April 14, 2014

When the yin meets the yang

Posted in Banks · 26 comments ·

My dad used to tell me about the numerous pawnbrokers in Dun Laoghaire, and how it was common for people to use them at the end of a week, or coming up to some big event, to get cash for clothes, jewellery or anything that could be used as collateral. If the person didn’t pay back the loan, the pawnshop sold the collateral.

It is thought that the three balls which symbolise a pawnshop are the coat of arms for the Medici family from Lombardy in Italy, because in medieval days banking in Europe was dominated by these northern Italians. Indeed, in many European countries a pawnshop is called a Lombard. There is still a bank in Ireland called Lombard & Ulster, indicating the endurance of the word in the world of lending.

Up until 40-odd years ago, small-time lending lubricated commercial life all over the world. Irish commercial life before 1950 was a massive system of low-level lending and borrowing. Typically, shopkeepers, publicans and undertakers provided credit to the town or village. In such a system, severe punishment for the defaulter was an essential part of the financial architecture, which ensured that the system worked. If the defaulter wasn’t punished, credit would dry up very quickly in the event that a payment or payments were missed.

As it was a profitable business, many entered the game in the hope of making good money.

My dad told me that in the 1940s when a new pawnbroker arrived on the scene, there would be a brief period when there would be lots of cash doing the rounds because the new pawnshop offered loans at lower interest rates to gain a bit of market share. In time, the market equalled itself out, but in the beginning, a new pawnshop meant a mini cash bonanza.

In modern financial markets, the central bank is nothing more than a large pawnbroker, giving banks money in return for collateral. The more money it gives out, the more the banks have the ability to make more new loans to the economy and the more likely it is that the economy will grow.

However, when the central banks lend out lots and lots of money, a portion of this new money finds its way into other asset prices and drives them up.

The opposite occurs too. One interesting difference between the old pawnbroker and the new omnipotent Central Bank is, because the central bank prints money, the sanction against the defaulter is less exacting than in the old days.

In the past few weeks, the power of central bank lending on financial markets has been evident, and so too is the evidence that defaulters get second chances.

Defaulting is nothing more than an acknowledgement that the loans are not worth as much as they were when they were first given out. Debt restructuring is an entirely natural part of the economic landscape.

Do you remember when experts in Ireland argued that if a country defaulted it would never able to borrow again?

Greece, not two years ago, presided over the biggest default in financial history. It refused to pay over €100 billion of its national debt. And what happened? Nothing much actually.

Chart 1 11 April

Look at the first graph, which measures Greek ten-year interest rates. You can see clearly that, despite refusing to pay its debts, Greece has been forgiven. Greek interest rates are back down to pre-crisis levels. What does this tell us?

It tells us that the story we were – and are – being told by the Irish financial establishment is not true.

Last week, a Greek bond sale which aimed to raise €3 billion at 4.95 per cent, attracted around €20 billion of bids. The very people who Greece defaulted on are back falling all over themselves to lend to the Greeks again. That’s just the way it goes. Financial markets have no memory. Mature adults do deals. In the eurozone, these deals are brokered by the ECB.

It is quite simple really. The two-year rally in peripheral bond markets (Ireland included) has been rented, not earned. It is rented because the rally is based on the ECB’s implied promise to buy all dodgy debts in the eurozone if it has to. These low yields on massive debts will only be earned when the growth rates increase, and this means that the ECB will have to adopt an aggressive form of QE soon to try to overcome Europe’s liquidity trap. This all implies that the pawnbroker will be working overtime in the years ahead, keeping interest rates low.

This means that assets in Europe, stocks, bond and property, will continue to rise for some time. This includes Dublin property prices.

But now look what happens when a central bank switches off the taps.

