In 1996, then-Chairman of the Federal Reserve (Fed), Alan Greenspan, popularized the expression “irrational exuberance” in a speech that sought to draw attention to the excessive valuations of financial markets. The Exchanges reacted to his words with falls. And a few years later, the tech bubble burst. This Wednesday, the European Central Bank (ECB) has rescued the term of the newspaper archives by speaking of a “remarkable exuberance” in the markets, and thus warning of a possible overheating. “The last six months have seen continued rallies in many financial markets and higher prices in the euro area residential real estate markets, raising concerns about overvaluation and the potential for abrupt asset price corrections,” noted the entity in its financial stability report.
Stock markets such as the United States or Germany are moving these weeks in an area of record highs, although in general in Europe they are at “more moderate” levels than on the other side of the Atlantic, where part of the ocean of liquidity with which the White House has flooded to homes has ended up on Wall Street. The ECB believes that buoyant stock indices are disconnected from still weak fundamentals, and the declines in recent days, triggered by fears of the return of inflation in the US, are not enough: valuations remain “high”.
The text includes several concerns beyond the impact of a correction on the markets. And they are unevenly distributed. For Vice President Luis de Guindos, “a higher burden of corporate debt in countries with larger service sectors could increase the pressure on governments and banks in these countries.” Although it is not mentioned, Spain, highly dependent on the tourism sector, and services in general, fits that description perfectly.
The supervisor is pleased that public policies brought corporate insolvencies down to record lows during the pandemic. But he warns that the gradual withdrawal of these aid may be accompanied by turbulence if insolvencies increase, a scenario that “cannot be ruled out”, infecting the states and banks that supported them, and causing unemployment.
The bank explains that household income has been sustained up to now thanks to the public lifeguard (measures such as ERTE or aid for the self-employed, for example), record savings rates among those who have kept their job, the solidity of the real estate market, and the recovery of the stock markets. But he believes that the vulnerabilities are there: due to the high dependence on public aid, the possibility that the economic weakness continues and employment falls, and due to an increase in household indebtedness through mortgages, in the midst of a residential market that it considers to be showing signs of being overvalued in the euro zone.
Frankfurt thus acts as a spoiler in the face of the euphoria of thinking that the beginning of the recovery is enough to compensate for the imbalances that have been accentuated during the pandemic. He acknowledges that market sentiment towards banks has improved “substantially”, with their rises in the Stock Market as proof, but he issues a triple warning: bank profitability remains weak; demand for loans uncertain; and credit risk may appear late, so he recommends increasing provisions to deal with bad debts.
The analysis also includes in this edition references to the impact of climate change on the financial sector. “A significant part of bank loans to companies could be subject to a high level of risk related to the weather, which directly affects the activity of companies,” he says.
And it launches the umpteenth volley against bitcoin, although its risk for financial stability is limited, given that its use as a means of payment is residual, and the large euro entities are generally not exposed to strong fluctuations in its price. “The rise in bitcoin prices has overshadowed previous financial bubbles such as the tulip rush and the South Seas bubble in the 1600s and 1700s. While this has been largely driven by retail investors, some institutional investors and non-financial corporations are also showing increasing interest. Its price volatility makes bitcoin risky and speculative, while its exorbitant carbon footprint and its possible use for illicit purposes are cause for concern ”, he concludes.
Eddie is an Australian news reporter with over 9 years in the industry and has published on Forbes and tech crunch.