Andrew Butter's  Instablog

Looks like King Canute may be having a reality check; perhaps house prices are going to go where house prices are going to go?

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Nov. 20 (Bloomberg) -- Federal Reserve officials are stepping up scrutiny of the biggest U.S. banks to ensure the lenders can withstand a reversal of soaring global-asset prices

 

http://www.bloomberg.com/apps/news?pid=20601103&sid=aP_4vjiIq7KU

 

Translation: The Fed has twigged that its actions can cause asset bubbles and that when they burst that can be dangerous.

 

That’s good news!

 

All the same, I’m a bit undecided about Mr. Bernake. Everyone is down on him for pumping a load of money into the banks and letting them borrow from him at 0% so they could lend to the Treasury at 3.5%; but then everyone agrees it would have been much worse if he hadn’t; personally I’m moving towards giving him the benefit of the doubt.

 

But there is no question that he’s sneaky, whilst Henry Paulson was making a big deal about that $700 billion, he was quietly shovelling $3 trillion or so out of the back-door  into the system, and all the time he just sat there with a bemused look on his face like as if he couldn’t quite remember which day of the week it was. But there again, in these “difficult” times, sneaky is good news.

 

There are two issues now (a) liquidity and (b) solvency.

 

Mr. Helicopter has no problem with pumping in liquidity; he can shift a trillion without anyone hardly noticing. But the question that I hope is going through his mind and the minds of the 220 PhD economists at the Fed, is whether or not banks will be solvent, in the future, if something happens.

 

That’s about valuation, not of what the assets are worth today (or more precisely not worth); because there is no requirement to sell them today, what matters is what they will be worth at the point in time that there may be a requirement to sell them. 

 

That’s a fairly new concept in financial circles which have been sheltered from that particular reality by a combination of benign accounting rules, Basel II, and implicit and explicit forbearance.

 

It’s all about the Valuations:

 

I read two good articles about valuation this year, one on oil reserves and another on M&A:

 

 seekingalpha.com/article/174575-the-oil-...  

http://epicureandealmaker.blogspot.com/2009/05/my-kid-could-do-that.html

 

Valuation is a funny thing, so simple, yet hardly anyone understands the concept, ask twenty economists how to do a valuation and you will get a hundred different answers.

 

In the comments to those two articles I noticed   there was a general sense of outrage that perhaps investors and/or regulators were cuckooed by the valuations.

 

As if a valuation is something that should be cast in stone and third-parties should be able to rely on them, like the Ten Commandments.

 

The reality is that a valuation is a normally just a starting point for a negotiation, and value, as any investment banker will tell you is what you can sell something for, to someone who is dumber than you are.

 

There are of course two problems with that line, first, by definition, value is going to be determined by the dumbest person in the room, and second, if you can’t find anyone dumber than you are, you are stuck.

 

But all the same; sometimes people convince themselves or others that a valuation is more than that, and that’s how they get cuckooed.

 

And there has been a lot of cuckooing over the past few years; investors are outraged, so are the taxpayers who have paid out and committed trillions of dollars to bail out the cuckooed.

 

Here’s an idea, if you believed that you could value an MBS by taking the value of an equivalent US Treasury less how much it cost to buy a CDS for it from AIG, and then you found that wasn’t a very reliable way to do a valuation, well you got what you deserved; and if you thought that the books of Petrobras were as clean as the books of BP, well…diddums.

 

The Best Way to Start a Bubble is to get a Valuation

 

The Wikipedia account of the South Sea Bubble makes interesting reading (http://en.wikipedia.org/wiki/South_Sea_Company ), change the dates and the players and you might have been talking about the Credit Crunch, although that was on a much larger scale than the South Sea Bubble.

 

 The key to that scam was convincing people (some were very clever people, Sir Isaac Newton for example), that some time in the future there would be a pot of gold, and that everything was “safe” and above board.

 

And it worked great, a dream, just like how investors were cuckooed into believing that house prices in USA would go on going up forever.

 

Granted the details were different, in the South Sea Bubble the promoters gave shares away to members of the aristocracy to create a feeling of “safety”, in the most recent scam, ratings agencies and Monte Carlo analysis were used to create that same delicious feeling; that’s progress for you.

