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Another Asset Price Bubble? Kroll Says ‘Yes’

housing-blocksTake a look back to the year 2008 and remember where you were when Bear Stearns crashed, and the credit crisis began, leading to a shaky summer and a distressing stock market plunge in early autumn.

Did you get many warning signs? Not really. So if the data coming in today doesn’t fit within the pessimistic paradigm created by some of the world’s leading economists, just call it a case of déjà vu, analysts with Kroll Bond Rating Agency said Wednesday.

Kroll analysts Christopher Whalen and Joe Scott sounded the alarm in a note after learning banks are reporting low default rates, which superficially looks like a good sign for lenders, but the devil 'as always' is in the details.

The two analysts reviewed the U.S. bank sector’s credit outlook and concluded that having the banking industry reporting zero or low default rates is a clear sign “of mounting future credit risk.”

Why? Wouldn’t this be good news? Not really, the analysts say. In fact, we may be looking at another asset price bubble within the housing sector among others.

During the mortgage bubble of 2004-2005, Washington Mutual and Countrywide—two of the lenders that eventually had to be bailed out by larger banking institutions—reported negative defaults, Whalen and Scott reported.  On the surface this looks like good news since it means the banks’ recoveries exceeded charge-offs, the pair explained.

“[T]he responsibility for the rising risk in bank loan portfolios lies squarely at the feet of the Federal Open Market Committee, which explicitly set a policy to push up asset prices to facilitate greater risk taking.” 

But it also could be a sign of overheating in the market with asset values exceeding economic fundamentals such as employment, income and GDP, according to KBRA's note.

Flashback to the home price bubble, and we all remember what happened next.

Whalen and Scott have this warning about the banking industry's low default rate data: “the credit results measured by metrics such as charge-offs and recoveries are simply too good to be believed—or sustained.”

While others have praised the Fed for keeping interest rates low on the grounds that economic fundamentals support a push back against rising interest rates, KBRA’s note says “the responsibility for the rising risk in bank loan portfolios lies squarely at the feet of the Federal Open Market Committee (FOMC), which explicitly set a policy to push up asset prices to facilitate greater risk taking.”

The problem with rising prices is the creation of an asset price bubble where as Whalen and Scott point out, “these higher asset values … have not been validated by the performance of the U.S. economy, either in terms of rising income or GDP.” In other words, you cannot create confident consumers out of thin air. They are either making enough money to swim in your pond and buy your house, or they're not.

They also warn that loan-to-value ratios are on the rise, which is another déjà vu moment, given the fact that LTVs reached a great imbalance in the years leading up to the housing crash.

The takeaway: The U.S. economy lacks robust employment and income figures to create the aggregate demand needed for a full functioning healthy economy. The Fed as a measure of compassion may be creating a low interest rate environment to spur demand, but the consumer is already defeated and has no room to budge.

With rates staying low, asset prices rise artificially, and now consumers who are taking a bite of the apple are buying into a price structure that is artificially stimulated since it is not supported by economic fundamentals.

Is this the year 2008 all over again?

About Author: Kerri Panchuk

Kerri Panchuk is an attorney and financial writer with more than a decade of experience covering real estate, default servicing, residential mortgage-backed securities, retail, macroeconomics, and commercial real estate. Panchuk graduated from the Southern Methodist University Dedman School of Law and texas Tech University, Panchuk previously served DSNews.com as online managing editor/producer and webcast anchor. In April, she rejoined the Fiver Star Institute as executive director of member groups, overseeing the development and growth of the National Appraisal Congress and Title and Closing Coalition. Panchuk is a member of the State Bar of Texas.
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