Why can we lose - because it's too loose ;-)

The interest rate environment in Poland (current benchmark rate of 1.50% unchanged since March 2015) is unprecedented for two reasons – firstly monetary policy has never been that stable and predictable; secondly, it has never been that loose. Guidance of monetary policy council members and statements of central bank’s governor is uniform – interest rates are going to stay intact for around two years. The monetary decision makers in their utterances point up they would sooner consider further loosening than jacking up interest rates; horribly.

Over eight years ago I wrote an essay in which I asserted why low interest rates are detrimental to the economy in the longer run. In that respect, my views have not evolved much over nearly a decade and I still fear the current near-zero real interest rates would do more harm than good to the booming economy of Poland. I do believe there are three reasons, why monetary tightening should be initiated right now, instead of waiting for dreadful stories to unfold.

Firstly, the wage pressure. Nominal wages in recent months were outpacing inflation markedly, reflecting not only rising efficiencies in production processes, but primarily labour force shortages in several industries. The salaries are rising predominantly among low-paid employees (partly side effect of 500+ allowance) whose supply is shrinking and employers are forced to compete for them. In that labour market niche pay rises reach 20% annually.

Effects?

1. Those people whose financial well-being has improved recently (good for them) would rather spend their additional income to have their needs met which generates additional demand on the market and might push up prices of basic goods.

2. Rising payrolls should drive prices of goods and services sold (otherwise profits of businesses decline or imported substitutes replace domestic goods.

Both effects contribute to increase in the price level, i.e. to future inflation.

Secondly, the situation on the property market, which is not in a bubble only thanks to record-high supply of new dwellings and several constraints on mortgage lending (which is pricey and subject to LTV restrictions and more stringent creditworthiness assessment).

The current bank deposits bring one-third of the income of property rental yield, so whoever is not afraid of risks and liquidity constraints associated with letting a flat does not keep their extra money on little-earning bank accounts and chooses to buy a flat for sale.

This also has several implications:

1.       Outflow of money from the banking system; whoever wants to invest in properties should realise unlike with a lending spree, here flow of new money might be cut short, as number of people with six-digit savings in Poland is finite.

2.       Increased supply of properties to be rented which might balance or not demand from tenants. In the final phase (especially after an interest-rate hike) the relative attractiveness of property rental might decrease and might trigger a sell-off from less experienced investors. This might as well go the other way round, as many people might be deprived of a chance to buy a property.

3.       Property developers have been increasing output of dwelling since 2014, so far with only marginal price increases. With current demand, surpassing supply and with increasing prices of construction materials and labour charges, property prices are set to rise inevitably with might not be put up with by buyers. margins in the industry will go down. Property developers as the group seem safe, however bankruptcies among general contractors and subcotractors loom large.

While until now the property market was generally heading in a good direction (increased supply of new dwelling, stable prices, higher availability defined as number of sqm can an average salary would buy), now the threat of imbalances has grown.

Worth noting other countries have already set off to increase interest rates, to somewhat dampen the economic boom and in many countries to stem double-digit growth in property prices which in longer run is dangerous to the economy and impoverishes the society.

I can moan, I can complain, while my grumbling will change nothing. I may only hope negative implications which I foresee do not materialise and the Polish economy does not suffer a shock.

Are we in 2007?

If I could revisit 2008 in 2011, why not turning back time even more and returning to 2007? If you look at the S&P chart below, showing some period of 12 months from December to November, your guess should be that it dates back to good, pre-crisis times, while in fact it illustrates recent 12 months. No major correction, low volatility and over 30% return over the year is what stockholders on average experienced in 2013.

Such patterns are typical, but for the late expansion phase, in which GDP growth is high, unemployment runs low, inflationary pressures intensify and have to be dampened by monetary tightening. Such chart could also come from a period of early economic recovery, when stock prices bounce back after a dismal bear market. But the bear market actually has not occurred since early 2009. Since late winter of 2009, stock markets have been in the bullish phase, with some major corrections: in spring 2010 when bankruptcy of Greece was a real threat, in summer 2011 when US sovereign rating was downgraded, in spring 2012 (was there a profound reason for the downward movement?), but since then most markets have been rising without a deeper break to take a breath.

Is the incline sustainable?

Every why has a wherefore. Sound bull markets the history has witnessed were grounded in economic fundamentals – economies were expanding, fewer people were jobless, taxpayers paid more in taxes and governments ran nearly balanced budgets, wheels in the economic machines were oiled property and central banks kept interest rates on moderately high level to prevent economies from overheating and preclude inflation from going up. Now the economic growth rate in USA stays below 3%, Western Europe economies are rebounding after deep slowdown. Unemployment rate in the USA is above 7% (which is very higher given the flexibility of labour market there), in the eurozone it is above 10%. To combat adverse economic conditions, tremendously loose monetary policy has been pursued over last five year. Not only have the interest rates in the biggest economies have been cut to near zero, but many central banks have been carrying out quantitative easing programmes, or in plain English, increased money supply in financial system.

Normally when if money supply goes up, everything else held constant, price level should increase by the same rate, to keep the financial system in balance. To many economists’ surprise, ultra-loose monetary policy has not sent overall price level rising. The reason for it is simple – the money intended to prop up the real economy through the financial system have not flowed out of banks and drove up asset prices.

Long ago it has been discovered that low interest rates distort economic decisions. The upshots are now visible on stock and property markets in many countries. House prices in the United States and in Great Britain have seen double-digit increases over the last year. Is this trend sustainable?

I keep asking myself a question: “why so good, if so bad?” Why are the markets red-hot if the economy is still fragile? The only plausible explanation is that market participant are buying the prospects of bright future. But can the next years be rose-coloured, if financial markets rely on drip of cheap money provided by central bankers? Near-zero interest rates cannot be kept forever. One day central bankers will have to bite a bullet on it and what then? The biggest corrections in the recent months on the stock market have been brought about by rumours of QE being tapered or petering out in near future. Central bankers realise the scale of pathological reliance of markets on monetary easing and the difficulty they have to get to grips with is how to pull out of the egregious practice of printing money without harming the markets, as the shock suffered by them would be transmitted into real economy. This dilemma niftily depicts the abnormality of current situation. In ‘normal’ environment raising the cost of credit above certain level just stifles economic activity and dampens enthusiasm of financial markets’ participants. At the present, leaving cost of credit on historically low levels, but only curtailing pumping money may wreak bigger havoc to financial system than unexpected jacking up interest rates by 100 points in a healthy economy.

Quite frequently you can hear of economists arguing, whether the recent unfettered stock market rally is a full-blown bubble, or it only has all makings of a bubble. Federal Reserve has already received a warning. Many indicators (P/E > 25, margin debt, bullish sentiment, low volatility, technical indicators) point at existence of a bubble, while other (business cycle phase, low participation of individuals in the market) may disprove the bubble theory. I only wish to stress the presence of the word “bubble” in the media and in the search engines might be a misleading gauge and should be interpreted with caution.

