Tag: Federal Reserve

Federal Reserve’s Review of Banks’ Capital Plans Highlights Some Gaps

In a release late last week, the FED said that as part of its annual examination of the capital planning practices of the nation’s largest banks, the Federal Reserve Board did not object to the capital plans of 34 firms but objected to the capital plan from DB USA Corporation due to qualitative concerns.

Due in part to recent changes to the tax law that negatively affected capital levels, two firms will maintain their capital distributions at the levels they paid in recent years. Separately, one firm will be required to take certain steps regarding the management and analysis of its counterparty exposures under stress.

The Comprehensive Capital Analysis and Review, or CCAR, in its eighth year, evaluates the capital planning processes and capital adequacy of the largest U.S.-based bank holding companies, including the firms’ planned capital actions, such as dividend payments and share buybacks. Strong capital levels act as a cushion to absorb losses and help ensure that banking organizations have the ability to lend to households and businesses even in times of stress.

“Even with one-time challenges posed by changes to the tax law, the CCAR results demonstrate that the largest banks have strong capital levels, and after making their approved capital distributions, would retain their ability to lend even in a severe recession,” said Vice Chairman Randal K. Quarles.

When evaluating a firm’s capital plan, the Board considers both quantitative and qualitative factors. Quantitative factors include a firm’s projected capital ratios under a hypothetical scenario of severe economic and financial market stress. Qualitative factors include the strength of the firm’s capital planning process, which incorporates risk management, internal controls, and governance practices that support the process.

This year, 18 of the largest and most complex banks were subject to both the quantitative and qualitative assessments. The 17 other firms in CCAR were subject only to the quantitative assessment. The Board may object to a capital plan based on quantitative or qualitative concerns.

The Board objected to the capital plan from DB USA Corporation due to qualitative concerns. Those concerns include material weaknesses in the firm’s data capabilities and controls supporting its capital planning process, as well as weaknesses in its approaches and assumptions used to forecast revenues and losses under stress.

The Board issued a conditional non-objection to the capital plans of both Goldman Sachs and Morgan Stanley and both firms will maintain their capital distributions at the levels they paid in recent years, which will allow them to build capital over the next year. Each firm’s capital ratios, under the capital plans they originally submitted and with the one-time capital reduction from the tax law changes, fell below required levels when subjected to the hypothetical scenario. This one-time reduction does not reflect a firm’s performance under stress and firms can expect higher post-tax earnings going forward.

The Board also issued a conditional non-objection for the capital plan from State Street Corporation. The stress test revealed counterparty exposures that produced large losses under the hypothetical scenario, which assumes the default of a firm’s largest counterparty under stress. The firm will be required to take certain steps regarding the management and analysis of its counterparty exposures under stress.

The Federal Reserve did not object to the capital plans of Ally Financial, Inc.; American Express Company; BB&T Corporation; BBVA Compass Bancshares, Inc.; BMO Financial Corp.; BNP Paribas USA; Bank of America Corporation; The Bank of New York Mellon Corporation; Barclays US LLC.; Capital One Financial Corporation; Citigroup, Inc.; Citizens Financial Group; Credit Suisse Holdings (USA); Discover Financial Services; Fifth Third Bancorp; HSBC North America Holdings, Inc.; Huntington Bancshares, Inc.; JP Morgan Chase & Co.; Keycorp; M&T Bank Corporation; MUFG Americas Holdings Corporation; Northern Trust Corp.; The PNC Financial Services Group, Inc.; RBC USA Holdco Corporation; Regions Financial Corporation; Santander Holdings USA, Inc.; SunTrust Banks, Inc.; TD Group US Holdings LLC; U.S. Bancorp; UBS Americas Holdings LLC; and Wells Fargo & Company.

U.S. firms have substantially increased their capital since the first round of stress tests led by the Federal Reserve in 2009. The common equity capital ratio–which compares high-quality capital to risk-weighted assets–of the 35 bank holding companies in the 2018 CCAR has more than doubled from 5.2 percent in the first quarter of 2009 to 12.3 percent in the fourth quarter of 2017. This reflects an increase of more than $800 billion in common equity capital to more than $1.2 trillion during the same period.

