Steve Keen Interview

Steve Keen gives a great explanation on how debt drives asset price bubbles and the implications for housing markets (especially in NZ and Australia). Well worth watching:

A New Tax System for New Zealand

For those who follow what's happening in NZ, the Tax Working Group (TWG) has submitted its recommendations to government. The TWG was set up to review the NZ tax system and provide advice for reform. Bernard Hickey's written a good break down of the report and what it means. For those of you who are interested but uninformed, there's plenty of previous articles from Bernard on the issues here.

As I've written before, there are structural problems with the NZ economy restricting growth and fueling inefficiency. Of these, arguably the most significant is the skewed investment preference of retail investors for residential real estate. This preference is driven by tax incentives and at a deeper level, ignorance.

If the government follows the TWG's advice, the tax incentive will change to a disincentive - with the intention of driving investment from non-productive to productive asset classes. But it won't fix the ignorance problem. Well, not immediately anyway. NZers' proclivity for buy-to-let residential real estate, junk debt (via finance companies), and over-priced domestic corporate bond investment is firmly ingrained. Market efficiency will deal with the ignorance and punish those slow to learn and adapt through poor returns for the risk assumed.

When the reality of the likely tax changes takes hold and domestic retail investors learn that diversification out of their favourite asset classes is helpful, that wall of equity will have to go somewhere. My guess is a good chunk of it will flow into the NZ Stock Exchange. The NZSE provides one of the consistently highest dividend yeilds in the developed world. Offering tax free With capital gains, the retail yield seekers that want their capital return cake too might find this too good to turn down. The NZSE has been under capitalised compared to its developed world peers since the '87 crash when retail investor aversion set in. My bet is things are about to change commencing with a structural break in the tax system - and the NZSE will be on the winning side of the bet.

The Trouble with New Zealand

The NZ Herald published an article today on the banking inquiry panel and the structural problems of the NZ economy. Worth a read for those interested in NZ. Some choice quotes:

New Zealand is "using the credit card to pay the mortgage" and if it continues we will lose our sovereignty to Australia, politicians were told today.

Commentators told opposition MPs holding an inquiry into bank pricing that New Zealand's obsession with property was the cause of most economic problems.

Bernard Hickey, managing director of interest.co.nz, told the inquiry the New Zealand economy was not an economy but a "housing market with a few other things tacked on".

I've written before on this blog how stupid New Zealanders are and their addiction with residential real estate as an asset class. For those that are interested and missed these, you can find them here, here, here and here - I won't bother reposting the facts. Those New Zealanders invested in residential property who lose their shirts and their pension pots will have no one to blame but themselves and their own ignorance. No doubt they will then vote the Labour party in with an election pledge to bail them out of their misery.

Kiwi Retailus Investo-Erectus - The Dumbest of the Breed?

Retail investors in NZ have to be the least savvy of the species in the known world. . .

For those unfamiliar with this ongoing car crash in slow motion, the story over the last 8 years or so has had three main stars: finance companies, corporate debt, and residential real estate. Retail investors have relentlessly thrown their cash at all three.

They have woken up about finance company risk. Hard not to when many of them allocated their entire life savings to one finance company for it to go bankrupt with no prospect of principal return. Non-Kiwi readers would be spellbound at how common this was. The stupidity was astonishing. A toxic combination of greed and a lack of risk premia understanding.

A few have started to work out that a 7.5% coupon yield on corporate debt is not such a good deal when it's not much above what high-street banks are paying for similar terms. NZ's corporate debt issuance typically clocks amongst the lowest spreads (over government backed paper) when compared against similar investment-grade issuance of other first-world countries. Yet the yield-chasing masses appear to care not, corporates keep on issuing and wonder how long this party can last, and brokers are complicit with their perennial ticket clipping. All in all, more retail investor stupidity.

And then there is residential real estate. . . Unlike the two investment classes above, retail investors seem to just not get how bad an investment NZ housing currently is.

That NZ housing trades so far in excess of fair value has been explained well numerous times elsewhere (refer Bernard Hickey here, here, and here. The Economist has also covered this globally for sometime).

There are a number of things that seem immediately apparent when assessing NZ housing as an investment:

• On any fundamental measure (such as house-price to wage-earnings ratio and house-prices to GDP etc.) it is expensive;

• Prospects for the economy look pretty grim at least up to the medium-term and prospects for house price inflation for a long way out do too. Indeed a good proportion of analysts are still predicting further decreases in house prices;

• Any debt-backed investor is facing a negative yield gap from time zero, except for those with the lowest of loan-to-value ratios. (Initial yields in greater Auckland are around 3.9% and 5yr fixed mortgage rates average 8%).
  

So why would anyone buy something that is priced above fundamental fair value, has little prospect of offering a capital gain any time soon, has poor prospects for earnings (rental) growth, requires active and hands-on management, and in a product where the income won't even service the debt?

And yet they're queueing up around the block for a portion.

No margin of safety. One can only conclude that they are all paid-up subscribers to the Greater Fool theory. Or just plain stupid.

Case Shiller Housing Happiness [updated]

Nick Gogerty has put together a video using Shiller data showing median incomes relative to house values for selected cities in the US.



The equity build-up and subsequent value loss is sobering. A lot of people have mused retrospectively that if only they had geared themselves to the hilt in '98 and started buying up streets in London, captured all that levered yield shift, and got out in early '07, they'd be zillionaires now. If only. . .

Some missed this boat, knew it and thought they'd jump on the momentum of the convergence play and get involved in some juicy CEE buy-off-plan/ buy-to-let action. Well we know how that ended. And it wasn't such a bad idea. Timing just ended up being everything.

Negative convexity is such a great thing. Except when yields move out.

I wonder how this data would play out for London? What if you bought your London house back in say '02 or even '04? Would you now be back to Y2k levels? Maybe you don't want to know. Ouch.

Nick offers a few more comments in his post over at Designing Better Futures.

UPDATE: Check out this excellent post over at Not PC on house prices. Very good. Hat tip to Batesy.