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Showing posts with label John Maynard Keynes. Show all posts
Showing posts with label John Maynard Keynes. Show all posts

Friday, 30 December 2011

Why Americans Should Wait To Buy A House?


The U.S. government is doing its best to convince the American public that there’s an economic recovery underway, but is that really true? The economy is being artificially propped up by $1,500 billion in annual debt, and the Federal Reserve has printed trillions of dollars to keep banks afloat. It was too much debt that got the country into trouble to begin with, yet the government is essentially saying that even more debt is needed to fix the problem. This is one of the fundamental pillars of the theory developed by economist John Maynard Keynes in the early 1900s.

Not everyone agrees with Keynesian economic theory. Free market capitalists believe that markets should be unfettered by government intervention and allowed to reach equilibrium on their own. Their argument is that supply and demand should set asset values and prices without interference by artificial stimuli and freshly printed cash. (To learn more, read How To Buy Your First Home: A Step-By-Step Tutorial)

When analyzing whether or not to buy a house in this economic environment, the best approach is to focus on reality, not the talking points offered by politicians. Here are some factors to consider before taking the plunge with a new mortgage.



The Bubble
The housing bubble was caused by a lethal combination of easy credit, low interest rates and rampant speculation. This “perfect storm” reached its pinnacle of power in four states: California, Nevada, Florida and Arizona. The landscape of these states is littered with unfinished housing developments and empty condominiums. Even though prices have dropped 50% or more in some areas of these states, they are all plagued by debt-to-income ratios (DTI) that are still higher than the historical norm of three to one. This will continue to put downward pressure on prices.

Nationwide, the inventory of unsold homes was 3.33 million at the end of October 2011, an eight-month supply at the current sales rate. While this is a positive downtrend from the inventory peak of 4.58 million units in July 2008, the inventory overhang is still having a negative effect on prices. The median existing home pricewas $162,500 in October for all housing types nationwide, a drop of almost 5% from a year ago.

Prices are also being impacted by the high rate of contract failures, which is almost double that of September, and four times what it was one year ago. These failures represent canceled sales contracts resulting from unqualified mortgage applications, appraisal values below the sales price, unsatisfactory home inspections and unfulfilled contract contingencies. One-third of all sales contracts in October did not make it to closing, causing those homes to re-enter the market and increase the unsold inventory.

100-Year Trend
Yale economist Robert Shiller, known for the Case-Shiller price index, has calculated that U.S. home prices rose an average of 3.35% per year during the period 1900-2000. This timespan includes extended periods of both falling and rising prices, from the Great Depression up to the bull markets of the late 1980s and late 1990s. (For related reading, see Understanding The Case-Shiller Housing Index.)

In January 1998, just before the bubble started to inflate exponentially, the price index stood at 82.7. If prices had followed the 100-year trendline over the next 12 years, the index would have reached 126.7 in October 2010. Instead the index hit 159, a full 25% above the long-term trend. So, even though prices have already dropped more than 30% nationwide in the past five years, data suggests that the bubble has not been deflated and more price drops could be on the way.

Important Factors
There are many forces at work contributing to instability in home prices:
  • Continued high unemployment, with weekly unemployment claims consistently hovering around 400,000
  • The possibility of higher interest rates to combat inflation fueled by the increased money supply
  • Strategic defaults, foreclosures and short sales all force prices lower
  • High levels of underwater mortgages
  • A “shadow” inventory of unsold homes held by banks will put pressure on prices when these homes are marketed
  • Stricter mortgage qualification requirements, including bigger down payments, higher credit scores and verifiable income
  • Lower conforming loan limits as of Oct. 1, 2011
  • Continued high levels of government and personal debt
  • The threat of more U.S. credit rating downgrades
  • The potential for a European financial collapse rippling through the U.S. economy and financial institutions
  • Changing demographics, slowing population growth and smaller families are causing reductions in overall demand
  • Many baby boomers are downsizing their lives, including the size of their homes
  • Possible future actions by the government between now and the 2012 elections: tax policy changes, stimulus spending, mortgage modification programs, etc.
The Bottom line
The evidence suggests that without government intervention, home prices would be much lower than they are now. Record low interest rates, the homebuyer tax credit, mortgage assistance programs and bailouts for Fannie Mae and Freddie Mac have all softened the freefall in prices. These actions have not changed the fundamentals of a weak economy that relies heavily on consumption for GDP growth and too little on industrial production.

Price stability is not likely to be reached until the excess is wrung out of the bubble that expanded by a breathtaking 19.2% per year between 1998 and 2006. Government policies have slowed the correction, but not stopped it. This has kept wary buyers out of the market because they don’t believe the market has hit a true bottom. This has delayed a sustainable housing recovery and prompted potential buyers to wait for lower prices next year. (To learn more, check out The Truth About Real Estate Prices.)

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Saturday, 20 August 2011

Capital controls: From heresy to orthodoxy





THINK ASIAN By ANDREW SHENG

 Principles for formulating capital control policies must take local conditions into account.

