Guyana in a housing bubble – not really (but maybe)

I was totally surprised at the very informed responses to last week’s introductory part on the country’s housing situation. What made it even more interesting were the sources of the comments and the insights they offered. Indeed they made me do some previously unintended research, the results of which are indeed quite revealing and troubling particularly given the level of accountability and integrity we have experienced in the housing sector.

What has now emerged is that there is more to the superficial impressions and conclusions on the government’s housing policy. They point to an absence of national planning and coordination, developments of some regions and areas at the expense of others, political opportunism and not unexpectedly and increasingly, concerns about accountability, transparency and corruption. Perhaps that is why in a recent talk to young members of the Alliance For Change, Dr Tarron Khemraj a talented economist and academic said that if called upon to grade the PPP/C’s housing policy, the most generous he could give would be a B Minus.

Just maybe
I will return to my concerns later, but for now I go back to the caption of this article and the question whether or not Guyana is in a housing bubble. Last week I was fairly certain that we are not. Further investigation however forces me to qualify that opinion and I have to state at this stage that a bubble is not entirely unlikely in the short term – any time in the next three years.

Recall from last week that a bubble arises whenever the fundamentals of the market do not apply to a sector of the economy. That fundamental states that as more of a commodity becomes available, prices fall. The converse is also true – as supply decreases, prices will rise as we are currently witnessing with the price of chickens. If there is a housing bubble, consumers will continue to pay higher and higher prices for real estate, regardless of whether or not the stock of housing units increases – that is until the Day of Judgment when the bubble bursts.

House lots and housing stock
We must of course be clear to distinguish between house lots and housing stock – something that I am not sure is understood by the government that continues a mad rush to distribute ever more house lots. Indeed it has now decided that with an over-allocation to residents, it must move to allocating lots to non-resident Guyanese and we ought not to rule out house lots for the Chinese and Brazilians too. The evidence points unmistakably to an oversupply.

But we must also distinguish between a bubble and its consequences. The fact that there is an oversupply does not mean there is a crisis, if there are persons who are prepared to pay the obviously inflated prices. The problem arises if the real estate is paid for by borrowings from the financial sector and if the borrowers are unable to meet their mortgage payments. The result of this is that a whole lot of properties come on the market as a result of foreclosures and forced sale of several properties almost simultaneously. This is essentially what happened in the USA and resulted not only in the collapse of the real estate market but a number of financial institutions as well.

Housing policy formulation has not been a recent phenomenon. The first formulation of a country-wide housing plan was undertaken in 1954 by the Interim Government which was put in place following the suspension of the 1953 government. Perhaps because of political considerations – the deficit was in unfriendly areas – the PPP government from 1957 to 1964 did not allocate sufficient funding for the programme and the housing deficit – the technical word for shortage – therefore increased. The policy was revisited in succeeding PNC administrations with a number of new schemes established mainly in – not surprisingly – PNC friendly areas.

Those efforts however did not fully satisfy the need for housing which at 1980 stood at 137,374 units, giving an estimated deficit of 12,360 units, according to a paper prepared by the Hoyte administration in 1986. That paper calculated that by 1986 the deficit had increased to between 25,000 and 30,000, a generous number but which the paper attributed to the increasing number of households arising from cultural factors, the need for specialised accommodation and the decline in housing construction.

It means that the PPP in 1992 inherited a housing stock of approximately 150,000 units and a deficit of 31,000 units for a population of 723,673 women, men and children. It responded with great speed – if not decency – and in a move that has become quite characteristic of the PPP, the Jagan administration immediately fixed the housing deficit for its political elite by the establishment of Pradoville 1 where several ministers, party chiefs and top civil servants were given prime real estate at peppercorn prices. Ironically, and for some strange reason the Housing Minister at the time, Dr Henry Jeffrey, was not among the lucky few.

In a Housing Policy paper tabled in the National Assembly around 1994 by Dr Jeffrey, the housing deficit to the year 2000 was projected at 20,078; a figure arrived at by assumptions of the then number of households (rather than housing stock), the size of the population and the replacement factor. Fast forward to 2000 when the population was 750,000 and divide that number by an average family/household size of four.

On that basis the number of housing units needed to house each family in their own homes would be 190,000. By that time the number of housing units had increased to approximately 160,000 leaving a need for 30,000 units. If we make allowance of one-third of that for construction on previously owned lands, lands purchased from both the state and individuals and houses bought from private developers then the house lots needed since 2000 to meet the deficit would have been approximately 20,000.

