As in all periods of speculation, men sought not to be persuaded by the reality of things but to find excuses for escaping into the new world of fantasy–-John Kenneth Galbraith, The Great Crash 1929
In this issue
BSP’s Diokno: No Asset Bubbles and Excessive Credit Growth; Ex-BSP Gov. Espenilla’s Minsky Moment, and Statistical Inflation of Real Estate Prices
I. Truth or Consequence: No Asset Bubbles and Excessive Credit Growth Says BSP Chief
II. The Late BSP Governor Nestor Espenilla Jr. Warned of a Minsky Moment
III. Credit Mismatches and the Boom Bust Cycle are Features of the Fractional Reserve Banking System
IV. Disguising Insolvencies with Liquidity: The BSP’s Php 2 Trillion Liquidity Injection To Revive the Animal Spirits
V. The BSP’s Bailout of the Stock Market
VI. The Statistical Inflation of the Real Estate Index amidst a Historic Slump
VII. Systemic Leverage Hits a Record 104% of the GDP as Other Reserve Assets Take a Larger Share of the BSP’s GIR
VIII. Like 2020, Expect the Unexpected for the Consensus
BSP’s Diokno: No Asset Bubbles and Excessive Credit Growth; Ex-BSP Gov. Espenilla’s Minsky Moment, and Statistical Inflation of Real Estate Prices
I. Truth or Consequence: No Asset Bubbles and Excessive Credit Growth Says BSP Chief
Most likely pressured by some sectors on the role of the BSP on the rising inflation, the BSP chief responded…
(bold, italics, underline highlights on all excerpts mine)
From the Businessworld (February 19 2021): THE Philippine central bank does not expect financial stability concerns to cause asset price bubbles and excessive credit growth after a coronavirus pandemic forced it to cut benchmark interest rates to a record. “We at the BSP believe that we are not experiencing a trade-off between monetary accommodation and financial stability,” Bangko Sentral ng Pilipinas (BSP) Governor Benjamin E. Diokno told an online news briefing on Thursday.
However, in a Bloomberg/Financial Post article titled “Pandemic-Era Central Banking Is Creating Bubbles Everywhere” last January 24, as part of the bubbles everywhere, the article attributed recent events involving a Philippine asset:
“With investors chasing returns wherever they can find them, the rising tide of money is flowing through to bonds sold by companies from poorer economies, too. This is the case even in nations that have been among the hardest hit by the pandemic. When AC Energy, part of Philippine conglomerate Ayala Corp., sold a $300 million perpetual green bond at 5.1% in November, CFO Dizon described the demand as “overwhelming.” Vaccine optimism, along with expectations for a strong recovery in 2021, helped clear the route for AC Energy’s fundraising. “In the morning we announced the mandate and in the evening we priced,” she says. “That usually takes two days. But we saw that the market was very strong, so our bankers recommended to just close everything in the day.” For all the market optimism that abounded as the new year began, one thing was clear: The global economy will need a powerful recovery to justify lofty valuations in global stock markets.”
So, no indications of asset bubbles?
First, a rewind.
In an August 2014 speech, the erstwhile Governor Amando Tetangco Jr. warned about yield chasing frenzy in the domestic markets. From the Bank for International Settlements (August 18, 2014): So in a period of low volatility such as what we have been experiencing, practice the discipline of setting limits. This discipline will not only help you to avoid the pitfalls of "chasing the market". More importantly, this discipline will help you take advantage of the obvious opportunities, as well as unearth those that are hidden. Discipline set during the sober low volatility period will guide you when you are confronted with factors that are not within your control, especially during a frenzied high volatility period.
In that period, the PhiSYx traded between 6,800 to 7,100.
Then Governor Tetango Jr. followed this up in a September speech. From the BIS (September 26 2014): While we have not seen broad-based asset mis-valuations, the BSP remains cognizant that keeping rates low for too long could result in mis-appreciation of risks in certain segments of the market, including the real estate sector and the stock market as markets search for yield. So far, coupled with changes in reportorial requirements and macroprudential measures, the monetary policy actions appear to have achieved some success in moderating the buildup of "irrational exuberance" in certain market segments.
In September 2014, the headline index segued into a higher range, trading from 7,050 to 7,400. The index closed at 7,283.07 at the end of the month as the BSP supposedly “moderated the buildup of irrational exuberance”.
