Uncomfortable times in real estate in store?

Patrick Chovanec has a fascinating article in Foreign Affairs, titled China’s Real Estate Bubble May Have Just Popped. This is interesting and important from two points of view.

First, bad news for China is bad news for the world economy. We are already in a bleak environment, with difficulties in Europe, Japan, the US, and India. It will not be pretty if China runs into trouble as well. I am reminded of the feeling of carefully watching real
estate in the United States in 2006
, with a sense that the future of the world economy was going to turn on how it turned out.

Second, it made me think about real estate in India. As with China, one often sees buyers of real estate in India have the notion that
this is a safe financial asset. This is a questionable proposition. Real estate is perhaps not an asset
class with a positive expected return in the first place; and it is certainly not a convenient asset class with features like liquidity,
transparency, diversification and easy formation of low-volatility diversified portfolios. I find it hard to explain the prominence of
real estate in the portfolios of even educated people in India.

In the article, Chovanec says:

For more than a decade, they have bet on longer-term demand trends by buying up multiple units — often dozens at a time — which they then leave empty with the belief that prices will rise. Estimates of such idle holdings range anywhere from 10 million to 65 million homes; no one really knows the exact number, but the visual impression created by vast `ghost’ districts, filled with row upon row of uninhabited villas and apartment complexes, leaves one with a sense of investments with, literally, nothing inside.

This has not happened in India. So in this sense, the situation in India is not as dire. But his second key message seems uncomfortably

As 2011 progressed, developers scrambled for new lines of financing to keep their overstocked inventories. They first relied on bank loans (until they were cut off), then high-yield bonds in Hong Kong (until the market soured), then private investment vehicles (sponsored by banks as an end run around lending constraints), and finally, in some
cases, loan sharks. By the end of last summer, many Chinese developers had run out of options and were forced to begin liquidating inventory. Hence, the price slashing: 30, 40, and even 50 percent discounts.

Part of this looks familiar. There is a lot of leverage in Indian real estate development and speculation. Real estate speculators and
developers are finding themselves in a bit of a scramble hunting for credit. One hears about very high interest rates being paid by
developers. Other sources of financing are also weak. This reminds me of the dark days before the global crisis, when borrowing by real estate companies was the canary in the coal mine.

If business cycle conditions and financial conditions worsen, the problems of borrowing by real estate developers and speculators will get worse. How might this turn out? Perhaps the borrowers will merely get uncomfortable. Or, a few firms could really get into trouble, and start liquidating inventory. That would have substantial repercussions.

Suppose there is a situation where there are many people who have speculative positions in real estate, but significant selling of
inventory has not yet begun. The longs would then be nervously looking at each other, wondering who would be the first one to sell, to take a better price and exit his position. The ones who sell late would get an inferior price. In such a situation, conditions could change sharply in a short time.

On a longer horizon, I would, of course, be delighted if real estate prices are lower. This would help shift the supply function of
labour, reduce the cost of setting up new businesses, etc. But that’s more about the long-term policy changes, which would remove barriers for converting land into built-up housing, while rising vertically into the sky with FSI in Indian cities ranging from 5 to 25.

Interesting History

Walter E. Williams, on the federal income tax:

During the legislative debate before enactment of the 16th Amendment, Republican President William Taft and congressional supporters argued that only the rich would ever pay federal income taxes. In fact, in 1913, only one-half of 1 percent of income earners were affected. Those earning $250,000 a year in today’s dollars paid 1 percent, and those earning $6 million in today’s dollars paid 7 percent. The 16th Amendment never would have been enacted had Americans not been duped into believing that only the rich would pay income taxes. It was simply a lie to exploit American gullibility and envy.

I believe it was either last year, or possibly in the spring of this year, when conservatives got their panties in know over how 49% of all taxpayers paid no income taxes (though, funnily enough, all taxpayers still paid their FICA and other payroll taxes). The theory was that there would arise a class of professional voters, who would simply elect officials to pay take money from the rich and give it to the more-deserving poor, of which said professional voters just so happened to be a part.

The reality appears to be a bit different, at least historically speaking. When the income tax was first enacted, it only applied to the rich, who comprised 0.5% of the population. Thus, the percentage of the population paying the income tax increased 100-fold over 98 years to 51%. If the theory of professional voters were true, the percentage of taxpayers should have at least remained stable (or even decreased) while the tax rates should have remained stable or increased. Reality, as it were, is markedly different.

In spite of all the attempts at class warfare in the last one hundred or so years, the poor still get screwed over by the rich. This is probably because there is a strong correlation between a general form of stupidity and poverty,* as well as a strong correlation between wealth and general intelligence. In essence, the wealthy are generally intelligent enough to figure out how to make things work to their advantage (hence their wealth). If one is cunning enough to convince people to buy something they don’t need, it seems plausible that one could also sell someone a political policy that works to their disadvantage.

The historical norm has been that poor people pay quite a bit in taxes, and the wealthy are often the beneficiaries of those taxes (think of the feudal system as a general model of this). The idea that those who are intelligent enough to become quite wealthy won’t also be intelligent enough to protect their wealth is, quite frankly, absurd, and the idea that somehow the poor will manage to “reappropriate” wealth from the rich is even more absurd.

* Two quick notes: a lack of education generally correlates to stupidity, which in turn correlates to lower income (as evidence by the myriad statistics showing that high school dropouts earn less than those with a high school diploma, bachelor’s degree, etc.) Also, shorter time horizons also correlate to stupidity as well.

Most Stable Region of Pittsburgh

So in the spirit of the end of year retrospectives we will be having all week this came to mind.  In October I pointed out that for the Pittsburgh region, it was the highest employment count for an October ever.  Same for November.  Following from that, I was thinking a bit about some analysis by the folks at the parent of the business times which showed Pittsburgh among a small set of regions that are at their decade high employment peaks.

That analysis might be misread a bit.  It is not that Pittsburgh is among the top employment gainers over the decade.  We are one of a few regions currently hitting their decade high peaks.  Lots of regions have had more growth over the decade, but many have dropped a lot from those peaks in recent years. In lots of ways it is a reflection of the relative stability here, not a lot of job growth.

So I made a graphic of the employment change for the 50 largest MSAs (currently, by employment) over the last decade.  So with November 2001 as a baseline, below is what those trends looks like; Pittsburgh is in red.  It works out, and I calculated this explicitly that Pittsburgh is in a sense the single  most stable employment time series among all 50 regions.  Stable as defined by the difference in this time series between the peak and trough over the decade.  The difference between the peak and trough for Pittsburgh works out to 6.67 across the decade, which works out to the lowest range for any of the 50 regions.

Economic Events on December 27, 2011

At 9:00 AM Eastern time, the monthly S&P/Case-Shiller home price index report will be released.  Given that most economists don’t expect the overall U.S. economy to improve until housing prices end their decline, the market will be watching this number closely.

At 10:00 AM Eastern time, the monthly report on Consumer Confidence for December will be released.  The consensus index level is 59, which would be a 3 point increase from last month’s number.

Also at 10:00 AM Eastern time, the State Street Investor Confidence Index will be released, which looks at changes in the amount of equities held in the portfolios of institutional investors.

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