According to the scenario in the paper linked above, the crash is very likely to occur in 2014. If so, I foresee it will not strike out of the blue, but the show will go on in the ordinary way. At some point stock market reaches its peak, then retreats, attempts of bullish speculators to drive prices up go in vain, then ensues the waterfall (shape of a price chart when prices plummet), then a rebound, then a gradual decline and at the end the tsunami strikes… This pattern is similar to what was observed in 2008 (peak in 2007, retreat, waterfall in early 2008, decline till the early days of September 2008 and then the Lehman earthquake). The first and foremost argument against such scenario is that financial system is not full of toxic assets as it was before the crisis. On the other hand, central banks and government have run out of tools the used to rescue financial institutions and economies in 2008 and 2009. Fhe frail economies cannot endlessly underlie exorbitant stock market valuations and the sooner market participant realise it, the better for everyone.

These musings take me back to the last semester of my studies, when in late 2010 I took a course “Financial crises and financial stability”, delivered by prof. Mieczysław Puławski. I recall well the lecturer mentioning a crisis model devised in 2009, according to which a much more wrathful crisis will hit in 2H2014. Time will tell, if the prophets’ of doom prediction was right.

A few paragraphs above I stated “financial markets rely on drip of cheap money” and laid my thought out very precisely – financial markets, not real economies. Real economies are capable of bearing the burden of higher cost of credit, it may bend them, but will not knock them down and in the long run sound monetary policy will lay foundations for returning to the path of sustainable economic growth.

Compared to developed markets, Poland comes out impressively safe. The property market has been on decline since 2008. In 3Q2013 property prices nudged up, yet it is too early to judge, whether the trend has reversed, or the rebound is just a correction in a downward trend. Unquestionably, the increased demand for properties is the effect of lower interest rates and constricting regulation regarding buyer’s equity for property purchase (min. 5% in 2014, this one hastened many buyers finance the planned transactions with 100% mortgage this year). One swallow does not make a summer and it will be the summer of 2014 when with hindsight the mid-term trend on Polish property market can be observed.

The Polish stock market has been consistently underperforming developed markets. While S&P 500 and DAX indices are well above their 2007 peaks, WIG (broad market total return index) and WIG20 (blue chip price index) are not only below their 2007 peaks, but also below their highs recorded in first half of 2011. Market analyst put it down to insecurity over future of pension system in Poland. If this is indeed the case, it only bears out the reform is a step in the right direction. Despite not beating ever-time records, the stock market in Poland is red-hot, judging by IPO frequency and successfulness. 4Q2013 already saw privatisation of PKP Cargo, which was priced quite high and debuted at absurdly high price. I subscribed for shares of PKP Cargo, took the 19% profit and made off. Recently I subscribed for Newag, just for fun I signed up for 50 shares, 19 PLN each. On Friday I discovered I had been allocated mere 4 shares, as individual investors’ demand surpassed supply over 25 times, which resulted in 93% haircut in share allocation… Demand for Energa among individual investors is also record-high and over-subscription is expected. I will subscribe for those shares as well, hoping to find the greater fool to buy them from it on secondary market. I realise this has become a fad and market sentiment clearly indicates I should rush to escape.

My strategy is to liquidate my stocks portfolio in first weeks of 2014. I last bought stocks in early September 2013, when pension reform announcement triggered a short-lasting sell-off, which turned out to be a superb mid-term investment opportunity. The only reason why I have not pulled out of the stock market recently is the sizeable loss from hapless 2011 which is carried forward into next years. According to Polish tax regulations, no more than 50% of a loss from a specific year may be used as tax shield in any of next following year, so this year (in 2012 my profit was very small) I cannot use it up and sale of securities in 2014 offers a chance to reduce capital gains tax payable. And after I scram, may it all collapse. By all accounts, Poland’s economy will not be severely impacted by the downturn on financial markets and subsequent bear market might offer interesting long-term investment opportunities.

Sadder, but wiser, in economics…

If you want to blame someone for the recent crisis, the easiest, and the most socially acceptable way of find a scapegoat is pointing at bankers. After all the bankers were granting mortgage loans to borrowers who could not afford even to make the first repayment. After all the bankers pooled the subprime loans, repackaged them and sold them to naïve investors, spreading the disease all over the world. After all bankers were living like lords, reaping profits when good times were rolling in and refusing to take responsibility for their wrongdoing when the house of cards fell apart.

I do not aim do detract from the banking sector’s salient and undisputable contribution to the crisis. I (not as a bank employee, but as a citizen and economist) call for looking at bankers’ faults in a broader social, economic and political context.

If you carefully dissect 20 years of run-up to credit crisis in the United States, you should notice:

- millions of people chasing the American Dream, part of fulfilment of which was home ownership – these were millions of people who could not afford to buy a house, but who thanks to easy access to credit were given a chance to fulfil their dreams, a considerable percentage of those people were those who wanted to live beyond their means,

- politicians and central bankers who wanted to make voters happy, and by decreasing cost of credit and passing laws facilitating home purchases fuelled the housing bubble,

- bankers, who noticed the excessive demand for mortgage loans, decided to earn on it and then discovered ways to earn even more without taking more risk by granting the loans and instantly pushing them away from their balance sheets.

The bottom line is that the whole societies, not only bankers and politicians, can be accused of lack of forethought. Beware though, applying collective responsibility is quite unfair in this case, as the there were several people, ordinary and among the elite, who refused to indulge in the bubble spree.

The problem is, however, that common sense advocates who try to warn of the impending moments when bubbles burst, are disliked, not only when a bubble swells, but also with hindsight. I recently read a comment under another article on property prices that in 2007 in which somebody argued six years ago, when property bubble (?) in Poland was reaching its peak, an average salary in Warsaw would buy 1/3 sqm of a flat, banks eagerly were giving out loans, everyone was happier than now, when banks rebuff many would-be borrowers, despite 20% lower (in nominal terms) property prices. These days for an average salary you can buy 1/2 sqm of a flat, so the purchasing power on the property prices has risen by 50%. Paradoxically, despite less steep prices, banks’ reluctance to grant new mortgage loans will hinder your decision to buy a dreamt-up flat. Thus I come to the conclusion people do not behave rationally – consumerist desire to possess goods without considering whether they can afford them distorts economic decisions…

To shed a different light on the issue, some more examples…

The Polish government blames pension funds for fetching inadequate returns and charging exorbitant fees, without emphasising the crucial role policymakers who set stringent investment policies, flawed system of benchmarks and capped fees at sky-high levels. Companies who were allowed to deal with pension fund management acted rationally – abided by the rules, didn’t try to stick their necks out, reaped profits and ripped off future pensioners quietly. The government regulations coercing every taxpayer to participate in private-run part of public pension system generated demand for pension fund services. Pension fund managers just came up with the supply.

Tobacco companies produce stuff that addicts is unhealthy and generally is considered harmful. Each pack of cigarettes needs to contain properly sized information on destructive impact on smoking on health and cigarettes carcinogenic effects. Are the cigarette-makers blamed for deaths of millions of people from lung cancer?

Carmakers for years have been producing vehicle reaching maximum speed at which any accident could be fatal. Does anyone who hears news of an accident with several fatalities caused by speeding think of blaming automotive industry for producing deathful machines?

Alternatively, when you have in mind the problem of prostitution, do you blame escort agency owners or prostitutes themselves for the phenomenon of the oldest profession? Maybe you see a giggling sleazy guy who runs a massage parlour who claims he runs a relaxation facility and what his female employee and his male customer do when they go together to a dim-lit room with red walls stays between them. Virtually anyone who looks into the issue of prostitution highlights misconduct of procurers and prostitutes, while has anyone bothered to delineate a profile of a typical customer of escort agencies?