FED Passes ALL The US Bank In Their 2018 Stress Tests

The 2018 results from the Federal Reserve bank stress testing are out, and as normal they include the results for all 35 named institutions, a laudable degree of transparency compared with the Australian version!

The Fed says that all 35 Banks will be fine, even if stocks crash by 65%, the volatility index reaches 60, home prices fall 30% and commercial real estate drops 40% all at the same time.

They say that in the aggregate, the 35 firms would experience substantial losses under both the adverse and the severely adverse scenarios but could continue lending to businesses and households, due to the substantial accretion of capital since the financial crisis. So that’s alright then…

Aggregate losses at the 35 firms under the severely adverse scenario are projected to be US$578 billion and the net income before taxes is projected to be −US$139 billion.

The aggregate Common Equity Tier 1 (CET1) capital ratio would fall from an actual 12.3 percent in the fourth quarter of 2017 to its minimum of 7.9 percent over the planning horizon. Since 2009, the 35 firms have added about $800 billion in common equity capital.

Goldman Sachs ended up with a Tier 1 minimum supplementary leverage ratio (SLR) of 3.1, just exceeding the required 3.0 minimum the Fed set for its annual capital plan, the lowest among participating banks. However,  Morgan Stanley was next, at 3.3, then State Street at 3.7. The others were above 4.

Projected aggregate pre-provision net revenue (PPNR) is $492 billion, and net income before taxes is projected to be −$139 billion.

Some US outposts of European banks are most at risk in this analysis, together with some of the big investment banks.

Some observations.

First, losses from trading and counter-party losses were estimated at $133 billion, stemming from 9 institutions, including $17.3 billion from Bank of America Corporation, $16.3 billion from Citigroup, $13.3 billion from Goldman Sachs, $29.4 billion from JP Morgan $29.4 billion, Morgan Stanley $11.7 billion and $12.2 billion from Wells Fargo.

These estimate of losses are calibrated based on historical performance, but given the massive size of the derivatives market, this is just a best guess. We discussed the size and shape of the derivatives market recently in the $37 trillion dollar black hole.

Second, its hard to estimate the potential impact of contagion and freezing of the markets as happened into 2007, as each bank is modelled separately. This begs the question as to whether the system level modelling is robust enough. Especially if one major counter-party fell over during a crisis. 2007 showed the problem when trust across the markets falls, and margins widen significantly.

Third the assumptions are that things will revert to normal conditions in a few years – suggesting this is a “blip type crises.” Some of the smaller banks may have performed better in the tests than they would in the real world.

But the bottom line, according to the FED is that the banks can stand on their own two feet in the mother of all crises, so not excuse for any bail-out then… We will see.

That said, the analysis is the most comprehensive in the world. Its worth reading the detail.

The Federal Reserve has established frameworks and programs for the supervision of its largest and most complex financial institutions to achieve its supervisory objectives, incorporating the lessons learned from the 2007 to 2009 financial crisis and in the period since. As part of these supervisory frameworks and programs, the Federal Reserve assesses whether bank holding companies BHCs with $100 billion or more in total consolidated assets are sufficiently capitalized to absorb losses during stressful conditions, while meeting obligations to creditors and counterparties and continuing to be able to lend to households and businesses.

This annual assessment includes two related programs:

  • Dodd-Frank Act supervisory stress testing is a forward-looking quantitative evaluation of the impact of stressful economic and financial market conditions on firms’ capital.
  • The Comprehensive Capital Analysis and Review (CCAR) consists of a quantitative assessment for all firms, and a qualitative assessment for firms
    that are LISCC or large and complex firms.

For this year’s stress test cycle (DFAST 2018), which began January 1, 2018, the Federal Reserve conducted supervisory stress tests of 35 firms.

The adverse and severely adverse supervisory scenarios used in DFAST 2018 feature U.S. and global recessions. In particular, the severely adverse scenario is characterized by a severe global recession in which the U.S. unemployment rate rises by almost 6 percentage points to 10 percent, accompanied by a global aversion to long-term fixed-income assets. The
adverse scenario features a moderate recession in the United States, as well as weakening economic activity across all countries included in the scenario.

