Sunday, November 21, 2010

All bubbles end in tears

Via the FT's Alphaville blog, Societe Generale's Dylan Grice has some great quotes on what he sees as a major credit bubble developing in China and other emerging market economies at present:
...a bubble is not a bullish scenario. It’s not bullish for the EM economies themselves, their citizens or for the world as a whole. The fact is all bubbles end in tears. The innocent bystanders who go to work not realising that their jobs derive from unsustainable demand suddenly find they’re out of work, through no fault of their own. The investors who believe the hype – generally but not exclusively na├»ve retail investors – get completely wiped out, or worse find themselves in debt after leveraging into the story. Those who are sceptical, but play along thinking they’ll exit before everyone else are rarely successful... Go to Ireland and ask them how they feel about bubbles. They’ll tell you a bubble is a curse, not a blessing.
Meanwhile, back in Australia the obsession with creating more "competition" in the banking sector continues. Let's take a look at Wayne Swan's latest economic note:
We have been working to build up more competition in the banking sector since we first came to office. Even during the crisis, we made a solid start on injecting more competition into the mortgage market, even while we were taking decisive action to secure our financial system. We are working hard to support the smaller lenders by investing $16 billion in Triple-A rated RMBS, which is helping to make this a more competitive source of funding again. The RMBS market was one of the key drivers of banking competition in the decade before the crisis, helping smaller lenders to drive a significant reduction in the net interest margins of the major banks, which you can see in this Reserve Bank chart.
All of this may be true, but to borrow a phrase currently in vogue, it is kind of ignoring the elephant in the room. As Steve Keen has pointed out, in the decade before the crisis, banks responded to this reduction in their net interest margins by massively increasing the volume of credit extended to households (and reducing lending standards). In fact, they kept up their frenzy of lending right through the GFC, when the Australian government decided it would be a good idea to reinflate the bubble.

The fact is that a "lack of competition" in the Australian banking sector is a secondary issue. Introducing more "competition" so that we can sucker another generation of young Australians into borrowing six or seven times their annual income to buy an illiquid and overvalued asset is not a good idea. How about we address the real problem of TOO MUCH DEBT?

As Dylan Grice says, all bubbles end in tears. And the more we try to kick the can down the road without addressing the real problem, the worse the fallout is going to be.

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