Excessively low interest rates, and excessively low capital requirement for banks, put house prices on steroids.

Sir, Edward Ballsdon warns about how “excessively low interest rates fuelled real estate booms built on debt.” “Once-virtuous circle has turned vicious” May 31.

That is true, but in much those excessively low interest rates are the direct result of excessively low capital requirement for banks against residential mortgages.

Had banks needed to hold as much capital as they are required to when lending to entrepreneurs, houses would not have morphed so clearly from being homes into being investment assets.

@PerKurowski

Three questions for Angus Deaton, the chair of The Institute for Fiscal Studies’ wide-ranging review of inequalities in UK

Sir, I refer to Angus Deaton’s “Inequality in America offers lessons for Britain” May 15.

I have three questions for him:

Regulatory subsidized credit for the purchase of houses, which has helped morph houses from being homes into investment assets, how much increased inequality has that caused between those who own houses and those who do not?

The increased benefits for those who have jobs, how much increased inequality has that caused when compared to those without jobs?

The risk weighted capital requirements for banks, which very much favors the financing of the “safer” present over the riskier future, how much inequality is it producing between current and future generations?

PS. Decreed inequality

@PerKurowski

We might not end up homeless, but homes might be the only thing we end up with… and so how do we eat homes?

Sir, Rana Foroohar writes “Central banks can’t create growth by themselves. They can only funnel money around.” “What Trump gets right” April 15.

Indeed, but the way they funnel money around can also promote obese growth, and impede muscular and sustainable growth.

If you fill a financial irrigation system with huge amounts of liquidity, QEs, and ultra low interest rates, and some of its most important canals, like the financing of entrepreneurs are, because you consider these as risky, blocked with high risk weighted bank capital requirements, there’s no doubt bad things will happen. Among other, that those channels relatively wider because they’re perceived “safer”, like sovereign and the purchase of houses, will get dangerously much credit.

Sir, just consider the role of so much the credit for the purchase of houses has had in turning houses from being homes into being investment assets. I have not done the calculations but were we to deduct from the assets of the 99% less wealthy the worth of their houses, I am sure that we would be horrified about what little savings we would find. We might not end up homeless, but homes might be the only thing we end up with… and how do you eat a home?

@PerKurowski

If universities and professors had in payment to take a stake in their student’s future, you can bet students’ merits would mean more than parents’ wallets.

Sarah O’Connor writes: “Those in the top 1 per cent of the income distribution complain that the growing wealth of the “0.1 per cent” has priced their children out of the sort of private education and housing that they themselves enjoyed.”“We must stop fighting over scarce educational spoils” March 27.

They are wrong! All the income of the growing wealthy “0.1 per cent”, is immediately returned to the real economy, when they buy a lot of assets, like yachts, and services, like yacht crews, which are all really not of much real interest, or use, to the 99.9 per cent rest of the economy.

And if there is anything that really has helped price out private education and housing, that’s the excessive availability of financing. For instance if the risk weights for the bank capital requirements when financing residential mortgages, 35%, were the same as when financing an unrated entrepreneurs, 100%, houses would be more homes than investment assets, and people would have more jobs with which service mortgages or pay utilities.

But that truth does not stop polarization and redistribution profiteers from stoking the envy levels in the society, especially when it can often be done on social media in an anonymous way, and at zero marginal costs.

Now if you really want less discrimination against those who poor might use education better, align the incentives better, and don’t let universities and professors collect all upfront.

@PerKurowski

If the inflation-measured basket used house prices instead of rental costs, the story would be different.

Sir, Rana Foroohar points to “The latest Consumer Price Index figures show that almost all core inflation… was in rent or the owner’s equivalent of rent (up 0.3 per cent) [while] Core goods inflation, meanwhile, was down 0.2 per cent” and argues “that the housing market is once again completely out of sync with the rest of the economy.” “America’s new housing bubble” March 18.

Yes and no! No! “Rent” in much is a laggard response to the price of houses, and so it would be more precise for the arguments made by Foroohar to compare core goods inflation to what is happening to those prices.

Yes! “Hyman Minsky would have had a field day [more precisely many field years] with his Financial Instability Hypothesis that [argues] two kinds of prices — prices for goods and services, and asset prices.”

