In Short of the year 2010 we wrote:
So the big next crisis will be outside the U.S, with the key being inflation and dollar liquidity. With the whole world depending on Helicopter's Ben dollars falling around on all [those who are] too big to fail, a short squeeze in the dollar (like what is maybe happening now with the potential collapse of the Euro) will bring [the entire] "emerging world" to it's knees. Another thing that could happen, with or without a dollar rally is a pickup in inflation which will force those central banks to tighten. In India and in China it seems like it is happening and in Israel it is happening for sure.
When the bubble in Israel pops CAPITAL WILL FLOW OUT OF ISRAEL AND FISHER WILL BE FORCED TO RAISE RATES, NOT LOWER THEM LIKE BERNANKE.
So a possible combined short on the Israeli government bond market, the Israeli currency, and the Israeli Banking index will probably make the short of the year.
Another possible way to capitalize is to short the Israeli stock market via an ETF in the NYSE (NYSE:EIS) But then you are not focused only on the banks.(But don't worry the stock market will sell off as well.). On the other hand, shorting an ETF of a forigen market is a way to short the stock market and the currency at the same time.
Thursday, The Bank of Israel issued stricter mortgage instructions to the country's banks. In an effort to slow the pace of the rapid rise in the prices of homes over the past few years, Friday, Supervisor of Banks Roni Hizkiyahu published new guidelines for mortgages.
According to the new instructions, homebuyers will be allowed a mortgage of only up to 60% of the price of a property instead of 70%. Banks going above 60% will be required to set aside 0.75% of credit extended for doubtful loans. The new instructions will in effect mean that homebuyers will need 33% more equity in order to buy a property because they will be required to find 40% of the value of the home instead of 30%. Banks wanting to give mortgages above 60% will likely charge as much as 1% or even 1.5% higher interest rate in order to comply with the extra expense involved due to the new debt guidelines.
The Bank of Israel said,
There is no bubble in the housing market and we will make sure that there won't be.
Fischer is concerned about the rapidly rising price of housing. In the year from March 2009 to February 2010 house prices in Israel rose by 22%. Even he fears that a "housing bubble" may be developing.
To prevent this, Fischer is obligating banks to increase the size of the reserves they keep for high-risk mortgages. The Bank of Israel defines high risk housing loans as mortgages where the bank is funding more then 60% of the purchase. The Bank of Israel warned that it would continue to monitor the housing market and may take further measures if necessary.
With the average mortgage being north of 600,000 NIS, and the average salary about 8,000 NIS the new instructions are equal to a 3% rate hike.
Unlike the American banking system, the Israeli banking system is extremely centralized, with two large banks, Hapoalim Bank (OTC:BKHYY) and Leumi Bank (OTC:BLMIF), and three medium size banks Mizrahi Bank, Discount Bank, and Habenleumi Bank. These 5 banks control basically the whole Israeli banking system while some other small banks have very little market share. (Come to think of it, maybe the United States is not so far away after the TARP scheme.)
In reaction to the global economic recession Israel’s central bank governor, Stanley Fisher, cut interest rates from 5.25% to a record low of 0.5% creating a giant housing bubble. (See: Israel's housing bubble)
The most popular mortgages are those that are fixed to the prime rate which is the interest rate determined by Israel’s Central Bank plus 1.5%. According to figures published by the Bank of Israel, the adjustable rate mortgages indexed to the prime rate were 65% of mortgages between January and August 2009, compared with less than a third in 2007. Leumi CEO Shuki Burstein even continued to maintain that up until Stanley Fisher started raising rates a few months back. Some 75% of the mortgages issued since then were adjustable rate indexed to the prime rate. (Small reminder- this is the LARGEST BANK IN ISRAEL.)
The mortgage rates people paid, and are still paying in Israel is completely ridiculous. With the average rate and adjustable rate mortgage indexed to the prime rate just 1.68%!!!!! This fact makes the Israeli economy, and the Israeli banking system in particular sensitive to rate hikes. (SEE: the affect of rate hike on Israel’s mortgage market.) So The Bank Of Israel decided not to raise rates, but to tighten lending standards instead.
In any case the market has officially topped. Stanley Fisher is still in a comfortable position since inflation expectations are 2.7%, but the Israel shekel remains strong. Once the Forex markets wake up, he will be caught between a rock and a hard place. A weak currency will force him to raise rates into a weak economy with a crashing housing market.
Currently Israel's government can finance its deficit by domestic sources, with a deficit of only 4.5% to GDP, but once the housing bubble pops, tax revenues will fall sharply and the export sector will suffer from the collapse in European demand and the weak world economy. At that stage, Israel will be at the mercy of foreigners and the yields on government bonds will rise, along with mortgage rates.
Disclosure: Short Israeli banks, short Israel's real estate index, short the israel shekel, short European banks, long gold