I am having a little problem understanding how Obama’s new Financial Regulations are going to prevent another meltdown in the future
I understand the limiting of financial institutions including the repeating of not allowing irresponsible behaviour (note: was already in the CRA bill) but how is it going to prevent individual people from repeating the same credit mess. The Banks were very much to blame but also the people borrowing irresponsibly.
If your credit rating is good, better access to your own credit ratings, in theory one can gear very highly. If your credit is mediocre, you can still gear fairly well on credit. The Banks may no longer borrow off and deposit off one another, but people can still play the field. Responsible people won’t be tempted, but this current crisis tells us that there are enough irresponsible people out there who will be tempted enough to force prices up pulling in more people to the upward spiral, that will burst and crash.
There needed to be recognition of all the failures and that there were several sides to the catastrophic melt down before writing the new legislation.
Credit growth needed better controls on individual levels. They have placed ceilings on it in South Africa, a bit harsh but implemented earlier would have lessened the crunch. Much of their crisis is due to the over extending of individual borrowing. We need to see a return to a more sound level of savings to credit ratio for families.
This also means the reviewing the way mortgages are handled and seeking decent deposits on family homes from the start and later curbing abuse by limiting the extending of mortgages for personal consumption as property values climbs. Limiting these extensions to home improvements and medical emergencies is not going to expose the market.
This also will mean that tax changes and other sudden impacts such as interest hikes or fuel increases are not going to have such an impact.
I dislike the idea of excess control of individual finance, however we are going to go through this all again in the next 15 years unless all the parties are more carefully monitored. Allow for continued and strong growth without letting the reckless ruin it for the rest of us all by domino effect down the chain.
Sunday, August 22, 2010
Tuesday, August 10, 2010
Retaining Skills in Africa - South African Tertiary System
People rarely get what they really want because there are trade offs on aspects of value. How do these people choose? People just make the choices that they believe will make them happiest. They accept the trade offs for the best solution.
So why is there a migration of skills from South African tertiary education institutions into commercial sector or even the export of the same to other countries? Well other than that they are not happy?
This year in particular I have been looking at tertiary education for my children, they are getting to an age that with all the competition for places we need to review what options are out there.
South Africa was my first port of call. That was a wake up call. Looking into the international standing of their degrees, given that 20 years ago they were very international and highly ranked, there have been some serious losses in some of their standings. Those whispered concerns over the past couple of years had some weight. They are now involved in an escalating pay dispute.
There are numerous ways that standing can be lost, many without actual standards being compromised. It comes down to the acceptability to the international corporations, governments and their perceptions. What is their confidence in the proffered tertiary qualifications? The loss of autonomy, their reorganisation of institutions, the reduction in research and the reputation of their disappearing staff. The school system’s social experiment has produced a confusing intake for the tertiary education.
In many post independence African Nations there has been the itch, urge to reform the tertiary education. Some justified, but without due consideration it has discounted and in several cases devalued the qualifications until they are only recognised within their own borders. In an effort to provide it all for everyone they are producing more of reduced value.
The biggest hit these institutions have taken is the retention of notable staff and even decent staff. Traditionally academic professionals are paid considerably less than their commercial counterparts. The security, lower stress and satisfaction have meant that they have traded income for satisfaction. The past few years their pay has been eroded by inflation and increases not near equal to inflation.
I was in South Africa a fortnight back and had a discussion with a friend, a past lecturer. He had been doing some part time work to keep in touch with the commercial sector and earn a few extra bucks. He has now dumped lecturing in favour of commercial sector. He could no longer make ends meet. I queried dropping his dreams of moving up the ranks of the University and the response that by the time he was a Dean he could look to living in a shanty town shack. Similar responses have been forthcoming from other lecturers that I know who are casting about for alternatives in the recession.
They have lost their satisfaction, eroded by poor remuneration and we see their Civil Service hustling for a 8% increment and the Govt refusing as they claim that the CPI (Consumer Price Index) is 7%. Working for a week there every few months has allowed me to see that the CPI needs segregation as the basket for civil servants, lower incomes, is not the same basket for others. There are some costs that have dropped bringing the CPI down with them and these are home prices and in real terms losses. With the World Cup the prices were ratcheted up and I note have not come down.
At the end of the day the dedicated and talented are most often very marketable and move to seek satisfaction and better remuneration in other countries. So South Africa is exporting it’s skills in key ministries that keep the population and next generation, on it’s feet and productive and we hear Africa’s lamentation “ we are loosing our skills”.
Education is a long term investment and commitment yet we see South Africa continues to loose it’s skills in key ministries that keep the population on it’s feet and productive. The standing of any tertiary institution is a live status, not unlike that of the tennis rankings, if it doesn’t move one way it will move the other. Rarely in stasis, there are new comers trying for a piece of the pie and those who fall find it a long climb back up.
