In this week’s Off The Cuff podcast, Chris and Wolf Richter discuss:
- The Market Is Making Some Dangerous Assumptions
- Right now it’s confident the Fed won’t hike this year. But will that be the case?
- A Rate Surprise Would Shock The Markets
- But the massive rebound seen since Jan supports hiking
- Higher Rates Would Help The Fed Address The Coming Recession
- Yet another reason rates can still go up
- But There’s No Guarantee The Fed Can Ride To The Rescue
- One day its stimulus will stop working, no matter how large
There’s been a lot of releases from the Federal Reserve lately which Chris and Wolf deconstruct here. Wolf is of the mind that the markets are interpreting the Fed’s recent dovish moves as complete capitulation. He’s not so sure about that — he thinks the Fed will raise rates if given the opportunity. And the massive market recovery since the start of the year is giving it more and more validation for further hikes. So Wolf warns that the market could be in for a nasty surprise should the Fed hike later this year.
But he also warns that the Fed is guilty of making some shaky assumptions of its own. Here he explains why its stimulus playbook may not work as expected when the next recession arrives:
Just watch what’s happening in Europe right now with the economies slowing, and the ECB trying to stop its QE program on paper. But it’s actually still increasing a little bit and it can’t raise rates. And now you have several economies slowing down dramatically, and the ECB is watching — what’s it going to do, cut the rates more into the negative? The banks are already squealing about that, and it hasn’t really helped stimulate anything.
The same thing in Japan. They have a permanent QE program – they’ve had QE before it was called “QE” – they taught us how to do it. They’re now using, for the last two years, yield curve targeting, so they’re actually trying to manipulate the entire yield curve, not just the short end, but the entire yield curve with its rate policy. And so, as the Japanese economy slows down further, what is the central bank going to do?
If the ‘stimulus’ theory is correct, there should be an enormous amount of economic growth in the Eurozone and in Japan. But that’s just not the case. So, we’ve got all this stimulus out there, and we get, essentially, zero or close to 0% economic growth in the early part of 2019 in those two areas.
This is against all the theories. When you apply this kind of stimulus and these kinds of government deficits and these kinds of negative intertwined policies, and you have quantitative easing, the thing is supposed to be booming. Instead, the economic growth is slowing and it’s heading towards 0%. It has become negative in some quarters, not just in Italy. Germany is playing with that, too.
So, it will be really interesting to see: What if the US economy goes into a recession and the stimulus being applied doesn’t do anything?
If you had asked me years ago, “If you have this kind of deficit spending, could you even have a recession?” I would have said, “No. No way.” But now, I’m thinking, “Yeah, it’s possible”, and it’s likely that we’re going to get a recession next year despite the enormous government deficit which is stimulus spending, and despite relatively low interest rates, and despite the stimulus going on in other parts of the world. The classic stimulus just becomes less and less effective.
Chris Martenson: Welcome, everyone, to this Off the Cuff. We're recording this on Wednesday, February 20, 2019. The Fed minutes got released today. We've got that news. The Australian housing market is not just plateauing at this point, as our guest is wont to say, they're having a bit of a collapse over there—for good reason too, because as we all know, bubbles always require two things: a good story, and lots of credit. Both of those are in jeopardy now as far as the Australian housing market goes. We'll get to that.
Before we go much further, we have the Senior Editor, the owner, the main driving force behind wolfstreet.com, Wolf Richter. Wolf, welcome back.
Wolf Richter: Thanks for having me back, Chris.
Chris Martenson: Alright. So, let's start with the... the Fed minutes got released today. Here's why I object to the minutes, because something always seems to happen on Fed minutes day, which is there's a little bit of a head fake in the first one or two minutes after they get released, the algos are digesting headlines. And then, for whatever reason, stocks go up and gold goes down. It's been like this for as long as I can remember, and maybe it's just Pavlovian at this point: the market knows which way to salivate.
But that always seems to happen, and what drives me nuts is that when I talk with guys like Axel Merk, they've got real good insider access to Fed officials, talking with Danielle DiMartino Booth—other people like that who have more direct access than I do. They say, "Look, Chris, what they're really doing now is they're scrubbing the heck out of these minutes; everybody now has a chance to look at them, revise them." So, they're not minutes of the meeting, per se, they're the minutes after they've held the meeting that the people had a chance to reflect on, gauge their little trial balloons out in the market, and then they sort of tune the minutes.
So, they're just words, right? But for whatever reason, these words have oracle-like impact on the markets. You're like, "Oh my gosh, the oracle has spoken." And it's the same stuff we hear every time: "The economy is strong, things look good, we're going to be patient, we're going to observe." Despite the fact that there's no new content in there that I can divine, we always seem to get these market moves that defy what you and I might call—or I wouldn't put words in your mouth—what I might call—they defy any sort of logic; they just have sort of a mind of their own.
