Minsky's Fragility Cycle Meets Wile E. Coyote: The Philippine Banking System’s Velocity Trap

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances—Ludwig von Mises 

In this issue

Minsky's Fragility Cycle Meets Wile E. Coyote: The Philippine Banking System’s Velocity Trap

I. Introduction: The Banking System’s Wile E. Coyote Moment

II. NPL Benchmarks Unveil Minskyan Fragility and the Wile E. Coyote Moment

III. Diminishing Returns: Policy Stimulus-Backstop Backlash

IV. Banks’ Drift Toward Consumers: Credit Cards and Salary Loans Power NPLs Higher

V. Stagflation Signals and the Death Knell of Benchmark-ism: Labor Frailty Meets Inflation’s Third Leg

VI. The Wile E. Coyote Dynamic in Bank Investments via Available For Sale (AFS) Assets

VII. AFS Surge and Recession-Grade Financial Losses

VIII. Benchmark-ism and the Illusion of Confidence

IX. Velocity or Collapse: The Wile E. Coyote Reckoning

X. BSP’s Tacit Pivot: From Sovereign Risk to Banking Backstop

XI. Conclusion: The Velocity Charade Meets Its Limits 

Minsky's Fragility Cycle Meets Wile E. Coyote: The Philippine Banking System’s Velocity Trap

The Wile E Coyote velocity game—credit expansion, AFS bets, and central bank lifelines—keeps Philippine banks afloat, but the stability it projects is an illusion

I. Introduction: The Banking System’s Wile E. Coyote Moment 

Inquirer.net, September 06, 2025: Bad debts held by the Philippine banking system rose to their highest level in eight months in July, as lenders—facing slimmer margins from declining interest rates—may have leaned more on riskier retail borrowers in search of yield. Latest data from the Bangko Sentral ng Pilipinas showed that nonperforming loans (NPL), or debts overdue by at least 90 days and at risk of default, accounted for 3.40 percent of the industry’s total loan portfolio. That marked the highest share since November 2024, when the NPL ratio stood at 3.54 percent. 

Time and again, we’ve detailed the escalating challenges facing the Philippine banking system—chief among them, its role in financing the government deficit amid elevated rates. 

This has led to record levels of held-to-maturity (HTM) securities, mounting investment losses from mark-to-market exposures, and potentially unpublished credit delinquencies buried in loan accounts. 

Together, these forces have contributed to the system’s entropic liquidity conditions: a slow, grinding erosion of institutional health masked by policy choreography. 

But recent developments take the proverbial cake. While NPLs remain elevated, their apparent ‘containment’ has served as public reassurance—an illusion of stability. 

Beneath that veneer, banks have shifted into a "velocity game" to preserve KPI optics: record-high credit expansion running in tandem with record-high NPLs. 

This statistical kabuki masks growing stress but sets the system on a path to its own Wile E. Coyote moment. 

While this sustains confidence in the short term, the moment loan growth slows, the cliff edge becomes visible—and the entire charade unravels. 

II. NPL Benchmarks Unveil Minskyan Fragility and the Wile E. Coyote Moment

Figure 1

Since the second half of 2022, Philippine banks have seen a structural uptrend in gross nonperforming loans (NPLs), with nominal levels breaching all-time highs by April 2024 and reaching a record Php 535 billion in July 2025. (Figure 1, topmost chart) 

Though the industry’s NPL ratio remains at a deceptively flat at 3.4 percent, this apparent stability is largely the effect of the ‘denominator illusion’: total loan growth (+11 percent) has been fast enough to offset the rise in bad loans.  (Figure 1, middle window) 

This accelerates procyclical risk-taking—banks extend more credit, often to riskier retail borrowers, to maintain headline ratios. 

Neo-Keynesian economist Hyman Minsky famously proposed that financial instability evolves in stages—from hedge finance to speculative finance, and finally to Ponzi finance—where borrowers can no longer generate sufficient cash flows to service debt and must rely on refinancing, rollovers, or asset sales to stay afloat (see references) 

But Minsky’s framework has a counterparty: the lender. 

In the Philippine case, banks have become enablers of this drift. To keep overleveraged firms and households solvent, they must sustain ever-faster credit expansion—rolling over weak loans, extending new ones, and deferring recognition of losses. 

This is the Minskyan drift on the supply side: not just borrower pathology, but lender complicity. 

A banking system whose apparent stability depends on pyramiding credit to increasingly marginal borrowers, refinancing delinquent accounts, and chasing yield into riskier consumer segments—exacerbating the very fragility it was meant to manage. 

The result is a velocity-dependent equilibrium—one that demands constant motion to avoid collapse. 

When the sprint falters or bad debts surge, the NPL ratio will spike—mechanically, inevitably—unveiling the proverbial skeletons long buried beneath the benchmark gloss. 