In the US, the Fed is gradually taking money out of the system – the pawnbroker is running a tighter shop. This means that the assets that were most dependent on cheap money are getting hammered. Interestingly, the assets that were actually most based on the traditional pawnbroker approach to finance were the very assets which promised a brave new future – the tech stocks

The Nasdaq has fallen much more aggressively than the Dow which is dominated by old companies. So the markets have gone from being tech evangelists to tech sceptics in the past few weeks. All the big tech names, from Facebook to Twitter, LinkedIn and Netflix have seen their share prices hammered.

Now look at graph number two, the S&P 500 versus the Nasdaq.

s&p nasdaq

Once the Central Bank begins to reduce the amount of money in the system, lots of basic things, like profits, that were assumed away in the tech boom, come back into focus.

People are now asking: do these tech companies actually have any chance of making money? Can Twitter translate users into cash? Can Netflix do the same? Maybe the peak in the Nasdaq coincided with the IPO of King Digital (the maker of Candy Crush), which wobbled and flopped three weeks ago.

Could this be the 2014 version of the Pets.com flotation in the last dotcom boom?

Like all bubbles, mini or not, when people start trying to get out they find the exit door is very small. That is why the tech crunch has plenty more potential to continue.

Like Irish housing at the top of the market between 2006 and 2007, when things start to wobble, and sellers run for cover, it’s very difficult to stop.

It’s impossible to see the Fed changing course to bailout the billionaires of Silicon Valley, so this tech price carnage could go on for a while. Across the pond, here in Europe, with ECB Central Bank president Mario Draghi promising more and more cheap funds, it is equally hard to see asset prices doing anything but rising – and that means three-bedroom semis in Dublin too!

David McWilliams writes daily on international economics and finance at www.globalmacro360.com

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  1. Subscribe – in your face Adam

    • Morning Oscar, I had a lie in.

    • “In modern financial markets, the central bank is nothing more than a large pawnbroker, giving banks money in return for collateral. The more money it gives out, the more the banks have the ability to make more new loans to the economy and the more likely it is that the economy will grow.”

      As I said many times before this is bullshit and once David even said sorry for misleading his reader, however he continues to do it. Now even the Bank of England admits that guys like David are misleading. http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf

      I don’t know his agenda but beware of this peoples’ champ

      • McGoo

        Wow, that brilliant article absolutely nails it!
        I can’t believe that the Bank of England would explain the smoke-and-mirror trick of money creation in simple, straightforward language, with diagrams that a 10-year-old could understand, and post it on their website! Everyone (this means you, David!) should read it, and make sure you save a copy to your computer before they realise what they’ve done and take it off the website.

        I’ve been trying to figure out for a while if this is really how money creation works, it seemed to awful to be true, but I’m not going to argue with the authority of the BoE. It is depressingly true.

      • verybearish

        This is not “bullshit”, when demand for credit by the consumer is low someone must step in and replace this lost demand with money to float around the system to avoid a deflation spiral.
        ” The more money it gives out, the more the banks have the ability to make more new loans to the economy and the more likely it is that the economy will grow.”

        Please note the use of the word “ability” to make new loans, QE provides the ability for loans to be made at low rates, it does not however magically provide the borrower of credit a good investment area to put that money to work and therefore the system is doomed to the sins of the past. Those with access to this credit will invest in areas where they rightly or wrongly see a potential for return , it does not mean that every wannabe mom n pop shop owner gets funding for a new business venture.

        Basically its a case of the theory works but the practice doesn’t. The US invested HEAVILY in a QE programme and got a fairly lousy return for its money, growth of circa 2% after 4-5 yrs and despite a relatively decent shift in the employment rate to approx 6.7% from the highs of circa 10% it is still open to debate about participation rates etc and the modern phenom of “underemployment”. The reason for this was not necessarily the plan but rather the transmission of the plan.

        Those with access to the capital resources enriched themselves and same will happen in Europe if not carefully policed.