Coming back to bankers – in Poland the banking sector has become a scapegoat for CHF-denominated mortgage loans and currency option crisis.

In the former case, many think the banks have earned on appreciation on Swiss currency and CHF-borrowers have been duped by the banks. In fact banks have earned on fees, margins and FX rate spreads, which are all loosely tied of FX rates. In other words, banks’ earnings have been independent of FX market movements and thus banks have not had uncovered FX risk exposure. The other story is that banks were encouraging borrowers to take out loans in CHF due to lower interest rates, which translated into lower instalments and higher creditworthiness. All this was because of the demand for cheap lending. When CHF-denominated lending was rampant, few voices of concern were audible. Banks were happy to earn on margins and FX spreads, borrowers were happy to see their dream of own flat coming true. Some even were called idiots, when they were converting their CHF-denominated loans into PLN at the rate of 2.10. With hindsight, their foresight is enviable. In Poland, unlike in other countries, all borrowers had to be extensively informed on FX risk and had to sign documents to confirm they were familiar with the risks, if they had not been properly informed by a salesperson in bank’s outlet, they should have badgered the salespeople to explain the risks… Ignorance of law is not an excuse and taking those loan contracts to the court would be senseless then…

In the latter case, when PLN was evidently overvalued, there was a natural demand from exporters being on the verge of breaking even, to hedge against risk of further appreciation and a supply from financial institutions coming up with solutions suitable for exporters (if properly used). Exporters noticed FX derivatives helped them not only offset unfavourable effects of PLN appreciation, but also earn extra income, if the same position was hedged more than once with more than one bank. Banks noticed they could earn extra income on margins and fees, if volumes of transactions hedged were higher and so foisted upon exporters the double-edged swords of currency options. When FX market capsized there was actually no winner in Poland (if Polish banks’ counterparties had their positions uncovered, they could have taken large profits). Exporters were facing financial distress, while banks had to face credit losses if their corporate counterparties defaulted. When things were going well and companies benefited from sophisticated derivatives, nobody cried out in outrage, when the tide turned against the companies some politicians were calling for nullifying options contracts. Until today I wonder if those companies that made profits on FX hedging would have to return their profits to banks…

In brief, all the paragraphs above narrow down to subject of sharing responsibility for a misery between the supply side and demand side. In each case described above, there is a demand for some service or product, matched by supply. You could of course argue, demand is a response to supply. I would point out in turn, the problem is not akin to egg and chicken dilemma. In overwhelming majority supply matches demand. Imagine there are no males willing to buy sexual services – then all escort agencies would go bankrupt and prostitutes would be jobless. Imagine nobody wants to take out a risky loan – would banks keep on foisting them upon not eligible reluctant clients?

The separate matter is whether the government should step in and impose restrictions which would prevent demand for harmful services or products from being matched by supply?

Should the government protect individuals from their own recklessness, ignorance, short-sightedness, etc. The answer to this questions probably depends on your view of a human and its autonomy. Conservatives and liberals claim a human is wise enough to take rational decisions and take responsibility for them. Socialists argue a human is fragile and pliable and someone else knows better what should be forbidden and what should be warranted. Moreover, the answer might depend on existence of spillover effects of an individual’s detrimental decisions. If a reckless individual is the one who pays the price, then OK, may the government stay away, but if price for one person’s decision is paid by other people (which indirectly limits their personal liberty), these other people are most often all taxpayers who chip in for government-funded bailouts, there is a deep rationale for governments to intervene.

Wishful thinking

Don’t wait for the perfect moment! Take the moment and make it perfect!

7 December 2008:

- Why do you argue now is the right time to buy a flat? When will the property prices go up again?

- Prices won’t rise soon, however in my opinion the third quarter of 2009 will bring the onset of slow, yet stable upward trend (…) Those who take decisions swiftly will be the winners.

- Do you think then prices on secondary market will not decrease in the coming months?

- Where they were meant to fall, they have already fallen.

1 March 2009:

The scales on the property market have not been tipped so favourably for a while. And it seems this won’t last long. Hurry up then!

3 June 2009:

Decline of property prices has come to a halt and prices are not going to fall any more. This is a good moment to buy a property, but a bad time for selling it.

12 July 2010:

Property prices are still low and banks are more willing to grant loans. According to property agents, this is the perfect moment to buy a dreamt-up flat.

Some time later in the second half of 2010:

This is the best moment to buy a property. It won’t be any cheaper!

24 November 2011:

Some property agencies seem affected by the slowdown on the market, other describe the current market as ‘stable’. Nevertheless, all property agents claim in unison this is the perfect time for property buyers.

11 December 2012:

Last days of 2011 and first months of 2012 will be the perfect time for property purchases – experts convince.

13 April 2012:

Whoever plans a property purchase should not put it back. Downward trend in prices is likely to reverse.

27 August 2012:

If you consider buying a property, this is the perfect moment. Prices have gone down, but fewer buyers can boast about desired creditworthiness. Even if next year prices fall, the decline will be negligible.

5 October 2012:

Planning to buy a flat? Property market practitioners point out sellers are ready to make bigger concessions in price negotiations. This indicates the perfect moment to buy has come!

19 April 2013:

Property prices keep falling and have reached the levels last seen in 3Q2006 – good moment to buy a flat!

20 September 2013:

Experts claim now is the best moment to buy a flat!

22 September 2013:

Over the last year property prices have significantly gone down. The economy is markedly reviving. The probability of further price decline is miniscule, while choice of flats is wide. It seems this is the perfect moment to buy a flat!

Chart 1: Average price of one square metre of a property on primary and secondary markets in Warsaw over last almost seven years. Source: National Bank of Poland’s quarterly report on property market, figures based on data collected from notaries (reflect only transaction prices, rather than asking prices (sellers’ wishful thinking!) in property ads).

Chart 2: Average quarterly prices of one square metre of a property in Warsaw, this time sample covers all properties from primary and secondary market. All data are transaction prices and are based on data collected from notaries. Source: excerpt (short version of) from AMRON-SARFiN’s quarterly report.

Conclusion 1: chart 1 is biased – by starting in 3Q2006 it omits the first phase of property market frenzy which kicked off in late 2005. Since then up to the peak of property market bubble (?) in prices went up by up to 100% - growth scale in time frame of 3 years (therein some 50% growth in 2006 alone) makes it justified to call it a bubble.

Conclusion 2: the perfect moment has lasted for five years. It has been one of the longest perfect moments in the history.

Conclusion 3: based on the recent history of property price fluctuations and frequency of developers and property agents bleating about the perfect moments, there is no significant correlation between intensity of obtrusive urging to buy and higher demand for flats reflected in mounting prices.

Conclusion 4: The regularity observed during many stock market and property bubbles, i.e. when everyone tells you to buy this is the best moment to sell has proved true between late 2008 and now.

