The Great Property Market Conspiracy – A €55 Trillion Plus Problem! - Part 1

Its not just in Britain that the government, the banks, estate agents, the media, and the central bank are involved in a huge attempt to keep property prices high, to deny that selling prices are falling sharply and so on. Why is that happening? The answer is that it has nothing to do with protecting home owners, still less potential home buyers, both of whom lose out as house prices are artificially propped up. It has everything to do with trying to save the banks. Those banks are still massively in debt, and are once again trying to hide those debts using complex derivatives. One German Bank alone, as set out below, has exposure to global derivatives of €55 Trillion. That is almost 20 times the GDP of Germany, or more starkly, its more than the entire global GDP! These derivatives are being used to hide the extent of exposure to property debt; property debt that sits on banks balance sheets on the basis of hugely inflated property prices. If property prices fell to rational levels, the banks would be exposed as bankrupt, much as happened in the US, Ireland, Greece and Cyprus.

One of the latest economies that looks likely to suffer such a property bubble bust is Canada, whose central bank chief, Mark Carney, is about to take over as Governor of the Bank of England. Throughout, the financial meltdown of 2008, where property markets and other asset prices, in most other countries, at least halted their lemming like stampede, property prices in Canada continued to bubble up, driven on by the money printing pursued by Carney. Despite, being one of the most sparsely populated economies on the planet, Canada now has some of the most overpriced property on the planet. So much, for the argument that high house prices are caused by housing need, and overcrowding! Providing a glimpse in to the UK's future, one reason Canada's house prices were able to bubble up in this way, was the role of the state backed mortgage provider, CMHC, which performs the same function that Fannie May and Freddie Mac, do in the US. They perform the same function that Osborne's proposals for state backed mortgages are intended to perform here. These state backed organisations, did what Osborne hopes will happen here, they gave the support to ensure that Canada's banks would lend the money that was being printed by the central bank, out to all those people who otherwise no self-respecting bank would lend to.

On that basis just as happened with Northern Rock, and as happened with the US sub-prime crisis, which was then seen to have happened across every economy with a large non-rental sector, tens of thousands of people were lent money, who had no prospect of ever paying it back. The consequence for these latter we all know. It was two-fold. Firstly, it blew up a huge property bubble, and secondly, it ensured that thousands of ordinary people then could not afford to buy their first home, or to move up to a more expensive one. The end result necessarily followed. As soon as no more “bigger fools” could be found to buy the over priced houses, because, however, little they had to put down as deposit, however low the interest rates offered, they could not afford, the bubble burst. In a number of places, like Canada, the UK, and to an extent Spain, that has not yet happened. On the one hand, new buyers have more or less dried up, but huge intervention by the state, to prop up the banks, and enable them to avoid foreclosing on bad mortgages has delayed the inevitable consequences.

In Canada, over half of mortgages are now thought to be backed by CMHC. But, in addition, two other organisations, AIG, and Glenworth Financial, receive 90% backing from the state. In other words, nearly all of the C$1.1 trillion Canadian market, is backed by the state! Canadian house prices have risen by 123% since January 2000, and the average house price there is now 6 times earnings, whereas the historical average is around three. For two storey homes the Canadian average rises to seven.

The same trend applies to rental prices. According to The Economist, the ratio of rent to price is currently 78% higher than the long-term average. That compares with just 68% in Hong Kong, which is one of the world's most expensive places.

But, the inevitable cracks are beginning to show through. In Toronto, sales are already down 40% compared with a year ago. The government has attempted to engineer a soft landing. It has introduced various measures, such as requiring a 20% deposit. But, that has just led to people finding ways around the restrictions, such as splitting up their loans. According to one brokerage, half of all outstanding mortgages are “high risk.” This is the solution that Osbourne wants to bring to Britain. But, past experience suggests that this conspiracy will only delay the inevitable.

Between 1999 and 2002, Gordon Brown, as Chancellor of the Exchequer, sold nearly 400 tonnes of Britain's gold reserves. At the time, it was obvious that the price of gold had hit rock bottom, and was starting to rise. Brown sold the gold at prices between, $256 and $296 an ounce. The low price for gold came in 1999, at $250 an ounce, and from 1999, gold, like other metals and raw materials, saw its price rise relentlessly, as the new global, long wave boom got under way. By September 2011, gold had hit its peak of $1943 an ounce, or almost 7 times the average price Brown had sold it for. The Liberal-Tories have liked to portray this as just an example of Brown's economic incompetence. It was far from that. In fact, Thomas Pascoe argued, in this Daily Telegraph article last year, that it was part of a necessary conspiracy to protect the banks, whose speculative activities were already threatening to throw the world financial system into chaos, at that time, a chaos that erupted anyway, in 2008, and from which we are still suffering today.