The system confronts its Wile E. Coyote moment: suspended mid-air, legs still spinning, gravity imminent. Once credit growth slows, the ground disappears—and the fragility long masked by velocity is fully revealed. 

III. Diminishing Returns: Policy Stimulus-Backstop Backlash 

This Minskyan drift is unfolding despite a full-spectrum easing cycle from the Bangko Sentral ng Pilipinas: reserve requirement cuts, interest rate reductions, the USDPHP softpeg regime, doubled deposit insurance, and lingering regulatory relief. 

Layered atop record fiscal stimulus, these measures were designed to cushion the system—but they now reveal diminishing returns. 

The irony is sharp: instead of stabilizing credit dynamics, these policies have parlayed into rising risks—encouraging yield-chasing behavior and masking stress through refinancing. 

And to maintain the illusion of stability, authorities have upped the ante on benchmark-ism—using statistical bellwethers to project ‘resilience’ while embellishing markets to fit the narrative. 

As nominal NPLs climb and consumer credit deepens, the central bank faces an unenviable dilemma: tighten policy and risk triggering defaults, or deploy unprecedented, pandemic-style liquidity injections to preserve appearances even as the system runs out of runway. At the same time, banks themselves may be compelled to conserve liquidity and pull back on credit expansion, exposing the system’s velocity game for what it is. 

Needless to say, whether in response to BSP policy or escalating balance sheet stress, banks may begin pulling back on credit—unveiling the Wile E. Coyote moment, where velocity stalls and gravity takes hold. 

IV. Banks’ Drift Toward Consumers: Credit Cards and Salary Loans Power NPLs Higher 

This fragility is no longer confined to institutional (supply side) exposures—it’s now bleeding into the household sector. 

The banking system’s transformational pivot toward consumer credit—particularly credit card loans—has deepened latent risks, building a larger stock of eventual loan portfolio losses. 

While aggregate nominal consumer loans (including real estate) hit a record high in Q2 2025, non-performing loans also sprinted higher from their December 2022 bottom. Gross consumer NPLs now sit just 4.7% below their Q2 2021 peak. (Figure 1, lowest graph) 

Though recent increases have been broad-based, the lag in consumer credit delinquencies reflects delayed stress transmission—especially in motor vehicle and real estate segments.

Figure 2

Crucially, the share of consumer loans to banks’ total loan portfolio (net of interbank) reached an all-time high of 22.34% in Q2 2025. Year-on-year growth in consumer NPLs has accelerated from single digits in 2024 to double digits in the last two quarters. (Figure 2 topmost pane)  

As noted earlier, surging NPLs have accompanied blistering growth in credit card loans—both hitting record highs in Q2. (Figure 2, middle image) 

But it’s not just credit cards: salary loan NPLs also spiked to a record, juxtaposed against all-time high disbursements. (Figure 2, lowest graph)

Figure 3

Strikingly, even as bank lending hits new highs, consumer real estate NPLs have climbed over the past two quarters. This uptick comes despite previously stable delinquency rates—a counterintuitive anomaly given the record and near-record vacancy levels observed in Q1 and Q2 2025, potentially a product of sustained refinancing. (Figure 3, topmost diagram)  

These pressures are permeating into the demand side of the economy—further evidence of a consumer squeezed by inflation, debt, and the slow erosion of repayment capacity. 

Taken together, weak household balance sheets, rising camouflaged NPLs, and a slowing economy raise systemic risks that extend well beyond macro fundamentals—threatening institutional health and reaching deep into the financial sector’s core, even as headline growth continues to mask the underlying fragility. 

V. Stagflation Signals and the Death Knell of Benchmark-ism: Labor Frailty Meets Inflation’s Third Leg 

Credit risk pressures should intensify with the July labor market data, which unexpectedly exposes the labor market’s underlying frailty. 

The unemployment rate (5.33%) and unemployed population (2.59 million) surged to pandemic-era highs (August 2022: 5.3%, 2.681 million), while the labor participation rate fell to 60.7%—slightly above July 2023’s 60.1%. (Figure 3 middle and lowest images) 

Stunningly, despite a 1.51% YoY increase in population, the non-labor force swelled to 31.45 million, the highest level since at least 2021. 

Combined, the unemployed and non-labor force accounted for a staggering 42.5% of the 15-and-above population in July 2025—a July 2023 high. 

Ironically, authorities amusingly blamed the weather. 

For banks, a looming storm is brewing: fragile household balance sheets, concealed loan delinquencies, and a deteriorating labor market set the stage for increased NPL formation in Q3 2025, with potentially systemic consequences

Figure 4

There’s more. 

