February 18, 2013, 6:57 p.m. ET

'Loose Talk' and Loose Money

The G-20 concedes that central banks rule the world economy.


The main message out of the Group of 20 nations meeting in Moscow on the weekend boils down to this: Countries can continue to devalue their currencies so long as they don't explicitly say they want to devalue their currencies. Markets got the message and promptly sold off the yen on Monday in anticipation of further monetary easing by the Bank of Japan.

This contradiction between economic word and deed shows the degree to which policy makers have defaulted to easy money as the engine of growth. The rest is commentary.

The days before the Moscow meeting were dominated by blustery fears about the "currency war" consequences of money printing in the service of devaluation. Lael Brainard, the U.S. Treasury under secretary for international affairs, gave a speech in Moscow warning against "loose talk about currencies." She seemed to have in mind Japan, whose new prime minister Shinzo Abe has made a weaker yen the explicit centerpiece of his economic policy.

In the diplomatic event, all of that angst went by the wayside. The G-20 communique bowed toward a vow to "refrain from competitive devaluation." But the text also repeated its familiar promise "to move more rapidly toward more market-determined exchange rate systems"—words that essentially mean a hands-off policy on currency values. So Japan can do what it wants on the yen as long as it doesn't cop to it publicly.

That message was also underscored by Federal Reserve Chairman Ben Bernanke, who implicitly endorsed Japan's monetary easing and declared that the U.S. would continue to use "domestic policy tools to advance domestic objectives." When the chief central banker of the world's reserve currency nation announces that he is practicing monetary nationalism, it's hard to blame anyone else for doing the same.
Finance ministers and central bank governors pose for a photo during a meeting of G20.
The upshot is that this period of extraordinary monetary easing will continue. Economist Ed Hyman of the ISI Group counts dozens of actions in recent months in what he calls a "huge global easing cycle." The political pressure will now build on the European Central Bank to ease in turn to weaken the euro. South Korea and other countries that are on the receiving end of "hot money" inflows may feel obliged to ease as well to prevent their currencies from rising or to experiment with exchange controls.

This default to monetary policy reflects the overall failure of most of the world's leading economies to pass fiscal and other pro-growth reforms. Japan refuses to join the trans-Pacific trade talks that might make its domestic economy more competitive. The U.S. has imposed a huge tax increase and won't address its fiscal excesses or uncompetitive corporate tax regime. Europe—well, suffice it to say that Silvio Berlusconi is again playing a role in Italian politics and the Socialists are trying to resurrect the ghost of early Mitterrand in France.

So the central bankers are running the world economy, with the encouragement of politicians who are happy to see stock markets and other asset prices continue to rise. Here and there someone will point out the danger of asset bubbles if this continuesECB President Mario Draghi did it on Monday—but no one wants to be the first to take away the punchbowl. It's still every central bank, and every currency, for itself.

The Collateral Damage of Europe’s Rescue

Hans-Werner Sinn

18 February 2013
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MUNICHThe eurozone is now in its sixth year of crisis – and of efforts by the European Central Bank and the international community to end it. Policymakers are becoming ensnared in a creeping interventionism that, as British Prime Minister David Cameron has put it, may alter the eurozonebeyond recognition” and violates Europe’s basic economic and political rules.
The newest demand, loudly voiced by French President François Hollande, is for the ECB to manipulate the exchange rate. Hollande is alarmed by the rapid appreciation of the euro, which has risen from $1.21 at the end of July 2012 to $1.36 in early February this year. The strengthening exchange rate is putting additional pressure on the rickety southern European and French economies, undermining their already low competitiveness.
The cheap credit ushered in by the euro fed an inflationary economic bubble in southern Europe that burst when the financial crisis hit. Credit terms worsened abruptly, and what was left was the thoroughly overpriced rump of economies that had become excessively dependent on foreign financing.
The French economy, in turn, is suffering because its customers in southern Europe are in trouble. According to a study by Goldman Sachs, France would have to depreciate by around 20% relative to the eurozone average, and by about 35% vis-à-vis Germany, to restore external-debt sustainability.
The ECB and the international community – particularly the International Monetary Fund – have tried to deal with the crisis by replacing the dearth of private capital with public credit. The ECB shifted its refinancing credit and money creation – to the tune of €900 billion – toward southern Europe and Ireland, as measured by the Eurosystem’s Target balances.

