Michael Pettis writes mostly about China in his China Financial Markets blog. However, recently, he has put up several good posts about sovereign debt. The latest is here. An excerpt:
[A]lthough I am not smart enough to tell you who will or won’t default (I have my suspicions however), based on my historical reading and experiences, I think there are two statements that I can make with confidence. First, we have only begun the period of sovereign default.
The major global adjustments haven’t yet taken place and until they do, we won’t have seen the full consequences of the global crisis...
The second statement I think I can make with some confidence is that there is no threshold debt level that indicates a country is in trouble. Many things matter when evaluating a country’s creditworthiness.
As a rule anything that increases the chance of a sustained mismatch between earnings and debt servicing undermines the creditworthiness of the borrower. But what really matters is not the expected outcome so much as the probability of an extreme outcome. The expected variance, in other words, is more important than the mean expectation, which is another way of saying that a country with less debt and more variance can be a lot riskier than a country with more debt and less variance.
Meanwhile, notwithstanding the warning from Pettis, sovereign debt concerns eased a little on Tuesday for some of the problem European countries. From Bloomberg:
Spain, Ireland and Greece auctioned almost 10 billion euros ($13 billion) of debt, while Hungary sold less than planned, as investors favored nations backstopped by the European Union’s 750 billion-euro aid package.
The yield premiums investors demand to hold the debt of the three euro-region nations, all covered by the EU lifeline, instead of benchmark German bonds fell following the sales, while the Hungarian yield spread with bunds rose. Prime Minister Viktor Orban’s government sold 35 billion forint ($157 million) of three-month bills, 10 billion forint less than planned.
Pettis, however, points out that real estate lending can be a source of sovereign debt problem because the debt burden is likely to soar "just when everything else is going wrong". Here, the news on Tuesday was not so good.
In the US, housing starts fell in June, according to Bloomberg.
Housing starts fell in June to the lowest level in eight months after the expiration of a U.S. government tax incentive caused sales to slump.
Work began on 549,000 houses at an annual rate last month, fewer than the median estimate of economists surveyed by Bloomberg News and down 5 percent from May, Commerce Department figures showed today in Washington.
The retreat following the end of government support shows it will be difficult for the industry that precipitated the recession to sustain a recovery. Mounting foreclosures will swell the supply of houses on the market and pressure prices, while prospective buyers shy away as a lack of jobs shakes confidence in the world’s largest economy.
However, it is China that could be storing up the next big real estate problem. From FT Alphaville:
‘Evaluating Conditions in Major Chinese Housing Markets,’ an NBER paper by Jing Wu, Joseph Gyourko and Yongheng Deng, is old-school by the way because it’s focused on land supply. From the abstract (emphasis ours):
Much of the increase in prices is occurring in land values. Using data from the local land auction market in Beijing, we are able to produce a constant quality land price index for that city. Real, constant quality land values have increased by nearly 800% since the first quarter of 2003, with half that rise occurring over the past two years. State-owned enterprises controlled by the central government have played an important role in this increase, as our analysis shows they paid 27% more than other bidders for an otherwise equivalent land parcel...
The magnitude of the increase in land values over the past 2-3 years in particular in Beijing is unprecedented to our knowledge. Not only do these increases post-date the Summer Olympics, but the recent price surges in early 2010 suggest a relationship to the Chinese stimulus package which itself is temporary. More broadly, the sharp rises in price-to-rent and price-to-income ratios since 2008 in Beijing and many of the other large coastal markets look to be very difficult to explain fundamentally.
Understandably then that, according to WSJ, the IMF has suggested that central banks take action to avoid asset bubbles.
... The IMF, in a paper released Tuesday, urged central banks to use tougher regulation to head off asset bubbles, including tighter capital requirements for banks, limits to banks' use of short-term loans and tougher collateral requirements for loans they make.
The IMF also said financial regulators would have to use their judgment about whether to take more specific actions, and have the independence to enforce their efforts.
But in cases where that isn't sufficient, central banks may have to use interest-rate policy to "lean against asset bubbles," the IMF staff said. For instance, "the combination of rising asset prices and rapid credit growth may warrant a higher policy rate," the IMF paper said.
Perhaps the Bank of Canada had the latter in mind as it raised interest rates on Tuesday despite the prospect of slower growth ahead. From Reuters:
The Bank of Canada raised its key interest rate on Tuesday, as expected, but warned the domestic and global recovery will be slower than it had previously forecast, suggesting any further hikes may be gradual.
The central bank became the first in the Group of Seven advanced economies last month to raise rates from the emergency lows introduced during the global financial crisis. It took a second step on Tuesday, lifting the rate 25 basis points to 0.75 percent...
But the hawkish stance on rates contrasted sharply with the dovish outlook in the accompanying statement, leaving markets in suspense about the bank's next move. It shaved its growth forecast for the Canadian economy this year to 3.5 percent from 3.7 percent and said Europe's bid to wrestle down sovereign debt would pinch the pace of the global rebound.
