by Brian Durrant
For the British, our homes have been more than dwellings, they have been
gold mines. Over the past 10 years real (inflation-adjusted) house prices
have doubled, while real disposable incomes have risen by only 29%. Latest
figures available show that in 2005, housing made up 53% of the total wealth
of UK households, compared with 39% 10 years earlier. Yet again we have been
told, the housing boom cannot last and the end is nigh.
A major contribution to the debate comes from David Miles, former advisor to
Gordon Brown. He says a UK housing bust is "likely in the next few years"
because house price growth has been grounded in unrealistic expectations of
double-digit annual increases. Once house price rises come down below
expectations, he thinks, significant falls are likely. But he is reluctant
to put his neck on the line regarding when this will happen. He says "A
sharp fall in real house prices is likely at some point in the relatively
near future, though it could be one or two years away".
Indeed Mr Miles himself admits that his model shows why trying to call the
housing market over the next year or two is "pretty much hopeless". So there
we have it, like those who tell the time from a stopped clock, the people
who predict that British house prices will tumble may be right one day. But
it has been a long wait and to date it has been wrong to take their advice.
Indeed, talk of a house price crash in the current cycle is already over 10
years old. In 1996 Bob Beckman, the self-styled property market bear,
predicted a 20-year fall in UK house prices. Then in 1997 some commentators
feared that a Labour win would hit prices hard. The September 11 attacks
persuaded many, but not us, that the housing market was about to dive.
Professor Oswald urged British homeowners to sell up in May 2003. Capital
Economics forecast that house prices would fall by 20% from 2004 to 2006.
Not to be outdone, in February 2004 stockbrokers Durlacher issued a report
warning of a 45% decline in house prices even if unemployment and interest
rates remained the same! But we have always maintained the view that the
housing market would have to be the victim rather than the assassin of the
British economy. Accordingly Durlacher's forecast turned out to be more
doomed than the property market.
Every previous crash in UK house prices, in the early 1930's depression, in
the stagflation years of 1973-76 and most recently the early 1990s were
accompanied by a severe recession. The crash of early 1990s followed a
doubling of interest rates to 15% and a near doubling of unemployment from
1.6m to 3m. So with Britain enjoying
57 successive quarters of growth there is no reason to believe that a house
price crash is imminent. History also tells us that the scale of house price
crashes, though painful for those that bought at the top, has been quite
modest. Both in the early 1930s and early 1990s the fall in house prices
from peak-to-trough was only 13%.
Mr Miles' thesis however does not require the economy to be the assassin of
the housing market. He believes that when house price inflation fails to
meet expectations, demand for housing will fall. But surely sellers will not
cut prices unless forced to do so by economic circumstances.
Most house moves are voluntary. If homeowners are faced with selling at a
price they consider to be too low, they are more than likely to withdraw the
property from the market. This is why when the property market is overvalued
the correction tends to take place by means of price stagnation rather than
a crash.
Asset bubbles emerge when the dominant motive for purchase is the
expectation of selling on soon to someone else (a bigger fool) at a higher
price. The dot.com bubble collapsed because the market ran out of bigger
fools. Now as far as housing is concerned, despite the growing popularity of
buy-to-let and second homes, the overwhelming majority of those who buy
property plan to live in it. The motives for buying are different from
dot.com stocks.
For five years now, the expert consensus that UK property prices are
overvalued has rested on one central observation that the ratio of house
prices to incomes is historically high. Of course you would expect a share
price on a demanding price-earnings ratio to revert back to its long -term
norm, but what about houses? Houses are different. They are both an asset
and a commodity.
Let me explain. The primary purpose of a house is to provide shelter.
Consider the market for real estate in Idaho or Nebraska. There is more land
there than anyone could wish to build on and usually there is not much to
choose between the prestige and convenience of different areas of spacious
cities. In these areas house prices are low, stable and tend to move in line
with income.
Now consider London or Manhattan. Most of the price reflects the location
rather than the accommodation.
Transfer a mews property in Belgravia to Paisley in Scotland and it would
lose most of its value.
You cannot make more houses in Mayfair or East 69th Street, so the prices of
properties in prestigious areas resemble the price of a commodity in short
supply. The aspirant rich do not displace the very rich from the most
prestigious locations but they make the very rich pay more for them. Unlike
a share in BP, houses in prime locations are also a symbol of status and
prestige and that is why the housing market does not conform to simplistic
valuation models. This is why forecasts of a house price slump are about as
useful as a stopped clock.