So, we're in a world of really, really super-easy monetary conditions; financial conditions are near a peak over the last decade when you measure the overall financial conditions index. So, we're right up near the easiest they've been in a long time. And just this week—and it's only Wednesday—we've seen the People's Bank of China come out and talk about easier conditions; the Bank of Japan, the European Central Bank, and the Fed have all come out and said, "We stand ready to do whatever is necessary to keep things easy and good. But the economy is strong, hiring looks good."
I can't put all this together. We were just talking about this before we decided to hit the "Record" button, let's talk about it here now that we have people listening. What are you making of this mess?
Wolf Richter: Well, the financial conditions were getting really tight, really fast just before Christmas. We've seen that in just about every index, whether it's leveraged loans, there is a sort of mini-panic breaking out. And I think that really spooked the central banks. Credit was tightening up on the high-risk side, there were no junk bonds being issued for quite a while before Christmas, leveraged loans have blown out, they were in the hole for the year, which is sort of unheard of in reasonable times, and it made it difficult for some of the riskier companies to get funding. So, I think we saw a reaction to that from the central banks. Now, the reaction is going, as you said, the other way, and financial conditions have bounced way back and they're loose again.
In terms of the Fed minutes, I developed sort of a half-joking and half-seriously, my Fed Hawk-o-Meter, and it's a chart that I have—and I would post it here in a moment—that measures how often the words, "strong," "stronger", or "strongly" show up in the minutes. And the thing is that the minutes is the Fed's effort—one of the Fed's efforts—to communicate with the public. So, this is a communications tool, it's not really what happened at the meetings, it's a communications tool. So, I'm trying to figure out what is sort of communicating here. Before we got to the hawkish part of the Fed years—so, up through 2017—the average time that the words "strong", "stronger", or "strongly" appeared was 8.7 times per meeting minutes.
And then in early 2018, that started rising, and by August last year, we had 32 mentions of "strong," "stronger", or "strongly". So, it goes from 8.7 to 32 in August; and then August, the Fed was preparing the world for its fourth rate hike that year. And you've got to remember that early in the year, people thought there would be one or two rate hikes; so, now we're getting—that's last year—so, we're getting four and the Fed dropped that in.
That was the peak. Since then, my Hawk-o-Meter steadily declined; I'm down by a few notches at every meeting. And in today's minutes, there were 23 mentions of that word.
Chris Martenson: Strong. That's strong.
Wolf Richter: That's still pretty strong. It's still above the red line; it's way down from the peak, but it's way up from—I mean it's still an outlier. When you look at the chart, it's just way above the last six years. So, that's kind of where the Fed stands. They demoted the economy during the statement at the last meeting from "strong" to "solid". Economic growth is now "solid" instead of "strong," but there are still many things that are strong. And it's at a level where... not like August where they're really pushing for rate hikes, but it's at a level where they're probably okay with where they are in terms of rates, and that's what they're trying to communicate. If it drops further, if you're going down back to the single digits, I think there'll be some concerns. But it's been in the single digits all these years since the financial crises and we didn't get any rate cuts. We were at zero, and then it goes up.
So, right now, I think they're communicating, "We're okay where we are, and it's still strong, but we're ready to hike if we see inflation ticking up and if we see economic growth ticking up from where it is right now." That's what that measure is telling me. When you look at the chart, you see how far that's backed off, so they're no longer near the rate hike panic that they were in August, but they're still above where they had been earlier 2018.
So, it's just sort of in the middle there, and I don't know that the market is overreacting. Right now, there's no rate cut in sight in this; it's all about leaving rates like they are, or ticking them up one notch or two, and I think that's the scenario that they're trying to communicate here.
Chris Martenson: Well, I don't know... the futures market for rates hikes seems to be set at 0 at the moment, from the charts I've been reading. So—
Wolf Richter: Yeah, this is really interesting. I love that you bring that up; that's a great observation. Because early last year, it was also at 0—between 0 and 1 rate hikes. And we got 4. The futures market is always that way. When it gets closer and the Fed communicates, "Okay, so within the next two months, we're going to hike rates," that's when the futures market really starts reacting to it. Right now, that's what the futures market is saying, it's 0, but it's not predicting anything about the second half. The futures market has consistently failed to predict anything about anything further away than three months.
Chris Martenson: Wow, it sounds like economists. Jeez. Wow.
Wolf Richter: [Laughter] I mean it's just fun to watch how they... and all last year, they're just lagging behind and the media cites the futures market, that's what is going to happen, and the futures market is just sort of wishfully thinking that there's not going to be anything. And then it gets closer, suddenly it ticks up. So, when you look at the charts, they all look the same. For each meeting, the futures market predicts no rate hikes eight or ten months in advance. And then gradually, it ticks up. The probability does. I love that future markets prediction, because it's probably the worst prediction there is in terms of when they're further away.