 

After the South Sea Bubble popped a resolution was put to Parliament that the bankers involved in the scam should be tied up in sacks filled with snakes and dumped into the Thames.

 

The resolution was not carried; perhaps history might have been different if it had been?

 

How to cheat on a valuation

 

Cheating on a valuation is as old as the hills, the key is to create a black box, then you feed numbers into the box, and by magic a valuation pops out of the other end; nothing new there.

 

There is nothing new about banks lending money against collateral either. That’s what was called the “Pound of Flesh” in Shakespeare’s Merchant of Venice; prudent bankers would commission valuations of the pound of flesh, so that in the event that a loan was not paid back, they would be made whole.

 

The point of course is that the estimate had to be what the banker might get for the pound of flesh at some unspecified time IN THE FUTURE.

 

The way the scam worked in the housing bubble was that the “players” persuaded the banks (and since the individuals were on bonus many did not require much persuading, particularly since it wasn’t their money), that the mark to market price on the day the loan was exchanged for the collateral, was a great marker for how much they would be able to sell the collateral for in the future.

 

That was a dumb idea in 1720, and it was an equally dumb idea in 2006.

 

What’s new?

 

Valuation Standards

 

There appears to be a slow realization creeping into the consciousness of investors and regulators, that perhaps the valuation standards that were employed to report on the condition of publically listed companies, investment banks etc, prior to the credit crunch (and are still employed), weren’t very good.

 

For example, when (then) Secretary Henry Paulson announced to the world in July 2008 “The US Banking System Is A Safe And sound One”…

 

Was he lying?

 

I doubt it; I suspect that he was convinced at that time that the US banking system was indeed safe and sound.

 

And how did he reach that conclusion?

 

Simple, he looked at the valuations of assets, took that away from the liabilities (no need to value those particularly if you are intending to have your old firm get paid 100 Cents on the dollar), and bingo! The US banking system was safe and sound.

 

Here is a piece of news, it wasn’t then and it isn’t now.

 

International Valuation Standards (IVS)

 

IVS were formally introduced in 2000, initially they were designed only for valuation of real estate; over the years they have been expanded to value more or less anything.

 

Although they are approved and accepted as by far the best valuation standards ever devised by mankind, by every valuation institute in the world of any consequence, IVS are not used for doing valuations by many people (I use them but I am a distinct minority).

 

One reason for that is that it’s a lot harder to cuckoo someone if you are following IVS, than if you are following any one of the thousands of valuation principles that are floating around.

 

For example if in 2000 IVS had been mandated for valuation of housing which was used as collateral for mortgages and mortgage backed securities (and all the rest that followed on), there would not have been a housing bubble and there would (probably) not have been a credit crunch.

 

But of course that would not have been much fun. And one has to remember that some people became indescribably rich thanks to the credit crunch; although since bubbles are zero-sum, a lot of people became indescribably poor.  Swings and roundabouts!

 

What’s special about International Valuation Standards (IVS)?

 

For a start IVS was written by a bunch of people, who spent most of their lives doing valuations and know every trick in the book (Americans, Brits and Australians mainly). They were designed so that even a very smart operator would find it hard to cuckoo someone if IVS was used.

 

Key principles in IVS which are not commonly found in other “systems” of valuation; are as follows:

 

1: The person doing the valuation has to explain in plain English (or whatever), how he did the valuation, in terms that his client can understand. It’s that simple, if you are too dumb to understand the explanation for the valuation, you tell the person doing the valuation to go back and do it again until even you can understand it.

 

By definition, if a really-really dumb person can’t understand the valuation, it wasn’t done properly.

 

 

And if there is a black box or some magic trick involved, he has to explain how that works; this is something that the rating agencies are dead against, since apparently their systems of valuation (like the ones they used to stamp AAA on all those dodgy bonds), are “proprietary”. The same goes for the Monte Carlo wizards that are “valuing” oil reserves.

 

2: As part of that process, the valuer has to obtain sufficient market-derived data to be able to demonstrate that whatever magic he performed, worked reliably in the past. Of course the Monte Carlo Black Box Shysters will argue that this is impossible because the technology is new! And SECRET!

