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The Great Reckoning (Part 3)Olly Newland's Column, 12 February 2009
Take a Deep Breath
The question on everyone's mind is, 'Are we really in a recession? Or aren't we?' We read or hear about huge staff lay-offs around the world, massive drops in corporate profits (or historic losses), banks falling like dominoes. Presidents, Prime Ministers and politicians openly talk of disasters, crises and even use the dreaded 'D' word. Depression. Yet, when we go about our daily business, the restaurants appear full, the shops appear to be fairly busy (mostly), cars still clog the motorway, and expensive boats of all sizes still cruise the harbour. 'What recession?' you may well ask. The news tells us that interest rates have been slashed (even if these haven't flowed through to our mortgages yet -- see my earlier column), and around the world emergency measures are being taken. Mortgagee sales and company liquidations seem to flood the daily papers and it all seems rather depressing. Then ask yourself a simple question: have you been personally affected? Are we perhaps the victims of a con-job by politicians who are playing the 'crisis' theme because it makes us easier to govern and control? Certainly that's one possible suggestion from President Obama's recent fireside chat. He is seen to appeal direct to the American public to send a message to their local congressman to pass his 'new and improved' bailout package. I think it is a mixture of both good and bad. Yes, there is a deepening recession which will get worse before it gets better and yes, I think the politicians are hyping it up to their advantage. But I sense that the recession will be shorter and shallower then we are being led to believe. In my opinion, it is more likely that we will soon enter a long flat stage, perhaps next year -- which, by the way, given the alternative, is fine by me. I can tell this from my mentoring and consulting clients -- who tell me of their successes or failures. Many are still upbeat and enthusiastic, seeing new opportunities ahead rather than collapse and doom. This, among other things, gives me an insight and some perspective on what is happening in the market right now, rather than waiting for stale statistics to tell us when it's far too late. Furthermore I keep in very close contact with valuers and solicitors who confirm that conveyancy and enquires have picked up and are much more positive compared to a few months ago. The worldwide printing presses keep rolling -- producing unimaginable amounts of money The wild card is inflation. Did you know that one trillion one dollar bills would be a pile 40,000 feet high? In other words it cannot exist. Money/credit/debt is being created on a gigantic scale as government bail outs and 'loans' to industry (motor cars etc) are promised. We (the world, that is) risk facing a tidal wave of cash which can only mean one thing: Mega inflation. If governments continue to print money unchecked -- in amounts that cannot be comprehended -- all predictions are cancelled as dollars turn into Banana Republic pesos. A year ago, speaking on America's National Public Radio David M Schwartz put it this way:
The 2009 budget ... weighs in at $3.1 trillion. But just how large is a trillion, anyway? A short history of Booms, Bubbles and Crashes "Those who cannot remember the past are condemned to repeat it." -- George Santayana Can we learn something worthwhile from an examination of past bubbles? One of the earliest crazes was the Tulip and Bulb Bubble 1634-1637. Tulips were bred in all sorts of colours and became a new fashion item, especially in Holland. Thousands of people pledged their homes and fortunes on a single tulip bulb of the right colour. The worried government of the time tried to intervene and shore up the economy. They offered to pay 10% of the face value of contracts (sound familiar?) but then withdrew at the last minute realising the enormity of the task and that it wouldn't work anyway. It all crashed, of course, wiping out the players, ruining whole estates, and financially decimating the population from top to bottom. The South Sea Bubble 1711-1720 was another one. Investors were promised untold riches by investing in trade monopolies. It all came unstuck when it was found that the directors of the very investment company, The South Sea Trading Company, were selling their shares for a quick profit. Shares that stood at a thousand pounds each at their height became worthless within weeks. (At the time a thousand pounds could have bought five nice houses in England.) Another was the Florida Real Estate Bubble 1926. Snake oil salesmen convinced the public that land in Florida was going to be better than gold. Within a year the price of land rose from $800 a section to $4million a section. That market crashed and burnt just like the others. Shades of Queenstown. Then of course the October 20th 1929 Share Market Crash. Stocks fell 40% in one month triggering the Great Depression. Academics, including one that has found his way to the Obama cabinet, blamed Government non-intervention and cutbacks for the length and depth of the Depression -- a mistake Central Bankers around the world are desperately seeking to avoid this time round. Many of us can remember the Share Market Crash October 20th 1987. Also the Asian Crisis of 1998 where stocks fell 63% and when land prices in Japan soared to 470 times their start value and shares a 100 times before falling back to stay flat -- to this day. Then there was the Dotcom Crash of 11 March 2000 which virtually ruined Silicon Valley with the hugely inflated stock and land prices collapsing into cardboard boxes on the back shelf of an accountants office.
From the above examples, I hope you will deduce that the current situation is not new. Bubbles and crashes have come and gone. The vast majority of people survived reasonably well. It's quite possible in a couple of years from now we'll look back and wonder what all the fuss was about. 'The greatest financial threat in 70 years' may yet end up as a footnote in history. In the meantime there are some issues which need addressing in light of the changing circumstances. Falling House Prices
The recent statistics showing that house prices had fallen around 8% from this time last year [Sunday Star Times] is, with all due respect, yesterday's news. Anyone in 'the business' knew that months ago.