Authorities also reported that despite rice price controls and the 20-peso rollout, headline CPI jumped to 1.5% in August—exposing the likely anomalous 0.9% dip in July. More concerning is the CORE CPI breakout, rising from 2.3% to 2.7%, the highest since December 2024. (Figure 4, topmost visual) 

Historically, a negative spread—where CORE CPI exceeds headline—has signaled cyclical bottoms for headline inflation. 

History rhymes. Peak CPI in October 2018 marked the launchpad for the record run in gross NPLs, which climaxed in October 2021 before slowing. (Figure 4, second to the highest image) 

Likewise, February 2023’s peak CPI became the springboard for the recent all-time highs in gross NPLs—records now eclipsed or obscured by the Wile E. Coyote velocity game. 

The pattern is clear: Each cycle shows how households use credit to bridge spending power losses during inflation surges, only to leave borrowers delinquent in its wake. 

The fatal cocktail of surging unemployment and a potential third leg of the inflation cycle—stagflation—could be the coup de grâce for NPL benchmark-ism. The illusion of resilience may not survive the next impact. 

VI. The Wile E. Coyote Dynamic in Bank Investments via Available For Sale (AFS) Assets 

There’s another aspect we’ve barely touched—yet it has become a critical factor in the banking system’s health challenges, now showing symptoms of the Wile E. Coyote dynamic: investment assets. 

First, the distribution of bank assets reveals a transformational shift—from safeguarding liquidity to an entrenched addiction to leverage. This seismic rebalancing is evident in the rising share of investments and, more recently, the rebound in loan activity, both at the expense of cash reserves. (Figure 4, second to the lowest graph) 

Since the BSP’s historic rescue during the pandemic recession, the cash share of bank assets has plunged to an all-time low of 6.93% as of July 2025. 

Second, as we’ve repeatedly noted, the pandemic-level fiscal deficit has driven the banking system’s net claim on central government (NCoCG) to a record Php 5.547 trillion (up 7.12% last July). This is mirrored in Held-to-Maturity (HTM) assets, which rose 2.15% to a record Php 4.1 trillion. Today’s deficit is not just a macro concern—it’s manifesting as a liquidity squeeze across the banking system. And that’s before accounting for the adverse effects of crowding out. (Figure 4 lowest graph) 

Third, the very investments that carried the banking system through the pandemic—buoyed by the historic BSP cash injections—have now become a source of friction. 

The need for sustained liquidity from the BSP to keep asset prices afloat has morphed into a Trojan Horse for inflation and a fuel source for increasingly speculative risk-taking engagements. 

To stave off asset deflation, the BSP must inject liquidity—primarily via bank credit expansion—yet this comes at the cost of spiking inflation risk.

Figure 5

This dynamic is most evident in Available-for-Sale (AFS) assets, which now constitute 41% of gross financial assets, fast catching up to HTMs at 52%. (Figure 5, topmost window) 

VII. AFS Surge and Recession-Grade Financial Losses 

The record build-up of AFS assets has heightened exposure to mark-to-market shocks, transmitting valuation swings directly into capital accounts and investor sentiment. 

The impact is already visible: In Q2, Philippine banks suffered an income contraction of (-) 1.96%, driven largely by a surge in losses on financial assets totaling Php 43.782 billion—the largest since December 2020, at the height of the pandemic recession. Let it be clear, these are recession-grade losses. (Figure 5, middle chart) 

With fixed income rates falling and bond prices rallying, the source of these losses becomes clear by elimination: deteriorating equity positions and bad debt. This is reinforced by the all-time high in banks’ allowance for credit losses (ACL)—a supposed buffer against rising delinquencies that signals institutional awareness of latent stress. (Figure 5, lowest diagram) 

Yet, like NPLs, these record ACLs are statistically suppressed by spitfire loan growth.

VIII. Benchmark-ism and the Illusion of Confidence

Figure 6

Nonetheless, this structural shift helps explain the growing correlation between AFS trends and the PSE Financial Index. (Figure 6, topmost window) 

In this light, banks—alongside Other Financial Corporations (OFCs)—may well represent a Philippine version of the stock market “National Team”: pursuing benchmark-ism or, perhaps, reticently tasked with pumping member-bank share prices within the Financial Index to choreograph market confidence. 

Patterns of coordinated price actions—post-lunch ‘afternoon delight’ rallies and pre-closing pumps—can often be traced back to these actors. 

Whether by design or silent coordination, the optics are unmistakable. 

IX. Velocity or Collapse: The Wile E. Coyote Reckoning 

The implication is stark: even as banks expanded their AFS portfolios —ostensibly for liquidity and yield, they deepened their exposure to volatility and credit deterioration. 

Equity-linked losses began bleeding into financial statements, and provisioning behavior revealed a system bracing for impact. 

The liquidity strain was hiding in plain sight—concealed by statistical optics and benchmark histrionics.

