Never mind the ‘Brexit’ debate, it’s almost as if the whole financial world can be boiled down to one word right now: yield.
Interest rates are pinned so low that the hunt is on to find yielding assets and buy them. That’s before investors get pushed further and further up the risk scale.
After all, the traditional asset class for the investing big boys — the government bond markets in Europe, Japan and the US — are tapped out. It’s estimated that 10 trillion in government bonds now have negative interest rates.
You can see this driving behaviour in the latest suite of deals and moves as investors look for alternative places to find revenue.
Did you notice that the first agency-rated subprime mortgage backed bond deal happened this month?
Subprime borrowers are baaaaaack
Yep — the same kind of loans that sourced before 2008 and infected the entire global financial system.
Now, the amount of money involved in this deal is barely even chicken feed. The significance stems from the fact a rating agency has verified and stamped the bond. Here’s why this matters. A lot of major institutional investors can’t buy assets unless they have been assigned a rating from an approved agency.
Now the rating agencies got burnt badly after 2008. They told the world many subprime bonds were ‘Triple A’, and they turned out to be junk. As you can see, it’s taken eight years since to tempt them back into these waters.
But it’s perfectly reasonable to assume that more and more of these loans will be bundled up, securitised and rated.
It’s the yield on subprime loans that’s tempting investors back. Subprime borrowers are higher risk, so they pay more.
There’s no shortage of investors who need to find asset classes they can earn them real returns. This is especially true for Japanese and European investors. Interest rates are the lowest for them.
We can assume that’s why BlackRock — the world’s largest asset manager — has also launched an Exchange Traded Fund (ETF) in Europe that invests in US mortgage-backed securities (MBS).
These MBS are not the same as subprime loans. These borrowers have higher credit scores and carry less risk. But the drive behind this float is the same — investors chasing yield.
This is a huge market. There are currently US$4.7 trillion worth of these ‘securitisations’ out there from US government-backed housing agencies Fannie Mae, Freddie Mac and Ginnie Mae alone.
That makes them the second most liquid US bond market after US federal government debt (‘Treasuries’). That’s huge.
The BlackRock ETF offers a yield of 2.1%. That has to be some kind of carrot for European investors when most Eurozone sovereign debt yields nothing.
Talk about history repeating.
So here we have it again. Wall Street inventing not-so-new ways for everyone to get right back into US real estate.
This European country looks juicy
In fact, we can say that about property in general. Blackstone — the world’s largest real estate asset manager — has raised 5.5 billion euros to go shopping in Europe.
They’re not alone. Private equity groups that are going to invest in Europe have raised US$40 billion in the first quarter alone, according to the Financial Times.
They’re doing this because Europe is further behind the US in terms of its recovery. There’s still property bargains to be had. That’s in the wake of the real estate collapse across the continent after 2007. Europe’s been slower to sort out the mess.
Groups like Blackstone made a killing previously in the US buying up distressed debts. Spain and Ireland and the UK have all seen similar moves.
But not so Italy. The reason we’re honing in on Italy today is that it still has 360 billion euros in non-performing loans it has to deal with.
What’s appears to have held investors back in Italy is the country’s complicated judicial system and laws around foreclosing. Hedge funds and private equity can see the opportunity. But they’re waiting for the government to clarify the situation.
Italy is a major economy. Once these distressed debts are dealt with, its banking system can be returned to health. When the Italian banks are firing again, Italy’s economy will go with it.
But you can see how central banks pinning interest rates is going to drive more and more money into real estate. The consequence is predictable. Eventually it will go completely over the top. The only question is when. For the timing on that, go here.
Editor, Money Morning