Author Topic: Negative interest rates take investors into surreal territory  (Read 22800 times)

Spekulatius

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Re: Negative interest rates take investors into surreal territory
« Reply #20 on: June 30, 2019, 06:32:48 PM »
Lots of possibilities here ...

Monte Paschi evidences that the impact of a European CB put on a DSIB (Domestic Systemically Important Bank); is much, much higher than most would expect. The DB, or a Monte Paschi, that suffers a market crises of confidence is not going to be allowed to fail - no matter what. So when the sh1te seriously hits the fan, use the opportunity to buy a longer dated call at a low strike, on said bank ;)

In most places only a domestic citizen, can buy domestic RE using a domestic mortgage; however it is not particularly onerous to get around the restriction if you hold 'dual' (EU/UK) citizenship. Put up the equity on that Danish property, let the property appreciate 20%, remortgage to pay yourself back, and let the bank pay down your mortgage at 0.49%/yr ;)

... and if it were a Danish bank that got into trouble, much of that equity you put up would be profit!

SD

I beg to differ on the long dated call. the ECB will not let a larger bank fail, but they will have no problem to make the equity a zero and run it as a state old bank or put it into the fold of an existing bank. In Europe, having the government own and run a bank doesn’t have the same stigma. If the German government would have to take over DB, nobody in Germany would give much of a hoot about it.

If we do get European style interest rates here, the US banks all will suffer greatly from reduced profitability, as will pension funds and insurance companies.
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SharperDingaan

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Re: Negative interest rates take investors into surreal territory
« Reply #21 on: July 01, 2019, 05:58:50 AM »
Lots of possibilities here ...

Monte Paschi evidences that the impact of a European CB put on a DSIB (Domestic Systemically Important Bank); is much, much higher than most would expect. The DB, or a Monte Paschi, that suffers a market crises of confidence is not going to be allowed to fail - no matter what. So when the sh1te seriously hits the fan, use the opportunity to buy a longer dated call at a low strike, on said bank ;)

In most places only a domestic citizen, can buy domestic RE using a domestic mortgage; however it is not particularly onerous to get around the restriction if you hold 'dual' (EU/UK) citizenship. Put up the equity on that Danish property, let the property appreciate 20%, remortgage to pay yourself back, and let the bank pay down your mortgage at 0.49%/yr ;)

... and if it were a Danish bank that got into trouble, much of that equity you put up would be profit!

SD

I beg to differ on the long dated call. the ECB will not let a larger bank fail, but they will have no problem to make the equity a zero and run it as a state old bank or put it into the fold of an existing bank. In Europe, having the government own and run a bank doesn’t have the same stigma. If the German government would have to take over DB, nobody in Germany would give much of a hoot about it.

If we do get European style interest rates here, the US banks all will suffer greatly from reduced profitability, as will pension funds and insurance companies.

It's really just a variant of a vega trade, there's no intent to own for any significant length of time. Simply buy when uncertainty/volatility is high, & the financial press is daily making the case that XYZ bank is about to collapse. Sell when the CB announces it support, and uncertainty/volatility declines. The more financial press/political machinery involved, the better it works. Granted there's always the possibility of outright nationalization, but it's usually telegraphed, and still a 'dead cat' bounce.

High maintenance, but relatively low risk

SD

 
« Last Edit: July 01, 2019, 07:03:37 AM by SharperDingaan »

John Hjorth

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Re: Negative interest rates take investors into surreal territory
« Reply #22 on: July 01, 2019, 09:32:21 AM »
... ... So at a high level, can't Draghi and Volcker largely determine the nominal price of housing over a decently long time frame? ...

Hi Jim,

It's a personal pleasure for me  to "meet" you for the first time here on CoBF.

Here I'm just grabbing a post by RuleNumberOne in the WFC topic in in Investment Ideas forum :

Denmark has negative mortgage rates and booming house prices. Governments and central bankers in Europe are far more crooked than the US. Throughout Europe you have rock-bottom interest rates and booming house prices. Debauchery of the currency is a mild description. How long can this go on?

https://www.globalpropertyguide.com/Europe/Denmark/Price-History

"Denmark´s negative interest rates continue to work their dangerous magic on both the housing and mortgage markets.

The price index of owner-occupied flats in Denmark rose by 7.88% (7.25% when adjusted for inflation) during the year to February 2018, an acceleration from last year´s growth of 6.87% (5.81% when adjusted for inflation), according to Statistics Denmark."

[Embedded quotations in RuleNumberOne's post omitted here for less dense posting.]

