A must read- Crisis or a mere recession?

Ajay Shah:A crisis or a mere recession? Ajay Shah / New Delhi March 19, 2008 This is not an emerging market-style crisis. While the US economy is beset with serious difficulties, there are equilibriating forces in play, which suggest that this could end up as a recession but not a crisis. The US economy is facing substantial difficulties. Housing prices have dropped. An increasing number of households are defaulting on home loans. Losses on home loan portfolios are affecting financial firms who hold derivatives on home loans. Some financial firms have gone bankrupt, and there is uncertainty about who else might be bankrupt.

With finance in difficulties, the monetary transmission is malfunctioning. Hence, while the US Fed has cut rates sharply, the full impact of these lowered rates on the economy is not going through. Inflationary expectations are worrisome.
This is undoubtedly a difficult situation. But is it a crisis? One estimate of the size of losses on sub-prime home loans is $400 billion. This is roughly 2.85% of US GDP. In India, with roughly Rs 50 lakh crore of GDP, a comparable scenario would involve home loan losses of Rs 1,43,000 crore. If such a shock hit India, one can only imagine how bad things would be. In such difficult times, why is the US economy still rolling with the punches? Why has the US economy not collapsed in a mire of failed firms, finger-pointing by government agencies, morchas in the streets, and JPC inquiries? Understanding how this shock is being absorbed, and the equilibriating forces in play, is important in making a call on whether this is a crisis or a mere recession. In the idealised world of securitisation, a parcel of home loans is converted into securities, which are then sold in the broad market. The ownership of these securities is dispersed amidst
international hedge funds, pension funds, etc. The originator of the home loan is largely immune to the outcome: if a default takes place, the losses are borne by the owners of the securities. Many critics of securitisation have pointed out that this theory has not quite panned out as expected. However, at the same time, there is no doubting the fact that securitisation has given a substantial dispersion of the $400 billion loss. For this reason, the impact of the massive loss on the US financial system is not as large as it might otherwise have been. The second equilibriating channel lies in monetary policy. Unlike many other countries which have experienced crises, the US has well-functioning institutions for conducting monetary policy. The US Fed has cut rates dramatically in response to difficulties in the economy. On March 14, the 90-day treasury rate in the US had dropped to 1.16%.

The impact of lowered interest rates on the economy is not as strong as it used to be, owing to difficulties in finance. However, a certain impact is surely there. Low interest rates are helping strengthen demand, and help attract smart speculators to buy assets at fire sale prices.
Difficulties in finance inflict damage on the economy when they trip up the debt financing of firms. However, US corporations are unusually under-leveraged and cash-rich. Hence, this recession-inducing channel from credit market distress to the real economy is absent. The health of US corporations today is very different from the health of Japanese firms in Japan’s lost decades. Low interest rates are doing their job in one critical respect: the decline of the dollar. Unlike other countries which have experienced crisis, the US has a floating exchange rate and an open capital account. The exchange rate pegging with capital controls, which has brought down so many emerging markets, is absent. When interest rates dropped, the dollar fell — exactly as it should. The weak dollar is bolstering net exports and helping the economy. These effects are large. The Q4-2005 current account deficit was 7% of GDP; this has shrunk to 4.9% of GDP in Q4-2007. In
other words, over these two years, the decline in the dollar contributed roughly 2% of higher demand for goods and services produced in the US. A second remarkable feature of the decline in the dollar is the funding channel for the US through Asian central banks and governments in West Asia. For each $1 trillion of reserves held in USD assets, a 10% decline in the dollar constitutes a transfer of $100 billion to the issuer of liabilities in the US.

Every Asian country should be asking whether this deal makes any sense for them, but in understanding the present situation, it’s useful to note that no other country facing a crisis in the past has had such a good deal, which produces fiscal transfers in the time of need.
Unlike many countries which have experienced crises, monetary policy in the US is manned by brilliant intellectuals like Ben Bernanke and Fred Mishkin. Few people in the world understand the interplay between monetary policy and financial sector difficulties as well as them. The Fed cut rates, but the monetary transmission was not quite working owing to difficulties in finance, so the rate cuts were not doing their job. Hence, the Fed has been innovating with new ways to get back into the game. These innovations include changing rules on collateral, reaching out to financing non-banks, etc. These strategies are on the right track and will help. Some hedge funds and private equity funds have failed. From the viewpoint of public policy, this reiterates the case for having hedge funds and private equity funds as major players, since these failures have no repercussions.

