A Number of Sectoral Credit Bubbles Become Evident
We have previously argued that the current inflationary echo boom (a boom with clear 'depression undertones' it should be added) is more diffuse than the previous two bubbles were, which were clearly concentrated in specific industries (namely technology and housing). This is still the case; the current echo boom is somewhat broader. Nevertheless, there are several areas in which the effects of the credit expansion have become decidedly manifest. One such area is the boom in student loans, a topic which Ramsey has discussed in some detail previously.
To the student loans debate we would add that the education sector is one in which the effects of the Fed's massive money supply inflation are most clearly visible. Prices are rising at breathtaking speed and have done so for some time. It is no wonder therefore that student loans are skyrocketing, as average real incomes have declined over the same period.
The cost of college tuition in the US, via – click for better resolution.
Mean family incomes, nominal, adjusted by official CPI and adjusted by 'corrected' CPI, via our friends at nowandfutures.com (the corrected CPI tries to adjust for the under-reporting of price increases in the government's official statistics) – click for better resolution.
The student loan bubble is also a prime example of malinvestment. What people get in return for paying these inflated tuition costs is simply not worth it. Many no longer find jobs in their designated fields, as the severe boom-bust cycles the economy has suffered courtesy of the Fed have abruptly shifted demand for specific labor in entirely different directions. Never before have so many college graduates been employed in minimum wage jobs because they can no longer find a job corresponding to their particular skill set. Not surprisingly, record amounts of student loans are delinquent as of today.
However, there are also other sectors in which credit bubbles have become evident. One is the bubble in margin lending at the stock exchange. Here is a recent chart of NYSE margin debt:
Margin debt at the NYSE has soared to the highs last seen at the top in 2007, via sentimentrader – click for better resolution.
Along similar lines, issuance of corporate 'junk' debt has reached new record highs, and even 'toggle bonds', a.k.a. 'PIK' (payment in kind) bonds are back. These bonds give the issuer the choice whether to pay interest in cash or by issuing even more bonds. They are essentially a kind of Ponzi scheme, and yet, investors are flocking into these securities in their desperate 'hunt for yield'.
An Explosion in Sub-Prime Lending
Another area where a credit bubble has formed is the sub-prime car loan business. Reuters has published a special report on the topic. What is so surprising to us is that Reuters has decided to correctly name the perpetrators: namely the Fed. The report is entitled: “How the Fed fueled an explosion in subprime auto loans”. A few excepts:
“The Fed's program, while aimed at bolstering the U.S. housing and labor markets, has also steered billions of dollars into riskier, more speculative corners of the economy. That's because, with low interest rates pinching yields on their traditional investments, insurance companies, hedge funds and other institutional investors hunger for riskier, higher-yielding securities – bonds backed by subprime auto loans, for instance.
Lenders like Exeter have rushed to meet that demand. Backed by Wall Street banks and big private-equity firms, they have been selling ever-greater amounts of subprime auto loans in the form of relatively high-yield securities and using the proceeds to fund even more lending to more subprime borrowers.
Expansion of the subprime auto business was chronicled in a 2011 Los Angeles Times series. Since then, growth has continued apace. Consider that in 2012, lenders sold $18.5 billion in securities backed by subprime auto loans, compared with $11.75 billion in 2011, according to ratings firm Standard & Poor's. The pace has continued so far this year, with $5.7 billion of the securities issued, compared with $4.4 billion for the same period last year, according to Deutsche Bank AG. On Monday alone, three deals totaling $1.6 billion of subprime auto securities were announced by Wall Street banks.
To make up for the risk of taking on increasing numbers of high-risk borrowers, subprime auto lenders charge annual interest rates that can top 20 percent.
Critics of the Fed say the growth in subprime auto lending is just one of several mini-bubbles the bond-buying program has created across a range of assets – junk bonds, subprime mortgage securities, and others. The yield chase delivered big windfalls to some Wall Street firms and hedge funds holding securities that soared in value. But so much money has flowed into these assets, the critics say, that the markets for some are beginning to resemble the housing boom in the run up to the financial crisis.
"It's the same sort of thing we saw in 2007," said William White, a former economist at the Bank for International Settlements. "People get driven to do riskier and riskier things."
A bust in the subprime auto market wouldn't have consequences nearly as devastating for lenders, investors or the broader economy as the housing bust did. Securities underpinned by subprime auto loans, estimated at about $80 billion between 2006 and 2012, are a fraction of the $1.6 trillion in mortgage-backed products Wall Street created between 2006 and 2009, according to S&P data and the Financial Crisis Inquiry Commission, created by the U.S. government to analyze the financial crisis.
And whatever its faults, the Fed's program, consistently supported by most members of the central bank's policy-making body, has helped pull the U.S. economy out of recession and boosted the stock market to record levels.”
We want to briefly comment on two of the points highlighted above. First of all, the fact that sub-prime lending bubble in car loans is 'not as risky as the mortgage credit bubble was'; that is no doubt true, but as noted above, sub-prime lending for cars is only one of several new credit bubbles now underway, if an especially egregious one.
Secondly, the sentence that begins with “whatever its faults”, which argues that, hey, central planning is working after all! All those wise men at the Fed support money printing, and the 'data' have gotten better, so they are obviously right!
This idea – 'just let the central planners work, they will fix everything' – is a widespread propaganda meme that is repeated over and over again. It overlooks the simply fact that inflationary policy always has 'feel-good' effects at first. Let us not forget, the argument that the Fed's inflationary policy was the correct choice was made from 2004 to 2007 as well, as house and stock prices rose. Everything seemed to be going well, and yet, today it should be clear even to the more slow-witted among us that it was not 'worth it'. Why then do so many people apparently hold that 'this time, it's different'?
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2 Responses to “New Fed-Induced Credit Bubbles”
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