Conclusion 5: the future trend is rather unpredictable… (deserves the ‘conclusion of the year’ award ;-))

…Albeit my expectation is that within the coming year (i.e. by the end of September 2014) average property prices will decrease by 3 percent year-on-year and with 95% probability the price change will range from –10% to +6%. Over the coming decade the prices are most likely to stabilise in nominal terms and drop in real terms on average (with some deviations from the long-term trend). Here’s the rationale:

Why property prices might rise:

1. Interest rates, now at their historical lows, are predicted to stay unchanged for about a year, and then are unlikely to rise quickly. Lower interest rates have a huge impact on amount of monthly instalment of a mortgage and hence on creditworthiness. Thus a borrower with the same earnings has some 30% higher creditworthiness than a year ago. But watch out – this is a trap. The capacity to repay a long-term liability is assessed based only on current market conditions and National Bank of Poland’s base rate will not equal 2.50% forever. If it goes up by 2 percentage points, monthly instalment of a 250,000 PLN loan with current interest of 4.00% taken out for 25 years will rise from 1,319 PLN to 1,610 PLN (by 22%) if the interest rate increases to 6.00% (note annuity payments are very sensitive to interest rate changes).

2. Low income on bank deposits discourages wealthier depositors from keeping their savings in banks and makes some of them to invest in properties in pursuit of higher yields on rents. Beware though, this is a trap as well – if everyone buys flats with the intent to lease them – will the supply of new properties be matched by demand from lessees? Won’t this trend exert a downward pressure on yields to make them equal with bank deposits? And note flow of income from a relatively small group of well-off people is a rather one-off occurrence, therefore the price incline cannot rely solely on demand generated by wealthy buyers.

3. There is a group of buyers who’ve already had enough of waiting for prices to go even lower and are running out of patience. In the meantime they’ve amassed some cash, so they can either pay in 100% or take out a small loan to finance the purchase – this group is capable of generating steady demand and unlike wealthy disgruntled depositors can make the upward trend sustainable.

4. Supply of new flats offered by property developers and number of new dwellings under construction are both shrinking. As the basic laws of economics state, lower supply should result in higher prices.

5. New government-run scheme (flat for the young), bound to take effect in January 2014 – the government will fund 10% - 15% of purchase price of a flat from the primary market only. The biggest restrictions in getting the subsidy are a square metre price cap (to be set at 5,865 PLN in Warsaw in 1Q2014) and the fact an applicant must not be older than 35.

Why property prices might fall:

1. Demographics, one of key drivers of the property market. People naturally seek to have their housing needs met and want to buy (or rent, or build their own) properties. Number of young people entering the labour market is decreasing year by year and given that the population of Poland is set to contract, prospects for price hikes in the long run are downbeat.

2. The biggest demand for flats is generated by youngsters looking for their first flat (later they swap one for another, bigger one, i.e. upgrade) – not only their number is lower, but also labour market is not on their side: unemployment rate among youngsters is higher than a few years ago, many of them work under ‘junk contracts’ (banks do not view it as steady source of income), salaries for workers under 30 are much lower than before the crisis.

3. Recommendation S, issued by Polish Financial Services Authority (KNF) which states a mortgage borrower will need to put up a specific percentage of purchase price as equity. This percentage will be rise 5% in 2014 to target 20% in 2017. This recommendation (banks won’t date to try not following it) will bring to the end dicey 100% loan-to-value lending.

4. Banks’ reluctance to increase their mortgage portfolios. This product is not the most profitable (hard to cross-sell it) and its risk seems to have turned out underestimated – for many CHF-denominated mortgages, outstanding debt considerably exceeds property market value, putting banks at risk of not recovering the lent amount in case of borrowers’ defaults.

5. Future insecurity among potential borrowers – given the scale of layoffs in the corporate sector (which should by all means fall back along with recovery in the economy), many people think twice before taking out a loan for several years (who can guarantee nothing bad happens in such time horizon). Even if someone has not been affected by a job loss or salary cut, they could have observed someone else losing their source of income. Mortgage-taking spree from 2006-2008 was fuelled by booming economy and over-optimistic expectations that good time would last forever. That craze is extremely unlikely to repeat in many years.

6. Despite considerable decline (some 20% in nominal terms over last 5 years in Warsaw on average), property prices are still steep in relation to ordinary people’s earnings and for many potential buyers out of reach. Currently an average monthly after-tax salary in Warsaw (some 3,600 PLN) is enough to buy a half of a square metre of property in Warsaw. This means after two months of putting aside 100% of one’s salary (in practice impracticable) you can buy one square metre of an average flat; after a year you can buy six square metres; after eight years of not spending at all you can buy a decent one-bedroom 50-sqm flat for cash.

7. In the meantime costs of living have risen disproportionately to nominal wages growth. This means the discretionary income, i.e. the share of monthly cash inflow that can be either saved or spent on mortgage payment has dwindled. Needless to say what effect it has on demand for properties.

I’m planning to buy a flat in about a year. Hope the wind blows in the right direction…

The Inside Job - film review

It starts with shots of intact Icelandic landscapes. In early 2000s the country finalised reform of its financial sector, which consisted mainly in deregulation. Until mid-2008 Iceland received glowing praises for the reform, which, as said by economists, strengthened the country’s financial stability and accelerated its economic growth. In fact deregulation of financial institution in Iceland gave rise above all to excessive credit expansion and, eventually, to an ultimate collapse of the country’s banking system.

This is just the prelude to another story told about the recent economic crisis. Clever, bright, yet not leftist and not politically involved. Some claim it does espouse leftists views on economy, but I did not discern it. If the film calls for something, it is surely not a revolution that would overturn the current unbridled capitalism, but for reverting to traditional capitalism, based on freedom, responsibility, playing by the rules and straightforward decency.

The main thesis the film sets out is that the financial industry in most developed countries has been allowed, by politicians and economists, to spiral out of control, then, by means of privatising gains and socialising losses, led to the recent crisis and went unpunished. The work, divided into five parts, explicates mechanics of events and decisions in the run-up to the crisis. I do not know if the way facts are presented is clear enough for a layman, but for me it seems the job has been done well.

Part 1: How we got there.

Filmmakers have come up with a theory that since the end of the Great Depression, until early 1980s when Ronald Reagan was sworn in as US president, the United States did not see any major economic crisis. This success, in fact untrue, since early 1970s saw oil crises, bringing about periods of stagflation, that put the era of Keynesianism to the end, is put down to the strict regulation of banking industry that prevented financial institutions from growing big. It was after Ronald Reagan took over and pressed ahead with his doctrine of Reaganomics when deregulated financial industry began to distend.

Two last decades of the 20^th century saw two financial crises triggered by deregulation – S&L crisis and the dot-com bubble. The former is thought to have been caused by excessive law liberalisation, the latter by simple lack of integrity. The film brings back commonly known, exposed by the press, examples of stock market analysts saying privately the dot-com stocks they had valuated at sky-high prices were just junk.

The end of the previous century brought also much more tie-ups between business and politics. Transfers from positions of CEOs of big investment banks to positions in state administration and the other way round became the order of the day. Number of lobbyists hired by financial industry to protect its interests soared. Belief in self-regulation of the financial industry became an officially recognised doctrine.

Part 2: The Bubble

Around 2000, deregulation was full-blown and any attempts to bring some markets under supervision met stiff resistance from financial industry, backed by officials from FED, at that time chaired by Alan Greenspan, an remorseless advocate of deregulation. One of the proposals eventually rejected around 10 years ago was the one to oversee derivatives market. Personally I’m in two minds about this. Derivatives are like axe, itself good, good when you use to it to chop wood, but evil when you use it to kill your mother-in-law. Derivatives can be used for transfer of risk, hedging and speculation. Two first purposes seem safe, but usually derivatives were used for speculation and this sparked the whole turmoil in the recent crisis.