When they get close, they are very accurate. Once you're within three months, I think it's a very accurate prediction. Two months or one month is nearly 100 percent accurate. So, I think they're telling you right now there won't be a rate hike, for sure, the next couple of three months or four months, I think that's accurate. What happens in the second half, I think the futures market is... it just doesn't know, it just thinks it's 0, but it could be anything. Last year, we got two rate hikes in the second half, and the futures market eventually adjusted to it.
Chris Martenson: Well, what can we really trust about what the Fed is going to do? Remember way back, Ben Bernanke said a couple things. First, he said, "We're not going to monetize government debt." And now that they're talking about stopping the balance sheet unwind, of course, they did monetize debt—trillions of dollars of government debt. So, A). there was monetization of debt. But, B). you remember Bernanke said, "We're going to do this by the books; here are our numbers. When unemployment gets to this level and inflation gets to this level, we're done. That's it." We're way past those levels. Unemployment, as measured—I don't believe the unemployment numbers for a variety of reasons—but as measured, we're way into territory where they should have been backing off a really long time ago, but we don't see the world's central banks backing off.
This is why I don't really follow what the Fed does all that much in isolation. I always have to know what's the Peoples Bank of China up to? What's the Bank of Japan up to? What's the ECB up to? Much, much, much, much lesser extents, I'll look at what Canada, and the UK, and Australia, and New Zealand are up to. But I think they're mostly in follow mode, or there's some locally-interesting stories about what they're up to. But otherwise, you follow those big four, and you pretty much have a handle on what's going on.
From that, I'm looking at a chart here, it's put out by Bloomberg, it's called the Financial Conditions Index, and it started to head down in December, but boy, it's rocketed right straight back up. Most of that heavy lifting on that has come from the Bank of China. Now, the Fed has had to be keeping an eye on these global conditions. They know they're global markets, they know now that when mysterious things, like when Apple reports less than stellar revenue growth, and the Japanese Yen/Australian Dollar cross pair tanks, they know that this is a global market. So, looking at that, they have to know that the financial conditions are just being horsewhipped higher, and higher, and higher again. And they seem to be okay with that; in fact, I see them cheering it on.
Wolf Richter: Yeah. It's such a double-edged sword, and financial conditions are... when they're loose, they create risks. The Fed was trying to tamp down on some of that risk-taking, and it just—like you said, they whiplashed the markets too fast; too much risk-off activity going on before Christmas. Now, it's completely bounced back in many sectors as you pointed out.
There's another way of looking this, and that's saying, "Okay, so now the Fed is looking at this and it's putting a foundation—a new foundation—mini-foundation, so to speak—under a somewhat firmer monetary policy going forward. They're worried about all kinds of things in both directions. When financial conditions are really loose and risk-taking is strong, then they are more justified in our minds in becoming a little bit more... I'm not going to say "hawkish", but a little bit less dovish about the markets and the financial conditions in the United States.
When you see markets crashing like they did last year, I think it's very tough for the Fed to raise rates and continue their balance sheet runoff. But if you've got that kind of rally that we now had, it just supports that. They're going to eventually stop the balance sheet runoff, maybe this year, maybe next year sometime. They're going to announce a plan pretty soon about that. Meanwhile, it keeps going on, and they're going to eventually when we get a recession, drop the rates. But until that happens, I think the kind of market activity that we've seen recently, supports them in any efforts to raise rates later this year. It goes both ways. So, a very strong market like that, any slight uptick in inflation would encourage the Fed to step on the brake a little bit.
Chris Martenson: It is kind of a mixed bag. I don't know what I would do if I was in the Fed's position, besides not have gotten into this position in the first place many years ago. But here we are. And by the way, a lot of the indicators that they claim to be following look pretty lagging. It's like driving with your eyes firmly on the rearview mirror. But if we look at things, it's kind of a mixed bag out there; we see the Baltic Dry Index really plumbing really fresh lows, and of course, that's carrying the base of the economic pyramid kind of stuff; you've got the iron ore, and copper, and wheat, and stuff like that.
So, that's kind of low. You've been tracking the trucking index. It's showing what we were seeing in 2015, '16, which as another near brush with recessionary times—I think we kind of got there globally, but not in the US. And we're seeing reasonably good hiring, if not strong hiring, depending on how you look at it; it looks like wage growth is up, but consumer spending took a mysterious big hit on that last report that came out.
So, kind of a mixed bag; nothing looking too great. But from everything I track—particularly the credit impulse—that's showing a very strong likelihood of a recession coming up in the next year or so.
So, given all that, is it really the central banks' jobs to attempt to predict and forestall a recession, and is there anything they can do about it this late in a credit cycle, really?
Wolf Richter: Personally, I think it's just the wrong responsibility to give the Fed to say, "Okay, Fed, you stop the business cycle. We don't want any more recessions, and it's your job to stop all recessions." We need to have recessions; recessions are an important part of the business cycle, there's a cleansing process associated with them—and I'm not talking about a financial crisis, but just a regular recession. It cleans out the dead wood and gets rid of some of the zombie companies, it allows debt to be restructured in bankruptcy court. So, when you emerge from a recession like that, the companies are less indebted and there's sort of a freshness that comes with the recovery.