Frankly, if this is the worst it can get then what is there to worry about? The people who will have a problem are those with 100% mortgages or near that, and of course developers/subdividers/traders trying to sell into a shrinking market. Although I have very real sympathy for individuals in this sector, in most cases they knew the rules when they got in and took the gamble. Some attention-starved market 'analyst' -commentators and the odd noisy spruiker are, a sceptical person might think, deliberately trying to frighten people suggesting that prices will fall 30%... I believe this to be nonsense and probably part of a cynical business promotion. What do you think?
As discussed last week, in New Zealand I can foresee maybe another fall of 5% or 10% overall but then I think we will flatten out. Remember, you're not buying the average, you're buying an individual property with its own value factors and (hopefully) a motivated vendor. The reasons for my optimistic line of thought are as follows: Immigration/emigration Over the past couple of years tens of thousands of Kiwis have have left home for greener pastures, mainly to Australia. Talk to the removal companies -- 95% or more of the families re-locating overseas in recent years have been heading for Australia. There is (or was) no doubt that the money was better and in some cases the cost of living better, overseas. This explains why 750 Kiwis have been immigrating every week.
This is all about to change. Imagine with me the pressure on the housing market if 60,000 people returned home. (And that's the equivalent of just one year's exodus.) If only half of them needed to buy or rent a home, then 10,000 extra new houses would be required ... not to mention normal market pressure from natural growth and demolitions. Add in an upswing in international student numbers and the picture looks even better. This emigration factor would feed directly into prices and at the very least stabilise them. Am I wrong? I don't think so. Couple this with Government incentives and stimulus plans (assuming they're not complete fizzers) and we may well find ourselves in a 'perfect storm' -- in the other direction this time. The effect of low interest rates Back in 2001 in the aftermath of 9/11 interest rates were slashed (just like now) to head off a crisis of confidence. At the time, I wrote several articles (one example archived here ) predicting the consequences. Even if I do say so myself, I got most of it right, making allowances for the politics and people involved at the time. It may take a while for the effects to set in, but I predict that we may have a dress rehearsal of the cycle that last big round of interest rates cuts sparked. As more and more people find that it's practically not worthwhile saving, then the wallets will come out again -- and off we go on the next consumer-driven merry go round. In the near future, I believe that the commercial market will be the biggest benefactor (with the exception of mega-malls and specialist buildings. The emphasis will be on multi-tenanted, bite-sized investments. Many big investors have been badly burnt. The recent reports of a fall in commercial returns was for BIG buildings and shopping centres etc. (Big is not always better.) Ask yourself: why would you leave your money in the bank at 3% pa (less tax) when good solid commercial property can be bought showing 6% or 7% or even 8% before tax benefits, providing you have that safe mix of tenancies. I have found that in a lot of cases small business owners are often oblivious to a recession, or, if they fail, they can be replaced with another tenant willing to give it a go. Commercial and industrial investment is like farming. As long as you look after your cattle by feeding them and loving them, they will thrive ... and so will you. Treat them badly and they will simply wander off. Let's face it. Part of the 'magic' of property is that your asset is tangiable -- something you can touch and feel. It's something which will not disappear into some shonky director's slush fund. And it's something that has the chance of some capital growth. The next few months will be undoubtedly bumpy and we may have a scare or two on the way but I believe that we will come through this wiser and certainly a lot more sober -- but intact. Closing thought: How to get the banks to lend. Lessons from yesteryear One of the biggest complaints from borrowers is the reluctance of banks to lend -- at all.
I recall a similar problem in the 1960s and 1970s. Back then mortgages were almost impossible to get. 'Key money' and 'carpet money' were also other ways to get around draconian government regulations which froze property prices (Lands Sales Act) or allowed tenants to stay forever at a fixed rent (Fair Rents Act). To free up the mortgage market, a new way was devised to overcome the problem of reluctant, risk-averse lenders. The answer was to get the reluctant moneybags to open their wallets by insuring your mortgages against default. It was such a success, it became a very common practice 30+ years ago. Borrowers were graded according to the risk and their credit history, and a small insurance fee was calculated -- usually 0.5% to 1% of the amount lent, payable as a one-off payment up-front. One company I remember well was the Australasian Mortgage Guarantee Co. (AMG) to whom I paid a fortune in fees but who, in turn, enabled me to wheel and deal to my heart's content. At the time it was insurance companies that carried the risk. Given the current situation and the rampant lack of confidence in the market, it seems that would be unlikely today... so why couldn't the government be the insurer? Really, what's the difference between the government guaranteeing bank deposits, as they do now, or guaranteeing mortgages and business loans from the same banks with fees set according to the grade of the loan? If such a scheme were introduced the banks should be happy to lend, the government would get a new source of 'tax' (the premiums) and the wheels would begin to turn once again. Could this be a simple solution for today's problems -- or is it too complicated for the pointy heads? Think about it and let me know.
Olly Newland
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