The Federal Reserve on a few separate occasions, as I noted late last week, has begun to peremptorily quash the growing use of the loaded word “bubble”. From academic papers to Fed speeches, US monetary policymakers want to make sure that investors and the public know they are watching for them though they have yet to appear. Vigilance is paired with extreme monetary actions. It is a simple reaction to a growing perception – there are so many candidates for asset bubbles right now we don’t often know which asset class might be the farthest along that path.
Across the Pacific, Ben Bernanke’s equivalent in the Bank of Japan, Haruhiko Kuroda, sees no bubble in Japanese stocks. It does not matter that the broad Nikkei index is up 45% in 2013 alone, that is simply the expected course for Japan according to Kuroda. His statement was in response to a question from the opposition party about the perception that the rapid ascent of Japanese stocks is incongruous to the actual condition of the Japanese economy.
That is the common theme in nearly every developed market in the world. From the US to Europe to Asia and back again, asset prices soar while basic economic needs like jobs and incomes are left far behind; looking more like depression than a historic boom period. Central banks, almost exactly four full years after the official end to the Great Recession, are still implementing emergency monetary measures to get the global economy just moving slightly forward. It is a blatant contradiction that is seeping through into the larger consensus the more this price vs. true value disconnect grows.
This disconnect extends even to Japanese bonds, where Kuroda separately assures the world that the dramatic volatility in that market is easily handled by the Bank of Japan’s operations. The message is, in full, there are no bubbles, but if there were central banks can easily handle them.
Relatedly, Reuters published a story today with the following lead paragraph:
“Salaries of presidents of U.S. public universities rose almost 5 percent in the last fiscal year, even as tuition rose and student debt soared, with the median pay package topping $400,000, according to a report released on Sunday.”
The article’s author makes a cognitive mistake very similar to the dismissal of asset bubbles. The salaries of US public university presidents did not rise in spite of the rising cost of US education, presidents’ salaries continued to jump because of the rising cost of US education. The awesome rise of student loan balances (another asset bubble class candidate) is the fuel and incentive for a feedback loop that is a required condition for asset bubbles.
Once decision-makers and primary beneficiaries of the uneven, irregular spread of inflation (asset inflation in these cases) are captured by their own profit motives, they seek to partner with the source of inflation and maintain it for as long as possible. This is not just economic reality, it is human nature. Structured finance sales forces in the housing bubble acted in the same manner, thus the dramatic spread of subprime, Alt-a and NINJA loans regardless of individual or systemic need or conformity.
For central bankers, they see all economic activity as equal – aggregate demand as a concept is an equivalent treatment of any and all economic activity as uniformly beneficial. For the Federal Reserve’s policy of trying to get credit flowing into the real economy, a bubble for student borrowers achieves that economic goal. It does not matter to the FOMC whether or not such debt-based activity is actually prudent and sustainable, these considerations don’t count. All that matters is aggregate demand in any form.
But the salaries of university presidents almost guarantee the lack of prudence. It’s not just university presidents either. The entire university system is a beneficiary, and thus the more activity that comes in on credit, the more dependent on the bubble the university system is, and thus the more pressure it will exert to keep the bubble growing long past any level of prudence has passed. In a crony system, this is actually easier to achieve than it should be (another feature of bubbles).
This is also the reason that bubbles always end in the same manner, disaster. No central bank can create a uniform, smooth dispersal of inflationary money. It cannot happen, and has never happened. Aggregate demand is a fantasy, a fairy tale conjured by economists to make their mathematical models produce meaningful results.
But what is most concerning is just how easily captured central bankers can be. They are supposed to be prudent monetary stewards, yet the asset bubble activity is exactly what they are appealing toward. It is too easy to accept a little asset bubble with the hubris to actually believe that they can be controlled and switched off. They cannot be controlled because this disharmony of inflation flow only leads to entrenched interests that are counterproductive to longer term economic health. The only way to stop asset inflation beyond the point of entrenched interests is to destroy it.
University presidents are in for a rude awakening, as is the entire university system. Total student loans are now the largest source of consumer credit at $1 trillion. But published default rates have also risen dramatically. Worse than that, these default rates are actually understated by quite a bit since they don’t count loans in grace periods and deferments. FRBNY explains here:
“To address this potential bias in calculating delinquency statistics, we exclude individuals who appear to be temporarily exempt from making payments because they are in school or newly graduated from school. These are students who, as of third-quarter 2011, owed as much as or more than they did in the previous quarter while maintaining a zero past due balance. We will be able to make our inference more precise when loan-level panel data are available, but this is our first-cut analysis given the available data. We warn that there is room for misclassification in this analysis. For example, there could be borrowers who are subject to the income-based repayment plan whose payment fell short of the accrued interest, resulting in a balance that increased. Recall that this exercise looks at the student loan borrowers who have a balance as of third-quarter 2011; therefore, those who had taken out a loan at one point but paid it off before third-quarter 2011 are not accounted for.
“From this exercise, we find that as many as 47 percent of student loan borrowers appear to be in deferral or forbearance periods, and thus did not have to make payments as of third-quarter 2011. Specifically, 17.6 percent of borrowers had exactly the same balance in the third quarter as in the second quarter of this year, and 29.1 percent increased their overall student loan balance by taking on new originations or accruing interest to the balance.
“We then recalculate the proportion of borrowers with a past due balance excluding this group of borrowers. We find that 27 percent of the borrowers have past due balances, while the adjusted proportion of outstanding student loan balances that is delinquent is 21 percent—much higher than the unadjusted rates of 14.4 percent and 10 percent, respectively (see charts below).”
More than one in four student borrowers has a past due loan, accounting for more than one-fifth of all loan balances. That means that those struggling to pay are students with lower outstanding balances on average (lower classmen that fail to finish?). It also means that these numbers are actually far higher right now since the FRBNY study used Q3 2011 figures. Current estimates of delinquency rates are about 17%, so might delinquencies actually be above the 30% range?
The federal government is less concerned with losses than private banks, but eventually political pressure will force some kind of “reform” or end to the constant flow. The bubble will end, but not before a lot of inorganic university-driven economic activity is created supported by nothing more than monetary flow. It will be ugly in higher education.
Bubbles take on many different forms and channel through different means and assets, but they are all common in their creation and their eventual destruction. The question is whether or not to play the Greater Fool game while they are in progress, and seemingly spreading like an aggressive cancer.
Stay In Touch