There are other bubbles out there beyond UK house prices
Anyone who’s anyone these days seems to be talking about a house price bubble in London and the southeast of England. Last week prime minister David Cameron echoed the view of Bank of England governor Mark Carney that the sharp rise in house prices now poses “the biggest risk” to the UK’s economic recovery.
It is about time. For too long policy makers have been in a bubble of their own, insensible to the frenzy on the ground, even pursuing schemes that have compounded the problem.
But to single out housing is wrong. There are bubbles across different asset classes in much of the western world. Stubbornly low interest rates – designed to cement economic recovery – have perpetuated a risky “hunt for yield”. Here is my pick of the five biggest bubbles.
1. Leveraged loans As this column highlighted a few weeks ago, the world has already forgotten one of the big lessons of the 2008 crisis – that it is foolish to fund private equity deals with high multiples of debt to equity, especially when the debt is backed by weak covenants. Last year, dollar-denominated covenant-lite leveraged loans reached a record $260bn, up 69 per cent on the already inflated level of 2007. This year is shaping up to be another record. Banks may be less on the hook than they once were, taking smaller, shorter-term bets on their own balance sheets. But that means the ultimate investors in the loans, such as the big pension funds, have more to lose.
2. ETFs Murmurs about the risks of exchange traded funds have been around for years. Yet the investor appeal of these easy-to-use shadow securities, which depend on their sponsors making markets in the underlying shares, bonds or other investments, continues to grow. Trading volumes were up 18 per cent over the past year. As my colleague Tracy Alloway pointed out last week, worsening illiquidity in some of the more risky underlying securities could be the thing that upsets this vast market, given the tension with the instant access principle behind the ETFs themselves. Bubble one and bubble two could easily combine to create a market shock. International regulators are watching the trends in leveraged loan ETFs with concern, after three consecutive weeks of outflows.
3. Eurozone sovereign debt Has so much really changed in Portugal, Italy or Greece since government bond yields spiked three years ago? Today, even Greece is raising five-year debt for less than 5 per cent; other periphery countries are paying barely 3 per cent for 10-year money. Those rates underestimate the structural reforms that have yet to happen and ignore the fact that growth remains anaemic. Barely two years after the Greek default, it is unfashionable to mention the D-word. But even without an extreme scenario, buying debt at these levels is exuberant.
Price indices have presented wildly contrasting pictures of the health of the housing market – according to some the boom is back, while to others the slump staggers on
4. European bank paper The bounce in eurozone government securities is nothing compared with the glut of money chasing European bank paper. Deutsche Bank recently attracted €20bn of demand for a planned €2bn issue of hybrid bonds paying between 6 and 7 per cent. There was a similar story when UK building society Nationwide launched a new twist on trendy contingent convertible bonds (cocos). Even regulators, once big coco fans, admit privately that there is dangerously hot demand for these rinky dink instruments, which convert from debt to equity if capital levels slump. Equity valuations are ahead of themselves, too, especially in the periphery. There was huge demand for recent share issues by Greek banks, despite the fragile state of the domestic market and persistently high non-performing loan rates. In Spain, where NPLs are now nudging 14 per cent, some banks, including Bankia, which collapsed just two years ago, are trading at close to double their net book value.
5. UK property Housing in the southeast of England has got to be the most bubbly asset class of all. When the PM acknowledges as much, despite impending elections, you know there is something to worry about. There is a minority view that house price inflation is risk-free because it has been fuelled by cash buyers from abroad, rather than stretched borrowers whose ability to service debts would go beyond breaking point once interest rates rise. But this ignores the facts. Consider Nationwide data on the average multiple of London house prices to average earnings among first-time buyers – a number that had remained relatively unchanged at about 4 times for decades but which is now running at 8. The risk is magnified because nearly half the mortgage market is on interest-only deals, whose monthly payments will jump dramatically with every rise in interest rates.
Patrick Jenkins is the Financial Times’ Financial Editor