In conducting its supervisory stress tests, the Federal Reserve calculated its projections of each firm’s balance sheet, risk-weighted assets (RWAs), net income, and resulting regulatory capital ratios under these scenarios using data on firms’ financial conditions and risk characteristics provided by the firms and a set of models developed or selected by the Federal Reserve. For DFAST 2018, the Federal Reserve updated the calculation of projected capital to reflect changes in the tax code associated with the passage of the Tax Cuts and Jobs Act (TCJA) in December 2017. As in past years, the Federal Reserve also enhanced some of the supervisory models to incorporate new data, where available, and to improve model stability and performance. The enhanced models generally exhibit an increased sensitivity to economic conditions compared to past years’ models.

The results of the DFAST 2018 projections suggest that, in the aggregate, the 35 firms would experience substantial losses under both the adverse and the severely adverse scenarios but could continue lending to businesses and households, due to the substantial accretion of capital since the financial crisis. Over the nine quarters of the planning horizon, which for DFAST 2018 begins in the first quarter of 2018 and ends in the first quarter of 2020, aggregate losses at the 35 firms under the severely adverse scenario are projected to be $578 billion. This includes losses across loan portfolios, losses from credit impairment on securities held in the firms’ investment portfolios, trading and counterparty credit losses from a global market shock, and other losses.

Projected aggregate pre-provision net revenue (PPNR) is $492 billion, and net income before taxes is projected to be −$139 billion. In the severely adverse scenario, the aggregate Common Equity Tier 1 (CET1) capital ratio would fall from an actual 12.3 percent in the fourth quarter of 2017 to its minimum of 7.9 percent over the planning horizon. The aggregate CET1 ratio is projected to rise to 8.7 percent by the end of the planning horizon.

In the adverse scenario, aggregate projected losses, PPNR, and net income before taxes are $333 billion, $467 billion, and $125 billion, respectively. The aggregate CET1 capital ratio under the adverse scenario would fall to its minimum of 10.9 percent over the planning horizon.

Here are the scenarios.

Fed Lifts Rate, More To Follow

The FED released their decision to lift rates, as expected. The T10 Bond Rate is up.

US Mortgage rates didn’t move much today. That keeps them in line with some of the highest levels in nearly 7 years, though the same could be said for a majority of the days since mid-April.

Higher rates will spill over into the capital markets too.  The DOW fell.

Information received since the Federal Open Market Committee met in May indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Job gains have been strong, on average, in recent months, and the unemployment rate has declined. Recent data suggest that growth of household spending has picked up, while business fixed investment has continued to grow strongly. On a 12-month basis, both overall inflation and inflation for items other than food and energy have moved close to 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-3/4 to 2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

Voting for the FOMC monetary policy action were Jerome H. Powell, Chairman; William C. Dudley, Vice Chairman; Thomas I. Barkin; Raphael W. Bostic; Lael Brainard; Loretta J. Mester; Randal K. Quarles; and John C. Williams.

Families in Financial Distress Are More Likely to Stay in Distress

According to the  latest from The St.Louis Fed On The Economy Blog, individuals who were in financial distress five years ago were about twice as likely to be in financial distress today when compared with an average individual.

Many households have experienced financial distress at least one time in their life. In these situations, households miss payments for different reasons (unemployment, sickness, etc.) and eventually file bankruptcy to discharge those obligations.

In a recent working paper, I (Juan) and my co-authors Kartik Athreya and José Mustre-del-Río argued that financial distress is not only quite widespread but is also very persistent. Using Federal Reserve Bank of New York Consumer Credit Panel/Equifax data, we reported that individuals who were in financial distress five years ago were about twice as likely to be in financial distress today when compared with an average individual.1

Consumer Bankruptcy

In this post, we focus our attention on a very extreme form of financial distress: consumer bankruptcy. We obtained financial distress data from the Survey of Consumer Finances (SCF), conducted by the Board of Governors. The data span from 1998 to 2016 with triennial frequency, and the respondents who are younger than 25 or older than 65 have been trimmed.2

We first measured the share of households that had previously experienced an episode of financial distress by looking at people who filed for bankruptcy five or more years ago.3 The figure below shows that the share of households with past financial distress increased from approximately 6.6 percent in 1998 to 12.2 percent in 2016.