ON Sept 1, 2011, it would be 13 years to the day when Malaysia first introduced capital controls to stem the effects of the Asian financial crisis on the domestic economy. In 1998, it was heresy to introduce capital controls on capital flows, since it was the International Monetary Fund (IMF) orthodoxy to liberalise the capital account.

From the perspective of history, one tends to forget that in 1945, when the IMF was first established, the consensus opinion among bankers and academics alike was for hot money to be controlled. Indeed, the intellectual father of the IMF, John Maynard Keynes, remarked that “what used to be heresy is now endorsed as orthodoxy.”

In the old days, courtesy to living persons and the statute of limitations would allow history to be written only after 60 years when official archives are opened to the public.

Today, we live in an age of unfettered information, when oral and documented history can be published rapidly, from authorised biographies issued shortly after a leader leaves office to unauthorised leakages from Wikileaks.

The publication of a new book by Datuk Wong Sulong, former group chief editor of The Star, called Notes to the Prime Minister: the Untold Story of How Malaysia Beat the Currency Speculators, only two months after the IMF announced in April 2011 new thinking on capital inflows, is a remarkable achievement.

Sixty-six years after the IMF was formed, capital controls have moved full circle from orthodoxy to heresy and back again to (qualified) orthodoxy.

The book comprises 45 Notes written by Tan Sri Nor Mohamed Yakcop, Minister in the Prime Minister's Department, between Oct 3, 1997 and Aug 21, 1998 to then Prime Minister Tun Dr Mahathir Mohamad.
In short, they were the key briefs that helped Dr Mahathir make up his mind on the key economic policies to help combat the Asian financial crisis.



Book offers deep insights

For both historians and practicing policymakers, this new book offers deep insights into the serendipity and the practice of successful policy decision-making. There is an element of serendipity, because Dr Mahathir recalled that he spotted Nor Mohamed walking down a street in Kuala Lumpur just before he left for Buenos Aires in September 1997 via Hong Kong, where he attended the World Bank Annual Meetings and clashed publicly with George Soros on currency trading.

On Sept 29, 1997, he summoned Nor Mohamed to meet him in Buenos Aires, because he needed someone who understood currency trading. It is a tribute to a politician trained as a doctor that he was willing to spend repeated sessions with an experienced currency trader to understand the intricacies of modern financial markets.

Reading the 45 Notes in historical sequence, one gets a far better appreciation of how the decision to impose capital controls was arrived at. The Notes not only have historical value, but also current-day applicability, as they explain not only offshore currency, the psychology of fear and greed that drive markets, but also market manipulation in thinly traded emerging market currencies.

The major problem of the proponents of the Washington Consensus in 1997 was that most of them were macro-economists who had little understanding or experience of how the markets actually worked. Free markets became a dogma and objective in their own right, rather than the means to an end for better livelihood for all.

The Notes also revealed that in complex decisions under uncertainty, it was vital to understand clearly the key parameters for action. Note 7 clearly pointed out that Malaysia was different from other countries under currency attack because it did not have large short-term external debt. Note 11, dated Oct 21, 1997, spelt out the factors that determined exchange rates, with a particularly illuminating explanation of market manipulation.

Market manipulation was seen as due to concerted effort by hedge funds, using large gearing and available tools and then triggering the element of fear among the long-term investors who have legitimate currency risk.

In other words, if the wolves can trigger the herd to move, then the fundamentals can move. The perception of fear changes the whole game.

Effect of CLOB

Note 39 dated July 9, 1998 is an important study of the effect on Malaysia of the central limit order book (CLOB) for trading of Malaysian shares in Singapore. The Note identified that the CLOB was a convenient way for capital outflows.

Hence, one of the most effective ways for exchange control was to impose the condition that Malaysian shares could only be traded on a Malaysian exchange, which came on Aug 31, 1998, with exchange controls imposed on the following day.

In Dr Mahathir's words, “during the financial crisis, we faced two parallel situations; the ringgit was falling rapidly and Malaysian shares were also falling rapidly. So we had to put an end to both.”
50th Mederka Malaysian National Day celebratio...Image via Wikipedi
The IMF has come out with six key principles for formulating capital control policies.

The first is that there is no “one-size-fits-all” policy mix. The second is that capital controls should fit long-term structural reforms. Third, capital controls are only one tool and not a substitute for the right macro policies. Fourth, capital controls can be used on a case-by-case basis, in appropriate circumstances. Fifth, the medicine should treat the ailment, and finally, the policy must consider its effect on other market participants.

It is hard to argue against these common sense “motherhood” principles. The trick in real life policy-making is how to apply them to local conditions.

On of the features of the current Chinese capital controls is that China also has a large amount of Chinese shares listed outside capital controls, such as Chinese shares listed in Hong Kong, Singapore and New York.

This is a book that is a must read for all emerging market policymakers interested in liberalising their capital accounts and for IMF experts to ponder emerging market experience.

I recommend that this new book be translated into Chinese, so that Chinese policymakers interested in internationalising the renminbi can look at the Malaysian experience.

Tan Sri Andrew Sheng is author of the book, From Asian to Global Financial Crisis.


Related Post:

The untold story of Malaysia foreign exchange controls