By Susan Tompor
Detroit Free Press
WWR Article Summary (tl;dr) Federal Reserve governor Lael Brainard, who spoke Sept. 12 before the Detroit Economic Club meeting noted that the Federal Reserve’s assessment suggests that “financial vulnerabilities are building, which might be expected after a long period of economic expansion and very low interest rates.”
Detroit Free Press
Just 10 years after the financial crisis, many people find themselves asking the same odd question that a friend asked me last week when we met for coffee.
“So, are we in a bubble?”
A decade ago, of course, we faced such a deep, brutal financial crisis that we couldn’t imagine ever seeing record stock prices or home values again.
It was an entirely different story as the dominoes tumbled in the financial collapse.
Investment banker Lehman Brothers filed for Chapter 11 bankruptcy on Sept. 15, 2008, triggering even more declines on Wall Street.
Millions of people lost jobs in the Great Recession. Millions lost their homes.
Now oddly enough, many are asking: “Are we in a bubble?”
The blue-chip index fell by nearly 54 percent measuring from its record close of 14,164.53 points on Oct. 9, 2007, to rock bottom when the blue chip index closed at 6,547.05 points on March 9, 2009.
But now the Dow is trading close to 26,000.
People who have money tucked away in mutual funds in a 401(k), and those who own homes in communities where home prices have surged, are wondering what’s next, as they’re seeing record values for much of their wealth.
You’re back watching CNBC; you’re once again opening those financial statements; you’re aware of what the house down the street sold for a month ago.
Everyone, of course, isn’t flush with cash or even back where they started a decade ago.
Many modest, Midwest towns once built around a big auto plant or other manufacturers continue to struggle after the factories shut their doors in late 2008 or 2009 and the better paying jobs vanished.
If you don’t have a good paying job anymore or you’re carrying a lot of debt, you’re not talking about bubbles. Instead, you’re talking about how to pay the bills.
“Half the population is a have and half the population is a have not,” said Mark Zandi, chief economist for Moody’s Analytics,
“If you’re a have not, none of this makes sense at all.”
Zandi told me that he would agree that asset prices, including those for stocks, bonds and real estate, are overvalued in many cases.
But he says he doesn’t think we’re in a bubble.
“Bubble to me means speculation,” Zandi said.
That’s when people start chasing hot tips, like those saying you can’t lose money by flipping houses or buying tech stocks.
The financial crisis in 2008-09 was built on a house of cards where way too many people were taking on too much debt as they made can’t-miss bets on stocks or real estate.
While the U.S. economy is about as strong as ever since the economic recovery began nine years ago, many people aren’t engaging in speculative investing, Zandi said.
Consumers continue to be confident overall and the labor market remains strong.
“The tight labor market is providing employment opportunities to more Americans,” said Federal Reserve governor Lael Brainard, who spoke Sept. 12 before the Detroit Economic Club meeting at Masonic Temple.
Yet she also noted that the Federal Reserve’s assessment suggests that “financial vulnerabilities are building, which might be expected after a long period of economic expansion and very low interest rates.”
“Rising risks are notable in the corporate sector, where low spreads and loosening credit terms are mirrored by rising indebtedness among corporations that could be vulnerable to downgrades in the event of unexpected adverse developments,” Brainard said.
Notably, she said, “leveraged lending is on the rise again.”
Charles Ballard, a professor of economics at Michigan State University, said the risks associated with corporate debt levels make him believe that “we are either in a bubble or close to one.”
The surge in corporate debt is not as out of control as the subprime mortgage explosion, he said. But he said it is worrisome.
“Each of the last three recessions was preceded by a big surge in corporate debt,” Ballard said.
“Sure enough, in the last few years, we have had another big surge in corporate debt. And that doesn’t even mention federal budget deficits of $1 trillion per year, which are further straining the credit markets,” he said.
He wonders if some companies are engaged in wishful thinking, and taking out loans that they will later regret.
While we’d like to think that corporations have the inside track on the outlook for the economy, the financial panic in 2008-09 should have confirmed quite clearly that CEOs many times can want to stay too long at the party.
Corporate America can overbuild, overborrow and overestimate how long the good times will roll just like everyday consumers.
“In the lead up to the Great Recession, we saw banks making mortgage loans to people who really did not have a good prospect of paying the loans back,” Ballard said.
“On the other side of those transactions, people were taking out mortgage loans more on the basis of wishful thinking than sound analysis,” Ballard said.
Right now, businesses overall appear to be in good shape. But Zandi noted that a significant number of highly leveraged companies are taking on sizable amounts of debt.
Zandi points to rapid growth of so-called leveraged loans _ loans extended to companies that already have considerable debt. Such loans tend to have variable rates that would go up in a rising rate environment.
Leveraged loan volumes are setting records and loans outstanding have increased at a double-digit pace over the past five years to nearly $1.4 trillion. Another concern: Lenders have been easing their underwriting standards for such loans.
What happens next, of course, is anyone’s best guess.
The Federal Reserve is expected to keep raising rates to reach more normal levels. After all, real interest rates were below zero for nearly 10 years. The next rate hike is likely at the Fed meeting Sept. 25-Sept. 26.
In her speech in Detroit, Brainard indicated that gradual increases in the federal funds rate could be expected in the next year or two, barring unexpected developments.
Recent tax cuts and government-spending increases will give tailwinds to demand over the next two years, she said.
The Fed’s direction for cutting or raising rates after the next year or two would depend on how the economy evolves.
Paul Traub, senior business economist for the Federal Reserve Bank of Chicago, Detroit Branch, said he doesn’t see a bubble. But he is concerned that the rising federal budget deficit will make it more difficult for Washington to use fiscal policy to help when the next downturn does arrive.
“I do think that the tax cut at this point of the expansion is inflating the economy and will push inflation higher more quickly than it otherwise would have increased,” Traub said.
“Stock prices are being inflated as some corporations are using their tax cuts to buy back stock and investors are taking those profits and re-investing them in the market,” Traub said.
“No one knows when the next downturn will arrive but we do live in a cyclical world,” he said.
Bubble or not, prices do not go up and up and up forever.
ABOUT THE WRITER
Susan Tompor is the personal finance columnist for the Detroit Free Press.