 

past distress

 

We then measured current financial distress by computing the share of households that delayed their loan payment on the year the survey was conducted.4 (We recognize that this measure is less extreme, as only a share of households that are late making payments will end up in bankruptcy.)5

The figure below shows that while there are minor fluctuations in the share of households with late payments throughout the sample period, the numbers remained around 8 percent.

current distress

 

Finally, we created a ratio to measure the persistence of financial distress. It compares the share of households with late payments among households that declared bankruptcy five or more years ago to the share of households with late payments the year the SCF was conducted.

If financial distress was not persistent at all, both shares would be equal, and the ratio would be one. Thus, a value greater than one indicates the persistence of financial distress. The figure below shows the evolution of the persistence of financial distress over the years.

distress persistance

The ratio fluctuates around 1.5, implying that the households that have encountered an episode of financial distress in the past are 1.5 times more likely to delay payment today, compared to average households.

US Production Numbers Strong In April

US Industrial production rose 0.7 percent in April for its third consecutive monthly increase according to data from the Federal Reserve.

The rates of change for industrial production for previous months were revised downward, on net; for the first quarter, output is now reported to have advanced 2.3 percent at an annual rate. After being unchanged in March, manufacturing output rose 0.5 percent in April. The indexes for mining and utilities moved up 1.1 percent and 1.9 percent, respectively. At 107.3 percent of its 2012 average, total industrial production in April was 3.5 percent higher than it was a year earlier. Capacity utilization for the industrial sector climbed 0.4 percentage point in April to 78.0 percent, a rate that is 1.8 percentage points below its long-run (1972–2017) average.

Market Groups

The rise in industrial production in April was supported by increases for every major market group. Consumer goods, business equipment, and defense and space equipment posted gains of nearly 1 percent or more, while construction supplies, business supplies, and materials recorded smaller increases.

Within consumer goods, the output of nondurables rose nearly 1 1/2 percent in April, as both consumer energy products and non-energy nondurable consumer goods posted increases. The output of durable consumer goods declined about 1/2 percent, mostly because of a sizable drop in automotive products. The advance in business equipment resulted from gains for information processing equipment and for industrial and other equipment, while the rise in materials was led by an increase for energy materials.

Industry Groups

Manufacturing output moved up 0.5 percent in April; for the first quarter, the index registered a downwardly revised increase of 1.4 percent at an annual rate. In April, the indexes for durables and nondurables each gained about 1/2 percent, while the production of other manufacturing industries (publishing and logging) rose nearly 1 percent. Among durables, advances of more than 1 percent were posted by machinery; computer and electronic products; electrical equipment, appliances, and components; and aerospace and miscellaneous transportation equipment. The largest losses, slightly more than 1 percent, were recorded by motor vehicles and parts and by wood products. The increase in nondurables reflected widespread gains among its industries.

The output of mining rose 1.1 percent in April and was 10.6 percent above its year-earlier level. The increase in the mining index for April reflected further gains in the oil and gas sector but was tempered by a drop in coal mining.

In April, the index for utilities advanced 1.9 percent. The output of electric utilities was little changed, but the output of gas utilities jumped more than 10 percent as a result of strong demand for heating due to below-normal temperatures.

Capacity utilization for manufacturing rose to 75.8 percent in April, a rate that is 2.5 percentage points below its long-run average. Increases were observed in all three main categories of manufacturing. The operating rates for durables and nondurables each moved up about 1/4 percentage point, and the rate for other manufacturing rose about 3/4 percentage point. Utilization for mining rose about 1/2 percentage point and remained above its long-run average; the rate for utilities jumped more than 1 percentage point.