Please note the following in the article linked to by RuleNumberOne:

Quote
... Effective January 1, 2018, the government introduced tighter lending regulations, in an effort to reduce the share of more risky interest rate and repayment-free mortgages on the overall mortgage lending portfolio of banks. Banks will be limited from offering housing loans that do not have fixed interest rates, or monthly installments. Moreover, the number of mortgages available to households seeking to borrow more than four times their income, or more than 60% of the value of the property will be heavily restricted.

"These are reasonable guidelines that should ensure that homeowners are more robust," said Lars Krull of Aalborg University.

The move is also supported by Nordea economist Jan Storup Nielsen, who believes that the move "represents a major departure from previous policies and will likely help reduce the risk of a new housing bubble."

In the past recent years, the International Monetary Fund (IMF) had been urging the Danish government to reverse its negative interest rates mandate and introduce new policies to avoid a disastrous housing bubble. ...

Add to that the 5 percent down payment of non-borrowed money imposed requirement mentioned by kab60 earlier in this topic. Please also note that most of the numbers mentioned in the article are YE2017 numbers. A lot of water has run through the river since then, and the imposed regulation has had effect, to avoid speculation, home-flipping and other similar kinds of folly going on, because a lot of interested buyers has been pulled out of the market, because they have lost the ability to bid in as prices have gone up, creating what I percieve as a high equilibrium - which was the purpose of the new regulation.

So for tiny Denmark, - in short - the answer to your question is actually : No. Draghi [et al.] does not decide or have jurisdiction/power over supplementary national regulation.

When looking on what's going on in EU with interest rates etc., you can't just look at it as whole. The economic situations & financial systems are only to various degrees similar among european countries.
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John Hjorth

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Re: Negative interest rates take investors into surreal territory
« Reply #23 on: July 01, 2019, 02:53:03 PM »
... . Do we care if negative rates are here to stay? How does this change the investment process? ...

I'm sorry for double posting here in this topic. Now back to Viking's starting post here, ref. the quote above.

I think it's important here to distinguish with regard to geographical areas. [For my part : Between US banks and European banks - I own both.]

US Banks :

There seem to be a general sentiment as of now, that US interest rates will be lowered [also here on CoBF - at least partially] - perhaps even so the steering interest rates may end up near zero, or even negative. With regard to that, I'm in the same camp as Jurgis [posted by Jurgis somewhere else here on CoBF recently] : Why should the FED lower interest rates, when USA is running at low, but still a fairly steady & positive clip, combined with a public deficit? [I don't get it, but then again : What do I know.]

European Banks:

I can here only speak as Danish citizen, what I can say is that the pressure on Net Interest Margin in Danish banks is very real, and as a Danish bank customer, I can feel & see it as being very real.

The consequences are already here and visible : The reach for non-interest earnings in Danish banks has become more aggressive, and to me it has already crossed the line of sound, healthy, prudent & most of all : honest banking. [To me "honest banking" is in the interest the customer, not the bank.]

I'll document it here, with anecdotal stuff, based on personal experiences and documentation. Stuff about Danske Bank however will go to the topic I started about Danske Bank A/S in the Investment Ideas forum today.

- - - o 0 o - - -

This naturally matters for investing in both US Banks & European Banks. I may be wrong about the future development of US interest rates, and what's going here may be relevant for a judgement about what will happen with the behavior of the US Banks.
« Last Edit: July 01, 2019, 02:55:00 PM by John Hjorth »
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Viking

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Re: Negative interest rates take investors into surreal territory
« Reply #24 on: July 01, 2019, 04:54:11 PM »
... . Do we care if negative rates are here to stay? How does this change the investment process? ...

I'm sorry for double posting here in this topic. Now back to Viking's starting post here, ref. the quote above.

I think it's important here to distinguish with regard to geographical areas. [For my part : Between US banks and European banks - I own both.]

US Banks :

There seem to be a general sentiment as of now, that US interest rates will be lowered [also here on CoBF - at least partially] - perhaps even so the steering interest rates may end up near zero, or even negative. With regard to that, I'm in the same camp as Jurgis [posted by Jurgis somewhere else here on CoBF recently] : Why should the FED lower interest rates, when USA is running at low, but still a fairly steady & positive clip, combined with a public deficit? [I don't get it, but then again : What do I know.]

European Banks:

I can here only speak as Danish citizen, what I can say is that the pressure on Net Interest Margin in Danish banks is very real, and as a Danish bank customer, I can feel & see it as being very real.

The consequences are already here and visible : The reach for non-interest earnings in Danish banks has become more aggressive, and to me it has already crossed the line of sound, healthy, prudent & most of all : honest banking. [To me "honest banking" is in the interest the customer, not the bank.]