Compounding this is the shadow of large corporate exposures—most notably San Miguel Corporation, whose Q2 profits were largely driven by asset transfers, shielding its Minskyan Ponzi-finance model of fragility 

For instance, if banks hold AFS equity stakes or debt instruments linked to SMC, any deterioration in valuation or repayment capacity would surface as mark-to-market losses or provisioning spikes. 

Alas, like Wile E. Coyote, banks now require another velocity game—pumping financial assets higher to sustain investment optics. 

Without it, they risk compounding their liquidity dilemma into a full-blown solvency issue.

X. BSP’s Tacit Pivot: From Sovereign Risk to Banking Backstop 

The drain in the banking system’s cash reserves appears to be accelerating. 

Following June’s 11.35% jump (+Php 224.78 billion), July posted a 12.8% contraction (–Php 281.87 billion), fully offsetting gains of June, and partly last May (+Php 66.11 billion). Nonetheless, cash and due from banks at Php 1.923 trillion fell to its lowest level since at least 2014. 

And July’s slump signifies a continuum of long-term trend. However, from the slomo erosion, the depletion appears to be intensifying. 

So, despite interim growth bounce of deposits and financial assets, net (excluding equities), the cash-due banks to deposit and liquid-assets-to-deposit ratios resume their respective waterfalls.  In July, cash to deposit ratio slipped to all-time lows, while liquid assets-to-deposit fell to pre-pandemic March 2020 lows! (Figure 6, middle chart) 

Ironically, July’s massive cash drain coincided with the implementation of CMEPA. 

Importantly, banks drew a massive Php 189 billion from the central bank’s coffers as shown by the BSP’s claims on other depository corporations (ODC). (Figure 6, lowest diagram) 

This wasn’t a routine liquidity operation—it was a balance sheet pivot, redirecting support away from direct government exposure and toward the banking sector itself. The implication is clear: the system is leaning harder on central bank liquidity to offset deepening reserve depletion.

Figure 7

By shrinking its net claims on the central government (NCoCG) while expanding its claims on ODCs, the central bank has effectively told the Treasury to park its funds at BSP, while opening its own balance sheet wider to banks. This reduces BSP’s exposure to sovereign credit, but leaves banks more dependent on central bank lifelines to cover liquidity shortfalls. (Figure 7, topmost visual)  

In practice, this means banks are now forced into a double bind. On one hand, they must absorb more government securities and expand credit to keep up the optics of balance-sheet strength. 

On the other, they rely more heavily on BSP’s injections to plug holes in cash reserves. This rebalancing masks systemic strain—liquidity looks managed on paper, but the underlying dependence on continuous velocity (credit growth, AFS positioning, and central bank drawdowns) signals fragility. 

Far more crucial, what emerges is a structural shift: the BSP’s balance sheet is less about backstopping fiscal deficits and more about propping up the banking system. Yet this is not a permanent fix—if banks stumble in their velocity game or government borrowing intensifies, the pressure could quickly return in the form of crowding-out, valuation losses, and even solvency fears. In short, the pivot may buy time, but it also deepens the Wile E. Coyote dilemma: run faster, or fall.

With the BSP pivoting towards a backstop, bank borrowing growth decelerated to 8.9% YoY or fell by 14% MoM in July to Php Php 1.58 trillion—about 17% down from the record Php 1.907 trillion last March 2025. (Figure 7, middle image) 

This deceleration underscores the limits of the velocity game: even with central bank support, banks are struggling to sustain credit expansion without exposing themselves to deeper asset and funding risks. 

XI. Conclusion: The Velocity Charade Meets Its Limits 

The deepening Wile E. Coyote dynamic—where velocity props up optics of loans and investments—is unsustainable. (Figure 7, lowest cartoon) 

Surging NPLs and rising latent loan losses belie the façade of credit expansion. 

Accelerated exposure to AFS assets injects mark-to-market volatility, while HTMs tie banks to the unsparing race of public debt. 

There is no free lunch. Policy-induced fragility is no longer theoretical—it is compounding and irreducible to benchmark-ism or statistical optics. 

The illusion of managed liquidity is cracking. Each policy lifeline buys time—but only deepens the fall if velocity fails. 

Yet banks and the political economy have locked themselves in a fatal trap:

• Deposit rebuilding is punished by state policy,
• Recapitalization is constrained by fiscal exhaustion,
• Capital markets are dominated by overleveraged elites,
•  Hedge finance is crowded out by Ponzi rollovers,
• Tax and savings reform is politically dead under “free lunch” populism 

In short: a trap within an inescapable trap. 