FED Held US Cash Rate This Month

The Fed held this month, but is still talking about more adjustments later in the year.

The Dow closed lower as the market digested the inflation commentary.

Information received since the Federal Open Market Committee met in March indicates that the labor market has continued to strengthen and that economic activity has been rising at a moderate rate. Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Recent data suggest that growth of household spending moderated from its strong fourth-quarter pace, while business fixed investment continued to grow strongly. On a 12-month basis, both overall inflation and inflation for items other than food and energy have moved close to 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong. Inflation on a 12-month basis is expected to run near the Committee’s symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1-1/2 to 1-3/4 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

Has The Next Asset Collapse Begun?

From  Econimica

After nearly a half century of unlimited dollar creation, multiple bubbles and busts…the current asset reflation has been the most spectacular…but alas, perhaps too successful.

The Fed’s answer to control or restrain this present reflation is raising interest rates to stem the flow of business activity, lending, and excessive leverage in financial markets.  But in the Fed’s post QE world, a massive $2 trillion in private bank excess reserves still waits like a coil under tension, ready to release if it leaves the Federal Reserve.  Thus, the only means to control this centrally created asset bubble is to continuously pay banks higher interest rates (almost like paying the mafia for protection…from the mafia) not to return those dollars to their original owners or put them to work.  With each successive hike, banks are paid another quarter point to take no risk, make no loan, and just get paid billions for literally doing nothing.

The chart below shows the nearly $4.4 trillion Federal Reserve balance sheet, (acquired via QE, red line), nearly $2 trillion in private bank excess reserves (blue line), and the interest rate paid on those excess reserves (black line).  While the Fed’s balance sheet has begun the process of “normalization”, declining from peak by just over a hundred billion, bank excess reserves have fallen by over $700 billion since QE ended.  So what?

 

The difference between the Federal Reserve balance sheet and the excess reserves of private banks is simply pure monetization (the yellow line in the chart below).  This is the quantity of dollars that were conjured from nothing to purchase Treasury’s and mortgage backed securities from the banks.  But instead of heading to the Fed to be held as excess reserves, went in search of assets, likely leveraged 2x’s to 5x’s (resulting anywhere from $3 trillion to $7.5+ trillion in new buying power).

 

From world war II until 1995, equities were closely tied to the disposable personal income of the American citizens (DPI representing total annual national income remaining after all taxation is paid, blue line).  However, since ’95 lower and longer interest rate cuts have induced extreme levels of leverage and debt.  The Fed actions have created progressively larger asset bubbles more divergent from disposable personal income at peak…but falling below DPI during market troughs.  But after the ’07 bubble, the pure monetization found its way into the market with spectacular effect.  As the chart below shows, the Wilshire 5000 (representing the market value of all publicly traded US equities, red line) has deviated from the basis of US spending, US total disposable income (the total amount of money left nationally after all taxes are paid, blue line).

In the chart below, the growth in monetization has acted as a very nice leading indicator for equities.  As each successive pump of new money left the Federal Reserve and entered found its way to the market in search of assets, assets subsequently reacted.  Likewise, each drawdown in monetization saw a similar pullback in equities.

What happens next?  The Federal Reserve plans to systematically reduce its balance sheet via raising interest rates on excess reserves.  This is to incent and richly reward the largest of banks to maintain these trillions at the Federal Reserve.  As the chart below shows, theoretically this means the monetized money is set to continue evaporating, and assuming it was highly levered, then the unwind and volatility of deleveraging should only continue to worsen.

And…if the Federal Reserve is true to its word and even halves its balance sheet while banks maintain the excess reserves at the Fed, then all the digitally conjured $1.5 trillion is set to be “un-conjured”.  Again, assuming the monetized monies were at least somewhat levered, the unwind of that leverage will continue to produce a chaotic and volatile slide in markets.  As the chart below suggests, if US equities (and broader assets) follow the unwind of the monetization, then equities are likely on their way back down to and through their natural support line, disposable personal income.  Conversely, I’ve included the 7.5% long term anticipated market appreciation for reference (green dashed line).  Quite a spread between those differing views on future asset valuations.