Those who have never dwelled on the mechanism of mortgage lending in the US in early 2000s are recommended to see the part clarifying how this all happened. The same part brings up the ever-lasting issue of risk vs. return trade-off. So either you grant loans to creditworthy borrower and make safely small profits, or give risky loans and cash in more, as long as they perform. You just cannot circumvent this!

The film reminds that one of the causes of the crisis were flawed remuneration schemes that put emphasis only on performance, regardless of risks taken. Risk-adjusted salaries and loss-sharing together with profit-sharing before the crisis could have mitigated the aftermaths of the financial meltdown.

Very remarkable is the last episode of this part in which a psychologist tries to examine the specific features of a typical banker’s personality. As you would have thought this an alpha male, compulsive risk-taker, inconsiderate, acting on the spur of the moment. Such types were much desired by banks and still are, since only thanks to their bravado profits of banks in good times could be that high and banks did not spare money to finance entertainment for them…

Part 3: The Crisis

Begins with the face of Ben Bernanke and his utterance from mid-2005 in which, when interviewed by a journalist of one of US TV stations, he claimed there was very tiny risk that there was a tremendous housing bubble and found it improbable that bursting of it would plunge the whole country into a recession. Several economist claim to have warned Bernanke of the impending disaster but he would always shrug off those warnings. Deliberately?

His pronouncement coincided with the peak of the housing bubble. The film indicates a direct cause why it burst and it is strikingly simple – the housing market run out of suckers who wanted to buy houses at exorbitant prices and financial markets run out of suckers who wanted to buy securities backed by lousy mortgages.

Then comes another commendably clear explanation of how financial crisis spilled over into real economy. Finally, the makers conclude that, as always, those who suffer the most are not those guilty, but the poorest. The bailout programmes rescued big financial institutions (as an economist I realise it was cheaper to help them out than to let them go bust and the whole plan was purely pragmatic) and left millions of ordinary people unaided. This is again symbolised by empty houses, may this bleak sight serve as a symbol of human folly and may it caution others not to repeat the same mistakes.

Part 4: Accountability

What accountability? Current “crony capitalism” is based on lack of responsibility. Either I win or you lose. What a game! Fortunes of banks CEOs who brought institutions the had run on a brink of collapse are intact. Bankers got away with punishment. If someone went to jail, it was only for fraudulent activities. In 2008 and 2009 correlation between remunerations and performance and financial standing of managed institution was totally disrupted.

The film also lays bare the hypocritical take of financial industry on deregulation. Prior to the crisis they were against, in autumn of 2008 when financial tsunami was about to wipe out the whole industry they called for tighter regulation, and when in 2009 the worst was over again they returned to their previous stances.

The crisis has changed nothing. Financial institutions are bigger and more powerful than ever before.

At the end, the film outlines several tie-ups between renowned academics from best business schools in the US and the financial industry. The study of economics, as carried out by people financed by the industry and who get well-paid jobs there, is described as “corrupt” and indeed conflicts of interests are visible… Should we believe scholars then?

Part 5: Where we are now

I am thankful, again, I do not live in the United States. Level of inequality in the US society is continually increasing, while social mobility is decreasing. In Poland, by sheer hard work, it is still possible to rise from rags to riches. Many poor people in Poland still can afford to get in to university and break away from poverty. In the US it is out of reach. The US economy has made a huge shift towards innovativeness and high-tech. Jobs in new industries require good education which, due to its costs, is out of reach for more and more Americans. In Poland financial institutions are not powerful, their power is as big as it should be, maybe except for Pension Fund Managing Companies, which showed how to defend their interests during the debate on pension system earlier this year.

Filmmakers also blame the “culture of going into debts” for the crisis. Media and financial institutions, as they claim, have incited people on consumption spree, brought them into troubles and profited from their misery. Also limited access to higher education is said to be one of the reasons why people run up huge debts.

Barack Obama’s presidency turned out to be a big letdown for all those who had hoped for the CHANGE. He went back on the promises to curb excesses of the financial industry. European government somehow managed to tackle the issue, Mr Obama failed.

The film ends with a lovely conclusion: Real engineers build bridges, financial engineers build dreams. Many people dreamt of their own houses. Their dreams have turned into nightmares.

Personally I have two main reflections after watching the film.

Firstly, if so many people “declined to be interviewed for this film”, are their consciences not clear?

Secondly, I could not resist the impression that many people who agreed to be interviewed mastered lying through their teeth to perfection. This is an immensely useful ability in the contemporary world. Sadly…

Who's to blame for the crisis, part 2

Exam period report: two down, seven to go!

First days of the new year turned out particularly conducive to various musings about economics. Several questions have been running through my head, but they all have one common denominator…

Did US politicians think increased home ownership ratio would solve social problems and make many poorer US citizen happier?

Did Alan Greenspan think pursuit extremely loose monetary policy that eventually sent property prices soar would bring Americans closer to fulfilling their dreams?

Did mortgage borrowers who could not stand any chance to repay mortgages off their income think they would refinance their loans endlessly thanks to ever-increasing property prices?

Did “financial engineers” think Gauss-Copula would work miracle and turn subprime loans into prime securities?

Did David X. Li. think if one subprime mortgage is a lousy underlying security, two subprime mortgages are two lousy underlying securities, ten subprime mortgages are ten lousy underlying securities, then million subprime mortgages bundled together and packed as Mortgage-Backed-Securities would make up triple-A securities?

Did credit portfolio managers at banks think they could push away the credit risk from their balance sheets through securitisation and did they think it would not return to them?

Did risk analysts at banks think they would always recover principals and interests on subprime loans through foreclosures and selling houses on the market at higher prices?

Did shareholders of those banks think focusing on short-term profit was a sound growth strategy?

Did governments and regulators think greed could, in long run, do more good than harm?

Did market participants think they could reap an extra profit without taking an extra risk?

Did CFOs of Polish companies which speculated on currency options think they had just discovered a gold mine?

Did borrowers who had taken out mortgage loans denominated in foreign currencies when zloty was overvalued think they had stroke a great deal?

Did grannies who bought stocks or invested in equity funds think stock prices could plummet in the coming months?

Did Greeks think living beyond their means would sustain economic growth in their country?

Did Irish home buyers who bought properties despite steep prices think the prices were still reasonable given their growth potential?

Did pension fund managers from all over the world which were buying summer houses on Spanish coast think the demand on them in the coming years would be so high that it would drive prices even higher?

Did Ben Bernanke think keeping interest near zero would kick-start the US economy?

Did analysts at the end of 2007 think stock indices would fall by roughly 50% in 2008?

Did PiS, Samoobrona, LPR and PO think by raising spending and cutting taxes and sickness benefit contribution they would turn around Polish public finances?

Did Polish airlines managers think oil price would rise to 200$ per barrel and hence purchased future contracts at 150$ per barrel (they had to pay so much when prices dropped to 40$)?

I could flog the dead horse and reassert they all took it for granted that nothing could go wrong. Or, alternatively they knew everything was goings to collapse, but they thought they would escape the disaster?