___

References: 

Hyman P. Minsky, The Financial Instability Hypothesis, The Jerome Levy Economics Institute of Bard College, May 1992 

Prudent Investor Newsletter Substack Archives: 

-Goldilocks Meets the Three Bad Bears: BSP’s Sixth Rate Cut and the Late-Cycle Reckoning August 31, 2025 (substack) 

-Philippine Banks: June’s Financial Losses and Liquidity Strains Expose Late-Cycle Fragility August 7, 2025 (substack) 

-Liquidity Under Pressure: Philippine Banks Struggle in Q1 2025 Amid a Looming Fiscal Storm May 18, 2025 (substack) 

-BSP’s Fourth Rate Cut: Who Benefits, and at What Cost? April 13, 2025 (substack) 

CMEPA 

The CMEPA Delusion: How Fallacious Arguments Conceal the Risk of Systemic Blowback July 27, 2025 (substack)

The Seen, the Unseen, and the Taxed: CMEPA as Financial Repression by Design July 20,2025 (substack) 

  

Phisix: The Impact of Slowing Banking Loans

BSP Official on Property Bubbles: Move Along Nothing to See Here

Pressed to comment by the media on the ‘formation’ of a property bubble based on the recent rise of Non-performing loans (NPL) of the thrift banking industry, a BSP official brushed aside such statistical data as a “blip” and readily dismissed concerns over bubbles as non-problematic[1]. 

NPLs increased to 5.34% as of the end of 2012 compared to 4.97% period in June of last year.

The same BSP official cited that “real demand” and not speculation has been the main force driving the property sector and that current boom has not compromised the banking system’s underwriting standards for “the sake of growth”.

Here is the latest year-on-year bank lending growth for the each month during the first semester of 2013.

The BSP says that 80% of the banking system’s loan portfolio has been extended to production activities, where for the month June, overall banking lending growth slightly receded to 12.2% from 13.5% in May (revised data). 

Meanwhile loan growth to the domestic consumers eased slightly to 12.1% from 12.2% over the same period[2].

Since we understand that only 21.5 of every 100 households[3] have access to the banking system, growth in consumer loans can be seen as less of a systemic threat.

In addition, in contrast to the popular wisdom which sees the Philippines as being driven by consumer or household spending, the reality is that current exemplary performance by the statistical economy has mainly been powered by supply side and government spending bubble dynamics[4].

Yet if household demand have been growing at the range of 4-6%, while the rate of growth of supply side expenditures (particularly real estate and real estate related sectors) have been more than double the household rate, then to suggest that the current boom represents final demand or where there has hardly been any yield chasing going on, signifies as a bizarre or contradictory claim which practically ignores reality or substitutes reality with statistical data mining.

Yet how sustainable is the economic framework where supply side growth continually outpaces the demand side?

The mainstream often confuses statistical analysis as economic reasoning. Statistics without causal theory underpinning them tends to mislead. As the French classical liberal economist[5] Jean Baptiste Say wrote in A Treatise on Political Economy[6],

Hence, there is not an absurd theory, or an extravagant opinion that has not been supported by an appeal to facts; and it is by facts also that public authorities have been so often misled. But a knowledge of facts, without a knowledge of their mutual relations, without being able to show why the one is a cause, and the other a consequence, is really no better than the crude information of an office-clerk, of whom the most intelligent seldom becomes acquainted with more than one particular series, which only enables him to examine a question in a single point of view.

Of course, we understand that officials need to “toe the line” or be a part of the political PR campaign to promote the administration’s agenda.

Despite the declining year on year rate of bank lending growth by the supply side (production activities) and the steady growth of demand side (household), the current pace credit growth expansion remains largely above the previous years. 

Nevertheless the declining trend looks portentous.

For June, real estate renting and business services grew by 22.35% which has significantly been down from the peak at 28.53% in January.

The construction industry continues to sizzle with 48.7% growth in June albeit at the low side of the year’s growth. The massive rebound in the construction industry has been a belated effect since construction growth during the past few years has been negligible. For the year, construction growth has been at the 48-56% levels.

Meanwhile, offsetting the decline in the real estate loans has been the sterling growth of the wholesale and retail trade (which have been part of the shopping mall bubble) has been reaccelerating from a low of 10.02% in April to June’s 15.74% (or a 50% jump).

Also lending to Hotel and restaurant (casino bubble) remains brisk at a 19.55% y-o-y which is slightly off the mean growth of 20.385% for the year.

Despite the apparent slowdown, bank lending in support of supply side ‘interest rate-sensitive’ bubble blowing industries continues to overwhelm demand side growth. If such trend will be sustained then the outcome will be anything but pleasant.

Is the Financial Intermediation Sector the Canary in the Coal Mine?

A good example has been the ballooning shopping mall bubble in China. The race to expand shopping malls has led to a massive oversupply, where many developers and landlords resort not only to foregoing rents to attract tenants, but likewise to paying popular mass market based retail firms to have a presence in their malls[7].

In China’s second tier cities, mall vacancy rates are expected to surge to over 30% by next year! If these malls have been mainly financed by debt or leverage, then rising vacancies will extrapolate to mass insolvencies that will pressure China’s formal and informal (shadow) banking system which similarly will have a contractionary spillover effect on the economy.