Of course, the “data dependent” Fed could change its mind, or perhaps banks will continue to pull those excess reserves and put them to work (with growing leverage) rather than take the risk-free money from the Fed…either way this is something worth watching.

A Global Perspective On Home Ownership

From The St. Louis Fed On The Economy Blog

An excellent FED post which discusses the decoupling of home ownership from home price rises. We think the answer is simple: the financialisation of property and the availability of credit at low rates explains the phenomenon.

In the aftermath of WWII, several developed economies (such as the U.K. and the U.S.) had large housing booms fueled by significant increases in the homeownership rate. The length and the magnitude of the ownership boom varied by country, but many of these countries went from a nation of renters to a nation of owners by around the late 1970s to mid-1980s.

Historically, the cost of buying a house, relative to renting, has been positively correlated with the percent of households that own their home. From 1996 to 2006, both the price of houses and the homeownership rate increased in the U.S. This increasing trend ended abruptly with the global financial crisis that drove house prices and homeownership rates to historically low levels.

It is reasonable to expect prices and homeownership to move in the same direction. A decrease in the number of people who want to buy homes to live in could lead to a decrease in both prices and homeownership. Similarly, an increase in the number of people buying homes to live in could lead to an increase in both prices and homeownership.

However, recent evidence indicates that the cost of buying a home has increased relative to renting in several of the world’s largest economies, but the share of people owning homes has decreased. This pattern is occurring even in countries with diverging interest rate policies. It is important to delve into this fact and try to find potential explanations. (For trends in homeownership rates and price-to-rent ratios for several developed economies, see the figures at the end of this post.)

Increasing Cost of Housing

The price-to-rent ratio measures the cost of buying a home relative to the cost of renting. Factors like credit conditions or demand for homes as an investment asset affect the price of houses but not the price of rentals. These and other factors cause the price-to-rent ratio to move.

Over the period 1996-2006, the cost of buying a home grew more quickly than the cost of renting in many large economies. For example, the price-to-rent ratio in the U.S. increased by more than 30 percent between 2000 and 2006. Even larger increases occurred in the U.K. and France, where the price-to-rent ratio rose by nearly 80 percent over the same period.

The price-to-rent ratio declined in the wake of the housing crisis in the U.S., the eurozone, Spain and the U.K., but in the past few years, it has started to increase again. The price of houses is again increasing more quickly than the price of rentals.

Decreasing Homeownership

However, the homeownership rate has not increased along with the price-to-rent ratio. The homeownership rate (the percent of households that are owner-occupied) has fallen in several large economies:

  • In the U.S., the homeownership rate fell from around 69 percent before the recession to less than 64 percent in 2016.
  • In the U.K., the rate fell from nearly 69 percent to around 63 percent.
  • The homeownership rates in Germany and Italy have also fallen.

Diverging Policies

The pattern of increasing house prices and decreasing homeownership has occurred even in countries with diverging monetary policies:

  • By 2016, the Federal Reserve had ended quantitative easing and had begun raising rates in the U.S.
  • In contrast, the Bank of England and the European Central Bank continued quantitative easing throughout 2016 and reduced rates.

Nonetheless, the homeownership rate continued to fall in the U.S., the U.K. and many parts of Europe, while the price-to-rent ratio continued to increase.

Housing Supply

Several factors could be driving the decoupling of the price-to-rent ratio and the homeownership rate. From the housing supply side, there is a trend toward decreased construction of starter and midsize housing units.

Developers have increased the construction of large single-family homes at the expense of the other segments in the market. From 2010 to 2016, the fraction of new homes with four or more bedrooms increased from 38 percent to 51 percent.

This limited supply, particularly for starter homes, could result in increased prices for those homes and fewer new homeowners. One possible factor is regulatory change. The National Association of Home Builders claims that, on average, regulations account for 24.3 percent of the final price of a new single-family home. Recent increases in regulatory costs could have encouraged builders to focus on larger homes with higher margins. Supply may be just reacting to developments in demand that we discuss next.