In doing so, however, it put itself in peril, because the only way to implement the shift was by lowering the collateral requirements for refinancing credit. To a large extent, this collateral consisted of government bonds.
In order to stop these securities’ downward slide – and thus to save itself – the ECB bought these government bonds and announced that, if need be, it would do so in unlimited amounts. At the same time, the European Stability Mechanism was established to safeguard states and banks.
These assurances managed to calm the markets and restarted the flow of capital from the eurozone’s core to its periphery. But capital is flowing in from other countries as well. Holding euros and acquiring euro-denominated securities have become attractive again around the world, pushing up the exchange rate and causing new difficulties.
Here, it should be said that the Bank of Japan’s manipulation of the yen’s exchange rate has played only a minor role, notwithstanding Bundesbank President Jens Weidmann’s strong condemnation of the policy. Japanese intervention cannot explain the revaluation of the euro against the dollar and many other currencies.
The ECB can curb the euro’s appreciation through purchases of foreign currency. But, ultimately, it would have to do so by inflating its own currency until confidence in the euro falls back to the level that it had before the assurances were made.
That is why ECB President Mario Draghi rejected Hollande’s suggestion almost instantly. Draghi is well aware of the enormous sums that were lost during the 1970’s and 1980’s, after the collapse of the Bretton Woods system, in futile and costly interventions to stabilize exchange rates, and he does not want to jeopardize the ECB’s goal of maintaining price stability.
The euro’s appreciation lays bare the huge collateral damage that Europe’s rescue policy has caused. The measures taken so far have opened channels of contagion from Europe’s crisis-ridden peripheral economies to the still-sound economies of Europe’s core, placing the latter’s taxpayers and pensioners at great financial risk, while hindering long-term recovery in the troubled countries themselves.
True, Europe’s rescue policy has stabilized government finances and delivered lower interest rates for the over-indebted economies. But it has also led to currency appreciation, and thus to lower competitiveness for all eurozone countries, which may yet turn into a debacle for the southern eurozone and France, which are too expensive anyway, and for the euro itself.
The ECB’s rescue operations have hindered the internal depreciation – lower prices for assets, labor, and goodsthat the troubled economies need to attract fresh private capital and regain competitiveness, while the euro’s appreciation is now compounding the challenge. In short, Europe’s rescue policy is making the eurozone’s most serious problem – the troubled countries’ profound loss of competitivenesseven more difficult to solve.
Hans-Werner Sinn, Professor of Economics at the University of Munich, is President of the Ifo Institute for Economic Research and serves on the German economy ministry’s Advisory Council. He is the author of Can Germany be Saved? 

February 18, 2013 7:11 pm

Housing: The long climb back
Investors made a killing after the US bubble burst, but for average Americans the recovery is likely to be gradual
On the up: builders work on the roof of a new house in Alexandria, Virginia

To the Green brothers, everyone seemed to be getting rich off the great Florida housing boom of the last decade except them. Their fledgling construction company couldn’t compete with cash-rich rivals who had been building houses in Cape Coral, a city carved out of a mangrove swamp on the Gulf Coast.

By 2008, the Greens were in trouble. “Our margins were razor-thin and we were constantly being outbid on jobs,” says Bill Green, a bearded former construction worker with a degree in real estate from Florida State University.

They had borrowed from friends and family, and their savings were nearly depleted. It was becoming obvious that the downturn in housing was less a dip than a disaster. As the crisis spread and banks began to foreclose on houses in Cape Coral, the Greens changed tack. Instead of building houses, they would buy them.