I'll document it here, with anecdotal stuff, based on personal experiences and documentation. Stuff about Danske Bank however will go to the topic I started about Danske Bank A/S in the Investment Ideas forum today.

- - - o 0 o - - -

This naturally matters for investing in both US Banks & European Banks. I may be wrong about the future development of US interest rates, and what's going here may be relevant for a judgement about what will happen with the behavior of the US Banks.

“There seem to be a general sentiment as of now, that US interest rates will be lowered [also here on CoBF - at least partially] - perhaps even so the steering interest rates may end up near zero, or even negative. With regard to that, I'm in the same camp as Jurgis [posted by Jurgis somewhere else here on CoBF recently] : Why should the FED lower interest rates, when USA is running at low, but still a fairly steady & positive clip, combined with a public deficit? [I don't get it, but then again : What do I know.]”

John, i really enjoyed reading your post, especially the part i quoted above. It looks to me like the globe might be slowly slipping into a deflationary spiral. What will stop the slow spiral we are seeing? China seems more constrained in options than in 2010. Japan to the rescue? No. How about Europe? They look to be following down Japan’s path. US? Trump has already slashed taxes and is running very large deficits so spending more (and running even bigger deficits) is likely not an option. The Fed can cut rates. Which is wherevwe are at.

I am watching to see if the global slowdown continues or if it improves in Q3/Q4. If we actually get a recession in the US in 2020 we will be in unchartered waters in terms of what central banks will do and the impact those actions will have on the larger economy over time.

I think we also could see a shift from Trump from a focus on tarriff war to currency war. It this happens we will get a brand new layer of instability. Interesting times :-)

TwoCitiesCapital

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Re: Negative interest rates take investors into surreal territory
« Reply #25 on: July 01, 2019, 06:04:41 PM »

Draghi & Volcker do not set market prices on real estate - buyers and sellers do.


Yes, but a central bank controls the growth path of the unit of account, which is the main measuring stick for those "buyers and sellers". 

The central bank can almost completely dictate the size of the nominal economy going forward.

The below table kinda shows that housing (as % of nominal GDP) has been relatively constant.

So at a high level, can't Draghi and Volcker largely determine the nominal price of housing over a decently long time frame?

https://www.nahb.org/-/media/Sites/NAHB/research/housing-economics/housings-economic-impact/housing-contribution-gdp-q1-2019-0426.ashx?la=en&hash=DB4820E7942613C16F65F3BF6739E0462AC168EE


(Would add that there's no iron law that housing must be a fixed % of GDP - Its just that with various zoning laws, it's (imo) likely to stay relatively constant.  Without those laws, there's a (good?) chance that housing would represent an ever decreasing % of GDP, much like food has done over the last century)

https://cdn.theatlantic.com/static/mt/assets/business/1900%201950%202003.png

Agreed. The more financial-ized housing becomes (i.e. the more house finance and package into a product to sell to retail investors), the more it's value depends on interest rates and money creation and the less on its fundamental value.

Back in the days of banks keeping mortgages on their books and buyers having to put 30% down, you wouldn't have near the housing prices we see today.

The prices are this high because with rates this low, you can finance 97% of the house and still end up with a reasonable mortgage payment - and banks don't care because they just package and sell it to retail investors who are just glad they can beat 2% on the 10-year treasury.

Upside is more mortgages and more affordable mortgages. Downside is housing inflation and increasing housing's dependence on low interest rates.

RuleNumberOne

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Re: Negative interest rates take investors into surreal territory
« Reply #26 on: July 01, 2019, 09:33:27 PM »
https://www.ft.com/content/c060e162-98c1-11e9-8cfb-30c211dcd229

"In Frankfurt, Germany’s financial centre, prices have doubled since 2010...

...real house prices in Amsterdam rose 64 per cent in the five years to September 2018, but real disposable household income grew just 4.4 per cent in that time, despite ultra-low unemployment."

Klaas Knot, head of the Dutch central bank who also sits on the ECB governing council, said low interest rates “are a contributing factor”, with mortgage rates “down to levels where I don’t think we’ve seen them before in the Netherlands”.

Bloomberg claims the same Klaas Knot thinks inflation is too low
https://www.bloomberg.com/opinion/articles/2019-07-01/stock-market-can-t-be-fully-brain-dead-right

"Dutch Governor Klaas Knot, typically considered on the hawkish wing of the Governing Council, said it was “indisputable” that inflation is too low. "

JimBowerman

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Re: Negative interest rates take investors into surreal territory
« Reply #27 on: July 02, 2019, 02:26:04 PM »

Denmark has negative mortgage rates and booming house prices. Governments and central bankers in Europe are far more crooked than the US. Throughout Europe you have rock-bottom interest rates and booming house prices. Debauchery of the currency is a mild description. How long can this go on?

https://www.globalpropertyguide.com/Europe/Denmark/Price-History

"Denmark´s negative interest rates continue to work their dangerous magic on both the housing and mortgage markets.