Now, that wasn't really allowed to happen during the financial crisis, so the debt was never gotten rid of in that process, and it's stayed with us now, we're loading up on that pile of debt, we've got a lot more debt than ever before in every sector, and this is government, corporate debt, and household debt.
So, we've not been through that process properly—the households deleveraged a little bit during the financial crisis, but the corporate sector did not properly deleverage, and that's where the—
Chris Martenson: Not even close.
Wolf Richter: Yeah, not even close. Now we've got this problem that we never really cleared out the deadwood last time, now it's sort of like the woods in California. I mean there's too much deadwood on the ground from last time—from years ago—and we really need a recession to clean this out. I think it's silly to expect the Fed to keep stopping or preventing these recessions, but that's probably what they're going to try to do.
When we take this a step further, they are better equipped to sort of slow down the recession or stop it or create a recovery if they have higher rates to begin with, so that they can cut more rates, can cut it more deeply and create more of a sudden stimulus to the economy. That's one reason why the Fed would like to have relatively high interest rates before the next recession hits, so they can actually do something... do something beyond cutting rates by 2 percentage points. If they can cut them 3 percentage points or more, that'd be great.
Now, they're not going to get there, but that's kind of classically… or 4 percentage points, 5 percentage point cuts. Those were the measures that really stimulated lending during prior recessions, and the Fed doesn't have that leeway. So, it's a little bit handicapped. In Europe and in Japan, rates are negative, and they don't have any leeway to cut rates in terms of going from a positive rate down to 0; they're already in negative territory, so they're more constrained. Europe is heading into a recession already, with several countries already in it, and Germany teetering on the edge of it.
The ECB policy rate, one of them is just slightly negative, and the other is at 0. So, their tools are really... they don't have the classic tools anymore to deal with this, because of that. So, I think there's some reason to think that the Fed would continue to want to raise rates before we get a recession. We will get a recession, I mean there's just no way around it, it'll probably get here, I don't know... next year, maybe. If the Fed has one or two more rate hikes in its pocket before that recession hits, then it has a little bit extra leeway to deal with it. That's something that enters into their thinking, and I think we have to be aware of that.
Chris Martenson: Well, sure. And one of my critiques of all of that too, is that it is a little bit different this time, because in the past when the Fed would fight a recession by making things easier, they would do that by lowering interest rates. In the past, what that meant was they would go out into the open market where interest rates are set, that's the overnight bank lending rate—that's what the Fed directly controls—and the way you would make the interest rates go down is you would push cash out into that system, that ecosystem would get tons of cash. They would push cash out there until the banks were lending to each other at an overnight rate that said, "Hey, we have sufficient liquidity out here."
Directly, you would see people experience slightly lower interest rates on car purchases, on their mortgage, things like that. That would be stimulative, but ultimately, it meant there was plenty of liquidity out there. Now, this time, Wolf, the problem is they've just been setting the interest on excess reserves like a dial. They haven't been withdrawing any liquidity from the marketplace, there's plenty of liquidity already in the marketplace.
So, I think the mistake might be thinking that, if next time... let's imagine a recession surprises us, starts in six months, and they're roughly at the 3 percent mark at that point in time. Then when they cut, even if they cut a full 2 percent in that mode, what that really means is they're just going to be dialing down the amount they're paying on interest on excess reserves, but there's still trillions of dollars of liquidity—tons of liquidity out in the marketplace. So, the interest rate goes down. Again, minor direct effects on auto loans, mortgages, thing like that. But it doesn't have any impact on the amount of liquidity that's out there.
So, that was... I think they've taken their toolkit, and they've basically whittled it down and made it... it's probably going to be less potent next time, I would think.
Wolf Richter: Yeah, I agree with that. You just need to watch what's happening in Europe right now with the economies slowing, and the ECB trying... as you pointed out before or were recording—trying to stop its QE program on paper, but it's actually still increasing a little bit, and they can't raise rates, and now you have several economies slowing down dramatically, and the ECB is watching. What's it going to do, cut the rates more into the negative? The banks are already squealing about that, and it hasn't really helped stimulate anything.
The same thing in Japan. They have a permanent QE program—they've had QE before it was called "QE"—they taught us how to do it. They're now using, for the last two years, yield curve targeting, so they're actually trying to manipulate the entire yield curve, not just the short end, but the entire yield curve with its rate policy. The Japanese economy slows down, what is the central bank going to do?
With all the stimulus that would be—if the theory is correct—there should be an enormous amount of economic growth in the Eurozone and in Japan, and that's just not the case. So, we've got all this stimulus out there, and we get, essentially, zero or close to zero economic growth in the early part of 2019 in those two areas.
