In an op-ed column in the influential New York Times on December 21, 2007 Paul Krugman, winner of the 2008 Nobel Prize in Economics, columnist, bestselling author and professor of economics at Princeton University, wrote of the mortgage crisis in the USA that “the explosion of ‘innovative’ home lending that took place in the middle years of this decade was an unmitigated disaster.” He was responding – in his usual confident manner – to a statement from Fed Chairman Ben Bernanke in connection with the then pending mortgage crisis in the USA stating specifically that “Market discipline has in some cases broken down, and the incentives to follow prudent lending procedures have, at times, eroded.”
Do the sentiments in that column have any resonance in Guyana where the term ‘housing bubble’ has appeared twice – albeit by one writer – in the letter columns of this newspaper? When it was first raised President Jagdeo, the country’s economist-in-chief sought to counter the fear, noting in his usual manner that the exposure of the financial sector to housing is not very significant. When Clico collapsed he said the same thing, ignoring the six billion dollar hole in which the NIS was thrown and from which it is still reeling.
Pool of fools
What really is a housing bubble? It is a marketplace phenomenon in which one of the most basic fundamentals of economics does not apply – that as supply increases, prices fall. In a bubble, prices go up simply because prices are going up. Persons invest in the expectation that there will be someone who will be willing to pay a higher price – the Greater Fool theory. Of course at some point the pool of fools is exhausted and there is no one willing to pay the exorbitant price not justified by economic fundamentals. At this point the bubble bursts, sanity returns to the sector and several persons start counting their losses. For those who can afford to hold the asset on the expectation that prices will recover, there is only a paper loss. For those who have to sell, the loss is real since they recover much less than they have invested.
But let us return to the bubble and take as an example the recent sale of the St Barnabas Church in Regent Street for $500 million. The Greater Fool theory states that the next property of similar size and location that comes on the market would fetch more than $500 million. For speculators, it does not matter if the annual return on their investment is less than the interest they will receive if they placed their money in an interest bearing account. They bank – pun intended – on prices going further up and what they lose in holding costs they recover in capital gains when they sell in a rising bubbling market. Of course even in such an irrational situation rational economics are not completely thrown out of the window and there are still expectations of things remaining equal.
Guyana – an unequal place
Things in Guyana are not only distinctly unequal but there are other considerations that have to be factored into the equation. Take for example the sale by President Jagdeo of his Pradoville 1 house to PPP/C friend and confidante Ernie Ross at the unrealistic price of US$600,000. There are other and far better properties in Pradoville 1, but one can be sure that none will fetch a price anywhere close to US$600,000, much less $750,000 which would be the pre-Capital Gains Tax equivalent. For this there is more than one reason, with one being the unexpressed statement that Pradoville I is no longer the commune of the super elite; that is now Pradoville 2 where the President and a limited number of persons will be taking up ocean-front residence.
The second is that there is probably only one Ernie Ross who would be willing and able to pay above market price to the President, confidently assuming that his intensive work in the months of the 2011 elections will provide him with tons of money to compensate him for buying a property which he still has not occupied or rented.
Another telling factor at the higher end of the market is the levelof narco and illicit money to be washed and what better to do so than casinos, gas stations, restaurants and cambios – all essentially cash operations.
A hotel can incorporate many of these, making it an excellent vehicle for laundering money. Notice the eagerness with which hotel ownership or operation is pursued by the cash rich businessperson despite the fact that the level of occupancy in Guyana is by far the lowest in the Caribbean. Our one-man (and little support) anti-money laundering unit is harmless and ineffective in this marketplace where any currency of any amount is available on the street, often at low interest and in respect of foreign exchange, at very favourable rates.
Economic logic does not apply to the world of the elite and their friends. They enjoy a high level of immunity in law enforcement, administrative rules and regulations and probably assume that any attempt to investigate them will be terminated with a single nudge or a telephone call.
The importance of information
Let us now seek to examine, as far as a column can, whether there is any danger that Guyana is in a housing bubble. And if it is, what are the potential consequences and what the lenders and the authorities should be doing to prevent a situation referred to as locking-the-barn-door-after-the-horse-is-gone, that is to regulate lending while it is booming, rather than after it will have collapsed – ie taking curative rather than preventive action.
To make any sense of this real or imagined problem it may be necessary to understand who the players in the housing market are and to examine their respective roles.
It goes without saying that a discussion on such a crucial issue requires proper and reasonably accurate information, something that is regrettably scarce in this economy. In this country where telling the truth is not considered necessary or virtuous and where politicians routinely lie, hard facts from regulators are the best check against anything that politicians say.
By law and necessity the Bank of Guyana and the Statistical Bureau are supposed to be independent, but in practice they are controlled and compromised by politicians, often merely following instructions, continuing to do what they did last year, their output seldom demonstrating innovation, initiative or even relevance. So that like the politicians, they simply assume that the obvious benefits of broadened home ownership justify a rather liberal approach to lending by the commercial banks and the non-bank financial institutions.
The government and its agencies
For the government any attendant mishaps to its housing policy – which even its critics agree has been a defining success – will be a major setback, but nothing compared with the losses which the bursting of any bubble would have on the individuals and investors in the housing sector and their lenders.
The government’s main role has been to conceptualise and to facilitate its housing policy largely with below-market sale of state-owned land, infrastructural works and tax exemptions on income earned by approved lenders. As an instrument of social policy, land allocation is dictated not only by economic considerations but takes account of several non-financial variables including of course politics.
The Bank of Guyana has the statutory obligation to regulate the financial sector, and now as well, the insurance sector, a task for which it does not appear to be properly equipped. For years I have complained unsuccessfully about the inadequacy of its statistics and the arrangement of the information in its periodic reports which include a Statistical Bulletin, a Banking System Statistical Abstract, and half yearly and annual reports.
These reports serve different purposes and seem to ignore the need for aggregate statistics to enable a proper understanding of the key sectors and equally importantly, for purposes of policy formulation. It is amazing that any government would actually make important monetary and fiscal decisions in the absence of proper information.
The other players are the lenders and the borrowers. Not too long ago, financing for the housing sector came mainly from the non-bank institutions. The most prominent was the New Building Society, with the insurance companies a smaller player using part of their long-term funds for housing purposes. It was an insurance company Demerara Mutual that played a major role in the development of Happy Acres, a success story on the East Coast Demerara, but which it did not seek to replicate elsewhere.
There has been a marked shift in the market share of real estate and housing loans over the past ten years. We estimate from various sources that the total amount of mortgage loans at December 31, 2010 was approximately $60 billion, with the non-bank sector accounting for about 42% and the banks accounting for 58%. That is a dramatic change from ten years ago when the banks accounted for 25% and the non-banks for 75%. The dramatic shift in the non-bank sector is attributable to the declining role of the New Building Society in lending to the housing sector.
From available information, we estimate that in dollar terms, lending by the non-bank financial institutions has remained practically static over the period 2007 to 2010. This coincided with the contraction of lending by the New Building Society resulting in a significant decline in market share and losing out to the Republic Bank whose lending on mortgages moved from near zero in 2001 to $6.6 billion at December 31, 2010.
Over the past ten years total mortgage lending has increased at a compound annual rate of 14%, ranging from 2.54% for the non-bank financial institutions, Citizens Bank 10.41%, and Republic Bank 29.4%, a high percentage coming from a negligible base ten years ago. My inability to provide similar information for other financial houses, including those commercial banks that publish annual reports, is because comparable information is not readily available.
To be continued