In July I tried to park swiftly in front of my house. I did not manage to manoeuvre properly and smashed into the fence. It ended up with a dented bumper. I did it because I thought would simply make it (today at home we recalled that accident after my father dropped his mobile phone into the toilet bowl). But three months earlier pilots of a plane thought they could, or rather should, or even had to touch down the plane despite thick fog and poor communication with air traffic controllers. They thought they could, somehow, make it. They did not. 96 people died.

I will not dare to pass judgement about the causes of Smolensk disaster, but the dented bumper was a result of nothing but my own thoughtlessness.

The ongoing crisis does not just have one, financial, facet. As outlined above, this is also the crisis of thinking, or a result of years of thoughtlessness.

Almost a year ago I drew a conclusion that the crisis was caused not by greed, but by lack of fear. Now another conclusion – the crisis was also caused by LACK OF FORETHOUGHT…

Or maybe... Did they think, or did they believe?

On broken promises

In 1990, before presidential election, Lech Wałęsa promised to turn Poland into “second Japan”. In 2007, before parliamentary election, Donald Tusk promised Poland would follow the path of Irish economic miracle and would become “second Ireland”. Both politicians have gone back on their promises and Poland has not taken a leaf from Japanese, nor Irish book. Now do not grumble, we should be grateful they have failed to put those economic miracles into practice.

What do those two countries have in common? The lie on different continents, both experienced periods of long lasting economic growth, both were held up as examples of excellent economic performance, both made quantum leaps, both have been going through severe crises and even despite being hit by them are now far higher developed then the moment they were in “square ones” of their growth path.

Japan got up of its knees over ten years after WW2. Thanks to easy borrowing terms, support from the government and protectionist measures Japan’s industry began to grow rapidly. Japan corporations relied on cutting-edge technologies and were highly efficient what helped the country boost its exports and flood markets of developed countries with high-quality and reasonably-priced products. In 1960s annual GDP-growth rate was running at above 10%, in 1970 it slowed down due to oil crisis, but Japanese economy soon adjusted to rising demand on energy-saving technologies and not only rode out the crisis, but even emerged from it stronger. The period when interest rates were low, pace of economic growth remained high and inflation low lasted until 1990. The last five years of boom were marked by surging stock and property prices – both tripled between 1985 and 1990. Companies and individuals eagerly borrowed money from banks to buy assets, since interest rates on loans were far lower than returns on stocks or properties. The bubble burst in 1990 and the economy of Japan slipped into a period of sluggish growth for a decade. Banks were hardly hit by write-offs on non-performing loans, individuals and companies struggled to repay the debts they had run up in the times of speculative frenzy. Customers were reluctant to spend, what caused the domestic demand to decline. Firms instead of investing in capital stock were paying back its debts. Interest rates were slashed to near zero to stimulate the economy, but neither banks could grant new loans, nor were the enterprises keen to take them out. GDP growth rate averaged out 1% in the 1990s. Adverse effects of bursting of sizeable economic bubble are felt until now.

Ireland in a relatively short period of time turned from backward agricultural country into one a modern, fast-growing economy. The economic miracle is often put down to Social Partnership under which government, employers and trade unions settled on taking a concerted effort move the country forward. They did bring it off, inflation was on decline, growth rate was on the rise, the country attracted outward direct investments owing to corporate tax cuts. For many years Ireland ran budget surpluses and consequently its public debt was decreasing. Good economic performance was fostered by low interest rates and deregulated financial industry, which caused the property bubble to arise. Banks were lending recklessly and bubble grew splendid before it burst. From then Irish banks reported huge numbers of defaults among borrowers, their capitals shrunk as a result of losses on non-performing loans, the government had to bail out most banks and the bail-out programme has caused the public debt to mount. Now not only Irish banks but also the Irish state is on the verge of insolvency.

So what do they have in common? Economies of both countries have been hurt by bursting bubbles. In both countries interest rates were abnormally low for an extended period of time (there was no need to raised them as there was no threat of rising inflation), banks loosened their lending criteria and foisted loans upon almost everyone. In both countries prosperity was brought to a halt by bursting bubbles.

But brush aside economic aspects of economic bubbles, take a look at them from psychological perspective. Bubble (as any other misfortune) inflates when people take for granted nothing bad can happen. Japanese and Irish banks took for granted the property prices would only go up, so even if a borrower failed to repay their debt, they would foreclose a property and recover the money. Individuals and firms also took for granted asset prices would only go up. When an economic bubble is robust almost everyone believes the boom will last forever. Voices of sceptics who claim the disaster is imminent are drowned out.

It is very hard to crack down on the bubble, because as long as it swells, it is convenient to everyone. Government gets higher proceeds from property taxes, property developers count up sky-high profits, banks make lots of money on mortgage loans, property owners are happy because their wealth is increasing, flat broke non-owners are over the moon because banks are leaning over backwards to give them 40-year mortgage for a tiny, dilapidated 30-square-metre flat. And the unemployment is falling, because construction sector needs more workers, who do not get paid worse than qualified workforce. And bear in mind efficiency in construction sector is low, so economic growth generated by it is in a way delusive.

Lessons to be learnt? Do not let property bubbles happen. In the long term they always do more harm than good. Imbalance in an economy will sooner or later cause a turmoil and those to pay for any possible bailouts will be taxpayers. Interest rates on mortgages should not be low (cheap corporate loans have positive impact on the economy in the long run)! Lending for housing purposes should be under supervision! Poland escaped the scenario of bursting property bubble. Property prices did double in some cities between late 2005 and late 2007, but the boom was not followed by bust. Interest rates were never too low, Polish financial supervision did its best to curb lending, particularly in foreign currencies. Banks’ profits in boom period were not as high as they could be, some applicants had their mortgage applications rejected, but Poland averted a much worse scenario. May we never try to repeat any country’s path to economic miracle. Mr Wałęsa and Mr Tusk did not know what they were saying. Their promises were made just before bubbles in Japan and Ireland burst.

Funnily enough, Poland was going through a property boom when Prawo i Sprawiedliwość was in power…

More on economic bubbles in 2011, after I graduate (in my MA thesis I explore the topic, some excerpts to be translated into English and published here after I “defend” it).

Turn on your printing machines

This post may be treated as a follow-up to my short essay on monetary policy from December 2009. On 3 November Mr Bernanke, the governor of Federal Reserve Bank, announced the launch of QE2 programme under which the central bank of USA will buy up government securities in the total amount of 600 billion dollars to kick-start US ailing economy.

Almost two years after Fed’s discount rate was slashed to 0.00% – 0.25% range US economy is still in the doldrums. Unemployment rate fluctuates around 10%, figures of economic growth are positive mainly thanks to large-scale stimulus programmes which slowly peter out (the two factors above combined give a new buzz-phrase “jobless recovery”), consumer prices also levelled off, but central bankers say despite extremely loose monetary policy deflation is still a much bigger threat than inflation.

The recent crisis has changed American consumers’ habits. Before the meltdown an average American household had negative savings and consumers generally tended to consume more than could afford, thus propelling world economy. This was easy to attain, as banks were eager to provide them with lending and turned a blind eye on creditworthiness criteria many borrowers didn’t meet. Much has changed since then. Consumers are now reluctant to part with cash they have, their propensity for spending and borrowing has declined. The tough lesson of crisis they have learnt will probably bring about a gradual shift from spending and borrowing towards saving.

