JOSEPH G. CARSON: There's a new housing bubble. It's bigger than the last one
'The new tipping point comes from a sharp reversal in asset prices after a long period of large increases'
History sometimes repeats itself in the world of finance. Soaring asset prices have lifted the market capitalization of the household balance sheet to a record high, exceeding the lofty valuations of the end of the housing and tech-equity bubbles.
A recent report by the Federal Reserve showed the market value of household real and financial assets totaled a record $114.4 trillion at the end of 2017, up almost $50 trillion since 2009. That market cap was 5.9 times the level of nominal gross domestic product in 2017, exceeding the housing-bubble peak of 5.8 times in 2006 and the tech-bubble peak of 5.1 in 2000.
The surge raises several questions: Have policy makers pushed the monetary experiment of zero interest rates and asset purchases so far such that a reversal in the policy could tip the scale in asset values that threaten the economic expansion? Or has the vision of an endless cycle of growth, with falling unemployment and low inflation and interest rates, led to excessive investor optimism and speculation in the asset markets?
The experience of the past two decades has demonstrated a fundamental change in the tipping point of business cycles. It no longer stems from the destabilizing forces of rising inflation as each of the prior two downturns occurred with relatively modest core consumer price inflation. Instead, the new tipping point comes from a sharp reversal in asset prices after a long period of large increases, and the interaction of abrupt changes in balance sheets on the servicing of debt and spending and investment decisions.
Over the past eight years, household balance sheets have clearly benefited from asset-price inflation. According to the Fed’s data, 65 percent of the increase in the market value of real assets came from price appreciation and only 35 percent came from new purchases. On the other side of the ledger, asset price inflation was even more dominant; 75 percent of the increase in financial asset values came from price appreciation and 25 percent from new purchases.
Stated another way, in terms of household balance sheets, real asset prices posted an average annual increase of little more than 4 percent over the past eight years, while financial asset prices’ average annual gain was more than 8 percent.
There is nothing unique about asset markets that would suggest prices can consistently outrun general inflation, income and nominal GDP growth without costly imbalances at some point. One clear lesson from recent experiences is that excessive debt accumulation can make an asset price reversal more costly. That was true on the corporate side during the tech bubble and on the household side during the housing bubble.
In the past eight years, nonfinancial corporate debt has increased $6.5 trillion to around $19.5 trillion, and for the first time in the postwar period it is roughly equal to nominal GDP. A sizable part of that debt accumulation was used to buy back stock, given how cheap debt was, with official rates close to zero. Even though the leverage is on the corporate side, that doesn’t mean the household sector wouldn’t be impacted, as any long and sharp slide in asset prices would no doubt trigger significant wealth loss and hurt companies’ liquidity and collateral positions, affecting jobs and income in the process.
One of the big risks from a monetary policy standpoint has always been “falling behind the curve.” In terms of price stability, that was always easy to monitor since there were visible inflation benchmarks published each month. Yet, how does the Fed gauge when it’s behind on financial stability, or when asset prices have risen to excessive levels? Although the central bank is charged with maintaining financial stability, it has never defined what that means.
Warren Buffett once said that the market cap of the equity market to nominal GDP “is probably the single measure of where valuations stand at any moment.” If we apply that measure to total asset values on the household balance sheet, it would appear the Fed is already behind the financial stability curve.