The failure of Carlyle is very different from the failure of financial firms like banks or insurance companies which have assured returns obligations to the general public. It is an excellent risk management strategy for society to have hedge funds where rich people place their money, which can blow up when times go bad inflicting losses on rich people.
In the failure of Bear Stearns, there was no bailout. Senior managers will be sacked, and the shareholders were expropriated. In this fashion, bit by bit, the losses on the housing market are being absorbed by various portfolios. Conditions in the US are undoubtedly difficult. However, it is important to also understand the institutional depth of economic policy making, and the equilibriating responses which are in play. This may well be a recession, but it is not an emerging market-style crisis.

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Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.

Nothing in this article is, or should be construed as, investment advice.
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Indian Real Estate- bursting?like stock market?

The Harshad fix of 1992 repeated in 1994, the tech bust of 2000 that continues till date and much before these two were the drought linked bust-ups of Rajiv Gandhi's tumultous 5 years as PM.

The latest, fuelled by foreign and God knows which source of money is the Indian Real Estate bust. Just think, a 300-500 sq feet shop now sells for roughly Rs 1 crore and over in the Malls of Ludhiana, the same may sell for over Rs 3 to 5 crore in Bombay.

What returns would you need to sustain an investment of such magnitude for so small an office space? What type of business could have margins that would justify investment into Reality this expensive and which are the guys who are forking out money to buy them?

On the flip side, what kind of a Rental Income is this outrageously valued asset earning? About 1 per cent per annum, this type of asset was earning roughly 8 per cent three years ago, 6 per cent two years ago and now virtually nothing.

At the cost of sounding trite I think HDFC chairman Deepak Parekh has got Wool in his head or he is demented. Here is one guy who talks down Real Estate everywhere he goes, but his company keeps funding Real Estate. So either everyone at HDFC is equally lost or this nation has seriously run out of shrinks..anyway.

In 2008 your financial world is going to change... dramatically

For a decade it's been so simple for property investors. All they've had to do is buy property, and then sit back and watch it soar in value.

It's been so easy to make money that people have started treating their houses as a bank and a pension, as well as somewhere to live.

They've taken out loans against their homes on the basis they'll make a big profit in the future. They've bought houses they can't afford on the basis - again - that they'll make a big profit in the future. They've planned their retirement around property on the basis that - you've guessed it - they'll make a big profit in the future.

And every time that someone predicts a property crash, and nothing happens, those same people have become more and more convinced they're doing the right thing.

But they're making the most expensive mistake of their lives.

No bubble lasts forever. That's a FACT. There is a mountain of evidence that the property market is in a sick, sick state. FACT.

A property slump is coming....And, crucially, it's going to start very soon...

2008 Investment death-trap
#1: Buying property

According to the housing bulls, panicky estate agents and other crash deniers, house prices won't slump in 2008 because:

a] the supply of property can't cope with demand and...
b] the economic fundamentals are still strong

We don't agree. It's perfectly possible to have falling house prices even if GDP growth is respectable and employment is strong - as the American property market is proving right now.

And if supply and demand really was the crucial factor, rents would have gone up at the same rate as house prices. They haven't. In fact, house prices are now overvalued compared to rents by at least 50%.

No, the real reason why house prices have boomed is that interest rates have been low and lenders have been excessively lax. And that has allowed people to pay prices they really can't afford.

Now the gravy days are over. Interest rates rose 4 times in 2007 alone. And lenders, spooked by the US subprime disaster and worried about a repeat over here, are turning off the supply of cheap credit.


The result? The housing market is left without the two crutches - low interest rates and easy credit - that were keeping it upright. Right now, it's teetering alarmingly. Eventually it has to collapse. And when it does, it could have a long way to fall...


'The extent of house price over-valuation may be considerably larger in some national markets in Europe than in the
United States,' - IMF Report, Oct 2007

House prices are set to fall. Almost every objective observer says so. But by how much?
Last October the International Monetary Fund warned that homes were overpriced by up to 40%.