Regards,
Brian Durrant
for The Daily Reckoning
Bill Bonner from Paris, France:
"It's worth remembering that markets were very upbeat in the early summer of
1914", said former U.S. Treasury secretary Larry Summers.
Summers was warning the attendees to this year's upcoming World Economic
Forum in Davos, Switzerland, that there are precedents for such bountiful
seasons.
The trouble is history shows that such incredibly good times tend to be
followed by incredibly bad ones.
"Financial history demonstrates that the biggest liquidity problems always
follow the moments of greatest confidence," Summers continued. "Complacency
can be a self-denying prophecy", Summers says.
"A glut of cheap money and the strongest global economic growth in three
decades have encouraged banks, private- equity firms and hedge funds to bet
that the good times will keep rolling," says a Bloomberg report.
``It's too good to be true,'' adds Vittorio Corbo, head of Chile's central
bank, who will speak at a seminar in Davos about the dangers of derivatives.
``Tomorrow the mood could change. We have to be prepared."
These voices of warning will soon be echoed by Jean- Claude Trichet, head of
the European Central bank. They will all certainly be dismissed. The crowd
will remind itself that it heard similar warnings last year. And lo...
nothing bad happened. Last year too, the self-same Summers told Davos
attendees to watch out... to be more prudent in their financial affairs and
more modest in their projections. Of course, they did just the opposite -
which is why the Great Credit Boom continued.
Takeovers last year rose to a record $3.6 trillion, according to the
Bloomberg report. Morgan Stanley's Capital International World Index of
stock prices rose to a new record high on Jan. 3rd... and the head of
Goldman Sachs, the alpha male of Wall Street, earned a bonus of $53.4
million.
Prices of London's priciest digs - where the super-rich are roosting these
days - grew even more expensive last year. They rose nearly 30% in a single
year. And, bonuses for Wall Street's masters of the universe, its five
largest investment firms, rose too - by 30%.
Meanwhile, one of those firms - Morgan Stanley - announced another mega-deal
in the real estate sector, last week. The company says it bought CNL Hotels
& Resorts for $6.6 billion.
What's a New York investment house doing buying a hotel chain? What does it
know about running a hospitality business? Nothing. But gone are the days
when the owners of a business knew the business they were in. Now, the
economy has been financialized and the financializers are getting rich.
In the old days a family might run a hotel chain, trade the stock among
themselves - at, say, 5 times earnings - and put an ambitious nephew, cousin
or son at the top post. They would, of course, be careful not to pay him too
much... and be sure to put other nephews and cousins in the business too...
to give the enterprise more management depth and to keep control in family
hands.
But along comes a big investment firm with a buyout offer, backed by debt
financing. The offer is too good to refuse. So, a 'liquidity event' turns
the family into billionaires. The company is placed in the hands of
professional managers and goes public at 20 times
earnings. The investment firm makes millions on
the deal.
And now, the new CEO earns $10 million a year and thinks he is underpaid.
Meanwhile, the firm sells millions in bonds, which are then repackaged and
resold, with swaps and derivatives all over Wall Street. And the stock -
which is now held by millions of people who wouldn't know the hotel business
from a gas station - soars.
Before... there was just a family with a family asset, a hotel chain from
which it earned a living. But now, millions of people own a stock that has
gone up in price. Investment bankers can afford to build a bigger, swankier
house in Greenwich, CT. Hedge funds, pension funds and wheelers and dealers
all have multi-million dollar positions in the company's debt. And
investment industry pros can earn their own fortunes just by trading the
company's stocks, bonds, and derivatives.
Is this a great system, or what?
'Or what'... is what we wait to find out. In real terms, there is still a
hotel chain, with a certain stream of revenue and profits. But this new
financialization has created a whole industry... and a whole new flood of
liquidity. People have 'wealth' that didn't exist before. The only trouble
is, the 'wealth' is a fiction.
But when you get to the top of a liquidity bubble,
who cares?
Debt... debt... debt... nobody seems to worry about it going down. The gap
between good debt and bad debt - that is, between emerging market bonds and
those of the U.S. Treasury - fell to a record low last week. And hedge funds
in the U.S. are the most leveraged since 1998, the year that Long-Term
Capital Management collapsed, according to Bridgewater Associates.
The European Central Bank at least still keeps track of its money supply. It
reports that M3 was clocked last fall rising at nearly a 10% rate - its
fastest in 16
years. This prompted the ECB to raise its key
lending rate.