And so, as far back in 2014, the BSP acknowledged signs of brewing bubbles from keeping rates too low.
Now, fast forward to 2017.
From the BSP’s Financial Stability Report 2017: “Stock market price-to-earnings ratios, on the other hand, have been persistently well past their textbook warning thresholds but there seems no evidence that investors believe the stock market to be overvalued. Whether this is a Minsky moment waiting to happen is certainly an important thought but the absence of clear-cut valuation measures for the market as a whole leaves the issue without an empirical resolution.
Persistently. Overvalued.
The PhiSYx closed 2017 at 8,558.42.
II. The Late BSP Governor Nestor Espenilla Jr. Warned of a Minsky Moment
What is a Minsky Moment in the BSP’s terms?
From the same 2017 FSR (p.25)
An economy is said to be undergoing a Minsky process when the aggregate cash outflows exceeds aggregate cash inflows and financial units are at risk of becoming insolvent. The starting point of a Minsky process is called a Minsky moment.
Instability in the economy
When the economy experiences periods of prolonged growth, financial units significantly improve their expectations and reduce their perception of risk. At some point, some of these financial units are pushed to insolvency and become highly distressed and have an excessive perception of risk. They start deleveraging simultaneously to improve their position. But such herd-like behavior reduces asset prices, causing them to deleverage further at prices far below the fair market value. The economy was initially stable but the heightened vulnerability of financial units to insolvency drives the economy to instability. A Minsky meltdown ensues unless authorities intervene to arrest a chain reaction of financial units going bankrupt rapidly.
So from the BSP’s perspective, the Minsky moment represents a degenerate process undergirded by a buildup of insolvencies that lead to financial instability triggered by accelerating asset liquidations.
So has the BSP’s “Minsky moment waiting to happen” signified an implicit reference on the mounting risk of insolvencies of some PSE firms? Or could they have been alluding to a prospective share price meltdown brought by it? Or could it have been both?
In the face of a record-setting headline index which climaxed in January 2018 at 9,058.62, the CPI surged alongside, prompting a panicked BSP to abruptly raise rates by 175 bps from 3% to 4.75% in 5 months from April to November 2018!
Even before this, the BSP’s FSR 2017 arrived at a stunning conclusion. (p.27)
While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise. What is not debatable is that repricing, refinancing and repayment risks (3Rs) are escalated versus last year and this could result in systemic risk if not properly addressed in a timely manner.
The BSP Chief then was the late Nestor Espenilla Jr.
Got that? Persistent overvaluation. Minsky Moment waiting to happen. Dislocations of crisis proportions. 3R risks are escalated.
Are these not signs of a bubble?
III. Credit Mismatches and the Boom Bust Cycle are Features of the Fractional Reserve Banking System
Moving forward to the BSP’s FSR covering the period 1H 2018 to 1H 2019: “Based on the audited financial statements of the 148 Philippine Stock Exchange (PSE)-listed non-financial corporations (NFCs), the growth of interest expense (IE) has outpaced the rise of earnings before interest and taxes (EBIT). In addition to the rate of growth, the ratio of IE to EBIT shows a rise from 14.5 percent at the start of the first quarter of 2016 to 22.6 percent as of March 2019, with a high of 27.8 percent in December 2017. The same companies have also reported lower profitability with respect to return on assets.
One year after, increases in debt continued to outpace earnings. Or, the diminishing returns of debt translates to earnings becoming entirely dependent on a debt buildup.
More from the same FSR (p.13): As noted above, the build up of private sector credit is one of the most aggressive in ASEAN and yet the reported non-performing loans (NPL) ratio of corporate credit remains very modest. At less than one percent as of end-2018, the latest figure is PHP66 billion as of March 2019. 18 This rise may look minimal but a conservative approach requires that we monitor the NPL level which actually shows a V-shaped pattern. Since the inflection point in late 2015, the amount of NPLs has been increasing, reversing the previous positive trend of a decrease despite the rise in outstanding loans. p.13
2016. NPLs started to pick up in 2016, accelerated their upside in 2018-2019.
Next is this striking generalization.