China’s impending shopping mall bubble bust should serve as a crucial lesson to the Philippines[8].

And interestingly, one critical industry that has significantly contributed to the marginally declining trend of overall loan growth to production activities in the Philippines has been financial intermediation sector.

Coincidental to the bear market strike on the Phisix last May-June, the rate of growth on loans to the financial intermediation sector dramatically shrunk to a still positive but a measly 1.45% in June. In January, this sector grew by a stunning 39.25% y-o-y. In the onset of the financial market stress last May, the rate of growth has slumped by more than half the highs of January to 12.99%.

If a significant segment of the previous loan growth from this sector has been channeled to the domestic financial assets, such as the stock and bond markets, and if pressures on financial markets persist and or if domestic interest rates should rise in response to the ongoing bond market turmoil, then a call on these loans and or margin calls will likely be the response by the lending institutions or creditors.

The implication is that these will compound on the existing strains on the financial markets via the feedback loop between asset prices and collateral values. 

Debtors will be required to add collateral or creditors will require liquidation of soured loans. If the liquidations route dominates, then this would put additional downside pressure on financial asset prices. Lower asset prices would extrapolate to diminishing value of collateral which should prompt lending institutions to demand more collateral or for more liquidations.

In addition, what has been seen as a ‘blip’ and uncompromised underwriting standards will eventually extrapolate to a series of tightening of credit standards as asset quality deteriorates and as NPLs rise.

Such debt deflation dynamics ultimately will depend on the scale of exposure of financial intermediation loans on the domestic financial markets, which is something unspecified in BSP data. What is publicly known is that financial intermediation loans account for 9.4% of the overall loans to production activities in June. 

While this may seem small, it would be foolhardy to ignore the potential contagion effects on the highly leveraged real estate and allied industries which falling asset markets may spur or trigger.

Bubbles Operate as a Process

Bubbles don’t just appear from nowhere. Bubbles represent a process where people’s incentives are shaped by distortive social policies, which leads to a clustering of errors via discoordination or misallocation of resources. The eventual unwinding of such imbalances also undergoes a reversal process.

For instance the survival of shopping malls ultimately depends on mostly retail based tenants, whom are predominantly small and medium scale enterprises (SME).

The domestic shopping mall industry has been growing rapidly via the industry’s misperception or overestimation of the rate of growth of domestic consumers. They have been misled by the price signals brought about by zero bound rates or easy money policies and from the disinformation disseminated by mainstream media.

Popular wisdom holds that easy money represents a perpetual phenomenon. The reemergence of the bond vigilantes has placed the spotlight on viability of mainstream’s premises.

And like China, there has been a blitz of shopping mall expansion, mostly financed by debt, designed to capture profits from what seems as unlimited pockets by the consumer.

The Philippine consumers, if based on inflation adjusted GDP per capita growth, has been expanding by a top of the line 3.16% in 2006-2010[9]. If we estimate per capita growth for 2011-2013 at 7% (economic growth rate) per annum then per capita levels today would only be at about 3.87%. This would hardly be enough to finance all the double digit supply side spending boom. This is unless the informal economy has been far larger than estimated.

Yet if the profitability of the SME retail sector should come under pressure from a combination of factors: cut throat competition, oversupply, higher cost of capital via rising interest rates, and rising cost of business from non-regulation directly influenced factors such as rising input prices via rents, wages or producers goods and etc.., then loans from ensuing operational losses will most likely reflect on the lenders via impaired loans.

So any sustained amplification of the deterioration of NPLs from clients of thrift banks could signify as one of the possible symptoms of the periphery-to-core process of a bursting bubble.

To disregard them by comparing with the past when credit growth has not reached current levels would signify as imprudent anchoring bias or even apples to oranges comparison.

A Peak in Domestic M3?

The BSP also recently noted of a significant boost in domestic liquidity in June, where on a year on year basis growth ramped up by 20.3% to Php 5.7 trillion, which has risen faster than the 16.4% in May.

The surge in M3 has mostly been due to Net Domestic Assets (NDA) which jumped by 30.5% in June from 28.7% in May. Soaring NDAs, according to the BSP, reflected the sustained growth in bank lending to help finance economic activity[10].

Since 2004, M3[11] has been growing by a Compounded Annual Growth Rate (CAGR) of 11.05%. But this hasn’t been reflecting on the current state of affairs. One would note that M3 zoomed only during the end of 2012. Based on 2011, Philippine M3 CAGR soared by 13.815% from 2011, and from January 2012 until June 2013 CAGR catapulted by 14.53%. So we have a 2-3+% increase in money supply from the current administration.

