Are We It Yet posted

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This is a “reme­dial” post: I have just posted “Are We It Yet?” to this site, but for some rea­son it was posted after the “Naked Cap­i­tal­ism” post below.

If you’ve already read the paper I gave at the Min­sky con­fer­ence, then you’ve read what’s pub­lished there; the main rea­sons for putting it here in blog form were to make it more acces­si­ble, and to post a video of the talk I gave at the Levy. I’ve also repro­duced this below.

Steve Keen’s Debt­watch Pod­cast 

| Open Player in New Win­dow

Shortly I’ll be pub­lish­ing the video of the talk I gave in New York to mem­bers of the Debt­watch blog there–over 30 peo­ple turned up and a very lively dis­cus­sion ensued. I also went into con­sid­er­ably more detail on the mod­el­ling, and my approach to mod­el­ling in gen­eral.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • This is the edited speech:

  • csr

    Steve, Fig­ure 6 shows that it is only from early 2010 that total US debt has started to sub­tract from aggre­gate demand. Do you have some debt trends for major Euro­pean eco­nom­ics & China? I was think­ing how far the increas­ing lever­age in coun­tries like China or India could off­set the delever­ag­ing in US & Europe.

  • inquis­i­tive

    Dear Prof. Keen,

    I find your post pretty con­vinc­ing but was try­ing to dig into some of the pri­mary data and found some­thing con­fus­ing: the loan to value ratio of the mort­gage backed secu­ri­ties I see look pretty rea­son­able. For exam­ple, look­ing at the WST series at http://www.westpac.com.au/about-westpac/investor-centre/funding-securitisation/outstanding-issuance-summary/ sug­gests the loan to value (LTV) for these is around 60%. In the US, the LTV was much higher.

    Per­haps banks are just dump­ing the safe loans into mort­gage backed secu­ri­ties and keep­ing the dan­ger­ous stuff on their own books. I tried find­ing data on aver­age LTVs at banks but was unsuc­cess­ful. The clos­est thing I could find was chart 67 on the Finan­cial Sta­bil­ity Review (http://www.rba.gov.au/publications/fsr/2010/mar/pdf/0310.pdf) which sug­gests that the LTVs are not that high since a major­ity of the loans have LTV less than 80%.

    So here is my ques­tion for you or other read­ers: if Aus­tralia is in such a huge hous­ing bub­ble (which I think it is) then why are the loan to val­u­a­tion ratios fairly mild?

    Thanks,
    –I

  • Hi inquis­i­tive,

    I won’t cast any asper­sions on Westpac’s book, but in some instances LVRs for mort­gage-backed secu­ri­ties can appear con­ser­v­a­tive so long as you don’t ques­tion how the val­u­a­tions them­selves were arrived at. When you do, what appears con­ser­v­a­tive can be any­thing but.

    I can’t be any less vague than that I’m afraid, but if you check the tran­script of the House of Rep­re­sen­ta­tives hear­ing I par­tic­i­pated in back in 2007, you might be less reas­sured by reported LVR ratios.

  • inquis­i­tive

    Dear Prof. Keen,

    Thanks for the pointer to the tran­script from the hear­ings. Page 34 of the PDF has a very inter­est­ing piece from Mr. Warner which I have copied at the end of this post for ref­er­ence.

    Warner basi­cally says that lenders are not doing rig­or­ous eval­u­a­tions as you sug­gest but also men­tions high LVR loans on the order of 100 to 110 per­cent. I fully believe that there are pres­sures which inflate the val­u­a­tions. For exam­ple, see http://www.nytimes.com/2010/06/20/business/20gret.html?_r=1&ref=business, for the fol­low­ing quote from the US:

    “The pool prospec­tus also stated that the weighted aver­age loan-to-value ratio of mort­gages in the por­tion of the secu­rity pur­chased by Home Loan Bank was 69.5 per­cent. But the loans the Core­L­ogic model val­ued had an aver­age ratio of almost 77 per­cent.”

    What I find con­fus­ing is that I read reports of high LVRs (includ­ing adver­tise­ments by var­i­ous lenders) but can’t seem to find evi­dence of them in the banks books or the RMBS. So it seems like either:

    1. Lenders do not make explicit high LVR loans very often (although they may implic­itly be doing this if the val­u­a­tions are inflated).
    2. Lenders do make explicit high LVR loans at sig­nif­i­cant lev­els but con­ceal them in such a way that they are hard to find on the books.

    I’d be curi­ous to know which case you or your read­ers think is more likely and whether you have any sug­ges­tions on where to look for evi­dence of the explicit high LVR loans.

    Thanks again for your won­der­ful work on this topic.

    Below is page 34 of the house tran­script:

    Mr WARNER—It was inter­est­ing lis­ten­ing to the var­i­ous com­ments ear­lier on this morn­ing.
    It was inter­est­ing to note that a cou­ple of years ago pro­por­tional lia­bil­ity insur­ance was
    intro­duced into Aus­tralia. One of the rea­sons for that was in response to the var­i­ous lend­ing
    prac­tices that finan­cial insti­tu­tions were under­tak­ing. We do not have any large issue with the
    ADIs and the major con­form­ing loan prac­tices that they under­take, but what we have seen,
    par­tic­u­larly from a val­u­a­tion point of view, is that the asset test that many of the ADIs state they
    under­take, they quite lit­er­ally do not under­take. We do not have val­uers going out doing asset
    tests on all loans that are under­taken by finan­cial insti­tu­tions. Some banks get their own exman­agers
    to drive by to see if the actual house exists or we have a lower form of val­u­a­tion being
    under­taken.

