Thoughts From Joe – September 21, 2012

The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates.

 Top Eight

1. Private Equity firms are buying European real estate. By purchasing stressed properties and loans, these investors are looking to give liquidity in the near term in exchange for a significant payoff in the long term. The article compares this strategy to the Resolution Trust Corporation which was a government agency created to buy up bad loans and real estate in the U.S. during the bust of the early 90s. Though met with much criticism, the experiment worked and the economy (including real estate values) quickly corrected. When this was brought up in 2008, critics claimed it would never work because the scale was simply too large. I’ll be watching this new experiment closely to see if clearing out these “bad loans” helps capital begin to flow again in Europe.
    
2. Without warning, the Bank of Japan eases again. After the ECB’s promise to “Do whatever it takes” was followed by open ended QE by the Fed, Japan has now stepped into the easing mix. Do these moves neutralize each other? To the extent exchange rates are involved, yes. The more important question is: do they provide any value even in a vacuum? I don’t believe so. For a concise view similar to mine, but more eloquently explained by a voting member of the Fed, see Richmond Fed President Lacker’s recent comments.
    
3. QE3 to boost stocks, but likely not housing. Liquidity flows first to liquid assets, which in this case means stocks – but also gold, oil, and other financial goods. The Fed says they are targeting consumers by purchasing mortgages to lower rates, but as I said last week mortgage originations are not being held up by higher interest rates.
    
4. Housing starts, builder permits, home builder confidence, and existing home sales all increased according to data releases this week. The stabilization in this sector continues, but none of these or any other housing related, measures have truly broken out to the upside. With some 90 percent of new mortgages created through government programs that are scheduled to be cut back beginning in 2013, it is no wonder housing has limited upside in the near term.
    
5. European banks continue to grow, despite challenges faced. After promising to cut exposures by $1.2 trillion last year, the region’s banks have actually grown in size, encouraged most recently by the ECB’s funding activities. The central bank’s three year loans extended the time horizon for banks to cut exposures, but did nothing to fundamentally change them. Instead, Europe’s banks are likely to be in worse shape when these new loans come due. Central bank tinkering in this manner has not been helpful anywhere in the world (see Japan).
    
6. On the other hand, publicly gathered deposits are dropping at a shocking rate. Over the last year, $425 billion has been pulled from banks in troubled eurozone countries, in favor of banks in less challenged countries. Taking this and item number five above, we find can see the socialization of the banking sector in troubled regions. The model is now: Borrow from the government, lend to the public. This can only last as long as Germany supports the ECB.
    
7. The debate of “structural” vs. “cyclical” unemployment rages on. The difference determines whether structural reforms are necessary to address unemployment today. The Fed insists unemployment today is cyclical in nature and therefore more stimulus efforts in the form of QE3 bond purchases should help. I take a different view. It seems to me that today’s unemployment is cyclical in nature, but it also seems to me that today’s cyclical downswing is being exacerbated by legislative inactivity and rule obscurity. The solution lies in Congress, not the Fed.
    
8. Chartered Financial Analysts don’t believe in QE3. A poll run by the CFA Institute on the potential effects of QE3 shows that 89 percent of respondents believe QE3 will have “no effect” or the “unintended effect” of excessive inflation. It seems almost no one except the Fed believes this massive increase in their balance sheet will help the economic situation. Could everyone outside the Fed be wrong?

 Key Indices

Looking Ahead

• Next week brings a packed economic calendar that will shape expectations for overall third quarter performance. Included is data on housing, consumer outlook and regional manufacturing activity.
• Earnings releases include:
• Monday: Red Hat
• Tuesday: Jabil Circuit
• Thursday: Micron Technology
• Innovation sector IPOs scheduled for next week include Qualys Inc. on Thursday.