"Current risks are ludicrously underpriced", says Willen Buiter a professor
at the London School of Economics.
"At some point, someone is going to get an extremely nasty surprise."
So far, the surprise has been that no surprise has come.
But the longer it delays... the nastier it is likely to be.
More news from Eric Fry:
---------------------
Eric Fry...in California:
- The rain falls on the rich and the poor alike. That's symmetry. But after
the rain lands, the rich receive a much larger share of the water than the
poor. That's asymmetry. Indeed, some of the rich funnel as much water as
possible toward their own personal reservoirs... even
though they have more than enough water already.
That's greed.
- And some of the rich drain the wells of their neighbours and clients to
water their golf courses.
That's Wall Street and the City.
- Greed is one reason why brokerage stocks might be
dangerous stocks to own at their current
lofty valuations.
- No automatic connection exists between greed and poor stock market
performance. But bad things just seem to happen to the common shareholders
of companies that greedy managements oversee. Names like Enron, Tyco and
Worldcom come to mind.
- In this context, names like Merrill Lynch and Morgan Stanley do not yet
come to mind. But the big brokerage firms of Wall Street and the City have
veered perilously close to the shoals of excessive greed. And this course
endangers shareholders because it squanders capital that could be funding
productive activities, or providing a balance sheet buffer against future
unanticipated "adverse outcomes."
- As long as the financial markets remain robust, however, no one will care
how many billions of dollars might slosh into the brimming bank accounts of
elite traders. But financial markets are not always robust.
The same Citigroup that is today lavishing billions on its top employees was
once the Citibank that flirted with bankruptcy in the early 1990s.
- Bank and brokerage stocks are already risky enough, thanks to the
perennial risks of falling financial markets, rising interest rates and
exploding derivatives
books. Avaricious management teams do not lessen
these risks.
- The owners of brokerage shares, therefore, do well to remember that Wall
Street and the City are forever and always about money. They are about
making as much money as humanly possible, in as many different ways as
legally defensible. They are not about charity or altruism or the "greater
good."
- Wall Street and the City are also about survival of the fittest - the
"fittest" being those who manoeuvre themselves into obscenely
overcompensated positions. Do these alpha-bankers and alpha-traders deserve
their millions? In a primal sense, yes... just like a great white shark
deserves a slow-moving harbour seal... or a falcon deserves a hapless
bunny... or a coyote deserves the neighbour's dozing Pomeranian.
- But these metaphors become a bit sinister when one realizes that the
"hapless bunny" and the "dozing Pomeranian" are the common shareholders.
- The big brokerage firms make most of their money by speculating with
capital that does not belong to them, or by levying fees and commissions on
capital that their clients put at risk in the financial markets. In other
words, shareholders and clients bear most of the risks.
Yet whenever any form of success arrives, the elite of Wall Street and the
City always garner an outsized share of the rewards. That's asymmetry. And
in this case, asymmetry might just be another word for "greed."
- Consider the case of Morgan Stanley. The firm posted net income of $7.4
billion in 2006 - an impressive $3.7 billion more than 2003 earnings. But at
the same time, total compensation at Morgan Stanley last year topped
$14.3 billion - a whopping $5.8 billion more than in 2003. Does it not seem
odd that employee compensation is nearly twice the firm's net income? And
does it not seem odd that employee compensation has jumped 60% more than net
income since 2003, even though the number of employees has barely increased
at all? In fact the employee count has DROPPED since the end of 2002.
- Most of the individual recipients of year-end bonuses are not to blame, of
course. They are simply blessed.
And as blessed individuals, they enjoy the privilege of sharing their wealth
in altruistic and charitable ways... or not. Likewise, the stockbrokers who
toil for these firms deserve no scorn. They earn their keep like
entrepreneurs, and must conduct their activities in a very open and
competitive marketplace.
- But the leaders of Wall Street and the City - those who perpetuate the
status quo - might consider taking a minute of "quiet time" to consider the
propriety of their practices. Do these folks honestly believe that they
deserve their multi-million-dollar bonuses, simply for presiding over bull
market trading activity? And do they honestly believe that "star" traders
deserve their multi-million-dollar bonuses, simply for speculating with
someone else's capital.
- To re-phrase the question: Isn't it possible that Wall Street's and the
City's elite employees should receive a somewhat smaller share of corporate
cash flows than they do currently... and that the common shareholders should
receive a somewhat larger share?