 

3: Needless to say the valuer is supposed to abide by certain ethical constraints, for example they are not supposed to take a kickback or an inducement to pump up the “value” like a free pass to the revolving door (that’s a novel idea).

 

4: IVS recognises only two values (1) Market Value (i.e. mark-to-market when the market is working properly), and (2) Other-than-market-value which is an estimate of what the mark-to-market value would be if the market was working properly.

 

This is the thing, the person doing the valuation is supposed to (a)  tell the client if the market is not working properly or in other words if it is in what George Soros calls “disequilibrium”, and (b) if the market is not working properly the person doing the valuation should always report other-than-market-value, and should thus qualify the valuation.

 

By that definition, Alan Greenspan would not be allowed to do a valuation; because he is proud of the fact that he doesn’t know how to spot a bubble (i.e. he doesn’t know how to tell if the market is in disequilibrium).

 

For example, if a house was being valued in 2006 in USA, under IVS it would be incumbent on the person doing the valuation to point out (a) the market was in disequilibrium (anyone who knew anything about valuation knew that), and (b) that if the bank was using the house as a collateral against a loan, they would be prudent if they considered a value of about 60% of the price at the time.

 

That’s if they wanted to be reasonably sure that in the event the person borrowing the money didn’t pay them back, then they would stand a good chance of being made whole by selling the property.

 

That’s not “risk management” by the way, that’s “stupidity management”.

 

5: IVS also mandates that the purpose of the valuation should be clearly stated, that sounds pretty obvious, but a lot of people don’t “get” that.

 

For example valuing a house in 2006 for the purpose of making sure that the buyer and the seller were not in cahoots to cuckoo the bank, and the price paid at the time reflected the market realities (at the time), that’s one value; but if the purpose was to estimate how much the bank might reasonably expect to sell the property for in five years time, that’s another value.

 

One of the reasons that there was the housing bubble in USA (and the hangover afterwards) is that NONE of the valuations were done explicitly for the purpose of figuring out a likely re-sale value in case of default.

 

That was in retrospect, probably not very smart, a sort of 1720’s vintage not very smart.

 

But IVS is Expensive!

 

You bet it is, that’s because it’s a lot more work and you need someone who can work out if there is a bubble or a bust. Sure you can buy an automated valuation on the Internet for $50 or less, a “proper” valuation costs a lot more.

 

I got a comment from a banker a while back on this subject, he said that Big And Very Important Banks, couldn’t afford to do valuations of their toxic assets properly, because they had thousands on their books, and that’s why they went with the equivalent of the “back of the envelope” valuation (A US Treasury less the CDS), or if they really wanted to splash out they benchmarked against an “exchange” with some selected tame bonds traded by their cronies and called that “mark-to-market”.

 

Certainly it would have been much more expensive to go through the inconvenience of doing valuations in accordance with IVS, like every year or so.

 

But what I’m not convinced about is whether the banks could afford to not do the valuations properly. Because if they could have afforded that (to not do the valuations properly), then why did they all line up for bail-out money, when it turned out, Big Surprise, that the valuations were wrong.

 

Here’s an idea, perhaps instead of handing over trillions of dollars to banks who “can’t afford” to do valuations properly, the regulators or the Fed might like to give them money to do the valuations properly; instead of giving them bail outs. I suspect that might work out a lot cheaper for the long-suffering US taxpayer.

 

Same goes for oil companies, and in fact any company that works out a large part of its P&L from an estimate of what an asset will be able to sell for, some time in the future. That is if investors are expected to make rational and informed decisions when they put money in such entities.

 

Well don’t we just live in interesting times!

 

The past year has certainly been a roller coaster, established words of wisdom have been trashed all over the place, economics as a “profession” is in complete disarray, ratings agencies, once “Gods” with the magical rubber stamps, are viewed on about par with realtors selling sub-prime.

 

Who knows, perhaps the Fed will start mandating that valuations are done according to IVS.

 

Now that would be really radical!

NO POSITIONS

Got confused by my chart - very confusing chart.

Revision is edited on my Instablog

Trying to ghet the editors to change on the main article

SORRY!!

On the sidelines of the Big News there are two stories making the rounds: Dubai property and Dubai debt.

 

In the grand scheme of things Dubai is a pretty small place (the economy is about 45% the size of Singapore), but it’s interesting from the perspective of bubbles.