Also banks, severely hit by write-offs on bad loans have modified their credit policies. Gone are the times when credits were foisted upon not creditworthy borrowers, these days bankers think twice before the grant a loan. Just think what happens when a loan goes bad. Can it be prevented? Can financial standing of a debtor be monitored effectually? Probably not. How long does it take to recover money? Sometimes years. What the recovery ratio will be? No one knows – a bank can recover principal and interest, a principal only or nothing, and costs have to be borne to wrangle with bad loans. Is there any alternative? Is something less risky?

Regular readers of this blog surely remember the story of 1,000 PLN lent to an ex-classmate. I still didn’t get that money back. For a comparison, on my worst speculation on stock market I lost 23%, so out of 1,000 PLN put in I still could put out 770 PLN (minus transaction costs), so it’s much more than zero. Stock markets look like an alternative. Stock indices reached their many-year lows in late winter 2009, bottomed out and since then have risen by 50% - 100%. The bull run was spurred on by loose monetary policy. Ample liquidity provided by central banks was not directed at lending activities, but at stock and commodity markets. Yes, the capital markets are said to anticipate changes in real economy, but this time market valuations discounted a rapid recovery owing to a flow of newly printed money. Just look at it from the perspective of a bank. A central bank gives you an unlimited credit facility, you begin to buy fundamentally undervalued stocks. If you don’t have power to drive the market up, you just pull back. Such a scenario is unlikely, so the prices do go up and because you are obliged to comply with mark-to-market accounting rules, your profits also rise. You report profits to shareholders and get a generous bonus from them. This is how it works… And there’s no need to grapple with bad debts, positions can be closed as quickly as they were opened and after all at the end of the day stocks will be distributed to some nitwits who will believe the prices will be rising forever and eventually will be end up duped. Stocks seem riskier assets than loans, but for the reasons I delineated above I think this is where the money from QE2 will go.

I forgot to mention the mechanics of the programme. Fed will not be buying up securities from individual holders but from financial intermediaries, i.e. banks, with a view to provide them with extra liquidity that should buoy up the economy through bank credit channel. However, the Fed is not in the authority to tell banks to turn the new money into corporate loans. Bank are free to do with that money whatever they won’t and this money in the long term will cause lots of bubbles on asset markets (excluding real estate market) to arise. The beneficiaries of the programme will be mostly financial institutions and other speculators who might strike it rich on increasing market prices. The programme might result even in hampering recovery, mostly if prices of commodities (crude oil, copper, even food) shoot up. Finally, it will cause US dollar to depreciate against other currencies and make US exports more competitive. And in the long run the rising money supply will result in higher inflation. I surmise Fed in liaison with US government were absolutely aware of long-term implications of this decision, mostly because it will allow US government to pay off its whopping debts, at the expense of its creditors, at the expense of the rest of the world actually.

Markets have witnessed a substantial rally from the beginning of August as speculators have anticipated the move of Fed, they could only bet how big the scale of the programme would be. Fed met their expectations, but hopes for a continued rally in the coming months might be dashed. Markets have priced the programme before, another price surge will ensue soon as the new money has to be allocated somewhere, but a significant correction should not come as a surprise. How long can stock prices rise if the economy is on its knees and even near-zero interest rates and printing money fail to bolster it up?

The experts tear Mr Bernanke’s move into pieces. One of the most eminent investors, Jim Rogers said the governor of US central bank “doesn’t understand economics (…) all he understands is printing money”. I would like to remind you mustn’t turn on your printers and print as much money as you want because you or your friends are hard up for cash. It is a crime! But Mr Bernanke can do it and he is not dubbed a criminal.

For the past few days I’ve been mulling over a concept of economic crime. Is there anything like this? In Poland we have police departments that deal with przestępczość gospodarcza those are economic crimes, but I’d prefer “business crimes” term. In Polish public discourse there is an insult szkodnik gospodarczy (economic pest), used by Andrzej Lepper and his fellows to describe Leszek Balcerowicz and his fellows, or conversely, by liberal intellectuals to name statist populists. But I don’t recall hearing about zbrodnia ekonomiczna.

General Wojciech Jaruzelski chose the lesser of two evils and declared martial law, many Poles have forgiven him. Current prime minister failed to carry out painful, but necessary reforms, but if he had had more courage, many Poles with hindsight would forgive him. Will the world forgive Mr Greenspan and Mr Bernanke their thoughtless decisions?

I believe one day we’ll bear the brunt of what is getting under way now. The next financial meltdown will be much more severe because indebted government will not be able to step in and bail out financial institutions on the verge of bankruptcy. I don’t claim to have come up with this scenario. Many far wiser people have spoken about such scenarios much earlier, it is estimated to come to a pass in 2014 or 2015. Before it happens we will witness era of super bubbles, so take advantage of it before the whole machinery goes under :)

Bubbles and bursts

If you don’t have an idea what to write, it never hurts to find an anniversary and make it a topic of your post. This exactly what I did today and the event I’ve found is one not to be sneezed at. I bet few of you, even those who have been keeping track of capital markets for years remember well that the dot-com bubble burst exactly ten years ago, on 10 March 2010 2000.

Dot-com rally is a quaint example of the role of psychology on financial markets. Stock prices soared not because fundamental values or companies had been rising rapidly, but because of what investor had believed in. They had seen the Internet as a breakthrough invention. Indeed, it revolutionised our lives, made it much easier, but they had overestimated its role. No new era had begun, not every company which had begun to operate in the Net turned into gold. Many of them were actually worth very little.

The history of speculative bubbles, back from tulips in the Netherlands four hundred years ago, up till the last officially recognised crude oil bubble in 2008 (the mortgage bubble was penultimate, it’s still early to say whether what is under way on stock exchanges all over the world is a new bubble or not), is a long record of human folly and misperception, mostly notably is how the risk has been underestimated or forgotten about.

The major beliefs that underlie the growth of speculative bubbles are the ones that a new era has begun or that a price of an asset can rise endlessly, which strengthen with time (I still find it mind-boggling). This funny but destructive mechanism works orderly until it loses momentum the moment when there are no more suckers eager to buy a certain asset (please note this is one of possible explanations). What causes a rise of a bubble and what pops it have been subject of numerous debates among economists. I will be trying to explore those issues in my MA thesis. From time to time, I’ll be sharing with you some my new discoveries and conclusions. This topic is a really fascinating combination of economics and psychology.

And at the end I have to eat a humble pie. Once again, what shouldn’t have even surprised anyone, my stock market forecast was far off mark. In late January I forecast much lower levels of stock indices. Today they are a step away from reaching their new peaks in the current bull market. I can make out where the markets are going, but what drives them in such a direction remains beyond my comprehension. Have we forgotten about the ‘R’ word once again? This word is RISK.

Should I be proud?

My school has announced on its website two professors from Warsaw School of Economics had been appointed as members of Monetary Policy Council. My university employs a lot of outstanding experts in monetary policy, like professor Krzysztof Rybiński, but for no apparent reason the current president decided to pick some of his buddies and once again set personal relationships above competencies. The previous president also for no apparent reasons designated renowned specialists – Andrzej Sławiński, Andrzej Wojtyna and Dariusz Filar.