This is against all the theories. When you apply this kind of stimulus, and these kinds of government deficits, and these kinds of negative interest rate policies, and you have quantitative easing, the thing is supposed to be booming; instead, economic growth is slowing and it's heading towards 0. It has become negative in some corners, not just in Italy, and Germany is playing with that too.
So, it is really interesting to see, what if the US economy goes into a recession and the stimulus being applied doesn't do anything?
Chris Martenson: Yeah. Well, we're already at deficits at the US federal level that are running around 1.3 trillion. And 1.3 into 20, which is 20 trillion, it's about the size of the GDP, just a little under. When I run those numbers, I find that about 6.2 percent of the US GDP is deficit spending right now. So, the implication being if the US government suddenly ran a balanced budget, what would happen would be about a 6 percent hit to overall GDP level—roughly.
So, when we look at that, to say that the economy is chugging along at 3 percent, that's with a pretty—a 6 percent deficit is really high. If you were any European country trying that, you'd be in violation of the Maastricht Treaty, which limits you to 3 percent deficit to GDP. So, the United States would have had to undergo about a $650 billion reduction in its deficit spending for this year. And this is with an economy that's 32 times strong, right?
Wolf Richter: Yeah. If you had asked me years ago, "If you have this kind of deficit spending, could you even have a recession?" I would have said, "No. No way." But now, I'm thinking, "Yeah, it's possible, and it's likely that we're going to get a recession next year, despite the enormous government deficit which is stimulus spending, and despite relatively low interest rates, and despite the stimulus going on in other parts of the world. The classic stimulus just sort of becomes less and less effective.
Chris Martenson: Yeah, it does. Now, let's talk about one of my favorite subjects, it's bubble dynamics. I love them and I introduced this by saying all bubbles have two components. One, you have a story; two, you've got to have credit. I can't find a bubble in history that didn't have both those things. They're human creations, not financial creations.
In Australia, Sydney and Melbourne, you had a really interesting stat I didn't know about—you said they account for about two-thirds of the residential property value in Australia. So, we read about all the different parts of Australia, you got your Perth in the Northwest, all that stuff. But Sydney and Melbourne, it's about two-thirds of the total pie such as it is, and those house prices are down 12 percent and 9 percent respectively, across Sydney and Melbourne—that's big, particularly given the amount of leverage that a lot of people were carrying in that.
Let's talk about that housing market right now, and what you think the chances are of that becoming something of a systemic problem for them, in the banking system.
Wolf Richter: The Sydney and Melbourne markets are metropolitan areas. So, there are very large metropolitan areas around those two cities. The cities are gorgeous. They're huge, huge cities. When you go into the rest of Australia, the cities are much smaller, the metropolitan areas are much smaller, and much of Australia is desert, and some of it is agricultural.
This is part of a densely-populated cultural area, and these are very expensive, expensive, expensive housing markets. Unlike the United States, there really wasn't any kind of serious downturn in those markets during the financial crisis. Australia never even experienced a recession during the financial crisis, but there was a little dip in the home prices in those markets, but it wasn't much.
So, they've had about two decades of a housing boom with enormous price increases, and it got to the point where middle-class Australians couldn't afford to buy housing anymore in those markets. There was a political problem, and also there were all these revelations in the media about all the things you need in order to create such a housing bubble, which is banking shenanigans and mortgage fraud.
So the banking regulators started to crack down a little bit starting in 2015 and '16, and there wasn't all that much movement, but there was some. Then in late 2017, the Royal Commission was established to investigate these banking shenanigans, and they have found what's been called "an epidemic of crime" in the lending side of the business. That's what you need. In order to create such an enormous bubble, you need to have credit and the credit needs to be blindly handed out, and risks need to be completely shuffled off, and everybody needs to be super optimistic that home prices only go up, and that, therefore, you can lend recklessly, because you know if the buyer gets in trouble you can always sell the house and get more money for it than they borrowed for it.
All this is now being vividly displayed on a daily basis, these revelations keep coming out, and there's a lot of regulatory pressure on the banks, there have been all kinds of rule changes, the interest-only loans—and most of the mortgages in Australia are variable-rate mortgages. So, rising interest rates can have a huge impact on the market. Now, Australia's central bank has left the interest rate at its historic low.
So, it is not the interest rates that caused this—the interest rates are still very low, but it's a regulatory crackdown on the abuses. It has essentially eliminated buyers from coming into the market that shouldn't and normally couldn't have bought, because they couldn't have gotten credit, and they only got credit because of these lending shenanigans. So they have been pushed out of the market.
There are other pressures: Chinese buyers have been a very important factor and there's pressure from China on capital flows overseas, so that has been... the spigot has been turned off. There are also problems now—because the Chinese buyers are investors, they're overseas investors, non-resident investors, and now they see the property prices plunging, so they're getting cold feet, they're trying to pull out.