That's far more than the overpricing in the US before the current property slump began there. Credit agency Fitch reckons that prices are overvalued by 20%; HSBC by 30% or more. Global banking group ABN-AMRO puts the figure at almost 50%.

Ed Stansfield, of Capital Economics, forecasts an overall decline in prices in 2008 of 3%. Henry Pryor, CEO of property website PrimeMove.com predicts a fall of 15% this year. Economist and MoneyWeek contributor James Ferguson thinks prices will go down by 3-5% in 2008, and by 41% in the longer term.

We're predicting a fall of 20% in real terms over the next 3 years.

So what should you do?

Well, if you already own a house, you're happy there and you're comfortable with your mortgage debt, don't do anything. You can think about selling at the top and investing elsewhere but why not just relax and enjoy your home.

But if you're thinking about getting onto the ladder, or of upsizing, then I'd urge you to think again.

Just look at the figures...

The average price of a detached house in the UK is now £323,000. The average price of all property is now £211,000. If we're right, and property is set to come down by 20%, people who buy the average detached house now could see £64,600 wiped off their assets in the next 3 years.

Plus you'll be paying higher and higher mortgage fees to cover the original cost.

We believe the solution is obvious. If you absolutely must buy a house to live in, then make sure you have a decent deposit and a sensible mortgage. And that means no interest-only mortgages, no 'lie-to-buy' deals, no sharing with friends and definitely no 50 year life sentences.

But if you don't really need to buy, why not rent? You'll save money in the short term. You'll protect yourself from the spectre of negative equity. And you'll be perfectly placed to grab a bargain when house prices come crashing down.

You'll also have more money to invest in alternative, lucrative sectors.

I'll introduce you to MoneyWeek's 3 favourite investments for 2008 later. But first let's move on to the next investment death-trap.. .

2008 Investment death-trap
#2: Buy-to-let

At the start of a raging bull market, buy-to-let seems close to the perfect investment. You buy a property, tenants queue up to pay the mortgage for you and then, when you decide to sell, you bank a massive capital gain.

But when interest rates are rising, rental yields are plunging and house prices are all set for a long downturn, it's a sure-fire way to lose money.

According to the industry hype, buy-to-let landlords rake in 8.5% each year from their tenants. In the real world the gross rental yield is more like 5.5%.

After fees, maintenance and other costs that figure slumps further, to 3.5% (and we haven't even mentioned stamp duty and other buying costs yet).

With interest rates just below 6%, many buy-to-let landlords are already swallowing big losses. And the fallout from the credit crisis means it's going to get worse and worse.

Why the credit crunch is set to wipe out Buy-to-Let

Many people think that mortgages are priced off the Bank of England's base rate. In fact they're normally priced off the rate at which banks can borrow from each other. And since the Northern Rock crisis, when the banks became more reluctant to lend to each other, that rate has shot up.

And this is the crucial bit. Interest rates for buy-to-letters and subprime buyers, which started off higher anyway, have risen particularly quickly. In September 2007, for example, two buy-to-let lenders, Advantage and Edeus, increased their average rates by 0.75% and 0.65%.

In the circumstances it's no surprise that people are starting to jump off the buy-to-let bandwagon. The number of buy-to-let investors selling their property leapt by 27% in the first quarter of 2007.

By December 2007, the proportion of landlords choosing to sell up at the end of the lease had jumped to 6.5%. I'd urge you to steer clear of this dead investment too. It could easily cost you £20,000 in the next 3 years.

And if you already own a second property I'd urge you to sell it soon.
This is why...

'Revealed: the 231 year-old 'secret' of perfect property market timing'

You probably won't have heard of the economist Fred Harrison.

But that's all set to change. After analysing 231 years of business cycle statistics, Harrison has made a discovery that's enabled us, for the first time ever, to predict when housing bubbles start and end.

I'm not going to get into the complex details of it here. But basically Harrison has discovered that the housing market operates on a cycle that's based around land prices.

As an economy grows, so does the demand for land. Because the supply of land is fixed, it becomes more expensive. As prices go up, corporate profits and wages are squeezed. Finally there comes a point when prices simply can't go any higher because people can't afford to pay them any more.