And yes, Daniel Alpert is correct: “What we have now is a form of inflation that’s never been seen before — it’s all concentrated in housing.”

To explain that with as “something the US Federal Reserve has actually exacerbated (albeit unintentionally) via low interest rates and quantitative easing that boosted housing prices in the very cities where the best paying jobs are located”, is correct but quite incomplete.

If banks needed to hold as much capital against residential mortgages as against for instance loans to entrepreneurs, something that was the case before the Basel Committee got creative, that would be happening much less.

As is, the resulting abundant easy financing when purchasing a house has helped morph houses from being homes into being investment assets. 

PS. In a letter I wrote and that FT published in 2006 (before it stopped doing so) titled “The information Mr Market receives could also be neurotic” I argued:

“Inflation as they, our monetary authorities, know it, is just obtained by looking at a basket of limited consumer goods chosen by bureaucrats and that although they might be highly relevant to the many have-nots, are highly irrelevant to measure the real loss of value of money. 

For instance, who on earth has decided for that the increase in the price of houses is not inflation? And so what should perhaps be argued is that really our monetary authorities have not been so successful fighting inflation as they claim they have been.”

@PerKurowski

Bank regulations placed populist socialism on steroids, but neo-class-wars represent challenges

Sir, David McWilliams writes:“Mr Bernanke’s unorthodox “cash for trash” scheme, otherwise known as quantitative easing, drove up asset prices, left baby boomers comfortable, but the millennials with a fragile stake in the society they are supposed to build… spawning a new generation of socialists. Soaring asset prices, particularly property prices, drive a wedge between those who depend on wages for their income and those who depend on rents and dividends “‘Cash for trash’ was the father of millennial socialism”, March 2.

I agree. With QEs central banks renounced to all possible cleansing benefits a hard landing could provide, and decided to kick the can forward. But that is not the whole story. 

By distorting the allocation of bank credit with risk weighted capital requirements, which much favored the “safer” present/properties over the riskier future/ventures, it was de facto bank regulators who caused the crisis.

As a brief background, after Basel II in 2004, for all European banks and for US investment banks, the following were the standardized allowed leverages for banks: a) for loans to sovereigns rated AAA-AA the sky was the limit; b) 62.5 times when holding AAA rated securities; c) 62.5 times when holding any asset, no matter how risky, if it had a default guarantee issued by an AAA rated entity, like AIG; d) 35.7 times when holding residential mortgages and e) 12.5 times when lending to unrated entrepreneurs or SMEs.

The 2008 crisis was caused, exclusively, by excessive bank exposures to assets perceived as safe, and that could be held against the least of capital. In US and Europe it was the b, c, d and e assets, and a bit later in Europe, sovereigns, like Greece, that not withstanding it did not have an AAA rating, not withstanding it was taking on debt in euros, which de facto is not their domestic printable one, was assigned by EU authorities a risk weight of 0%.

After the crisis, with Basel III, some new capital regulations were introduced, notoriously a minimum leverage ratio, but the distortions produced by the risk weighted capital requirements are still alive and kicking a lot on the margin, there were it means the most.

As a consequence the can has been kicked forward in precisely the same wrong direction from where it came. Therefore, the day it begins to roll back on us, it could be so much worse.

McWilliams opines: “One battle ground for the new politics is the urban property market”. Indeed, there is a de facto class war going on between those who want their houses to be great investment assets too, and those who simply want to afford to own a home. Just as there is a de facto new class war between those who want higher minimum wages and those unemployed who want any job.

For the time being the old and new socialists on the scene have not been forced to take sides in these wars, as they still gather that going after the filthy rich will suffice to become elected. But the more voters realize that what the wealthy have is not money but assets, and that converting those assets into redistributable money can have serious unexpected consequences for the value of assets, some of which could trickle down on every one… that day redistribution driven populism will lose some power.

Hear this question: “Do you want us young to afford houses or do you want our parents’ houses to be worth more? Make up you mind, you cannot serve both.”

@PerKurowski

The world’s banking systems are dangerously fragile, courtesy of inept and statist regulators.

