this is funny. I was at a party about six months ago and the property market came up in conversation.

The host said he was worried about the level of interest-only loans out there.

He looked at me and said, ‘You write about economics and stuff. Should we be worried?

I can say with a straight face that I wasn’t. I said so at the time.

There was a reason for that. As a general rule, the thing in the market to worry about is what you don’t know.

Certainly, if someone brings up an issue at a party, whatever issue it is has long been telegraphed and priced in.

The general public is always going to be the last to know.

Why am I talking about this?

The Australian reports this morning that interest-only lending is now at its lowest level in two decades.[1]

The regulatory crackdown has done its job.

Another point is that the interest-only borrowers currently rolling off are coming into a market with lower rates.

As yet, there’s no spike in defaults, either. The big property bears appear to have gone back into their caves.

Will these benign conditions of responsibility and prudence last?

Of course not.

The entire history of the last couple of centuries is financial credit booms running riot before collapsing in a heap.

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Precisely nothing will stop another one happening, as things stand today.

I have finished my book about the actor Michael Caine. I mentioned this on Tuesday (read it!).

I’ve now moved on to another one called A Brief History of Doom: Two Hundred Years of Financial Crises.

The first chapter is already a revelation. That’s because it lifts the obscurity around what caused the Great Depression.

Drumroll, please…

Are you ready for the answer?

(Spoiler alert!)

It was a real estate boom and bust!

Yep. For almost a century, economists have wondered what caused the Great Depression.

Was it the Fed keeping rates too low? Was it something to do with the gold standard? Was it all the bank failures after 1930?

Here we have the facts. Americans went nuts for speculating in property after 1920.

Private debt soared…and that drove construction and consumption through the roof.

Then the hot boom times sent Americans buying up stocks…on margin…which usually means with credit created out of nothing from the commercial banks.

It sent US stocks soaring to astonishing levels.

Private debt was 161% of American GDP by 1928.

But such booms cannot last. And as soon as loans started going sour, the American banks were toast.

The credit bust follows the boom as night follows day.

American GDP was cut in half from 1929-1933 — still the worse contraction of the last 120 years for the US.

We could go into this a little more, but I don’t want to lose you.

There are some other juicy tidbits we can glean from all this history.

In 1923, the US government introduced policies and tax breaks to help Americans get on the housing ladder.

Sound familiar?

Brokers started pushing loans with long maturities and low down payments.

Sound familiar?

Real estate bonds were sold off to retail and institutional investors. Those selling the bonds shifted the credit risk of the loans from themselves to unsuspecting buyers.

Sound familiar?

Author Richard Vague writes: ‘By the late 1920s,sky-high real estate values had started to fall — in the same way that housing values started to decline in 2006 well in advance of the 2008 crisis.’

Sound familiar?

Everything above was repeated before 2008. In fact, it was repeated multiple times after the Roaring Twenties and before the year 2000.

Credit booms — built around real estate values — drive the boom and bust nature of the economy. History teaches no clearer lesson.

What, then, for the future?

I’ve said it before. We must watch for how banks try and circumvent the rules to tighten their lending, especially around property.

That is where the millions in profits and bonuses lie, so that’s where they must head.

It will take some time here in Australia. The Royal Commission bruised the banks and regulators are still watching closely.

But, if we are awake to developments, one day we’re going to hear about a financial innovation that facilitates more lending against property.

My guess is that it will be something to do with cryptocurrency.

The singlets and t-shirts in Thailand say it best. Booms and busts are always ‘same, same, but different’.

It’s always private debt built on the fragile foundation of rising property values…until they start falling in a big way.

Best wishes,

Callum Newman Signature

Callum Newman,
Editor, Profit Watch

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