If there are risk issues to raise, it will have to be the prospects of managing liquidity. Aside from simply having more loans versus deposits, using liquid assets as a source for funding more earning assets needs our attention. However, the bigger issue will be that continuing on the path of being a bank-based financial market means that the provision of credit will require taking on mismatches in tenor and in liquidity. As more credit is dispensed, such mismatches will only increase. Certainly, the banking industry has been able to sustain itself despite these mismatches but moving forward, there is value to providing other avenues to alleviate the pressures on the banking books.
If, for the BSP, the fundamental source of the mounting pressures on financial liquidity are the mismatches of credit tenors, thereby affecting the banking books, why can’t they seem to get off the hook?
The crucial answer from Austrian economist Professor Joseph Salerno.
Under the current monetary regime, there is thus absolutely no check on the natural propensity of fractional-reserve banks to mismatch the maturity profiles of their assets and liabilities, to expand credit and deposits, and to artificially depress interest rates. Without fundamental change in the US monetary system, the growth of bubbles in various sectors of the economy and subsequent financial crises will continue unabated
Joseph T. Salerno, Let Unsound Money Wither Away, a written testimony submitted to the Subcommittee on Domestic Monetary Policy and Technology of the Committee on Financial Services, US House of Representatives, "Fractional Reserve Banking and Central Banking as Sources of Economic Instability: The Sound Money Alternative," June 28, 2012.
That is to say, credit mismatches are a natural feature of fractional-reserve banks for which boom-bust cycles are a consequence.
The incumbent BSP Governor even raised the specter of systemic risks from a massive failure in the settlement/payment system (P 28-29): “At the most basic, the amounts processed for payments are significant, of the order of 15 times that of the resources of the banking system or of the economy (Figure 3.13). This highlights the substantial amount of (gross) liquidity needed to support financial market activity. This point is not trivial because it means that the magnitude of settlement/pre-settlement risk may be a much bigger concern than credit risk. It also suggests why unwinding failed transactions can have broad system-level implications. Despite institutionalizing the delivery-versuspayment protocol, the system remains vulnerable because a single bilateral failed trade may require a network of unwinding. Unfortunately, such data is not easily accessible and the extent to which these “settlement fails” represent a possible systemic risk—not just in size but more so in terms of interlinkages that can spillover to the rest of the economy—is not readily determinable, at least at this time.”
Put differently, the risk of "payment/settlement fails" emerge from counterparty risks as a result of credit-based mismatches that induce collateral gridlocks.
Credit risks remain the primary order, with potential financial spillovers on collateral flow, payments/settlements, and liquidity. The next order is the economy.
How are these not symptoms of a massive bubble?
IV. Disguising Insolvencies with Liquidity: The BSP’s Php 2 Trillion Liquidity Injection To Revive the Animal Spirits
Yet, despite being aware, the BSP is trapped. The failure to inflate credit is to magnify the risks of systemic deflation. The Minsky Moment!
Proof?
From the Businessworld (December 2, 2020): THE property market could emerge as a risk to the banking sector if prices stall, while an increase in bad loans overall in 2021 is not likely to significantly threaten bank profits because of aggressive provisioning by many banks early on, Fitch Ratings said….“[A] sustained or significant decline in property prices would have wider repercussions on the banks’ balance sheets — given the sector’s high correlation with the broader economy and as it accounts for 20% of the banks’ loan portfolios,” Fitch said in a report.
And so, the BSP’s answer or response to what they call risk aversion is to inundate more inflationary credit into the system that should revive the animal spirit.
From their latest FSR (2H 2020) p.38: This impasse on risk aversion gets addressed only if the initial uncertainties are managed or if there is a collective rise in altruism. Certainly, one can act on the former, without prejudice on the possibility of the latter. There is an appreciation on why lending institutions are averse to taking on additional credit risks at this juncture but there is also a recognition on the availability of liquidity. Thus, the objective is to re-deploy the liquidity as part of a general strategy for the lending institutions to get more comfortable in taking more calibrated risks.
For the BSP, excess liquidity may restore the public’s confidence only through asset inflation. Increase and stabilize collateral values, confidence follows.
As billionaire investor George Soros wrote,
Busts can be very disruptive, especially if the liquidation of collateral causes a sudden compression of credit. The consequences are so unpleasant that strenuous efforts are made to avoid them. The institution of central banking has evolved in a continuing attempt to prevent sudden, catastrophic contractions in credit. Since a panic is hard to arrest once it has started, prevention is best practiced in the expansionary phase. That is why the role of central banks has gradually expanded to include the regulation of the money supply. That is also why organized financial markets regulate the ratio of collateral to credit.