Where has all these 13-14% money growth been flowing? The most probable answer: property, stock and bond market bubbles. Yes, the 13-14% money growth from sharp increases in bank loans been responsible for, or represents as the trade secret of the current administration’s ‘good governance’ ‘rising tiger’ statistical economy.

Unfortunately the recent declining trend on bank loans spearheaded by the financial intermediation sector will reduce the speed of rate of change of M3 overtime. Such decline may have already been signalled by the domestic stock market.

Similarly, should the rate of growth of bank loans continue to shrivel, then this would also be reflected on the rate of growth of the statistical economy.

The populist glorification of the so-called politically driven economic boom will face reality.

Philippine 10 year Bond: The Odd Man Out?

And speaking of asset bubbles, last week’s actions in ASEAN’s bond markets brought upon a huge surprise.

Yields of the Philippines 10 year bonds[12] has fallen nearly to the pre-Taper market seizure levels (upper left window) even as yields of our bigger and far richer ASEAN neighbors climbed. As of the actions of last week, the Philippines has decoupled from the region!

This implies the following:

One the Philippines doesn’t need a Moody’s upgrade or that the bond markets has been front running or pre-empting a Moody’s upgrade.

Two, current yields demonstrates the prevailing low interest rate environment.

Three, Philippine yields is just about 103 basis points away from the US counterpart as of Friday’s close, which if I am not mistaken accounts for as the narrowest spread between 10 year Philippine Peso and 10 US treasury note ever.

However this also means that the vastly narrowing yield spread will likely work as a disincentive for US based investors who will likely look for bigger spreads as margin of safety.

Four, such record low spread or near record low yield means that the Philippines is seen as having lesser interest rate and credit risks relative to her bigger and wealthier neighbor. Said differently, the Philippines despite having a US dollar GDP nominal per capita of only US$ 2,617 (IMF 2012)[13] compared with Indonesia’s US$ 3,910 (IMF 2012), Thailand’s US$5,678 (IMF 2012) and Malaysia’s $10,304 (IMF 2012) has been valued by the markets as having been far more credit worthy or has higher credit standings.

The Philippines at $2,617 per capita seems now at par with Australia US $67,723 (IMF 2012).

Wow this time is different! Or has it?

As of July 25^th 5 year senior Credit Default Swaps (CDS)[14] of the Philippine has marginally been higher or exhibits the higher risk profile compared with Malaysia and Thailand (upper right window). It is unclear if the CDS markets have replicated the bond markets over the last few trading days.

But one thing is certain, during the last market seizure emanating from the return of the bond vigilantes in response to Bernanke’s Taper Talk, CDS prices of the four ASEAN majors surged concomitantly (lower window). While CDS prices have fallen from their peaks in June, they have been creeping higher during the last few days ending July 25^th. My guess is that they are above the July 25^th levels considering the recent actions in the bond-stock and currency markets.

And speaking of currency markets, the Philippine Peso continues to drop along with her regional peers. This reveals of the sharp divergences between actions of the 10 year bond yields and the Peso. 

Importantly, stock markets of the three of ASEAN majors appear to be substantially faltering. The decline in the Phisix along with the Peso appears to be departing from the signals emitted by the domestic bond market.

Such huge divergences and the record (US-Phil) spread exhibits of the enormous misperception, misappraisal, maladjusted and deeply mispriced markets.

Given what seem as the odd man out, Philippine 10-year bonds look like a great short opportunity.

The Philippine Government Spending Bubble

Apart from titles to capital goods (stocks and property), another aspect of the risk of bubbles, which the public can’t or refuses to see, has been the government’s spending budget.

The Philippine President has recently submitted to the Congress for approval a proposed Php 2.268 trillion (US $52 billion) budget for 2014 which is reportedly 13.1% higher than this year[15].

While the general public has been debating over who gets what, they hardly realize that the current trend of growth of the Philippine government’s spending is unsustainable and will lead to a debt or currency crisis.

According to the data from National Statistical Coordination Board or NSC[16], over the past 17 years CAGR for revenues has been at 8.07% (green) whereas the CAGR for expenditures has been at 9.1% (red). The Philippine budget has turned into deficit in 1998 and never looked backed. 

The CAGR for the budget deficit has been 11.1% over the past 17 years.

If the economy grows at 5-6% while growth trend of deficits remains at the current pace then we will see huge increases in taxes or higher inflation or exploding debt overtime.

The budget gap was almost closed or the elusive balancing of the budget was nearly a reality in 2007-2008. But a crisis exploded, whose epicenter was in the US, which rippled through the globe, and nearly caused a recession in the Philippines.

The effect of the near recession was felt a year later or in 2009, where the deficit swelled as revenues slumped amidst sustained increases in government expenditures.

Interestingly, the pattern where government revenues plummet in the aftermath of every banking crisis[17] affected the Philippines even in the absence of a domestic banking crisis.