    These days it is get­ting to the point where you actu­ally have the val­uer who would not actu­ally
    even see if the house or asset existed in the first place. You have a drive-by which is at best a
    cur­sory glance to see if there is a prop­erty on the lot that has been pur­chased. If it is a bat­tle-axe
    block you have no way of actu­ally see­ing what is there. We have major dis­crep­an­cies about what
    appears on the out­side and the actual value of the house if you include the improve­ments on the
    inside. Some of these could be to the tune of over a cou­ple of hun­dred thou­sand dol­lars, but there
    is no way the val­uer is going to do that because the client’s instruc­tions are not to under­take that
    sort of val­u­a­tion. There are issues that arise around the propen­sity to give a loan based on what
    may be not the best assessed facts. These are prob­a­bly a small pro­por­tion of the total num­ber of
    val­u­a­tions that are under­taken by finance insti­tu­tions, but it is still an area that does give rise to a
    degree of con­cern. What we are see­ing now with desk­tops, for exam­ple, for $50 or what­ever the
    amount is, is that the surety is there not for the consumer’s point of view but for the finan­cial
    insti­tu­tion and, as a result, you get a ten­dency to lend a large amount of money based on a
    spu­ri­ous asset val­u­a­tion because the prod­uct val­uer is not able to fully assess the value of that
    prod­uct.

    What we have had is a num­ber of insur­ers who state quite openly that they want the val­uer to
    do this because they have PI insur­ance. At the end of the day it gets down to being a risk issue
    for finan­cial insti­tu­tions and mort­gage insur­ers as to the risks they want to take in lend­ing their
    money and the risk min­i­mal­i­sa­tion fac­tors which they utilise to lend that money. At the end of
    the day what we are see­ing is that an increased abil­ity for lend­ing actu­ally dri­ves up house prices
    because there is a greater propen­sity for peo­ple to obtain funds to pay more for hous­ing. And that
    actu­ally has an adverse impact on hous­ing afford­abil­ity. Although that is not an issue for this
    inquiry, those are some of the issues that we see.
    As to the issue in rela­tion to reg­u­la­tion, if you go back 20 years loan val­u­a­tion ratios were
    typ­i­cally no more than 80 per cent. What we are see­ing now is 100 per cent, 110 per cent, so it is
    extremely dif­fi­cult for some peo­ple with a high loan-to-val­u­a­tion ratio to be able to make
    repay­ments fur­ther on down the track. You can­not see what is going to hap­pen to a person’s
    finan­cial sit­u­a­tion in a year’s time, but the ques­tion is whether there is any sub­stan­tial
    con­sid­er­a­tion given to the like­li­hood of that per­son being able to pay at an inter­est rate of, say,
    one per cent higher. I am not say­ing it has to be a built-in fac­tor, but there should be
    con­sid­er­a­tion given to the abil­ity to make repay­ments. It is just a buffer. You obvi­ously can­not
    plan for every sin­gle cir­cum­stance but those sorts of issues do need to be taken into account as
    well.”

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  • GH

    Hi Steve

    You said (July 14): “I favour redefin­ing shares and prop­erty own­er­ship in such a way that spec­u­la­tion on asset prices will be unprof­itable. Two basic ideas there are to make shares on the sec­ondary mar­ket time-lim­ited (expir­ing after say 30 years) and lim­it­ing the amount that can be secured against a prop­erty to ten times the annual rental of that prop­erty.”

    Your first sug­ges­tion is unlikely to work — in most of the first half of a 30-year time-lim­ited share’s life, its value would gyrate almost as much as an unlim­ited share with changes in expec­ta­tions of earn­ings and inter­est rates. I don’t think its a good approach any­way, why not use gear­ing lim­i­ta­tion as per your prop­erty sug­ges­tion.

    In the real world, of course, peo­ple will get round any restric­tions that are attempted, includ­ing lim­its on gear­ing.

    My (utopian) sug­ges­tion would be to abol­ish debt. It may sound crazy, but the prin­ci­ples of Islamic bank­ing might offer a way out of the cycle. (Although Islamic bankers now try to get around their restric­tions to cre­ate West­ern-style debt that still meets the let­ter of their reli­gious law.) 

    I think of debt as a con job — the lender thinks they’re get­ting safety, but in fact they are ulti­mately tak­ing some kind of equity risk. Your bank takes your deposit and lends it to over-geared house own­ers, or to busi­nesses, or devel­op­ers etc. They charge (what they think is) an appro­pri­ate return for the risk, and give you a fixed lower return. If cap­i­tal was only avail­able on an equity-par­tic­i­pat­ing basis, no-one could lever­age up a fixed fund­ing cost to cre­ate a super return for them­selves on a heads-I-win tails-you-lose basis. Bor­row­ers would be forced to pay away most of their gains to their fun­ders (ie the ones that are tak­ing the risk) and fun­ders would be more aware of the risks they were tak­ing and demand com­men­su­rate returns. And with­out debt, it is quite hard to go bust. Assets that fall in value rarely go to zero. Busi­nesses fail to meet oper­at­ing costs much less fre­quently than they fail to meet fund­ing costs. In a slow­down you would end up with smaller losses, more widely spread, and a much dimin­ished forced-sale down­wards asset price cycle.

    Would that kill the leverage/debt-deflation cycle off? I think it might. The prob­lem would be stop­ping peo­ple cir­cum­vent­ing restric­tions to cre­ate debt by another name as per what’s hap­pen­ing in the Islamic world.

    PS I am a Chris­t­ian-back­ground athe­ist, not a Mus­lim.