Archive for June 19th, 2008

Mervyn King is disappointing and confusing

June 19, 2008

I have always been a big fan of Mervyn King’s speeches and especially the wit and humor he uses in his speeches. Alas, I have been very disappointed lately as his speeches have become confusing and defending BoE turnarounds especially while saving Northern Rock.

His recent speech is also disappointing. He begins like this:

Over that year, the west wind of a credit crunch emanating from the United States and the east wind of higher energy and food prices resulting from the strength of Asian economies have been stirring up the waters through which our economic ship must pass. These two challenges of rising inflation and falling economic growth have led to a crop of doom-laden predictions…

I was like yeah sure. As if all blame lies with Asia and United States. I can understand Asian economies as one of the reasons for this rising inflation but the way all these central banks put it, it looks as if they shouldn’t have grown.

And I can understand if someone in Africa etc blaming US crisis for financial market woes as they had little exposure, but not UK. The UK financial firms were very active in the US subprime space (see this paper which shows UK had the second highest exposure to mortgage assets in US after Cayman Islands) and had to fall.

What was also perplexing was his take on falling growth and rising inflation:

The fact that growth and inflation are heading in opposite directions has led some commentators to question our monetary framework. Target growth not inflation is the cry. I could not disagree more. This is precisely the situation in which the framework of inflation targeting is so necessary. Without it, what should be a short-lived, albeit sharp, rise in inflation, could become sustained.

But Sir you are already targeting growth aren’t you? I had pointeda while back that in its April meeting BoE lowered rates in wake of rising inflationary numbers and expectations. In May BoE paused but didn’t raise the rates as it was uncertain over falling growth and rising inflation. If it was targeting inflation, it would have raised rates as King says:

Price stability – returning inflation to the target – is a precondition for sustained growth, not an alternative.

So, if price stability is a precondition, why not fix it? And that too when BoE expects inflation to touch 4% (see his letter to Chancellor) and inflation has been rising for sometime now. So, it is not as if it has been a big surprise.

Improving housing market practices via banks

June 19, 2008

In his open letter to RBI Governor , V. Raghunathan (CEO, GMR Varalakshmi Foundation) starts like this:

Dear Dr Reddy, have you ever read—I mean really read— the contracts builders hand out to ordinary homebuyers to sign for a transaction worth lakhs and even crores?

People would know what is to follow next. He goes on to say the contract leaves the home buyers without any help whatsoever. He is completely at the mercy of the builder as the contract is lopsided. The builder charges a huge penalty if the buyer misses an installment on the due date but hardly any penalties are there if the builder misses his completion stages.

While the buyer will have to pay a penal interest of 18% per annum for a delay of even 15 days on his instalments to the builder, the builder has no such obligation for delaying the completion of the work by any length.

Then he points there is no say to enforce quality of construction promised. It all depends on the builder. All sellers say it is high quality stuff at time of sale but we all know how false these claims are. Other products don’t matter as much as a house. In a house most people put their lifetime savings (or are entitled to pay the bank for near life time) and there is no recourse. In Navi Mumbai for instance, whichever property you buy, it starts leaking in the first rain itself and you can’t do anything except spend more to fix it. 

The author then asks RBI Governor to use banking system to impose some standards in this industry:

Often, the agreements with the builder are linked to the loan contracts, so that the loan disbursals go directly to the builder. So it should be possible for banks providing the housing loan to require all payments from buyers to the builders to be made through an escrow account. The bank could also hold a limited power of attorney from the homebuyer (borrower) to ensure that the builders have met their obligations and once so satisfied, clears the escrow.

I must say it is a good thought. The practices in housing markets in India (particularly in metropolitan cities , where we have multi-storey apartment system) are so bad, that any help would be great. The Builder-Broker nexus is too strong and you feel duped all the time, but can’t do anything. Whether you take a house on rent or buy it ( See the economics of house-hunting in Mumbai), there are such huge transaction costs that you always feel burdened.

For instance, in Mumbai you have something called a “super built up” area which is roughly about 35%-40% of area. So, if the builder quotes 1000 sq ft area what you get is 600-650 sq ft area but you pay for the entire 1000 sq. ft. Super-built up includes area of terrace, balcony, parking, garden etc. and as this also involved development costs. the buyers have to pay for it collectively. But why 35-40% from all the buyers??  This was earlier called built up which was 15-20% but now has been extended to 35-40%. And worst of all, this has now been included for all flats. Even the old properties are selling at superbuilt up areas.  

Apart from this, Banks can also be very usefully used to do some rating of the builders. As of now, Banks just approve certain builders but there is no rating. You really do not know which builder is a good one. As a result, the apartment prices are near similar and depend on the area, not the quality of the builder. Some builders have developed a brand equity but they are very few in number.

The author also points to a problem which provides some food for thought for beh eco guys: 

And the most unfortunate thing is that most buyers do not (and others cannot) even read what they are signing on, thinking the process to be a mere formality.

This is also a big problem. The form is a mixture of legal and financial lingo and very few people have the speciality to understand both. The forms should be made simpler and shorter. But again this is a less of a problem than solving the above issues.

Housing is big problem in places like Mumbai and it is a very basic issue. If banks can help, it is most welcome. Moreover, research and debates are advocating that Central Banks need to look at asset prices (discussed here) and asking banks to monitor developments in housing markets might just be a good idea.

Assorted Links

June 19, 2008

1. WSJ Blog points Chicago Univ Professors are protesting setting up a Milton Friedman centre.

2. MR pointsto a paper which analyses the happiest looking economist. Answer- Ned Phelps

3. JRV pointsto market microstructure case study on recent Ranbaxy deal

4. ASB points to a new paper linking Legal system’s impact on finance in INdia. Looks quite interesting. He also points to the new GS paper that has another 10-reform list. My views on this paper are here. I am expecting more of these lists.

5. IDB points to a story that people use below poverty cards as collateral against loans

6. ISB points MMRDA extends monorail bid deadline

7. MR points to Beijing airport experience.

8. PSD Blog points that FDI numbers in Russia are not right.

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