  2. atchman


    In the US QE benefited the already wealthy. The boom in property was in high-end property in places like Manhattan. QE did not flow into main-st lending, so your assertion that Dublin Property prices will rise on the back of QE may be true if some of the direct beneficiaries of QE in the IFSC decide they want to compete for trophy homes in Dalkey again. For ordinary families scrambling over the restricted supply of semi-ds in the suburbs your assertion may not ring through. Frankly, I think you need to be clearer about this. Your presentation on Prime Time the other night achieved nothing more than to fuel further unwarranted panic among already stressed house-hunters in Dublin.

  3. DC

    Too Much Yang – Too little Yin.

    “The very people who Greece defaulted on are back falling all over themselves to lend to the Greeks again.”

    No!!!!! – are back falling all over themselves to lend to the Greek Banks, Public Sector, and other vested interests, – Not The People.

    And why not – Borrow money at zero % rates for a Guaranteed return of 2% – implicit in that Guarantee is the further suffering of The People.

    “The Economy was made for Man – Not Man for the Economy”


    As for the Fed

    Tapering is tapering and tightening is tightening. The Federal Reserve tightens monetary policy when it believes the economy is getting a little too hot and risks creating inflation. It is the opposite of easing when the Federal Reserve cuts interest rates if the economy moves or threatens to move into recession. Tapering is the gradual reduction of the special monthly purchases of mortgage debt and long-term Treasuries the Fed has been buying since September 2012 (QE3).

    Basically the Fed is saying the economy still stinks, it stinks so bad that we are going to keep interest rates at zero for at least another year but not so bad that in addition to keeping interest rates at zero we are going to continue to purchase $85 billion in Treasuries to help keep interest rates low. We are going to buy a little less.
    The Fed will still be taking the extraordinary step of outright purchases of Treasury instruments.

    We are in uncharted waters, the most worrisome aspect of this experiment is the almost Orwellian propaganda of the science of Economics, with absolutely no regard for the social impact of endemic corruption, greed, and abuse of power.

    Democracy be Damned – Oligarchy Rules.

    Keep the people occupied with fruits of the so called Tech Bubble.
    The Romans called it Bread and Circuses – we have Tablets and Apps.

    • Deco

      The Romans had bread and circuses. The modern Europe has state intervention, and television. The lesser the intelligence, the more time spent watching serialised rubbish for TV audiences.

      Of course, with the survival of Greek debt markets is now seen as an metric of the performance of the ECB. In fact the problem currently is that central bankers seem to think that the bouyant behaviour of asset markets is essential to demostrate that the central bankers are delivering an escape path for bankrupt state systems – like those of Greece, Spain, Ireland, and possibly next….Belgium.

      The entire concept of authority and power is now on the line. Authority is making commands to preserve authority. The whole thing is headed for a climax of the nonsensical.

      Roll out the state programs, and the television serialised psycho control mechanism.

      One critical aspect about money – there is one thing more precious than it – time. How much time is lost forever by vast cohorts of society in front of the circus box ?

      Enough to make society permanently intellectually bankrupt. Ireland is “punching above it’s weight again”, no doubt.