Sir, Martin Wolf writes: “Should we be concerned about the state of the world economy? Yes: it always makes sense to be concerned. That does not mean something is sure to go badly wrong in the near future… It is the political and policy instability, combined with the exhaustion of safe options for credit expansion, that would make handling even a limited and natural short-term slowdown potentially so tricky.” “Why the world economy feels so fragile” January 9.

Sir, as you know because of the thousands of letter I have obsessively written to you on this subject, which you have equally obsessively ignored, I am absolutely sure something has been going very badly for a long time, and will explode… perhaps the sooner the better.

In April 2003, as an Executive Director of the World Bank, in a board meeting I said, "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

Likewise, a world obsessed with allowing banks to leverage their capital immensely only because something is perceived or decreed as safe, is doomed to overload what’s “safe” way too much with debt, while, relative to that, financing what’s “risky” way too little. That will sure exhaust, sooner or later, any "safe options for credit expansion". That makes for a hell of a fragile bank system. 

Wolf writes, “The long-term credit cycle reached its denouement in the disastrous financial crisis of 2007-08.” 

That crisis was solely caused by excessive exposures to what was perceived as safe, mortgages to residences and AAA rated securities, against which investment banks in the US and all banks in Europe had to hold little capital. Did regulators wake up and change their risk weighted capital requirements, which are so idiotically based on the idea that what’s perceive as risky is more dangerous to our banking system than what’s perceived as safe? No! No real denouement there.

And then Greece exploded in 2009, and the fact that statist EU authorities had assigned all Eurozone sovereigns a risk weight of 0%, which allowed EU banks to lend to Greece against no capital requirement at all, which clearly doomed the not so well managed Greece to excessive indebtedness, does not even appear listed among the causes for its tragedy. No denouement there either. EU sovereigns are still risk-weighted 0%.

Sir, just look at houses. Easy financing made available by very low capital requirements turned what used to be homes into investment assets. All this while entrepreneurs, those who could create the jobs so that house owners can afford to service their mortgages and pay the utilities, were denied credit or charged higher interest rates, because of higher bank capital requirements. Just you wait till that easy financing stream stops and too many house owners wish to convert their houses into main-street-purchase capacity again. It's going to be hell.

@PerKurowski

There's a new class war brewing, that between employed and unemployed.

Sarah O’Connor, discussing the challenges of the Gig economy writes, “Offering employment benefits to drivers might well help to snap up the best workers and hang on to them. But if customers were not to shoulder the cost, investors would have to.”“Uber and Lyft’s valuations expose the gig economy to fresh scrutiny” January 2.

Sir, to that we must add that if the investors were neither willing to shoulder that cost, then the gig workers would have to do so, or risk losing their job opportunities.

That conundrum illustrates clearly the need for an unconditional universal basic income. Increasing minimum wages or offering other kind of benefits only raises the bar at which jobs can be created, while an UBI works like a step stool making it easier for anyone to reach up to whatever jobs are available.

Sarah O’Connor also mentions how a collective agreement was negotiated between a Danish gig economy company and a union. Great, but let us not forget that in the brewing class-war between employed and unemployed, the unions only represent the employed… and we do need decent and worthy unemployments too, before social order breaks down.

PS. There's another not yet sufficiently recognized neo-class-war too. That between those who have houses as investment assets and those who want houses as homes.

@PerKurowski

The crisis of modern liberalism is caused more by authoritarian besserwisser distortions than by market forces.

Sir, Wolfgang Münchau writes: Margaret Thatcher’s successful brand of entrepreneurial capitalism in the UK in the 1980s… Through the sale of council houses, she turned tenants into property owners.”, “The crisis of modern liberalism is down to market forces” December 25.

True, but later immense injections of liquidity, ultralow interest rates, and extreme preferential risk weighted capital requirements for banks when financing the purchase of houses, has helped turn houses from being just homes into being investment assets. That of course has left all those who do not own these investment assets, even further behind.

Therefore I cannot agree with Münchau’s conclusion that liberalism is failing because of market forces. At least in this case the distortions are not caused by market forces, but by regulators and central bankers who have insufficient idea about what they’re doing. Of course, if crony statism forms part of market forces, which perhaps de facto it sadly could be, then I would be wrong.