 

Now that the initial chaos of the bubble bursting has worn off, it’s possible (perhaps) to plot what might happen next.

 

Property Prices:

 

Depending on who you talk to, “freehold” property prices either halved or went down 70% between October 2008 and March 2009.

 

(“Freehold” is property that foreigners can buy which currently accounts for about 30% of the stock in Dubai), here’s a chart of who lived where in Dubai 2008:

 

The point there is there are three markets, they go in different directions.

 

The main reason for the bubble was that the “foreigners” market is a 90% a rental market, and less than 20% of the residual are “high flyers” with a second home; in 2005 there was a huge demand for new accommodation because of economic growth plus the start of the freehold construction boom; that had to be accommodated by new units, and the rents of those went through the roof.

 

Existing accommodation lagged, so you could find one apartment in a building renting for $25,000, (since it had been rented a few years before and there was implicit and later explicit rent control for incumbents), and a newly vacated one next door being rented for $75,000; and being snapped up.

So the buyers only saw the rents on the (new) stuff on offer, and they thought “OK I’ll buy at a 7% gross yield or so, and that’s not counting for the “fact” that in Dubai house prices will go on going up forever”, Whoopee!!

 

But that price wasn’t a true reflection of market reality, and as soon as new units started coming on line (plus the economy slowed), reality was restored; yields didn’t change, just rents went down.

 

The rate of development of “new” accommodation is on the right on the chart, the current situation is that construction almost stopped (buildings under construction typically got finished, but a lot got cancelled although it’s not clear how many did).

 

The consensus projection in 2008 was 70,000 new units in 2010 (that’s not hard you just need to be able to count that far), some are projecting that will go down to 20,000.

 

How fast prices recover is an issue that depends mainly on the recovery of the Dubai economy; and that may depend on the second story in the newspapers.

 

Debt:

 

The second big story is that Dubai Inc (i.e. the Government of Dubai plus “government-related issuers” (GSI)) owes between $80 billion and $160 billion of relatively short-term debt; depending on what newspaper stories you believe.

 

http://www.kippreport.com/2009/08/dubai%E2%80%99s-debt-an-unsolved-mystery/2/

 

There are reports that they are having some complications rolling that debt over, thanks in part to the worldwide credit crunch (they got caught borrowing short and investing long).

 

Earlier in the year there were concerns that there would be defaults, although there was never any question that Dubai’s “rich relations” Abu Dhabi would make sure that the essential infrastructure of Dubai kept working.

 

There have been no defaults so far and Dubai has a long tradition of paying its debts, most of the development over the past thirty years was paid for with debt.

 

Of course there’s always a first time.

 

Some of the debt was recently downgraded from A3 to Baa1 by Moody’s, this is what they said:

 

“Following recent disclosures of increased conditionality around when support could be provided to the GRIs”

 (http://www.zawya.com/story.cfm/sidZW20091104000084/Moody%27s%20Downgrades%20Dubai%20Cos%20On%20New%20Govt%20Debt%20Conditions )

 

In other words a divide is building between debt that has some semblance of having a sovereign guarantee, i.e. implicitly or explicitly guaranteed by the UAE Federal Government (i.e. Abu Dhabi – via the Dubai Financial Support Fund), and debt that has either a personal guarantee or that is collateralized by assets.

 

How much of the debt is in the “good debt” camp, and how much is in the “not so good” camp is not clear, although reports suggest that perhaps the biggest debtor is the “state-owned” conglomerate Dubai World (which owns the developer Nakheel and Dubai Ports Authority (and which recently bought P&O Ports)), according to reports Dubai World owes between $40 billion and $60 billion.

 

The idea of “state-owned” is also an interesting concept; the latest twist that was noticed by Moody’s seems to imply that that the “state” owns the assets, but not the liabilities.

 

What’s also uncertain is how much of that was squandered buying assets outside of Dubai at the top of the market, possibly “double geared”.

 

Starting 2006 “Dubai Inc” went on a high profile shopping spree investing in projects such as the MGM development in Las Vegas, which was a bit of a departure from the tried and tested business model of investing every penny in Dubai itself.

