A decade after the global economic crisis, Bank Hapoalim (TASE: POLI) chief economic advisor Professor Leo Leiderman believes that one of the main issues facing the markets today is what he calls a kind of addiction to the money that central banks are injecting into the financial markets.
Leiderman says that these injections, together with the low interest rate and large-scale liquidity, are channeling investors into the stock and real estate markets. He notes that the International Monetary Fund (IMF) Global House Price Index is currently at the same level as on the eve of the crisis, and the same is true of the Standard & Poor's Case-Shiller Home Price Indices.
In the framework of the KSM Podium event, Leiderman told "Globes" capital market editor Shai Shalev today that what surprised him more than anything else about the crisis was "how few of the real risks were reflected in the markets, and how little the regulators and the US Federal Reserve Board know about the financial architecture that had developed and been streamlined following the liberalization in the US. With all the derivatives and financial products that have been marketed since then, how much all of us failed to realize that products would be created whose true risk was understood by no one can now be understood.
"The bankruptcy of the Lehman Brothers investment bank was also a surprise for me, because the markets assumed that it was too big to fall. After they rescued both Bear Sterns and the AIG insurance company the same year, the market also expected them to rescue Lehman Brothers," Leiderman says.
"Globes": 10 years have passed, and the stock and real estate markets are again breaking records. Are you surprised?
"No. I'm a great believer in the power of the interest rate, that it reflects the price of money. We're in a situation in which the interest rate is low all the time, and we're seeing growth. The money continues to move in these directions, although it may be that there will be additional correction points, because when you're flying very high, there are fluctuations, and you never know what the trigger is for it. Another important thing supporting the high levels in the markets is corporate profit margins, which are good, both in Israel and in Europe and the US."
How long do you think the bull market will last?
"It is hard to predict the markets, and hard for economists to see future changes in trend. The near-zero interest rate is a strong enough basic factor, but a hard cough by US Federal Reserve chair Janet Yellen is enough to shake up the markets. I'm concerned about the process by which the central banks are keeping the low interest rate for a prolonged period, because cheap money is encouraging leverage and a rise in asset prices. That is leading to a situation in which the risks are increasing almost exponentially."
Are you worried about another crisis like the one that occurred in 2008?
"In the current situation, one of the risks, about which the economists don't know if or when it will materialize, is the very rapid ascent in the stock and real estate markets and the dramatic decline in interest rate spreads that is fueling those rises. Some are asserting that the corporate bond market is not pricing the companies' real risks and their ability to repay loans. Today, however, it is hard to find an economist on Wall Street who expects such a crisis this year or next year. At the same time, with all the computer and forecasting systems, they were also wrong about the hurricane in Florida. Some crises can be predicted in advance, such as the 1983 bank shares crisis. In the current situation, however, it is very hard to make forecasts."
"Recovery from the crisis was rapid"
Leiderman says, "One of the significant things in analyzing the crisis is the fact that the recovery from it was very rapid, and growth returned almost everywhere in world as early as 2009. As part of this recovery, unemployment rates fell rapidly in both the US and Israel. We saw some lag in this parameter in Europe, but keep in mind that there is rather significant inelasticity in the European labor markets, and many structural problems there. It is therefore good that we have recently been seeing some improvement in this context."
Concerning the markets' response to what happened in the crisis a decade ago, Leiderman says, "The stock markets reacted significantly to the crisis, but today, a decade later, we're seeing record-breaking price levels. As measured by the VIX index, volatility is very low, and money is returning to the awakening markets in a big way: Brazil, China, and also South Korea."
Leiderman believes that "the main factor in the rapid recovery, and the big difference from the 1929 crisis in the US, is the almost universal participation of the central banks in addressing the situation." Leiderman compared the economic situation to medicine, explaining, "The patient was in a life-threatening situation, and the banks employed all the necessary means to get him out of intensive care - they cut the interest rate and printed money. There was no such response in 1929, because they were less inclined to intervene in the markets."
Is the fact that Israel was almost unaffected by the crisis linked to a correct policy by the leaders of the Ministry of Finance here?
"Throughout the world, we saw very little of the finance ministers. The burden was mainly on the shoulders of the central banks. There was an absence of leadership by the financial ministries, which were afraid to increase the deficit, so they let the crisis grow. In Israel, in contrast, the crisis took us with our feet on the ground, following reforms that had been made gradually.
"We're a small country, the Bank of Israel is very effective in its supervision, and so sophisticated financial instruments did not develop here, and they didn't take mortgages here like they did in the US. The fact that there was a crutch in the Ministry of Finance was helpful, and it can be seen that the ratio of debt to GDP has fallen over the year, there is effective supervision of the banks, and that we have developed a stable system, despite the volatile region."
How long do you think that the low interest rate environment will continue?
"The low interest rates are historically unprecedented. The Fed's interest rate is 1.25%, the interest rate in Europe varies from 0.4% to negative, and the rate in Israel is 0.1%. This situation will probably continue, because the central banks' concept now is to respond to developments in inflation and the Consumer Price Index, while no inflation is in sight. In Israel, we'll finish a fourth year of deflation, and inflation is also absent from the US and Europe. We are therefore remaining with low interest rates.
"Another thing that happens with a low interest rate is increased leverage. Today's world is one of enormous leverage on the part of both individuals and companies. It is likely that the effect of the hurricane in Florida will further delay the Fed's interest rate hike, because when you have to support the South in the US, and some of that support is rebuilding, it will be hard to raise the interest rate in this situation."
What lessons should stock market investors learn from the crisis?
"With hindsight, we're all wise and know that those who rushed to sell lost out. People should know, however, that there were episodes in history in which the Dow Jones Industrial Average stayed at the same level for 10-15 years. One of the things that should emphasized is therefore that in today's situation, for both economic and political reasons, the deeper the crisis is, the more the central banks will intervene in order to save us from the crisis. This is something that needs to be realized: the bigger the threats, the greater the challenge to central banks and policy-makers."
Published by Globes [online], Israel Business News - www.globes-online.com - on September 12, 2017
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