You've got this whole house of cards, so to speak, being taken apart from all kinds of sides. This is not a stock mutual fund, this is a highly-leveraged investment. That's what housing is in Australia, it's considered an investment. It's so highly leveraged that any price decline is going to cause major problems. That's exactly what's happening, and this is sort of escalating now that these price declines lead to further negativity in the market, and you've got the regulatory crackdown.
People that might be interested in buying can't get the funding, and it's in that cycle. The last few months in Sydney in Australia, the home price declines actually accelerated, and accelerated quite dramatically. The most expensive parts of the cities had the steepest decline. So, it's the high end that gets taken out and shot.
The lower end has not declined that much, even though it's starting to come down too, and the lower end being the lower-end condos, usually. There's the hope that the first-time buyers would salvage the market, but they are still strung out—the first-time buyers can't afford those prices, really.
This is a classic example of a housing bubble driven by lending shenanigans for two decades that regulators and investigative commission tried to crack down on. And then the deflation of that bubble takes on a momentum of its own. Even now, some of the regulators are trying to back off, now that the housing bubble is deflating on its own and investors are suddenly seeing the prices are declining and they don't want anything to do with it. They're pulling out, and people are trying to sell to get rid of their investment properties.
Now, it doesn't need the regulators anymore to be cracking down on it, this thing is deflating on its own momentum. That's fairly typical, but I don't think I've ever seen anything this large; this is just an uninterrupted, two-decade boom that's run into hard times, and it's going to deflate. The people I'm citing in this particular article forecast a 20 percent house price decline—15 to 20 percent in just 2019. So, that would be on top of the declines last year and late 2017. That would amount to—for Sydney—to something like a 30 percent decline by year-end from the peak.
And that might not be the end of that, but a 30 percent decline would set off a financial crisis in Australia because the banks are not able to handle that.
Chris Martenson: A 30 percent decline… I was watching Australia's 60 Minutes, and they were talking about the usual stuff that happens towards the end of a bubble: really shoddy construction, some big tower that was just cracking months after it had been finished... the usual stuff. But they pointed out that even at that point—I think this show came out a month ago—something like 450,000 mortgages were underwater. If you carry that forward—and this is with I think a then 9 percent decline or something, or 8 percent or something. So, if you went to 30 percent, we'd probably have to say everybody who took out a mortgage in the last what—five years—would be pretty deeply underwater at that point?
Wolf Richter: Yeah, and that's the problem. You have some people that paid off the mortgage, they're not the risk, and then you have some people that have been in their homes for 20 years and they owe a very small amount, and they're not the risk either. But then you have a part of the population that bought fairly recently, 5 years as you mentioned, and that part of the population is at risk. In the United States, during the mortgage crisis—I don't remember exactly if it was like 10 or 11 percent of the mortgages that defaulted. A relatively small percentage, but look what it did. It doesn't take half of the mortgages to default to cause a big problem. If 10 percent default, that's a big problem.
There's a lot of movement in Australia too, people sell their homes and buy new homes. So, there's a lot of people who own their homes for five years or less, and also Australia doesn't really have a 30-year fixed-rate mortgage. These are mortgages that reset, they're refinanced, and they have different options. So, building equity in a home under these conditions can be a little harder—or maybe less required as a large portion of these loans in recent years were interest-only loans, so there's no equity built up at all in that sense. So, that's what that housing market and what the banks are facing.
It's not like I'm the only one that's warning about that. The Australian banks are very exposed to the local housing market, I mean that's their four big banks, and they have really focused on mortgage lending.
The interesting thing is people say, "Well, you guys in the United States, you can just walk away from your mortgages, and that so-called jingle mail, and Australians can't do that because every loan is a full recourse loan in Australia, the same in Canada." But in the United States, there really are only 12 states where we have non-recourse loans and California is one of them, but there are others. The rest of the states are full recourse states, and that includes Florida.
During the financial crisis, jingle mail was everywhere, in every state, including in Florida where they have similar mortgage laws as they have in Australia. When you have a massive number of borrowers defaulting on their mortgages, it's really hard for banks to go after each borrower and try to chase down money from somebody... people have lost their jobs, and don't have the income, and what are you going to get? They don't have any savings, and so they default on their homes, and the only thing the bank can really get is the home and the collateral, and then beyond that, the borrower doesn't have anything. So, they essentially gave up on that.
For Australians or the Australian regulatory authorities to say, "Well, this isn't going to happen here because Australians are responsible and they can't walk away from their loans," etcetera, etcetera, that works on a case-by-case basis. But when you have a tsunami of defaults, that whole theory falls apart, as we have seen in Florida. I don't think the Australian housing market is protected from the kind of mortgage crisis that we have seen in the United States.
Chris Martenson: I agree, and I think it becomes a social phenomenon at some point. Case in point around that would be student loans in the United States; just some numbers came out recently, like 160 billion of them have missed a few payments—whatever the polite term is for a default. And if just a few people are missing, that's one thing. But if you have 160 billion people sort of on a walkaway, that's a little bit of a debtors' strike, if you will. I know a lot of millennials and other young people who have picked up those debts, who feel a little salty about the whole thing anyway.