The price index of owner-occupied flats in Denmark rose by 7.88% (7.25% when adjusted for inflation) during the year to February 2018, an acceleration from last year´s growth of 6.87% (5.81% when adjusted for inflation), according to Statistics Denmark."

So for tiny Denmark, - in short - the answer to your question is actually : No. Draghi [et al.] does not decide or have jurisdiction/power over supplementary national regulation.

When looking on what's going on in EU with interest rates etc., you can't just look at it as whole. The economic situations & financial systems are only to various degrees similar among european countries.

Hi John,

Good meeting you as well and great discussion. There's a lot of moving parts imo regarding monetary policy as it relates to asset prices, so i'll try to list out at least my thoughts in bullet point order:

#1 I'd argue that monetary policy in the EU has been TOO TIGHT, not too loose.  Yes, the supply of money has gone up quite a bit in the EU, but the demand for money has gone up even further.  I think it's helpful to judge tightness or looseness of monetary policy based on nominal G.D.P. (which has been very low in the EU since 2008).  Current short term interest rates are not a good metric for judging monetary policy and instead, low short term interest rates are usually a sign that monetary policy has (counterintuitively) been too tight.  Theres a lot to this, and I explain it in much more detail across 50-100 pages in my 2017 and 2018 letters (link below in my signature)

#2 Because monetary policy has been too tight, this has led to lower Long term bond yields in the EU.  As Buffett says, LT bond yields act like gravity on asset prices.  Again, it's counterintuitive, but the implication is that because tight monetary policy led to lower bond yields, this results in higher house prices as mortgage rates tend to track the low bond yields in the EU.

I'm no expert on the specifics of the denmark housing market, and surely i'm missing some factors here (local building codes, zoning, etc), but at a high level i'm not surprised to see house prices rising. But its not because the ECB has been printing too much money...its the opposite...they haven't printed enough money.

I'd like to see the ECB drop its current targets and instead promise to do unlimited open market operations until NGDP is growing at 5% a year.  Assuming they do this i'd argue that

1) wages would go up across the EU
2) real asset prices would drop (real house prices drop and  (which also reduces income inequality)
3) populism and political tensions are reduced.

edit: as a final example showing how ECB largely controls asset prices at a high level.  Lets imagine 2 scenarios. The first scenario (akin to what we currently have) is that ECB keeps money growth low and inflation low over the next 100 years.  In this case, I'd expect nominal house prices to grow at a slow rate in line with money growth, but for there to be a one time boost in real house prices as the housing market adjusts to lower interest rates.   At the other extreme lets imagine the ECB prints a lot more money than they currently are to the point where inflation averges 10%/yr over the next 100 years.  in this case, nominal house prices would rise much more quickly than in scenario 1 (again, nominal house prices tend to track with inflation), however i'd expect real house prices to be a bit lower than in scenario 1, as the high interest rates act as a drag to real asset prices (scenario 2 would also likely result in stocks having lower P/E ratios (proxy for "real asset prices") but HIGHER nominal earnings growth/stock prices over those 100 years).  I'm probably not explaining this very well so welcome any feedback!
« Last Edit: July 02, 2019, 02:34:22 PM by JimBowerman »

RuleNumberOne

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Re: Negative interest rates take investors into surreal territory
« Reply #28 on: July 02, 2019, 10:10:05 PM »
The problem in Europe is the absence of a free market.

- Bad borrowers never punished
- Bad lenders never punished
- Bad regulators never punished
- Bad politicians never punished.

Monte Paschi bailed out:
 - 17% non-performing loans
 - accounting for same collateral with different values multiple times
 - complex derivatives to hide losses.


What do we have now:
- Retroactive Rent freezes in Berlin (Wealth confiscation) to stop raging housing inflation in Germany
- Banks continue to make interest only loans, don't compensate for credit risk.
- ECB covers up insolvency, investors don't trust bank numbers.


It is like trying to generate inflation in Alabama with negative rates, regardless of how much capital gets misallocated. It would eventually work, but only after we have created a bubble that is as big as 1929 + 1999 + 2008. There is no escape from that box.

CorpRaider

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Re: Negative interest rates take investors into surreal territory
« Reply #29 on: July 03, 2019, 04:56:50 AM »
Rule, you are a good noob.  I enjoy and value your contributions to this site.