George Soros, The Alchemy of Finance, Chapter 4, Credit and Regulatory Cycle, p.88
Regulate the ratio of collateral to credit.
From the CNN (February 19) The Bangko Sentral ng Pilipinas said it is exercising caution in assessing when to ease out measures it had put in place to respond to the COVID-19 pandemic…The central bank so far has injected around ₱2 trillion in liquidity to the country’s financial system or around 11% of local economic output, he noted. “With this amount of liquidity, we are carefully assessing the appropriate timing of the unwinding of all these measures,” said the BSP chief. “Doing this too late or too early may have serious repercussions on the economy.”
Figure 1
In the 11-months of 2020, the BSP’s assets ballooned by a staggering 145% or Php 2.26 trillion, mostly on the upsurge in domestic securities and loans, and advances. The BSP’s total assets-to-GDP hit an eye-popping 42% of 2020, as of November. Historic.
But money is not neutral.
If the BSP chief thinks that an untimely withdrawal would “have serious repercussions on the economy”, why should the opposite—the massive injections—have only benefits? What are the costs, the hidden intertemporal costs in particular?
The assumption that the nation is “not experiencing a trade-off between monetary accommodation and financial stability” is not supported even by their data.
Since 1993, the BSP’s fading asset growth has coincided with the long-term downtrend in the CPI. Rather than the BSP, it is the banking system that became the foundation for money supply growth.
And it should be no coincidence that the spike in BSP’s assets last year has coincided with the sharp increase in the CPI. Since taking over the helm as the engine of inflation, BSP’s operations have an asymmetric impact on the economy.
As stated here elsewhere, the financial bailout translates to economic benefits for the financial and banking industry as well as the National Government. It increased demand for these sectors even as the economy slumped to an unprecedented recession. The GDP shows it. The growth of the IT sector was a serendipitous side-effect from mobility restrictions.
And it is a critical mistake to assume that any semblance of demand recovery, fueled by BSP’s QE, would have little impact on prices. There has been little appreciation of the risks from the supply disruptions caused by quarantine restrictions and price controls, aside from low investments.
Or, such massive supply disruptions in the face of a demand stimulus from the BSP could combust runaway prices or intensify the inflation risks, and consequently, risks on interests, currency, credit, and the markets.
And while the BSP seems fixated on bolstering collateral values to disguise insolvencies, they are clueless on the distribution of money, once it diffuses into the main street.
V. The BSP’s Bailout of the Stock Market
Figure 2
The spike of BSP assets has provided a cushion, and subsequently energized the stock market as the PSYei 30 joined its global contemporaries in a frenzied run-up since March.
In turn, such bailout pumped the BSP/PSE Price Earnings Ratio (PER) data to a level proximate to the highs of 1996! (Figure 2, upmost window)
Of course, the index in 1996 and today have different members.
Also, the distribution of market cap weighting has been so skewed that aggregate numbers don’t reflect on the actual conditions. Five issues—with close to 50% of the market cap share—dominate the index. (Figure 2, lowest pane) Aggregate numbers assume proportional distribution.
Importantly, there is no explanation of what comprises the period covering the denominator or the eps of the PER. As such, the biases of the index owners/maintainers may influence its published numbers.
Moreover, some entities continue to game or manipulate the stock market index with increasing regularity and intensity with the likely aim of bolstering it.
Such actions impair the functionality of the pricing system, which gives rise to systemic mispricing and overvaluations.
The false signals exacerbate the imbalances in the economy produced by artificially lowered rates. (read Tetangco above)
VI. The Statistical Inflation of the Real Estate Index amidst a Historic Slump
In the meantime, the real estate industry estate supposedly boomed in the 2Q of 2020, according to the price data from the BSP, even as the economy crumbled.
In the 3Q, the boom allegedly faded as the BSP’s national real estate index contracted slightly (-.4%) YoY, largely due to a plunge in NCR’s index (-12.2%).
These are incredible numbers that have NOT been supported by any other data.
Figure 3
First, reported numbers by listed property firms continue to show both revenue and earnings hemorrhage in the 3Q. Real estate sales of the property index plummeted 30.72%, while net income crashed 53.85% in the 3Q.