When Münchau finally opines, “Any system that leaves behind 60 per cent of households will eventually fail” that is not necessarily so. The world is plagued by examples by how such systems have too often proven to be even more resilient than those who do not. On a small model scale, just look at how Venezuela’s current regime has been able to hang on to power for at least a decade more than it should have been able to.

@PerKurowski

These are the houses that Jack built, baby, and their prices reaches up into the sky

Sir, I refer to Merryn Somerset Webb’s “UK property: The recent gains could turn out to be a huge historical anomaly” House and Home, November 17.

I would argue that more than an anomaly we are living the results of a humanly understandable political mistake of historical proportions, namely that of trying to make houses affordable by means of many preferential conditions.

After society, God knows why, decided that a home owned was much more valuable than a home rented, many different favors were awarded the purchasing of houses, many like those Somerset Webb describes, but also some other much harder to detect.

For instance, regulators decided that since they perceived residential mortgages as very safe, banks would be allowed to hold comparatively little capital against these. Since banks could therefore leverage much more with residential mortgages than with many other assets, banks had higher incentives to give a house buyer, who otherwise would not be able to buy a house, an easy credit.

That easy credit to the first buyer increased the demand of houses, so houses prices in general went up; and so the next time when a second buyer also wanted help to afford the house, you had to supply him with even more easy credit than what you helped the first buyer with… and so up and up and up it goes…

And those who own houses benefit and feel enriched by the increase in the price of houses are happy, while those who have not been able to jump on that bandwagon feel more and more frustrated, because the see their dream of a “real” home being made less and less affordable. That is of course something that the redistribution and polarization profiteers try to capitalize on.

And parents, so as to get their children out of the basement, now have to use their house to obtain the finance needed in order to help their children to make the down payments on the houses they want to buy. The sad story is that if banks had not invested so much in “safe” residential mortgages and had perhaps invested more in loans to entrepreneurs who could give them jobs, the children would have been able to afford, on their own, the lower priced houses. 

And so houses morphed from being only homes into also being investment assets. How much of current high house price is represented by the home value and how much by the easy credit value is anyone’s guess, but it sure would be interesting to see how much of their prices.

Whatever, the moment all those investment assets are to be cashed in by too many at the same time, for instance to cover some retirement costs, it will be ugly, for house owners, and for the banks, and for the taxman who has also been so much financed by the house bubble, in fact it will be ugly for all.

It all makes me remember Alan Price’s “Oh my, my, my, my, my, my, my, it makes you wanna cry. This is the house that Jack built, baby, and it reaches up into the sky”

These were the houses that Jack built... with plenty of easy credit, and which were taxed by the taxman

@PerKurowski

The dangers of the unknown unknowns are greater than those of the known unknowns.

Sir, Martin Wolf asks, “Is it possible to know the state of the UK public finances under present conditions?” He answers “No. The unknowns are too great.” “Some ‘known unknowns’ about the UK economy”, October 19.

Indeed, but to me, the most dangerous unknowns for the UK, and for much of the rest of the world, are the “unknown” unknowns. 

Like how much of the savings for the future, of those who are the least able to manage major upheavals, has been invested in houses; those homes that because of so much preferential finance increased their prices so much, that they were turned into also being risky investment assets?

Houses are good investments… until too many want to convert them simultaneously into main-street purchasing capacity.

Like how much of the illusion of public debt sustainability is solely the result of preferential regulations, like the Basel Accord of 1988 decreeing a 0% risk weight to sovereigns and a 100% risk weight to citizens?

Any sector given more preferential access to credit than other is doomed to unsustainable debt… just like Greece was doomed by the 0% risk weight some yet unknown EU authorities awarded it.

Sir, when compared to these in general unknown unknowns, the known unknowns, like Brexit or trade wars, are just peanuts. 

@PerKurowski

What has most made houses unaffordable for many is having made these artificially affordable for many.

Sir, John Dizard quotes and comments Robert Dietz, chief economist at the National Association of Home Builders with: “Affordability is at a 10-year low.” It is not just the tariff-driven double-digit rise in the cost of wood. “We have suffered labour shortages for the past [few]years. Now the builders say that [land approved for building] is low.” “Bad news for housebuilding recovery as America loses its free lunch from world”, October 13.