- "Nobody who is hired help and who plays with other people's money
'deserves' to earn $100 million," gripes Steven Pearlstein in an article for
the Washington Post.
"That's certainly true in a moral sense. But it is also true economically...
Let's start with the fundamental asymmetry of risk in the investment
business.
- "If you were putting your own money at risk,"
Pearlstein continues, "there's the possibility of making lots more, but
there's also the possibility you could lose it all. The same, however, can't
be said if you are an investment banker, a hedge fund manager or a trader in
credit default swaps.
- "In that case, if you do well, you get a percentage of the winnings or the
value of the deal. But if you do poorly and your clients lose money, the
worst that happens is that your bonus is zero. You never have to give back
anything from the bonus you earned last year.
And you still get a base salary comfortable enough to keep up payments on
the Upper East Side townhouse, the summer place on Nantucket and the
tuitions at Brearley."
- No one cares about over-the-top compensation schemes when business is
booming... and when share prices are rising. But on the downside, everyone
cares. During the Great Bull Market of the late 1990s, almost no one
bothered to question the exorbitant option grants that Silicon Valley
companies lavished on their employees (and on their board members!)
- But once the Great Bull Market ended, and the Nasdaq imploded, a new bull
market in recrimination and litigation began. Class-action shareholder
lawsuits erupted from the smouldering remains of former Wall Street
darlings, as desperate shareholders tried to recover some small fraction of
their losses.
- Would it not have been much better for these abused shareholders to sell
when the selling was good? Would it not have been better to have raised a
sceptical eyebrow toward the questionable corporate practices of the era and
headed the other way... even though questionable corporate practices were
producing rising share prices?
- "Excess compensation in one area leads to excess compensation in others",
Pearlstein concludes. "And that, in the end, is how this arms race in
executive pay comes about. It's more about envy than economics. The
corporate executives complain they should make as much as the investment
bankers, the bankers are upset if they don't make as much as the
private-equity guys, the private-equity guys demand to make as much as the
traders and the traders won't sit still until they are paid like hedge fund
managers."
- Excess compensation also leads to sub-optimal shareholder returns. Greed
and capital preservation just don't seem to mix very well, especially when
the greed belongs to someone else and the capital belongs to you.
---------------------
And more views from Bill Bonner...
*** Oil bounced at the end of last week. Maybe the bottom for oil is in.
Gold rose strongly too - up $8.30.
The correction in the gold market seems to be over.
Could it be that the 'financialization' of the economy has other investors
worried? Gold is the traditional way to protect against financial surprises.
As we explained last week, it is not a perfect way to store wealth; but it
is better than any other way ever discovered. Most of the time, you will do
yourself no favour holding it.
Most of the time, it is as useless as life insurance.
But come that day when you need it, nothing is more useful, or more welcome.
"Real Estate Will Underperform Inflation for Decades,"
writes Dan Forshee.
Most people think that real estate is a safe, reliable place to put your
money. But that is just a trick of perspective. Once you have climbed to
the top of a mountain, everything appears to be downhill. In fact, there
could be many steeps hills between you and the bottom... and long periods
where you are not going down at all.
>From 1915 to 1965, says Forshee, property doubled in price, but rose only
about 1.32% per year. But the dollar gave way during this period, too.
Housing prices didn't keep up. So the typical house owner actually lost
about a third of his purchasing power.
In real terms, the prices of 1910 went down all the way to the 1990s. Only
recently did they begin to go up enough to offset inflationary losses. And
only in 2005 did they regain the heights last seen early in the last
century. From here, it looks as though they did nothing but rise, but in
fact, property prices in the U.S.
mostly went down for the last 100 years.
Another way to look at this is to recall Larry Summers'
warning about 1914. Liquidity and confidence were running at epic highs just
before WWI. When they crashed, they crashed hard. Property in the US did not
recover for another 91 years. You can also see the long trends in real
property prices simply by opening your eyes, says Forshee. The higher real
property prices go, the taller the buildings property developers put up.
"Higher prices of real estate make it profitable to build tall buildings
because the higher construction costs are offset by lower land costs. Most
major cities in the United States had tall buildings built between
1914 and 1933 during the real estate boom of that time frame. After the
tallest building was built, it typically took about 41 years for the real
estate prices to return to levels that would justify buildings of similar
height." Here is a data set of example cities:
No comments:
Post a Comment