So, once enough of your friends and... once a critical mass has been reached, I say, it becomes a really big problem for the lenders, and they don't want to recognize it because once you start recognizing it, then you actually have to start booking the losses and all of that. A big thing that we found out here in the United States—because I do have people listening from Australia—was that we had case after case of people who hadn't paid on their mortgage, they were severely behind, they were in default, they were still living in that house, and nobody said anything to them for years. Because—and you understand this—the bank knows the numbers, they look at this, they say, "Gosh, this mortgage is way underwater. If we come and foreclose on the house, we're going to have to book the loss, and if we don't go through that action, we can still continue to carry it on our books at full value."
So, there's a lot of incentives that play out across all of that, but I think you're right: once a critical mass of people decides to jingle mail, they may mail the keys in, but they may not even move out. At that point, I think your next question is, "What are the squatter's laws in my state?" [Chuckles]
Wolf Richter: Yeah, all these laws are reasonably easy police when there's just one or two that are doing that. You have one household default on a mortgage and they're squatting, you can do something about that, you can move the legal process to deal with it, and the bank can take the loss. It's when you have tens of thousands of people doing the same thing; there is no manpower there to really police the laws anymore, the banks are not staffed to deal with these defaults, you don't have enough lawyers, enough judges, enough courtrooms to deal with all this stuff.
The borrowers can hide behind that. That's why, in part, a lot of people didn't have to move out, because there were just so many, and there was just such a huge backlog, and the banks were reluctant as you said, to recognize the losses. Nobody is prepared for a tsunami of defaults like that—it just goes beyond anything anybody ever prepared for, so when it does hit, it can't really be worked with.
Chris Martenson: Yeah, and I just—I don't know if you caught this, but four months ago, there was an interesting case out of Ireland, where a bank had foreclosed on a family farm and apparently there was a little bit of the old squatting thing going on. Some security dudes moved in to evict them—it was a pretty hard evict, and I think they had three or four gentlemen from a security firm come into this farm. They were there protecting the property, and 70 townspeople showed up, literally, with pitchforks and torches, and beat the crap out of them, and sent them on the merry way.
So, these things can take on a life of their own at a certain point—particularly if people feel like it's unfair. This is a component that you really brought forward, I didn't realize how rampant a lot of that corruption was. That's always part of every bubble: easy money just leads to loose practices, it's just part of it. But realizing that there was quite a bit of corruption going on in Australia—as there was in the United States during our last housing bubble—I think we're in another one now.
When you look at all of that corruption, that adds to it, right? Because sometimes people hear about all this corruption and how the banks made a lot of money while things were getting fast and loose and all of that. But now that things are getting a little tight, they want their pound of flesh back and all of their profits preserved—people get salty about that. So, there's some social dynamics that can certainly creep forward and become part of this too.
Wolf Richter: Yeah, that's a very good observation. When the moral high ground has been ceded, you can't apply morality to this issue anymore after you've had years of lending shenanigans that have been exposed. They say, "People owe this and they should pay back," or "they should do this, or should do that," that doesn't apply anymore. People say, "Well, screw you. This is a corrupt industry, and I know there's no morality in it at all, I don't need to follow any rules, I can do whatever I can get away with."
Once there's no more moral high ground, then it just comes all down to who's got the most political power, and in a sense, you have voters that have been pushed out of their properties, and they can exercise quite a bit of influence. This just will be really interesting to watch how this pans out. In a sense, nobody wants a housing collapse in Australia, except for the people that have been locked out of the market—and there are quite a few. For them, this is like the best thing that could happen.
They don't want a 30 percent decline—I mean it's not like everybody is losing, there are winners on the other side—there are lots of winners; there's a whole generation out there that's waiting for that moment, and they're waiting for these investors to get crushed, and they're waiting for the older generation to take its licks, so that this large part of the younger population can actually buy a house or a condo, and live in adequate conditions, and not have too much of a burden on its income. So, there's a very strong positive effect to this, if it's allowed to play out.
Chris Martenson: Well, exactly. And very well said. Turning now to something that really caught my attention, I'm wondering if you'd be willing to talk about it here. You had a fascinating article up on your thought processes, you went through the decision point between making WolfStreet—is it free, does it go behind a paywall, is it supported with ads? And I really like the way you parsed through that and said, of course dollars to help support the site is one thing, but you've got these larger goals in your life which is to reach a lot of people, and you went back and forth over it, and decided that under a subscription model, you would really not reach as many people, which doesn't align with your life goals.
So, I was just wondering if you'd be willing to talk about that, and sort of where you came to in your conclusion on that.
Wolf Richter: Sure. People have seen me at your last conference day—and that was a lot of fun by the way, and I guess we're going to go there again this year.