That might bear some influence bit let us be very clear, what has most made houses unaffordable for many has been all that preferential financing to make house purchases affordable to many, which turned homes into investment assets and increased the prices of houses and the wealth of those who own houses.

For example, should banks have to hold the same capital against “safe” residential mortgages that they need to hold against loans to “risky” entrepreneurs house prices would be much lower...(PS. But there surely would be more jobs to help allow the purchase of houses at its lower prices)

Sir, a monstrous real estate crisis is being fabricated by regulators who can’t come to grips with the simple fact of life that if you blow too much credit into a market, you will create a bubble that, sooner or later, will explode L

@PerKurowski

When the tide that turned safe homes into risky investment assets goes out, the wreckage will be horrific

Sir, Paul Mortimer-Lee in his letter “The tide that floated all ships is going out”, October 12, commenting on Martin Wolf’s “How to avoid the next financial crisis” (October 10), writes:“easy money has been pushing on a string as far as inflation is concerned”.

Not really, the problem is that, as I answered Martin Wolf in a letter published by FT 2006, is that when measuring inflation in housing, what is registered on the string is the cost of rental, not the prices of houses.

With low interest rates and especially low capital requirements for banks when financing the purchase of houses; unelected authorities have transformed houses from being safe homes into risky investment assets. When the tide goes out on that, the wreckage will be indeed absolutely horrific.

@PerKurowski

Sheer regulatory stupidity and statism caused the financial crisis. But that shall not be admitted!

Sir, Lord Adair Turner writes: “The financial crisis began because of dangerous features within the financial system itself. Massively leveraged investment banks engaged in socially useless trading of huge volumes of complex credit securities and derivatives… The excessive risk-taking was allowed by bad regulation justified by flawed economic theory.” “Banks are safer but debt remains a danger” September 12.

Turner, like all other involved, does just not tell it like it is! 

The “massively leveraged investments of banks” were caused, 100%, by the simple fact that regulators allowed for these.

The “socially useless” in complex securities were mortgages awarded to poorer house buyers in the US, the subprime sector. 

The “excessive risk-taking” was in fact an excessive risk aversion that led to the excessive build up of bank exposures to what was considered, decreed, or concocted as safe. 

Yes Turner mentions “bad regulation justified by flawed economic theory”, but there was none of that, there was only sheer stupidity. Like when regulators allow banks to leverage 62.5 times only because a human fallible credit rating agency has assigned it an AAA to AA rating.

And Sir, assigning a 0% risk weights to the sovereign, like to Greece is not based one iota on economic theory but all on flawed statist ideology.

Turner is right though when he writes that the “economic growth has been anaemic despite massive policy stimulus… “That poor performance reflects… inadequate capital regulation.”

Indeed, the distortions that the risk weighted capital requirements produced in the allocation of bank credit to the real economy that have not even been admitted much less were eliminated. “Debt burdens shifting around the world economy from private to public sectors” are just one symptom of those distortions. 

In fact by having raised the floor of bank capital requirements with leverage ratios, on the margins, the roof, the distortions of credit risk weighted capital requirements could be worse than ever.

Turner consoles us with “A deep economic recession, made worse by a large debt overhang, could occur even if not a single big bank went bankrupt or needed to be rescued with public money.”

Not true a deep economic recession, a dysfunctional economy is as dangerous as can be for the banks and for us. That is why the most important question that regulators need to answer before regulating banks is: what is the purpose of banks. Except for being safe mattresses to stack away cash there is not on word on this in the whole immense Basel Committee compendium on rules.

“The increasing role of real estate in modern economies is also crucial.” That is because, by means of giving house purchase access to credit on preferential conditions, a house is no longer just a home it has also become an investment asset. The day houses return to being home only it is going to hurt, a lot. 

“Rising inequality”… with capital requirements that favor the “safer” present over the riskier future, how could that be avoided?

PS. And Sir, you know it, FT has in many ways been complicit in the cover up of our mistakes stories peddled by regulators and their colleagues.

@PerKurowski