 

That “old idea” was the motto of Sheikh Rashid who is once reported to have remarked, “I will build the infrastructure (in Dubai); the rest will follow”, it was a good idea and the “rest” followed.

 

$1.3 trillion backstop?

 

Some estimates put the collateral backing up the $80 billion to $160 billion of debt, at $1.3 trillion, although there are no details on how that was calculated.

 

From the National Newspaper:

 

It's mere speculation at this point, but according to SJS Markets, a Swiss brokerage, the new law could even cause Dubai's government-owned companies to sell assets in order to pay down debt and reduce its overall borrowings. Says SJS in a research note:

 

The new law if enacted could limit Dubai's debt financed growth as the second largest emirate in the UAE has debt load of ~$70 bn while its GDP is ~$55 bn.  However Dubai's assets are estimated at $1.3 trillion and we feel the government could sell assets to pay down debt.

 

http://blogs.thenational.ae/cgi-bin/mt/msearch.cgi?blog_id=38&tag=federal+law&limit=20

 

It’s hard to figure out where that number came from seeing as the total amount of GDP declared for the whole of Dubai added up over the past twenty years was under $500 billion.

 

Certainly in a rare report on Dubai and Dubai Inc’s finances done in 2003 by the National Bank of Dubai, the assets were rather more modest, of course perhaps most of that $1.3 trillion was made over the past five years?

 

Oh well, perhaps the people in the know have a different way to do valuations than the “old fashioned” methods, that might explain why I read in the newspaper that RBS is in town “helping out”, they of course know all about doing valuations.

 

Where Next?

 

Dubai is either an economic anomaly or a free-marketer’s fantasy land, depending on your perspective.

 

Twenty years ago the economy was 15% the size of Singapore, in 2008 it was 45% ($US 80 billion), and Singapore is no slouch when it comes to economic growth. Dubai’s nominal GDP growth averaged 15% since 1988; and that growth was not driven (directly) by oil.

 

Why or how, or how much of that was inflation is a question economists can argue about, but the question of inflation is rather academic considering that 90% of the labour force are foreigners on temporary work visas. 

 

In any case it’s hard to explain that growth away by inflation since the currency is tied to the dollar and freely exchanged; and there are effectively no constraints on imports, of anything, including brains and brawn; Dubai can shop the world for the best deals on both of those commodities.

 

Details aside, the business model hardly changed since the then Ruler(s) of Dubai signed the Perpetual Maritime Treaty in 1835 and declared Dubai a “Free Port” in 1901 making Dubai one of the first Special Economic Zones (SEZ); although arguably the Square Mile City of London and Venice preceded Dubai in that regard.

 

That’s a formula that China adopted so successfully when it embraced the “dangerous” path to capitalism, although it kept those ideas well segregated from the “mother-land”; currently 80% of China’s exports are manufactured in such zones; often in factories owned by foreigners.

 

Regardless, the SEZ idea clearly works and the fact that Dubai (which hardly has any oil (left) to speak of), is located where it is, is not the secret to its success, that’s just geography – what’s fairly unique is the business model;  and the main difference from the China model is that in China the labour is from the mainland, whereas in Dubai the labour is from foreign countries (and labourers are treated much better in Dubai, don’t believe what you read in the newspapers).

 

Whatever happens, the core business model of Dubai is driven mainly by foreigners providing local and international goods and services; and it’s likely that will carry on.

That’s what made Dubai work in the first place; and without that Dubai will have not very much but a load of empty real estate; Dubai came to be what it is by being an open place and safe place with good infrastructure and transportation, to do business; that’s where the money and the demand for real estate comes from.

 

So regardless of what happens to the debt that is not explicitly or implicitly guaranteed by the sovereign state of Dubai, or whatever steps the bond-holders take to liquidate whatever assets they collateralized that debt with, (in the event that it defaults); it’s likely that the essential and very efficient infrastructure of Dubai will keep running, and will be kept running.

 

In which case there will still be demand for real estate.

 

Property Prices:

 

This is the “BubbleOmics” estimate of what happened and a projection of what’s probably in store:

 

By way of explanation:

 

1: In 2004 freehold property was sold too cheap, that helped fuel the bubble because people saw a disproportionate rise in prices – the “pebble”.

 

2: From 2006 to 2007 prices were at about the equilibrium.