Second, real estate GDP, whether on an annual (-17%) or quarterly (-19.4% 3Q and -15.4% 4Q) basis, recorded steep declines in 2020.
Figure 4
Third, real estate consumer delinquent loans rocketed in the 3Q even as the national real estate index. The share of Non-Performing Real Estate loans surged 57.15% to .66% of outstanding consumer loans. Soaring NPLs translate to expanded supply.
Fourth, the growth of bank lending to the supply-side of the industry, though still positive, continues to founder.
Fifth, all major categories of construction permits registered sharp declines in the 3Q.
Lastly, the trend of GDP, NPLs, and construction permits emerged before the pandemic.
The bottom line is that perhaps the supposed boom in the real estate price index may have part of the BSP's communications strategy in collaboration with some private sector appraisers to forestall credit deflation in the banking system.
Yet, despite the euphoric pumping of real estate stocks, the recovery hasn't materialized.
Manias marks the top of a boom-bust cycle.
VII. Systemic Leverage Hits a Record 104% of the GDP as Other Reserve Assets Take a Larger Share of the BSP’s GIR
We discussed the divergences between the CPI and Philippine Treasuries last week.
BSP and global central bank QE operations, designed to inject liquidity into the financial system, have been instrumental in forging such a dynamic.
Yet, the idea that excess credit wouldn’t jeopardize financial stability hardly represents consistent reasoning from the BSP. That’s because ironically, such risks had previously been raised in their FSRs indicating the Interest Expenses running hotter than profits, as well as liquidity drain from the mismatches in credit tenors.
Figure 5
Nonetheless, a plunging GDP in the face of stagnant bank credit expansion and soaring public debt has magnified national credit risks. Public debt and bank credit comprised 104% of the GDP as of 2020!
The cost of maintaining unproductive debt will weigh substantially on the growth potentials of the economy. Paradoxically, to generate GDP, mainstream experts have been appealing to authorities for more debt-funded public expenditures.
So, solve a debt problem with more debt.
Furthermore, to reduce credit risk through the exchange rate channel, the BSP has used derivatives and loans in shoring up its Gross International Reserves (GIR), thus helped in the powering up of the peso. Other Reserve assets continue to absorb a significant role in the BSP’s GIR.
January 2021 GIR reached USD 108 billion a tad below the record USD 110.12 last December.
Interestingly, the BSP appears to be unloading its gold holdings, which dropped to a one-year low last December, according to the IMF’s IRFCL.
Should a surge in global inflation continue, this massive USD short position can be expected to unwind dramatically.
And expecting higher inflation, yields of global bonds continued with their upside ascent this week.
And so echoing 2020, the seeming pivot in expectations from some of the mainstream experts.
From Philstar (February 19): Think tanks are seeing inflation as a potential top concern for policymakers in emerging economies, including the Philippines, with at least one projecting rising prices as impetus to roll back some of last year’s monetary stimulus… For Fitch Solutions, this means that rising prices of basic goods and commodities would leave the Bangko Sentral ng Pilipinas (BSP) with no choice but to raise policy rates by 25 basis points to 2.25% this year.
To repeat. Central bank money printing and disruptions in the supply networks from mobility restrictions and price controls, aside from other lesser forms of interventions, signify a toxic combination.
A sustained rise in local Treasury yields will force more experts to reverse their calls.
Also, the recently enacted FIST will do little to improve the situation.
VIII. Like 2020, Expect the Unexpected for the Consensus
Finally, although they have warned of a Minsky Moment, the BSP ignores or downplays the cyclical processes influencing the stock market, real estate, the credit-business, and the economy.
So their assumptions rest on the simplistic heuristic that what works for banks should also work for the economy.
Besides, in the context of interest rates and net claims of the central government, since 2008, a complete or even partial rollback or normalization of policies has yet to occur. (figure 5, lowest pane)
So with a surging CPI that is about to worsen bank conditions, expect the entrenchment of present easing policies until the markets compel them to reverse.
The unseen ramifications from their policies are about to catch them off-guard anew.
And please do realize that the BSP has been caught on the web of brazen self-contradictions, manifested by their moving goalposts, and critical pivots. All one has to do is to juxtapose their reports and speeches.