The Greens bought a foreclosed house for about $31,000. They renovated it, rented it out – and discovered a successful new business model. Today they own 76 homes, most of them painted with a signature blue front door.

“Our farming upbringing of being frugal with our money and hard work got us through a very rough period, for us and for Lee County,” says Ben Green, the clean-shaven accountant of the pair, of the housing crash. “But it presented a great opportunity for us”.

Now the Greens have a different problem: there are no cheap houses left to buy.

The nature of the recovery in Cape Coral and similar areas is bringing back bad memories: it is bubbly, driven by financial investors, and focused on the samesand states” as the last boom. In Cape Coral, one of the hardest-hit markets in the country, prices are up by 13 per cent on a year ago; in Phoenix, Arizona, they are 24 per cent higher.

But this is not the start of a new US housing bubble, nor is one likely for years to come. After five years in free fall, US houses are now at something like fair value, and new regulation means there is little mortgage helium to inflate prices again.

More likely, the US housing market is in the first, volatile stage of a return to normality, with gently rising prices and the return of new construction. That should support growth in the US economy – but not dominate it like a decade ago. This means Americans still hoping to build most of their wealth from their houses – a persistent notion even after the experience of the past five years – are likely to be disappointed.

stable housing recovery can only happen if prices really are back to normal. The six-year bubble upset all notions of what a house is truly worth. Sleepy little bungalows in Florida doubled in price; your house, suddenly, could make you rich.

There is no good way to define fair value for houses, says Robert Shiller, a Yale professor who warned of both the internet and housing bubbles. Today, he says US home prices are close to their long-run trend. The median sale price for an existing home was $178,900 in the fourth quarter of 2012, according to the National Association of Realtors, up 10 per cent on a year ago.

The US has plenty of land, so outside big cities the main cost of a house is construction, and the main cost of construction is labour. That means that in the long run, house prices should track rising wages – but not run ahead of them.

House prices have gone up a little bit since 1890 in real terms,” says Mr Shiller. With prices about right relative to history, there is no reason to expect big moves up and down over the next decade or two.

Another requirementabsorbing unwanted houses built during the boom – also seems to be met.
Although the US housing crash evokes an image of endless stretches of unwanted houses in a desert, over-construction was only a small part of the US housing bubble from 2003 to 2006. In fact, new building never matched its 1970s peak.

“I think the excess was in terms of home price appreciation and the excess was in terms of home ownership,” says Michelle Meyer, a housing economist at Bank of America Merrill Lynch in New York.

The slump in building during the credit crunch, however, was prolonged, extreme and spread across the whole country. Even today, construction is barely above the lowest levels of past slumps. “We’ve more than offset any overbuilding that we’ve seen,” says Ms Meyer.

. . .

That lack of unwanted houses is clear from a foreclosure auction in Lee County this January. The Green bid team is four-strong: Ben in his office on the website of the country clerk; Bill on his cellphone at another property; their assistant Heather Lawrence; and Brutus the poodle.

“They always talk before they buy anything”, confides Ms Lawrence. But all the houses in this auction are too dear and the Greens bid $150,100 on a vacant plot instead. The foreclosure was so long ago that the house there fell into disrepair and local officials demolished it.

The former occupants owed $632,000 on their mortgage. The bank wanted $147,500. “We got it,” Ben tells his brother. It is no longer enough to buy cheap houses; it is time to build.

Right now, rapid house price rises are confined to markets such as Arizona, Nevada and northern California, which were at the heart of the bust. States where a judge must approve foreclosures, such as Illinois and Ohio, are further back in the process.

Of the 100 largest housing markets, 15 are up by more than 10 per cent on a year ago; in 32 others, including big cities such as Chicago and Philadelphia, prices fell or rose by less than 3 per cent.

The narrowness of today’s revival – and the reason it is likely to evolve into a gentler recovery – is confirmed by the curious mixture of investor demand and restricted supply that is playing out in housing markets such as Cape Coral.