Housing Demand

From the demand side, there are three leading explanations, which are likely complementary and self-reinforcing:

  • Changes in preferences toward homeownership
  • Changes in access to mortgage credit
  • Changes in the investment nature of real estate

Preferences for homeownership may have changed because households who lost their homes in foreclosure post-2006 may be reluctant to buy again. Also, younger generations may be less likely to own cars or houses and prefer to rent them.

Demand for ownership has also decreased because credit conditions are tighter in the post-Dodd Frank period.

Real Estate Investment

The previous demand arguments can explain why the price-to-rent ratio dropped post-2006. As rents grew relative to home prices, together with the low returns of safe assets, rental properties became a more attractive investment. This attracted real estate investors who bid up prices while depressing the homeownership rate.

Moreover, builders increased their supply of apartments and other multifamily developments. From 2006 to 2016, single-family construction projects declined from 81 percent to 67 percent of all housing starts.

There are several types of real estate investors:

  • “Mom and dad” investors looking for investment income
  • Foreign investors who have increased real estate prices in many of the major cities of the world
  • Institutional landlords like Invitation Homes or American Homes 4 Rent

In fact, since 2016 the real estate industry group has been elevated to the sector level, effective in the S&P U.S. Indices.

In addition, the widespread use of internet rental portals such as Airbnb and VRBO has increased the opportunity to offer short-term leases, increasing the revenue stream from rental housing.

There are several potential explanations, but more research is needed to determine the cause of the decoupling of house prices from homeownership rates and what it means for the economy.

Rent vs Owning in U.S.

Rent vs Owning in Eurozone

Rent vs Owning in Canada

Rent vs Owning in Spain

Rent vs Owning in Germany

Rent vs Owning in UK

Authors: Carlos Garriga, Vice President and Economist; Pedro Gete, IE Business School; and Daniel Eubanks, Senior Research Associate

FED To “Tailor” Leverage Ratios

In another sign of weakening banking supervision, the FED proposes new rules to  “tailor leverage ratio requirements“.  Tailoring appears to mean reduce!

The Federal Reserve Board and the Office of the Comptroller of the Currency (OCC) on Wednesday proposed a rule that would further tailor leverage ratio requirements to the business activities and risk profiles of the largest domestic firms.

Currently, firms that are required to comply with the “enhanced supplementary leverage ratio” are subject to a fixed leverage standard, regardless of their systemic footprint. The proposal would instead tie the standard to the risk-based capital surcharge of the firm, which is based on the firm’s individual characteristics. The resulting leverage standard would be more closely tailored to each firm.

The proposed changes seek to retain a meaningful calibration of the enhanced supplementary leverage ratio standards while not discouraging firms from participating in low-risk activities. The changes also correspond to recent changes proposed by the Basel Committee on Banking Supervision. Taking into account supervisory stress testing and existing capital requirements, agency staff estimate that the proposed changes would reduce the required amount of tier 1 capital for the holding companies of these firms by approximately $400 million, or approximately 0.04 percent in aggregate tier 1 capital.

Enhanced supplementary leverage ratio standards apply to all U.S. holding companies identified as global systemically important banking organizations (GSIBs), as well as the insured depository institution subsidiaries of those firms.

Currently, GSIBs must maintain a supplementary leverage ratio of more than 5 percent, which is the sum of the minimum 3 percent requirement plus a buffer of 2 percent, to avoid limitations on capital distributions and certain discretionary bonus payments. The insured depository institution subsidiaries of the GSIBs must maintain a supplementary leverage ratio of 6 percent to be considered “well capitalized” under the agencies’ prompt corrective action framework.

At the holding company level, the proposed rule would modify the fixed 2 percent buffer to be set to one half of each firm’s risk-based capital surcharge. For example, if a GSIB’s risk-based capital surcharge is 2 percent, it would now be required to maintain a supplementary leverage ratio of more than 4 percent, which is the sum of the unchanged minimum 3 percent requirement plus a modified buffer of 1 percent. The proposal would similarly tailor the current 6 percent requirement for the insured depository institution subsidiaries of GSIBs that are regulated by the Board and OCC.