There is a perfect storm brewing in US financial markets. Whether or not it can be avoided in time to avert another disaster on the scale of last year’s Wall Street meltdown depends on a variety of factors. Follow the lead of North Dakota:
Posted Sep 11, 2009 09:17am EDT
Courtesy of The Business Insider, Sept. 14, 2009:
One year after America’s brush with economic catastrophe, there’s plenty of looking back at the bubbles that caused financial chaos.
But what’s next?
There are surely dangerous economic bubbles forming as we speak. As Alan Greenspan warned this week, “They [financial crises] are all different, but they have one fundamental source,” he said. “That is the unquenchable capability of human beings when confronted with long periods of prosperity to presume that it will continue.”
The trick, of course, is spotting them. By definition, most people don’t spot a bubble before they form and burst.
Here’s 10 for which you should be on alert:
1. China bubble: Despite the weak global economy, the Chinese stock market has soared like crazy this year. But many believe the rally has been driven purely by government-supplied liquidity, rather than fundamentals. The fear is that companies are flush with cash, but have little “real” to do with the cash, so they’re parking it in the stock market casino. The Chinese real estate market appears to be on a similar trajectory.
2. Green bubble: Green has been everywhere. With observers saying the “Age of Cleantech and Biotech” will be the next major economic revolution, and Washington pouring billions of dollars into alternative energy projects, you’d think a bubble would have already formed. But, as we noted this spring, it did not, at least from an investment perspective.
Still, as the economic recovery takes shape, alternative energy could see excess investment on hopes of big future returns. There’s plenty of hype left, and if investors regain the cash to get in the game, could green become the next internet or housing bubble?
3. Gold bubble: Gold prices just keep going up. They’ve risen for seven straight years, recently breaking $1,000 per ounce.
Is it a bubble? Right now, it doesn’t look too bad. Gold is good in both inflationary and deflationary periods, as it holds wealth tangibly. And, as the Telegraph notes, there’s real demand, especially from China.
But with some predicting a doubling of prices to $2,000 an ounce, too many people could jump in and spike the real value of the precious metal. The “rise forever” mentality usually means trouble.
At first glance, the Fed’s effort to clean up mortgage-backed securities is a winner. But, as Heidi Moore wrote for Slate’s The Big Money, the Fed is actually creating a bubble similar to the one it’s trying to do damage control on. By eagerly trying to save banks and stabilize the housing market, Washington is taking on too much: $1.25 trillion of mortgaged-backed securities, including both the original toxic assets and products of foreclosures to come. So who would bail the Fed out? You.
Click here to view the 10 bubbles in the make slide show.
5. Trash stock bubble: There’s a rush to trash going on. Stocks like Fannie Mae (FNM), Freddie Mac (FRE), AIG (AIG) and even GM made big runs in August — trading in trash financials made up nearly one-third of NYSE’s August volume.
So why are people buying junk? Charlie Gasparino says shares of junk financials — companies like Fannie, Freddie, AIG, Citi and Bank of America — are being pushed up by a short squeeze. The Wall Street Journal suspects its high frequency traders. And others say its retail speculation and day traders getting their way while Wall Street went on vacation.
6. Education bubble: More people are going back to college and taking on huge debt to do it, despite questions about what the degree is really worth.
Last year, the amount borrowed by students and received by schools grew some 25% over the previous year, to $75.1 billion. That’s a huge amount, especially with weak, low-paying job prospects for graduates in this economy.
As we’ve noted, all this student loan debt is crazy. Despite the desire to see more subsidization of college, we suspect there will be a collapse in student loan debt availability and desire to take on new debt.
Short of telling kids not to go to college, something’s going to give.
The pop may be starting already. As Bloomberg reports, as many as one-third of all private colleges surveyed said they expected enrollment to drop in the next academic year. And almost 40 percent of those colleges said some of their students dropped out due to personal economic reasons and a quarter said full-time attendees switched to part time. Half said families had to cut back their expected contributions as the value of college savings plans dropped 21 percent last year.
7. Subprime bubble, 2.0: What are banks doing with all those subprime mortgages? They’re repackaging with a higher rating — “re-securitization of real estate mortgage investment conduits” — and selling them.
As we’ve noted, it’s a plan nearly identical to the complicated investment packages of the financial crisis a year ago. That being said, the problem was not strictly securitization, but the underlying housing bubble. So the return of complicated products isn’t necessarily the end of the world.
8. Life insurance securitization bubble: In its search for new profits, Wall Street is planning on securitizing “life settlements” — policies that the sick and elderly can sell for cash while they’re alive — much like it did subprime mortgages. The New York Times warns that we could be looking at subprime all over again.
Maybe. As we’ve noted, it wasn’t securitization that caused the financial meltdown. It was the bursting of the housing bubble. Yes, there was a feedback loop, whereby securitization allowed more money to flow towards housing, but it seems unlikely that “life settlements” would get big enough to infect all portions of the financial world.
9. Commercial real estate bubble: This bubble is already hissing, if not popping outright.
While the economy is improving and some home sales are slowly coming back, the commercial real estate market could get far worse.
As The New York Times reports, “Even though industry lobbyists were able to persuade Congress to extend a loan program aimed at prodding the stalled securitization market back to life, several analysts said it was unlikely to head off a spate of defaults, foreclosures and bankruptcies that could surpass the devastating real estate crash of the early 1990s.”
As UPI notes, commercial mortgage defaults could reach 4.1 percent by the end of the year, up from 2.25 percent in the first quarter, and Real Capital Analytics estimates commercial property loans worth $83 billion have been involved in default, foreclosure or bankruptcy in 2009.
Badly hit will likely be malls. “The next financial tsunami to hit will be the widespread failure of shopping center mortgages,” says Peter Monroe, co-chair of REOMAC, a not for profit trade association to CNBC. “Half a trillion dollars of commercial loans financed on historically low rates, are due for refinancing in the next three years,” says Monroe. “The negative impact of these shopping center mortgages is enormous.”
10. Emerging market bubble: It’s not just China. Risk-tolerant investors are bidding up emerging market shares to valuations not seen in 9 years. With an average PE of 20x, they’re not in bubble territory just yet, but watch for things to get out of hand.
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