Some time ago I evaluated competencies of Zyta Gilowska, there’s nothing I can add about her. None of fellow students with whom I discussed the nomination of Mr Glapiński and we our views simply square – he lacks knowledge, but is a close friend of Mr Kaczyński and no one else would have appointed him. He will have to learn a lot.

When it comes to Mr Kaźmierczak, the matter is a bit more complex. His field of academic research overlaps the issues of monetary policy, but there’s one significant fact about him that might have been seen as a merit by Mr Kaczyński. The new member of monetary authorities has never been a reputable figure among economists. His opinions are not appreciated, few people heard about him. He publishes in Gnash Dziennik, a newspaper of Father Rydzyk’s empire. I may be biased against him, as his dovish views are totally dissimilar to mine. He doesn’t see inflation above target as a danger for economy, it’s even conducive to economic growth as he says.

Inflation, contrary to what he advocates has to be handled carefully. It hazardously easily spirals out of control. As soon as it gets noticeable for customers, their inflationary expectations rise, so they hold out for pay rises and then when they get it, the economy is on the verge of a slippery slope.

In Poland a relatively tight monetary policy prior to the crisis helped our country avert a financial meltdown. Monetary authorities, mostly Mr Balcerowicz, who was a governor of central bank at the time were harshly criticised for the policy they had pursued. Unlike some other countries.

As professor John B. Taylor (the author of famous Taylor rule) points out in his latest interview for “Polityka”, one of the main causes of the financial crisis were too low interest rates. He also blames central banks and government for inapposite responses and openly condemns monetary policy run by Alan Greenspan and Ben Bernanke. This short interview might be helpful in understanding the origins and mechanics of what has been called the worst recession since the Great Depression.

Who’s to blame for the crisis / Cherish the bearish!

Ask an economist a question and they’ll answer: “It depends”. The question for today concerns Barack Obama’s plans to impose precautionary regulations on banking industry. Many opponents and commentators say this is the revenge for bankers’ to the latest financial crisis. The others say we have to prevent societies from the disasters reckless bankers may trigger.

Bankers became a scapegoat of the crisis, but the question who is to blame is multi-faceted, but can be boiled down to a simple dilemma: the market or the people? This single problem could be a great topic for a separate post – maybe one day…

If the people, you’ll probably blame the bankers and the factor that has always driven them – the greed. But please note dear reader that the bankers acted within a certain system, which created incentives to what you call immoral behaviours. The main pillars of the system were too loose monetary policy, lax regulations and certainly flawed remuneration schemes, under which bankers got paid generously for profits made on taking excessive risk and the burden of losses was carried by shareholders. When the banks were bailed out by the states, the governments stepped in as owners. A lot of free market advocates pulled the governments up for their disagreement for big bankers’ bonuses. Didn’t they notice the governments many times acted not as the states but as owners and exercised owner’s right to influence executives’ pays?

I would sooner incline towards a notion that the institutional framework is to blame. Bankers behaved rationally, if they could profit from the situation, they just did it. Many times I heard it was the greed that brought about the crisis. “Greed is bad” – the leftist organisations chanted on Canary Wharf on Halloween 2008. Greed itself, as an axe is not bad. Axe itself is evil when you use it to kill your mother-in-law. Greed is what propels development, boosts effectiveness, makes people strive for perfection, moves the world along.

But now add to this reasoning that markets are driven by two factors: greed and fear. Fear was taken away from global financial markets for a few years prior to the crisis. The moment market participants forgot about the links between expected profits and risk and believed prices could rise endlessly, they hammered a nail to their coffin. Financial markets should always be in the shadow of fear. They should always reckon with the worst scenario and must not expect that anyone, particularly the governments will come in aid. Conclusion. The crisis was caused by LACK OF FEAR, not by greed.

When the markets function without fear, the disaster in inexorable. That is why I welcomed the proposal of American president. Mr Obama brought back fear to the markets and restored the balance, I received it with a sigh of relief, the current correction proves markets stay sound.

What will happen in the coming weeks? There is one reason why the stock prices could go up – low interest rates, but I see several reasons, why this can be a long awaited correction:
- stock markets had been rising rapidly for eleven months and they simply deserve a decent correction,
- stocks are overvalued, but it’s not an argument, stock markets do not rely on rational arguments, but on power of demand and supply,
- big speculators will take profits and buy back the same securities in a few weeks at the lower price,
- those who’ll lose on this shrewd move will be small investors who believed in the bull market just before the trend reversed – history repeats itself, but few are sadder but wiser,
- stock exchanges have already discounted the scenario of V-shape recovery, now everything indicates we revival will be rather slower, the big vulnerability of economies to stimulus packages and too loose monetary policy has been recognised, now the valuations should reflect this scenario.

Dear readers, see you in a few weeks (in early March 2010) somewhere below 2000 points on WIG20, 32000 points on WIG, 900 points on S&P500, 8500 points on Dow Jones or somewhere else, if time proves me wrong. Today I estimate the chances my forecast is flawed are 35 per cent. Yesterday they were around 50 per cent, but after the markets rallied after the publication of USA GDP data and totally ran out of steam within just four hours, I’m quite convinced we’re heading south.

The unrepentant...

It’s increasingly harder to find an economist who would admit openly they were wrong. When sometimes I see them speaking in public it occurs to me they would sooner try to convince me that black is white and the other way round than concede their mistakes.

Today’s The Wall Street Journal Europe raises the vexed issue of Ben Bernanke’s opinion on the Fed’s role in fuelling mortgage bubble in the United States – a view many economists disagree with. Loose monetary policy was one of the major causes of collapse, not the only one, but saying as Mr Bernanke that Fed’s policy “does not appear to have been inappropriate” sounds at least absurd. Keeping the interest rates too low for a long time does not appear reasonable. Once, in a difficult situation they could have been slashed, but should have been raised gradually as soon as the signs of recovery came up.

The commentator’s note was quite uplifting to me. Reading this is a must for an economist and everyone who is interested in economy and its mechanics. It clearly presents what I described in my post a month ago, that it how cheap money fuels irrational, unfettered speculation. Quite probably all bubbles would rise without help from monetary authorities, but their scale would have been much smaller and so the last downturn would.

Conceivably, Mr Bernanke is trying to justify what the institution he is chairing is doing is right and justified. He consistently ignores the threat of inflation and his speeches are more important for financial markets, not for the real economy.

Another noteworthy text from Polish finance minister comes in Financial Times. Mr Rostowski not only warns there against too loose fiscal policy, but also outlines a remarkable picture of market driven by fear and greed. As far as I’m concerned financial markets cannot run properly without fear. Fear keeps them in balance, whenever it is eliminated it gives way to greed and we have seen what it leads up to. Mr Rostowski openly criticises the Greenspan put idea and tells a scenario of next arising bubbles.

I believe Greenspan put was one of the greatest distortions of free market. If someone decides to invest money in risky securities, he should not expect any help when the worst scenario comes to a pass. As even wikipedia entry shows, this policy tool was not targeted at real economy, but to prop up distressed financial markets. Who should the central bank favour? Speculators or the real economy entities – businesses and customers? Now also the speculators benefit the most from extremely low interest rates. Fortunately, more and more economists foresee the possible relapse of the crisis subsequent from repeating the same mistakes.

Meanwhile in Poland. Newly appointed member of monetary policy council calls for hikes in interest rates. At long last! Let’s jack it up!