Skip to main content

Bubbles

Many would agree that we are once again in bubble territory in the pricing levels of financial assets.  In spite of a thorough absence of economic vibrancy and extreme levels of geopolitical instability that at the least drain resources that could otherwise be invested in economically productive endeavors, pricing of financial assets are at or near historical highs.  The questions that are on many people’s minds today include:  How long can this go on for?  What could cause the bubble to pop? How can I protect myself when it does?


For most of the past 4 years I have heard predictions of an imminent interest rate increase.   I recall sitting on a panel at a CBRE Investors conference around 2010 or 2011 while I was a senior member of their executive team, and in response to a question about rates I said that I believed that there was a great chance of rates declining than increasing in that next year.  There were murmurs of surprise, and probably some snickers too thinking that it was so obvious that I was wrong.  Just a couple of weeks ago someone very close to me who owns a fairly sizeable portfolio of well located commercial real estate told me he was selling everything.  How, I responded, could anyone rightly disagree with that plan given that he would be getting all-time record pricing for his assets?  However, I pointed out, I think that there may be a greater chance that his 4 cap assets move towards a 2 cap in the coming years than towards a 6 cap.

My reasoning was that:


  • There is a flood of capital seeking yield today;
  • There is an historic absence of yield available and his assets are very stable and thus will continue to be very desirable and thus afford great protection against monetary inflation;
  • Capital flight from many parts of the world will likely continue to seek the stability of U.S. real estate; and,
  • Over-indebted and economically challenged nations will do what they can to keep a lid on interest rates lest their already out of control budget deficits soar to absurd levels and a more expensive cost of capital squash out whatever juice is left in their economies.


The last bursting bubble, the one we now refer to as the “Subprime Crisis,” was a classic liquidity squeeze as an unprecedented amount of financial sector leverage began to rapidly unwind, which precipitated selling of financial assets to meet margin calls, which led to a spiraling downward of pricing levels.  While the financial leverage then was truly extreme, I believe that had the investment banks of that era, including the late Bear Stearns, the late Lehman Brothers, and the former Goldman Sachs, Morgan Stanley and Merrill Lynch (before they became chartered Commercial Banks) been members of the Fed then, the access that they would have had to the Fed borrowing window that all Commercial Banks have, and behind that to the Fed’s unlimited capacity to print money, would have stemmed the tide of that liquidity crisis well before it degenerated to the destructive force it became in 2008.

Today, the financial system of the world is tethered neatly to the Fed, so the unwinding we witnessed in 2008 won’t happen again, at least not in the same way.  There are, as smart economists point out, still significant risks, and bubbles do still inevitably burst, but this time will likely be very different.  In the meantime, with the holes that were exposed in 2008 now plugged, I would bet that rates will remain low and real assets will continue to be well bid for.  The stock market is a whole other matter given that, at least until today, the Fed doesn’t buy stocks.

Popular posts from this blog

Greed & Laziness

In this most contentious and fascinating of election cycles, when nearly each conversation leads to politics, and when polarization runs so high, I ask myself - what is the essence of the debate between left and right?  What does it really mean to be a Conservative or a Liberal?

Why Rates Must Remain Low

There is an old bond trader joke that I first heard in the 1980’s when I traded mortgage-backed securities at Drexel Burnham Lambert.  It went like this:  “Upon dying, Albert Einstein finds himself in what he is told is heaven.  He encounters another individual there and asks him what his IQ is.  When he is told that it is 175 he is overjoyed, knowing that he’s found an intellectual peer with whom he can share much.  Upon meeting another, he discovers that person’s IQ is 140 and is pleased to have met another highly intelligent person with whom he can enjoy chess and other pursuits.  He is feeling pretty good about heaven, when he comes across a person who tells him that his IQ is a mere 90, and he is flummoxed.  What, he wonders, is this guy doing in my heaven and what can I even say to this person?  Then it comes to him.  ‘Where,’ he asks, ‘do you think interest rates are heading?’”

CMBS In Flux

The CMBS market has been in a period of upheaval, with dramatic spread widening on bonds and a resulting much more expensive cost of capital for real estate borrowers who depend upon this channel for their debt financing.Market participants today wonder whether we’ve entered a period like the summer of 2011, when spreads on bonds last widened this dramatically and then snapped back within a year to provide tremendous returns for those who were courageous enough to purchase bonds at the time when there was panic selling.Or, people wonder, is this recent downturn a prelude to a structural or systemic problem, like what was experienced in 2007, when spreads widened and sucked investors in, only to punish those early responders with a much more dramatic price collapse in the next 24 months.