Chris Martenson: Yeah, totally sold out by the way. I just need to put that into this podcast somewhere. So, that's a good point. So, hey, sold out. Maybe next time.
Wolf Richter: And they had seen that I'm not the youngest guy, I'm in my 60s, and I'm fit and I feel good, and I feel young. But this is going to be my last gig, this website. I started it in 2011, the predecessor website. I've paid my dues in life, I've done things for work that I didn't really enjoy doing, like everybody, so this time around I decided I really want to focus in this gig on what I really enjoy, which is analyzing the world out there and writing it up in articles that even I can understand—that is my criteria—and putting charts together that even I can understand in one glance.
I have a lot of fun doing it, I have a lot of fun communicating with my readers, we have an active comments section. I would lose a lot of that... I would have to focus on running a marketing organization. Right now, I don't spend any effort on marketing my site, no money is spent on it, it's word of mouth, it's spreading, it's doing well, and it's growing. I focus on what I love doing, which is to create these articles, to think about stuff, to mull things over, and to explain it, and to communicate with my readers about it.
The important part is not that I do this with 1,000 people, or 10,000 people; I want to do this with hundreds of thousands of people, and the best way to do this is to just make it free. Free means that there are ads on the website, I try to be reasonable so they're not too obnoxious, there's no pop-ups or anything. But they're intrusive, and they get your attention, and sometimes it's these good-looking, young Thai girls that are lusting after older men, and distracts you from the story and that kind of stuff.
But it's the way I can keep the site free and not hide it behind a paywall. That's really important to me is reach, and I want to have a large… I'm a one-man show, so I don't have a marketing team, I don't have any partners in this, it's just me—and I really want to reach as many people as possible, and I want to enjoy doing what I'm doing, and focus on that. I figure that if I can put the best possible content out there that I can come up with, the growth will come. So far, that logic has been correct, and my ad revenues, for now, are going up.
There's another part in that article—quite a big part—that talks about the internet advertising situation. It is really sick. You have three giants in this—Google, Facebook, and Amazon—and we have many, many layers of middlemen. What the advertiser spends—like Ford Motor Company—what the advertisers spend and what the publishers get is just too huge... there's a huge difference between the two because the middle layers suck most of it out of it.
You have major publications—and there's a whole slew of them this year—that are laying off people, such as Vice and BuzzFeed, and Dallas Morning News, and others—because they don't make enough money on internet advertising revenues, because the middle layers take out too much. Google doesn't leave you enough, and these other sites don't leave you enough. By the time the advertisers' money gets to you, it's just a few crumbs that are left over, and it's not enough to run a news organization, even though these are very popular sites, big sites. They have a good presence and lots of traffic, and they can't make it.
And this is getting worse, it's getting worse every year. So, a website makes less money on a particular ad every year.
Chris Martenson: Don't I know it?
Wolf Richter: Yeah. You have an ad that shows up 10,000 times; one year, you make this amount on this add, and next you make a little less, and then next year you make a little less. So, the only way you can stay even is to have more traffic every year, and...
Chris Martenson: Or you got to do what Zero Hedge does and absolutely destroy people with popups and junk ads, and make the site a practically unusable experience.
Wolf Richter: Yeah, and that does two things. One, you drive away readers, and so that's not good. And two, you encourage people to use ad blockers, which are even worse, because then you don't make any money off of the work that you put out there. So, this aggressive advertising, I totally get it. I totally get why people block ads. Some websites are actually completely unreadable without it, and I don't blame readers for doing that. But the free internet runs off advertising, and if everybody used ad blocking, the internet would be dead, there would be no free content out there.
Chris Martenson: Yeah, that's true. It's a balancing act, and I support whatever steps you make, and there are hybrid models out there, but I just thought it was interesting you're wrestling with it, and I just wanted to alert our people. We wrestle the same thing. Ad revenue is not a really dominant or a reliable thing, and worse, they change the algorithms on you all the time. So, on both ends of the thing, whether you're receiving ad revenue or spending it, it becomes really hard to figure out what's happening, because they're always tweaking the things in the background.
It's hard to build a business around something where your major uncertainty is in hands of an algorithm that you don't control, can't see, don't understand, right? You sort of have to look at the effects of it by your dwindling ad revenue. And that's what they're doing, they're just squeezing as much as they can, because Facebook wants to report the most ad revenue it possibly can, and Google wants to report the most ad revenue it possibly can. So, they do that, but it's absolutely creating a lot of difficulty on the other end, and so that's how this is going to have to mature.
So, kudos for wrestling with it, I liked how you did that very publicly. I thought it was well done.
Wolf Richter: Thank you very much.
Chris Martenson: And with that, we're all done for today. So, thank you so much for your time, and we'll see you soon.
Wolf Richter: Thank you, Chris. I'm looking forward to our meeting in April.
Chris Martenson: Absolutely. Me too.