 

3: Then there was a bubble; it was short; (18 to 24 months), but intense, 40% mispricing about by my reckoning.

 

4: Then a bust, accompanied by a drop in nominal GDP and an increase in inventory (that’s why the equilibrium line goes down).

 

5: Then the “overshoot” drop below the equilibrium which was right on target (28% 1-1/1.4))

 

6: The exposed debt is now out of the market, anyone who had to run away, has (that’s what all the cars at the airport were); likely therefore the time for “overshoot” will be about the same time-span as the previous mis-pricing; that’s what normally happens.

 

7: So by that logic perhaps a 10% bounce from the lows until the equilibrium is regained in 18  months or so.

 

8: The path of the equilibrium line assumes oil (the main driver of the Dubai economy, which has no oil but services a region that has), will stay above $70.

 

One other factor that might hasten a recover is the carry trade in US dollars since the UAE currency is (and likely will be for some time), denominated in US dollars, and it’s fully convertible.

 

Perhaps there will be another bubble in Dubai...thanks to the US Fed?

NO POSITIONS

The SIGTARP Report doesn’t pull any punches.

 

http://www.politico.com/static/PPM136_091116_sigtarp_report.html

 

“Questions have been raised as to whether the Federal Reserve intentionally structured the AIG counterparty payments to benefit AIG’s counterparties — in other words that the AIG assistance was in effect a “backdoor bailout” of AIG’s counterparties,” said the report. “Then-FRBNY President Geithner and FRBNY’s general counsel deny that this was a relevant consideration for the AIG transactions.

 

“Irrespective of their stated intent, however, there is no question that the effect of FRBNY’s decisions — indeed, the very design of the federal assistance to AIG — was that tens of billions of dollars of Government money was funneled inexorably and directly to AIG’s counterparties.”

 

If AIG had been in liquidation the "cronies" would have been lucky to get 40 Cents, if that.

 

And if that had been a liquidator any other creditors of AIG and the shareholders (remember that word “minority shareholders”), could have reasonably asked, “what about us?”

 

What it doesn’t clearly explain is what they were thinking.

 

Perhaps there was a conflict of interest, let me guess, perhaps they were thinking that if the $68 trillion of derivatives that related to the crisis started to blow like a nuclear chain-reaction it might ignite the world-wide $500 trillion or so derivatives “weapon of financial mass destruction”.

 

That was obvious before the $700 billion TARP program would be approved by Congress, it was all about derivatives then, it still is.

 

http://www.marketoracle.co.uk/Article6495.html

 

A good account of those “negotiations” can be found here:

 

 http://epicureandealmaker.blogspot.com/2009/10/never-send-boy-to-do-mans-job.html

 

So was it a scam, inexperience, bad negotiating skills, or simple stupidity? Or perhaps there was there a conspiracy?

 

Perhaps the “good friends” at GS explained to Chancellor Geithner that they had a nuclear bomb in their bag and if he didn’t play ball they would detonate it?

And in which case Wonder-boy’s chances of cleaning up on the revolving door would be out of the window?

 

So much for the policy of not negotiating with terrorists; in the final countdown, what matters is how big a bomb you got!

 

Looks like GS et al had the biggest bomb, much bigger than the whole nuclear arsenal of USA, and now they are sitting pretty, so Chancellor Geithner.

 

Better get used to it

MO POSITIONS

Many years ago I met an old sweat Brit from Hong Kong, he told me two things (1) Hong Kong is the closest you will ever get to a pure free-market economy (2) that’s because it’s regulated.

 

He was absolutely right, it’s funny how health services, education and public utilities in Hong Kong are the best in the world and everything works, yet you step back and for a second you would think it’s a socialist dream. It’s not, it’s Adam Smith on Speed.

 

Another thing about Hong Kong is something that Simple Ben and Ann Ryan’s Pinball Prodigy and even perhaps Moron Gordon might learn from.

 

That is (a) bubbles are very dangerous to free market economies, like the ultimate kiss of death; (b) it’s not hard to recognise them (http://seekingalpha.com/article/173395-bubble-spotting-isn-t-hard-but-whose-job-is-it ) (c) tinkering with interest rates is an exercise in futility if you want to either prevent one, or mitigate the damage that happens after they pop.