The demand comes from private equity firms gorging on distressed housing. Over the past year, Blackstone, one of the biggest, has spent $3bn on more than 17,000 houses in a dozen cities, says Jonathan Gray, the company’s global head of real estate.

Mr Gray says he began considering how to invest in US housing in early 2011, when “almost every statistic, other than reading the newspaper, told you things should be getting better”. Blackstone has dedicated nearly 1,000 workers to housing investments, with thousands of subcontractors scattered across the US.

Blackstone and the Green brothers rent out their properties – a big reason for the lack of supply for sale today. Meanwhile, those homeowners who avoided foreclosure still have mortgages worth more than their house, and so cannot sell. A pop in prices is the result.

Sam Khater, deputy chief economist at housing data supplier CoreLogic, points out that this situation is somewhat artificial and the house price rally may soon run out of steam. There are lots of peopleinvestors and homeownerswho will want to sell as soon as prices get a bit higher. “What you might have is a series of rolling bubblettes,” says Mr Khater, as investors work through the available inventory in distressed markets.

Ms Meyer expects another shift in the market once it is driven less by investors and more by people seeking a place to live. “We’re not in a normal market. There’s still a higher share of institutional investors than normal; there’s still a higher share of distressed homes than normal,” she says. “As we see these being handed back to primary homebuyers I think we’re going to see some volatility in prices.”

In theory, conditions are good for those regular buyers: interest rates of just 3.5 per cent fixed for 30 years mean that houses are cheap relative to incomes and rents. But at the moment only strong borrowers, most of whom already have their own home, can get credit.

. . .

Since the bubble burst, the federal government has struggled to revive the supply of credit – and it is still struggling. Obama administration policies have had, at best, a modest effect on the housing recovery.

Over the past 18 months a revamped scheme called the Home Affordable Refinance Programme, or HARP2, has helped those with a mortgage worth more than their house to refinance at today’s low interest rates.

HARP2 only works for those with mortgages backed by the government controlled housing agencies Fannie Mae and Freddie Mac. Barack Obama, US president, has endorsed the idea of allowingunderwaterborrowers with private mortgages to refinance too. More refinancing would help the move back to a normal housing market, but the odds are slim that Congress will act on Mr Obama’s plan.

Unless regulators ease up on the strict lending requirements brought in after the crash, house prices are likely to be steadier. All the signs are that loans with no deposit or proof of income – the so calledliar’s loans” that were a hallmark of the bubble years – are gone.

Credit availability defines what kind of access to home ownership people have,” says Ms Meyer.
After years in which home ownership was an important policy goal, the debate now is how far government should retreat from housing finance. The home ownership rate in the US is down to 65.4 per cent after peaking above 69 per cent during the bubble. If people remain in rented property because credit conditions are too strict for them to buy, then the fuel for a new bubble is not in place.

That means that housing can help the overall growth in the US economy, but not drive it. In the best year of the last recovery2004, when the economy grew by 3.5 per cent housing investment directly provided 0.5 percentage points of growth. Borrowing against rising house prices contributed to the 2.3 percentage points that came from rising consumption.

In 2012, housing added 0.3 percentage points to growth, after six consecutive years when it subtracted from the total. That return to expansion is a big boost for the economy.

Bill Green compares his strategy in the immediate aftermath of the financial crisis in 2009 to being “a fireman, running in when everyone else is running out”. Conditions have improved lately, so it may be time to do the opposite, he says.

“We used to look at 15 to 20 houses a day, cherry-picking the best ones,” says Ben. Now we’re lucky if we see two to five good houses a week.”

But they are confident that the fundamentals of their market – a steady stream of retirees who come to Florida for the sun and low taxesfavour rising house prices in the long term.

Many tried to live the dream of riches from housing during the bubble; what let the Greens succeed was the bursting of it. Unless there is a shift in US financial regulation, however, they may be some of the last Americans to make big money from houses for some years to come.

Copyright The Financial Times Limited 2013.