  4. CorkRob

    So, Nobody but the Real Estate Shylocks wants to see a runaway House Price Bluff all over again – that’s for sure.
    However, many like myself will be praying that Variable rates stay low a little longer – especially if you’re struggling to just about meet your interest repayments and a little more each month.
    Higher rates for over 20 % of mortgage holders (those in long term arrears) could prove to be the tipping point and just the incentive those in the bank’s Arrears “Support” Units with Tea Party vigour for repossession, need to increase the carnage of family home seizures – and for what?
    Who are they going to sell to and at what price? The families will still be left with the unpaid debts and have nowhere to live.
    The “cash buyers” will win again and the debt laden families lose – everything.
    Moral Dilemma is coming back to haunt us in more ways than one.
    It’s nigh time that family homes were given the protection they had – not to be used to spay down the banks/developers gambling losses.
    Banks make profit on Interest Rate differential – not Capital payback.\
    If you are paying your monthly interest and anything above that, the bank is making profit (difference between the rate they charge you e.g. 4.4% and the rate the Central Bank charges them e.g. Interbank rate plus 1.5%).
    If they obsess about recovering all your capital NOW, ask them what they’ll do with it to make MORE money ? If they loan it out again to another mortgage holder, they’ll get the same variable rate – so no more profitable than your loan.
    The longer you take to repay your loan the more profit (interest differential) the bank makes.
    So, the real reason the banks want to repossess and sell family homes is to recover capital to cover the huge gambling losses they made loaning hundreds of millions of Euros to developers on projects that went south.
    We all see adverts with “95% of all First Time Buyers Mortgage Applications approved” but do you know anyone who has gotten one recently? And how many applications did they accept anyway?
    Finally, Take ANY and ALL proclamations from the pathetic Estate Agencies (DNG/Sherry Fitz/DAFT) with a large grain of salt – they are nothing but vested interests in scalping the house buying public.
    Consider this, it always amused me during the housing bubble how the chief economists with any/all of these Estate Agencies could predict the exact future House Price rate increase for the next 12 months, to 0.01 of a percent !!!!! All inflationary crap and scaremongering.
    Lets hold tough and await the CSO’s report of a 3rd monthly DROP in a row for Dublin house prices – that’s right – they dropped for the last 2 months !!! Imagine that !

    • Adelaide

      “Carnage!”. Good grief.
      Let’s knock the melodrama on the head regarding repossessions.
      To date there have been no repossessions in Ireland.

      QUESTION: How many recorded repossessions were there in the last five years?
      ANSWER: 3000. That is Three thousand. So negligible not worth mentioning.

      QUESTION: Are repossessions accelerating or decelerating?
      ANSWER: Decelerating. There were 168 (One Hundred & Sixty Eight) repossessions in the last quarter 2013.

      QUESTION: What percentage of the population reside in mortgaged accommodation?
      ANSWER: One third. Another third reside in rented accommodation. There are no statistics regarding children
      but based on the 50-50 split mortgage-to-rent then half of Irish children reside in rented accommodation.

      QUESTION: Why the persistent focus on property prices in the mainstream media?
      ANSWER: It is a distraction. A sleight of hand. At this stage the fate of the property market has no bearing
      on the severe bigger-picture correction that awaits us.

      Lastly, it is such a tedious subject. As I said before, it’s socialism for mortgage holders, capitalism for renters.
      It’s simple, if you can’t afford your mortgage you can’t afford your mortgage, no more than if you can’t afford your rent you can’t afford your rent.

    • Colin

      ‘Socialism for the rich’ brigade, out defending their patch again.

      Carnage? No way, your house gets repossessed, and the nice people at the council put you on a waiting list for a council house, and in the meantime, the council will pay your rent while you rent a house in a nice surburban setting. Absolutely nothing to get alarmed about. Ok, your kids might have to move schools, but that’s about it. Get a grip. Someone will buy repossessed houses if they are sold at a low enough price. Life goes on.

  5. EugeneN

    I am fairly unconvinced that there is a credit boom in Dublin, in fact I think we are in the dying stages of a Dead Cat Bounce. My theory is

    1) In early 2013 the government brought in the ban the bedsits law.
    2) This took a few months to work through the system but rents increased fairly substantially from late 2012 to 2013. That wasn’t, as David points out, demographics. Nor was it economic growth although that did pick up.
    3) Because rents increased cash moved in, and because cash moved in a floor was set in the market, and more cash moved in.
    4) Cash was about 50% of the entire market and 60% in the Summer. There were 12K transactions.
    5) This cash for residential properties was not foreign. There may be some Chinese parents buying their students some property but REIT’s would buy commercial and/or full apartment blocks, but thats not where the growth is. It’s houses in SCD.
    6) Cash can’t continue to be 50-60% of an increasing market. Will it grow by 10% a year this year? Only if cash is available to pay more than the 1.2 Billion it paid last year – (assuming 50% of 12,000 transactions at about 200K.) So it would need 1.4B this year, but only if the supply doesn’t increase.
    7) David is far too pessimistic about supply. It wouldn’t take that much to destroy a market with only 12K transactions. Lets say just 3000 extra sellers are convinced to sell this year, pushing the market to 15,000. To stay at 50% of that market, and to lock in the 10% increase expected this year cash would have to be 1.6B. Assume a few more sellers and cash has to pony up vast sums.
    8) Repossessions are accelerating.