Such transmission mechanism has apparently been an offshoot from today’s financial globalization.

Admittedly the incumbent administration has accomplished marginal improvements.

Revenues (CAGR 8.31%) grew more than expenditures (5.305%) in 2010-2012, but such has not been enough to push back deficits to the 1998-2007 levels.

But to consider, we supposedly are in the salad ‘economic boom’ days where budget gaps should narrow. Obviously this hasn’t been the case.

And yet if the current budget will be approved and spent accordingly, then this will signify as a big jump on the expenditure side. Of course, the hope is that these expenditures will transform into future revenues. This seems as wishful thinking. Aside from arguing that public works are unproductive, the public has obviously discounted risks even when the Philippines look vulnerable from both directions or from external (capital flows, remittances, merchandise trade, external debt) and internal (level of domestic debt).

Yes I know, the popular approach has been to use the above as ratio to GDP. But again, I don’t think that the conventional accounting GDP identity represents a useful indicator since I have been pointing out these have been puffed up and manifest on a credit driven asset bubble and unproductive government expenditures which may unravel and easily cause a swift deterioration on what seems solid ratios today.

My understanding of the theory of business ‘boom-bust’ cycles, backed by the history of banking, sovereign and currency crises tells me where and what aspects to monitor. I wouldn’t like to be subjected to a Black Swan event when the latter can be predicted.

Deficits will have to be financed by debt, taxes or inflation.

In terms of debt, the rate of increases in Philippine debt outstanding[18] both from domestic and from foreign lenders over the past 17 years have been at CAGR 9.49% and 9.62% respectively. Total debt has grown 9.59%. The growth rate during the past 17 years, if sustained, enhances sovereign credit risks.

But boom days have cosmetically improved debt levels.

It is true that the current administration has reduced the rate of growth in total debt levels by almost half or 4.84% from 2010-2012, aside from changing the mix of the debt exposure in favor of domestic debt, where domestic debt grew by 8.46% while foreign debt contracted by .523%. Domestic debt now commands nearly 64% share of the total outstanding debt. The shift to tilt the balance of debt outstanding towards domestic debt from foreign debt deftly avoids external debt risks and at the same maximizes the Philippine government’s financial repression policies, through not only the stealth transfer of people’s savings in favor of the government (debtor) but importantly by keeping interest artificially rates low, such reduces the government’s interest expenditures which effectively operates as a covert deficit reduction mechanism.

But these again are boom days which can easily be reversed by a dramatic collapse of revenues and from potential bailout policies—should a crisis emerge from anywhere from the world.

And all it takes is a snap of a finger, from Professors Carmen Reinhart and Kenneth Rogoff[19];

Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence—especially in cases in which large short term debts need to be rolled over continuously—is the key factor that gives rise to the this-time is different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang!—confidence collapses, lenders, disappear and a crisis hits.

The bang! actually represents a state of unpredictable time, where accumulated imbalances have reached a tipping point that radically overturns the positive perception of the critical mass of creditors against debtors.

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[1] Inquirer.net Property ‘bubble’ a remote possibility August 3, 2013

[2] BSP.gov.ph Bank Lending Sustains Growth in June, July 31, 2013

[3] see The Flaws of BSP’s Real Estate Monitoring and Banking Stress Tests May 20, 2013

[4] see Phisix: The Myth of the Consumer ‘Dream’ Economy July 22, 2013

[5] Wikipedia.org Jean-Baptiste Say

[6] Jean Baptiste Say A Treatise on Political Economy, Library of Economics and Liberty

[7] see China’s Shopping Mall Bubble: Free Rents to Attract Tenants, July 2, 2013

[8] see Philippine Economy’s Achilles Heels: Shopping Mall Bubble (Redux), January 13, 2013

[9] Wikipdia.org List of countries by GDP (real) per capita growth rate

[10] BSP Domestic Liquidity Growth Accelerates in June July 31, 2013

[11] Tradingeconomics.com PHILIPPINES MONEY SUPPLY M3

[12] Investing.com Philippines 10-Year Bond Yield

[13] Wikipedia.org List of countries by GDP (nominal) per capita

[14] AsianBondsOnline.org Credit Risk Watch

[15] ABS-CBNNews.com PNoy to submit P2.3T budget for 2014 July 23, 2013

[16] National Statistical Coordination Board, Statistics, Public Finance

[17] Carmen Reinhart and Kenneth Rogoff BANKING CRISES: AN EQUAL OPPORTUNITY MENACE December 2008 NBER Working Papers

[18] National Statistical Coordination Board Lubog na ba tayo sa Utang? May 9, 2012; Bureau of Treasury National Government Outstanding Debt

[19] Carmen Reinhart and Kenneth Rogoff, Preamble: Some Initial Intuitions… This Time is Different Princeton University