 

And yet just a few days ago Simple Ben declared at a NYC University shindig:

 

 "I would have used interest rates to stop the housing bubble, but it is hard to tell if you are in a bubble".

 

That was following faithfully in the great tradition of Pinball who remarked once:

 

 “If the market can’t recognise a bubble then how can I?”

 

Sure Pinball, try applying brain, rather than, “so to speak”, figuring out after spending eighteen years destroying the American market economy that:

 

“A flaw in the market that I perceived was the critical function and structure that defines how the world works, so to speak”

 

…”so to speak”…try learning how to speak English too!

 

The actions taken by the Hong Kong Monetary Authority recently to guard against a serious bubble re-emerging in their property market could have been lifted straight out of George Soros’ playbook; they mandated that the maximum LTV on home mortgages was 60%.

 

Imagine what that would have done to the US Housing bubble if Pinball had done that in 2003!

 

This is my take on the Hong Kong property market (annual data):

 

 

Note: The “Equilibrium” value is what some people call “Fair Value” although my approach to valuation is to use International Valuation Standards (IVS) where “Fair Value” is a meaningless expression; “Other Than Market Value” (OMV) is essentially what the price should be if there wasn’t a bubble which is something the person doing the valuation is (always) supposed to work out (if he is competent, or unless he is in America or UK and uses US GAAP or IFRS in which case he can just make it up as he goes along, which is one reason they get into so much trouble over there).

 

So yes there is a bubble or more precisely there was a bubble and it was a big one (about 36% mispriced in 2008 by my estimate).

 

Although in fact that may be an over-estimate because the OMV estimate is based on demand for housing by people living in Hong Kong and doesn’t account for buyers from “out of town”, for example wealthy Chinese buying a pad in the Big City, which is difficult to track accurately.

 

What that does is effectively remove stock available to people living in Hong Kong, that’s not a bubble particularly though, that’s supply and demand.

 

The way to combat that (i.e. to make sure that the residents of Hong Kong have accommodation available that is consistent with their economic circumstances and stable economic development in Hong Kong), is to open up more land for development.

 

The logic there is that whenever housing gets too expensive in relation to the economic circumstances of a country (or city) that destroys segments of the economy.

 

That’s what happened in USA, what really drove jobs out of USA to China and Mexico was the excessive house prices, and as American and Brits are finding out the hard way, it’s a lot easier to keep hold of jobs and the economic infrastructure that sustains them than it is to bring them back once they gone.

 

 

It’s all very well saying you are going to “innovate”, but the reality is that bubbles are just a way for crony capitalists to grab an unfair share of the product of past “innovation” at the expense of ordinary people, they are zero sum; fat cats win and ordinary people lose, no different from how monopolies distort free markets.

 

Hong Kong traditionally handles that quite efficiently by selling land for development, although developers are complaining that the land reserve price on land-sales is too high.

 

The developers have a point, setting the land prices by where the bubble prices reached does no one any favours, first because it constrains development which fuels the bubble, and second because bubbles pop, that makes real estate development risky, which in turn can cause economic damage when they all go belly-up, which is also why developers in those circumstances like to focus on building products targeting the external (luxury) market rather than for the internal market.

 

A better strategy would be to base land sales on OMV and instead of screwing the developers for the best price, to make sure that they build (some) stuff which is consistent with the needs of the economy (i.e. more affordable housing rather than luxury penthouses for rich Chinese).

 

By the way much has been said about the 1997 “bubble”, in my opinion that “bubble” was caused mainly by the drop in economic activity after Hong Kong was handed back to China, the appreciation of prices up to about 1993 was simple supply and demand although the government could have done something to increase supply to avoid jobs going elsewhere, which they did.

 

Either way, it looks like some “players” might have had some fun over the past few years in Hong Kong, particularly thanks to all the free lunches that Simple Ben was handing out at the expense of the American taxpayer via the carry trade (thank you Ben, thank you very much), but it looks like Big Daddy in Hong Kong woke up, so that might be game over soon.

 

So anyone who has some “wasta” in the superbly corrupt US banking system and is inclined to find another place to play with the American tax-payers money that they seen so determined to throw away – try Dubai.

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