    Daft looks like it’s increasing the number of properties available week by week already, so I expect some drops in the summer. In fact I think Irish cash is all used up. The “smart money”/”Acummuluated savings” is gone.

    • Adelaide

      I would definitely agree with your observation on Daft, a dramatic increase in properties for sale. Also a noticeable drop in asking prices (outside Dublin). I would say against that a large percentage of that are simply piles of bricks with the hilarious “Refurbishment Opportunity” tags.

      It would be helpful if Daft installed a filter to exclude these decrepid “Refurbishment Opportunity” properties.

      PS Can someone explain to me why there are so many ads with a single photo? Surely the vendor is not serious about selling? Why even bother with one single photo, makes no sense.

    • Deco

      Good work there Eugene. We need peopel who see things for what they really are, and who call them thus.

      You points are more useful than a months supply of the IT Property supplement.

      There is a lot of Irish cash abroad – for the reason that returns are better there. And a lot of people on state pensions are resident abroad.

      The market is very small. And there is an explanation for that. There seems to be )i) a social more based on superficiality and keeping up appearances, and (ii) mortgage provider reluctance involved in releasing property onto the market in case it would drive down prices.

      i) “ya might be in negative equity…but ya wouldn’t want to sell cause you would look like a right fool…what would the neighbours thingk ? and anyway wait until prices rise again and then sell if you need to….

      ii) same thing is already preventing the Spanish property market reaching the floor. The Irish mortgage providers are not allowing defaults. I don’t know how they are holding it together. Maybe people are resigned to the fact that they are not going to win as a result of it. Maybe the fact that most of the mortgage holders are committed to staying in Dublin, or the east region ? Maybe people are unable to save a new deposit. Maybe it is boiling frog syndrome. But there has been no revolt of the mortgage payers.

      Anyway, the Irish financial system is still very sick. All that is holding it together is EU money, a tech boom in Dublin, and some cash returning from elsewhere in other counties.

      Strangely enough Noonan’s DIRT tax increase was probably the stupidiest decision of all because it makes savers feel less secure, and drives money out of the banking system.

      If anybody can create a mess of a key ministerial portfolio it is surely Michael Noonan. FG are praying that the tech boom will not become evident as a bubble until after the May election.

      • Pedro Nunez

        No worries of accountability, sure after the court outcome yesterday, its not just Gerry & the shinners that bleat ‘we’re all to blame, we’re all blame’


  6. obamazymandias

    “Financial markets have no memory” is,however unintentional, somewhat misleading i feel,to the uninitiated in stocks/bonds etc ,like myself. We are all agreed ,i hope,that the financial markets are certainly not suffering from amnesia and senile dementia hasn’t set in either ;)

    The ‘success’ of these new Greek bonds has feic all to do with the memory of markets and/or lack thereof, or of mature adults doing deals either.The markets know all too well and are motivated by the Fact, that all things being equal, Mario D will be,is, “the buyer of last resort”, for the sake of the ‘Euro family’s’ cohesion and stability too ,or at least the outwardly appearance of same,and gamblers,gamble accordingly.

    “Defaulters get second chances” ( are we talking about a ‘time out on the naughty step David ?’) when the stock is priced well against risk and because real value in the commercial battleground of stocks/bonds etc is so so competitive and tight nowadays, that every basis point is a prisoner.

