Canada, Let's Not Minsky Words
After tonight’s significant downgrade and warning from Moody’s about Canadian Banks, the following seems extremely prescient now.
Stability breeds instability – this was economist Hyman Minsky‘s lasting contribution to the craft. The Minsky Moment , popularized during the 07-09 US housing crisis, basically suggests breeding animal spirits too long creates systemic problems.
Essentially, the ongoing rises in asset prices back then created the sense of a new paradigm, that the elevated activity was safe, and home prices couldn’t fall – they’d never done so. As the cycle progressed and prices rose, normal course mortgage lending turned to borrowing for speculation and then, ultimately, for ponzi-like leveraged derivative structures that proved unable to withstand volatility. Turns out, Federal Reserve policy and over-sight engendered it all, and even Bernanke whistled into the then soon-to-be graveyard top of the market.
There’s no reason Minsky thinking couldn’t apply today. Central banks have forced years of emergency level interest rates and QE upon the markets with the very intent of manipulating asset prices higher and preached this in the name of stability. Normal course lending has lead to borrowing for speculation, seen in real estate and margin stock trading accounts everywhere.
As for Canadian real estate, the truth is Minsky instability could’ve been argued, say a year ago for example, and yet despite no real change in fundamental backdrop Toronto real estate prices have still risen by an additional 1/3 since. The Canadian economy now relies on real estate for stability and growth and is in no position to cool the frenzy with higher interest rates. Pretty safe to say that policy goals of stability are leading to instability. So this is Minsky redux, with a twist. Central banks have created unstable market monsters that they neither can afford to feed nor fight.
Another truth is that it’s happened everywhere. Increasingly, increasing the world’s cost of living to fight a world of too much debt places today’s central bankers in the history books as those who would double down on fighting Minsky’s warnings.
It’s hard to universally claim Canada is driven by ponzi-like lending, but it’s easy to point out that record consumer debt levels include a record stretch in borrowing to chase these rising home prices. So Home Capital’s breakdown should be viewed as a warning sign. In fact, Canada’s big 5 banks came out to support the Equitable Group – maybe this should be viewed as the industry trying to contain cracks in their system?
The stock price action in the big 5 banks seems to convey growing concern too, breaking down on higher volumes. Is it just the HCG and mortgage market noise or are big picture markets sensing other issues in Canada too?
Oil. Loonie. NAFTA and Trump. Metals markets. Softwood lumber. Seems Trump’s reflation trade could also be fading. Between new questions over US trade policy and re-emerging China credit concerns buzzing again, the list of things that could unnerve Canadian markets over and above the real estate and consumer debt picture are popping up too.
Maybe the most troubling signs regarding our real estate markets come from the powers that be. After years of being so sanguine, only now is CMHC issuing concerns over select regional markets. Finance Minister Morneau suggests there is no link between risk in housing markets in Toronto/Vancouver and HCG. We’ve had ultra-low rates for several years and Bank of Canada head Poloz actually claimed low interest rates have nothing to do with fuelling speculation! Is this the height of detachment? Arrogant deflection? Has he not studied Minsky? After this last decade, this statement may go down as the most fantastical I can remember.
Minsky laid out a salient concept and it was only several years ago that the world was brought to its economic knees experiencing it. I know those in the position of policy influence are mandated to speak with tone and instil confidence. Unfortunately recent history shows us that these powers that be, who steered us into the rocks, also end up being the ones who try to manage us out. That makes me nervous. That, and of course, the whistling.
A few select Ben Bernanke quotes from back in the day.
“House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals.” Oct 05
“Housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise.” Feb 06
“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency.” Mar 07
“All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well. Past gains in house prices have left most homeowners with significant amounts of home equity, and growth in jobs and incomes should help keep the financial obligations of most households manageable.” May 07
“It is not the responsibility of the Federal Reserve – nor would it be appropriate – to protect lenders and investors from the consequences of their financial decisions.” Oct 07
“The Federal Reserve is not currently forecasting a recession.” Jan 08
“The financial crisis appears to be mostly behind us, and the economy seems to have stabilized and is expanding again.” Aug 10
“One myth that’s out there is that what we’re doing is printing money. We’re not printing money.” Dec 10
“I wish I’d been omniscient and seen the crisis coming.” Dec 10
Pretty sure Minsky didn’t suggest omniscience was required to avoid repeating our mistakes.