I was aware of the rumours of such a conspiracy, back in 2000, and decided to make it a part of the novel, that I was writing at the time - See Chapter 1 Here - about the manipulation of markets for revolutionary purposes. But, the rumour, at the time, was not just that this was Gordon Brown that was involved in such a conspiracy, rather that it was central banks and governments in a number of major economies, including the US. The basis of the rumours was, as Pascoe sets out, that a number of very large banks had made big, short bets against gold, bets that were going bad, as the price of gold began to soar. Because many of these short bets are undertaken using leverage, i.e. the bank or other speculator borrows huge amounts of money to finance the trade, in the expectation that they can close out their position at a profit, before they need to make good on their margin call, a number of these banks were threatened with bankruptcy.

Two things were at play here. Firstly, there is the effect of leverage. Suppose I come to buy $1 billion of shares in Apple. In fact, I can buy these shares for just $100 million on margin. I basically put down 10% of the cost to buy the shares, borrowing the other 90%, which I only have to make up when I get the margin call some time later. If Apple shares rise by 1%, I sell my now $1.01 billion worth, pocket the $10 million gain, and have the rest to pay off the margin call. Great if the shares go up, not so great if they fall. But, secondly, there is the problem of shorting. Suppose, I buy that $1 billion of Apple shares, and they go bust. Nasty, I've lost my $1 billion, but if you are a bank or multi-billionaire you can survive. However, suppose I short Apple stock. That means I think their share price will fall. So, I sell Apple shares, I do not actually own, in the expectation that, at some point in the future, before I actually have to transfer ownership of those shares, I can buy the shares needed, at a lower price than I've sold them for. The problem here is its the same as spread betting. There is no limit to how much I can lose. If the value of Apple shares, rather than falling, goes up, I make a loss, and although a share price can only fall to zero, there is no limit to how high it can go.

This was the problem these banks faced with gold. For years, after 1980, the price of gold had gone in only one direction – down. The general view of financial analysts was that gold was an historical relic. Unlike even silver, it had few industrial uses. It was used for jewellery, and not much else. Global trade was financed now by dollars not gold. Unlike shares, or bonds, or even a cash deposit, gold paid no dividend or interest. Therefore, if you were going to hold it, it could only be if its value was going to rise to give you capital gain, but given the aforesaid, why would it. No wonder its price had kept falling for 20 years. It was a one way bet, and speculators love one way bets. It is what provides the basis of the kind of carry trade that Pascoe describes.

So, it is not surprising that these banks had exposed themselves, to such a massive degree, in short gold positions. Remember that this is not long after Long Term Capital Management, in the United States, had gone bust, and had to be bailed out, by other banks, to the tune of $3.6 billion. It too was supposed to have developed an infallible algorithm for making money. It was also not long after the Asian Currency Crisis, and the Rouble Crisis, and slap bang in the middle of this process came the Stock Market crash of 2000, that wiped 75% off the value of the NASDAQ index. Just before that crash, as happens now with property, there were no end of analysts, newspaper column writers and others, who claimed that the market could only ever go up, because this time it was different from every other bubble!

No wonder governments and central banks were worried. No wonder they decided to engage in some market manipulation, to ensure the banks did not go down. In fact, such manipulation and intervention is nothing new. In Hong Kong, the state has for many years directly intervened in both the stock and bond markets, buying shares when the stock market looked like it was going to fall sharply. The US Federal Reserve and Treasury deny that they do the same, and its probably illegal for them to do so, but many rumours abound that they do on a regular basis, coming in at the end of the trading day, when they can have most effect, for example. And, in the last few years, there has been no doubt that the US Federal Reserve and Bank of England, as well as other Central Banks have directly intervened in the market. That is what Quantitative Easing is. In fact, the Bank of England, and Federal Reserve, have intervened so much, that both own around 30% of the total debt, issued by their respective governments, and buy up around half of the newly issued debt.

What does this have to do with the conspiracy in the property market? Only that it sets out that such conspiracies are, in fact, quite common, and sometimes undertaken in plain sight. The common theme is protection of the banks themselves, almost at whatever cost to the rest of society, who always end up picking up the tab for the bail-out. Witness, Greece, Ireland, Portugal, Cyprus and coming soon Malta, Slovenia, Luxembourg, Spain, Italy, the UK and possibly France and Germany too.

The experience of Cyprus was perhaps most illuminating. It is literally only months ago that Europe's banks were “stress tested” to see if they could withstand some unforeseen shock. The first of those stress tests, three years ago, were widely seen as a sham. The last stress tests were, we were told, more rigorous. Yet, that didn't stop some of those banks, across Europe, failing. And the banks in Cyprus were given a clean bill of health. In fact, a couple of years ago, the IMF was commending Cyprus for its economic model! Yet, the Cypriot banks went bust, and not only Cypriot taxpayers, but also the depositors, in those banks, are the people who have been handed the bill. Looking at the situation of banks in those other economies listed above, including Germany, the situation does not look any better.

Forward To Part 2