    Of what I’ve read,but don’t fully understand, the English law Greek bonds that were last week oversubscribed, did NOT get a hair cut when Greece defaulted,unlike the Greek law Greek bonds, that DID receive a ~70% haircut,so the risk factor on these English law Greek bonds,is not close as high…another significant motivator!

    And in a rigged market,where players are scramblin’ for any decent yield,these (ELG) English law Greek bonds were much more attractive than GLG bonds,considering their lower risk exposure for reasons already mentioned and these bonds are marketed more at international buyers, and NOT Greece’s banks ( which required a law change/ammendment i’m almost sure?) as was the case when Greece defaulted ( i.e. where govt/soverign owned a huge chunk of cds’s,as Kyle Bass explained on HardTalk way back when ) Again, more motivators for investors!

    So there was 20billion of bids attracted for many reasons,right? One doesn’t generate that level of interest from an advert on gumtree !

    So,our Greek comrades are too reduced to serfs by international finance and must find it just impossible to yin to that monstrous level of yang, but what’s new!

    “a club worth joining”,my arse!!


  7. Deco

    David – if you know anybody thinking of putting their name forward on the EP ticket before the deadline kicks in this week, please give them your encouragement.

    The line up on some of the constituencies is abysmal. Serial non-performers and “business as usual” types prevail. Some of them are even confident that all they have to do is stick up posters and they will get elected on the back of large party votes, and party money.

    Diarmuid Flynn and Nessa Childers are the only ones that inspire any solid confidence of greater transparency from EU institutions, with no agenda, and no party whip to keep them in line. Perhaps Marian Harkin might do likewise, or Mairead McGuinness if she is not restricted by the party whip.

    We cannot complian, if we continue to send mediocre representation to the EP.

  8. Deco

    Let’s see if there is a housing bubble on the other side of a decline in the amount of cash flowing into social media companies…..

    Many of these companies are investing money on the basis that they are getting it, and they are chasing market share – they are not investing money on the basis that is is realised revenue.

    It is unsustainable. What is it about the east of Ireland in general, and DART line Dublin in particular, that loves a housing price boom ? Many participants do really think that Dublin is the centre of the universe. I remember years ago backbacking in India, and I came across this sense that the Indians think that India is the centre of the known world. And I cannot blame them. There are 1.3 billion of them. They have had the Far east on one side, and the Middle East and Europe on the other. They were between the two. I mean fair enough – who wants to argue with a billion plus Indians ?

    But people buying real estate in Dublin, thinking that it is the centre of the known world are bonkers. There has been a bull market in centralism in Ireland since the 1960s.

  9. Dorothy Jones

    German Banks as Pawnbrokers to Ireland;they’re very exposed anyhows ‘NYTimes article: @Ireland’s Debt to Foreign Banks Is Still Unknown’ http://www.nytimes.com/2010/11/24/business/global/24banks.html?src=tp&_r=1&

    Goes some way to explain all the nonsense in German media about Ireland as ‘Musterschuler’.

  10. Dorothy Jones

    Right. On the 7 am to Frankfurt. Each week. Why were the Irish politicians so subservient during the so-called recession? We fit out ca. 12 x 7k sqm / p / annum in DE. I don’t understand why ie inc did not use its leverage? The German Banks are exposed to ie, not the other way around.
    David, why do you write for Capital? Diametrically opp to what you stand for. Puzzled

    • Hi Doro,

      David, why do you write for Capital?

      Well, LOL, what choice is left after all, nothing but the junk content provider Gruner Jahr.


      FTD? …Gone!
      Impulse? …Gone!
      Boerse Online? …Gone!

      Capital? Relaunched by Gruner Jahr in 2013. DMcW chest bursting for pride announces to write a column in there. Utterly Risible in my opinion!

      Capital Interests? Advertisers!
      DMcW Interests? Selling his views&talks to potential investors.

      Junk publisher meets junk publishing house. Perfect marriage… for a while.

    • Diametrically opp to what you stand for.

      On the contray, on the contrary in deed!

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