The PPP/C’s manifesto for the 2001 elections states that the number of house lots projected to be distributed is 50,000 – well over twice the number needed to meet the deficit! Then in its 2006 manifesto the party boasted of having created a housing boom in Guyana with 70,000 house lots distributed since 1992 – or sufficient to house 280,000 persons in households of four.

That means that by 2006, if all the house lots had been used for housing, there would be sufficient houses for close to nine hundred thousand persons – more than the entire population of Guyana. And as we have said this does take in the number of private houses built by individuals on privately acquired lands.

Friendly domestic capitalists
The situation is worse when we consider certain other developments. In the Providence East Bank Demerara area the Jagdeo administration has given/sold some one thousand acres of GuySuCo land to close friends, supporters and contractors including Messrs Lumumba and Shivraj both of whom have been the beneficiaries of the Jagdeo administration’s largesse, BK International, Courtney Benn Construction and VIKAB.

These new capitalists are now offering lots of 50 yards by 100 yards which gives eight lots per acre. In the Providence area alone there will therefore be land for another eight thousand housing units or 32,000 persons! And then there is the other friend Mr Eddie Boyer who acquired from the Privatisation Unit some 103 acres, of which some 400 hundred lots are on offer which will house another two thousand persons!

The housing bazaar
The other factor that actually makes the whole bazaar for house lots more suspicious and that can create problems for the housing market is that except for the Linden area the house lots are on or within miles of the coast. In other words even the very strange situation painted by these facts is decidedly worse if we deduct the population in the hinterland areas to which the concept of house lots is completely alien.

What has emerged recently is that the house lot policy is not devoid of political considerations and reminds me of the word gerrymandering – a favourite word of Cheddi Jagan when he wanted to accuse his opponents of redrawing the demographic map for electoral purposes. The allocation of land at Diamond and Eccles on the East Bank of Demerara will make an enormous difference in the 2011 elections and can for the first time give the PPP control of Region 4.

In the government’s reckoning, economics take second place to politics and it matters not that there are implications for the other regions from which large numbers of allottees are drawn, issues of public services, utilities, access, etc. In any case none of the political elite lives in Diamond and only a few remain in Eccles.

Oversupply and its implications
Based on these numbers, Business Page safely concludes then that there is an oversupply of housing land, if not yet housing. Had there not been selective controls over disposals of house lots, market forces would have brought down the price for land since it is clear that there are lots of house lots which have not been developed into houses. And of course the price for land cannot be entirely divorced from housing market.

What then are the implications for a bubble? That depends on whether or not the housing boom is financed by borrowings from the banking sector. The real estate problem in the US was triggered by the mortgage crisis as homeowners faced with a contraction in the economy and the loss of jobs were unable to finance their sometimes 100 % mortgages, causing the lenders to foreclose or the borrowers to sell and cut their losses. The effect was the same – too many properties going on the market at the same time and prices collapsing. What started as a problem for individual homeowners and single financial houses soon became a deluge that affected the entire economy from which the US has so far not recovered.

Bank lending
As noted last week, available information from official sources indicates 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%. The 2010 Bank of Guyana Report shows that the share of the commercial banks’ loans and advances to the private sector in real estate was 31%. At first sight this might seem to include both commercial and personal loans but there is reason to believe that lending is categorized by the nature of the underlying business rather than the purpose of the particular loan or advance.

In other words, lending to the distribution sector for real property acquisition is classified not as real estate but distribution. This means that the 31% is really only for personal loans and that the banks are more exposed to the real estate sector than may at first appear. Since commercial properties are on average much more expensive than residential housing, President Jagdeo may have been far too quick and way off target to lightly dismiss concerns about a potential housing bubble.

Banking resilience
What the Bank of Guyana 2010 Report unambiguously discloses is that the total assets of the commercial banks at December 31, 2010 amounted to $296 billion of which total loans and advances were $112 billion, or approximately 38%. On the other hand foreign assets owned by the commercial banks at December 31, 2010 alone amounted to $47 billion, investments in central government were $67 billion and amounts with or claims on Bank of Guyana of $45 billion.

This is more than enough to weather any drastic decrease in real estate prices and prevent any shocks. It would mean however that the value of the banks’ securities and the matching lending would decrease, their profitability and tax obligations would fall, and their overall lending framework would alter. But as we saw some years ago in the rice crisis, and are even now seeing in the US, banks can be extremely resilient and have a remarkable capacity to recover, even from the sternest of tests.

Next week I will look at the implications for the non-bank financial institutions of any sharp decline in the housing market and any other dark clouds hovering over the horizon. As one is always forced to do with matters concerning the Ministry of Housing, I will also ask where all the money for these land sales has gone.

Guyana in a housing bubble – not really

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.

Other players
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