And this is the really interesting bit. In every single case the cycle lasts the same time - 18 years, which consists of 14 years of stable or rising prices and 4 years of recession.

The last UK housing bubble burst in 1990...

Which means that the value of your property investments could start to plummet right now in 2008.

There are a huge number of scary stats and facts that scream that a crisis is on the way. Here are just a few...

The average house is now worth an extraordinary 9 times average earnings. The long-term average is just 3.5!

Last month (January 2008) the Royal Institution of Chartered Surveyors (RICS) announced that December 2007 was the worst month for the housing market since the aftermath of Britain’s last recession in 1992.

In 1993 first-time buyers made up 55% of the market. That figure has now slumped to 29%.

According to the Empty Homes Agency, there are 850,000 empty properties in England alone. So the 'supply v demand' argument used by crash deniers might not be such a factor after all?

Individual insolvencies are up 225% in the last 2 years as a nation of debt junkies struggles to cope.

In May 2007 Jon Hunt, founder of Foxtons, sold the UK arm of the business. A smart move from the first big rat to jump ship?

For the first time ever, personal debt is higher than the entire value of the economy. GDP is forecast to hit £1.33 trillion for 2007 - less than the £1.35trn which was outstanding on mortgages, credit cards and personal loans in June. [5]

A study from ABN-AMRO found the UK is even more vulnerable to a housing slump than the US. Sales of existing homes now stand at their lowest rate since records began.

In December 2007 Halifax reported the biggest biggest three-month fall in house prices since 1995.

One million debt-ridden householders are using credit cards to pay their mortgage or rent.
Here's what we think will happen.

Investors will do the maths on buy-to-let and then rush to sell up.

People who've overstretched themselves won't be able to meet the higher mortgage payments. They'll either lose their homes or have to sell up.

People will scramble to sell their property. For sale signs will dominate streets. Repossessions will rocket.

And first-time buyers, the traditional lifeblood of the market, won't be around to take up the slack. Instead they'll wait and see if prices go lower.

But as panic hits the markets, and unprepared investors scramble to save themselves from devastating losses, a wave of profit opportunities will open up.

Traps like this...

2008 Investment death-trap
#3: Commercial Property

The era of easy credit and low interest rates didn't just spark the housing bubble, it also fuelled a spectacular boom in the commercial property sector.

Prices for shops and offices went through the roof. Overall the retail sector achieved a whopping 60.5% gain in the three years to 2007 alone.

But now the boom is officially over. The price of commercial property has been pushed so high that the average yield (the amount of rent paid compared with the purchase price) now stands at just 4.5%, well below the UK base rate.

Investors can now get a better return from buying risk-free government bonds than they can get from investing in the increasingly volatile retail sector.

Commercial property funds, including the market-leading schemes run by New Star and Norwich Union, have all seen their values dive in the last 12 months.

Between December 2007 and January 2008 alone 3 of Britain’s biggest property funds – Friends Provident, Scottish Equitable and ScottishWidows – were forced to shut their doors to withdrawals by small investors after an outbreak of panic selling.

Other fund managers, including Schroders and UBS, have already put a block on withdrawals by institutional clients.

The UK’s commercial property market is now in a worse state than at any time since the early 1990s.And there is little hope of things getting any better soon. In fact they’re going to get a lot worse. Investment bank Morgan Stanley predicts a market fall of 50%.

Economics consultancy Capital Economics predicts that commercial property prices will fall by 18% in real terms by 2010.

In the circumstances our advice is simple. If you're thinking of sinking money into commercial property schemes, please don't.

The idea of swallowing substantial losses in the short-term in the hope of cashing in sometime in the unknown and distant future doesn't make a lot of sense to us.

'Cut your losses and run your profits' is the general advice given to investors in shares. We see no reason why you shouldn't do exactly the same for asset classes, particularly commercial property.

If you've already sunk money into a 'lame duck' retail scheme our advice is to get it out if you can - even if there are exit charges to pay.

And don't get back into commercial property till there are clear signs that the market is bottoming out.

Safe Harbor Statement:

Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.

Nothing in this article is, or should be construed as, investment advice.
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