So why is there a migration of skills from South African tertiary education institutions into commercial sector or even the export of the same to other countries? Well other than that they are not happy?
This year in particular I have been looking at tertiary education for my children, they are getting to an age that with all the competition for places we need to review what options are out there.
South Africa was my first port of call. That was a wake up call. Looking into the international standing of their degrees, given that 20 years ago they were very international and highly ranked, there have been some serious losses in some of their standings. Those whispered concerns over the past couple of years had some weight. They are now involved in an escalating pay dispute.
There are numerous ways that standing can be lost, many without actual standards being compromised. It comes down to the acceptability to the international corporations, governments and their perceptions. What is their confidence in the proffered tertiary qualifications? The loss of autonomy, their reorganisation of institutions, the reduction in research and the reputation of their disappearing staff. The school system’s social experiment has produced a confusing intake for the tertiary education.
In many post independence African Nations there has been the itch, urge to reform the tertiary education. Some justified, but without due consideration it has discounted and in several cases devalued the qualifications until they are only recognised within their own borders. In an effort to provide it all for everyone they are producing more of reduced value.
The biggest hit these institutions have taken is the retention of notable staff and even decent staff. Traditionally academic professionals are paid considerably less than their commercial counterparts. The security, lower stress and satisfaction have meant that they have traded income for satisfaction. The past few years their pay has been eroded by inflation and increases not near equal to inflation.
I was in South Africa a fortnight back and had a discussion with a friend, a past lecturer. He had been doing some part time work to keep in touch with the commercial sector and earn a few extra bucks. He has now dumped lecturing in favour of commercial sector. He could no longer make ends meet. I queried dropping his dreams of moving up the ranks of the University and the response that by the time he was a Dean he could look to living in a shanty town shack. Similar responses have been forthcoming from other lecturers that I know who are casting about for alternatives in the recession.
They have lost their satisfaction, eroded by poor remuneration and we see their Civil Service hustling for a 8% increment and the Govt refusing as they claim that the CPI (Consumer Price Index) is 7%. Working for a week there every few months has allowed me to see that the CPI needs segregation as the basket for civil servants, lower incomes, is not the same basket for others. There are some costs that have dropped bringing the CPI down with them and these are home prices and in real terms losses. With the World Cup the prices were ratcheted up and I note have not come down.
At the end of the day the dedicated and talented are most often very marketable and move to seek satisfaction and better remuneration in other countries. So South Africa is exporting it’s skills in key ministries that keep the population and next generation, on it’s feet and productive and we hear Africa’s lamentation “ we are loosing our skills”.
Education is a long term investment and commitment yet we see South Africa continues to loose it’s skills in key ministries that keep the population on it’s feet and productive. The standing of any tertiary institution is a live status, not unlike that of the tennis rankings, if it doesn’t move one way it will move the other. Rarely in stasis, there are new comers trying for a piece of the pie and those who fall find it a long climb back up.
Monday, August 9, 2010
Community Reinvestment Act and its Place in the Property and Financial Markets.
Here I express my concern of how the current crisis has been blanket blamed by Politicians on the financial sector when the dance was with other willing partners. The financial sector led the dance but it seems that everyone was willing and more than a little tipsy on success. There is considerable denial that the C.R.A was even at the dance. The Govt’s apparent lack of control seems like they were complicit, collecting the tax ticket sales at the door.
In searching I have come up with considerable denials that C.R.A was responsible for the Sub-Prime crisis. Ahh – no it isn’t, certainly not directly. However it was part of the dance and partly responsible for a Black Tie event turning into an orgy.
When considering that the economy is built on several foundation stones that include the mix of legislation, property development (that is tightly intertwined) with the financial industry we can note that none stands alone. One may lead, but not without the willing approval of the others.
Property and legal systems are very much part of the crash, the legal systems were relaxed far too much and there has been much hustle and bustle putting in place legislation to prevent a repeat of this. This quietly acknowledges that the legal system played a part in the problem.
The property industry has a significant proportion as “homeowners”, the “homeowner” sector formed a bubble that popped. The “homeowner” sector includes a significant amount of disadvantaged C.R.A members. The following work is about the C.R.A and it’s place in the building and property industry.
Importance of the Building and Property Industries
The building industry provides employment for a considerable proportion of the workforce. These people in turn provide purchasing power into the market. The building industry buys in a large proportion of the nation’s production promoting other industries.
This industry provides premises for business, industry and families. This occurs through the provision of new and refurbished premises.
Thus industry, businesses and homes can maintain standards and when the economy expands it can provide more space.
Property is an asset used as security for funding new industry and home loans. This is a powerful tool for economic growth. The lack of this tool is evident in many nations with poor property rights.
The building industry is a major economic indicator, and I believe a foundation stone of any nation’s economy. The multiplier effect means that any government spending/cuts into this sector has a high ratio geared effects on the economy thus it is a valuable fiscal tool.
Supply of Buildings
Buildings take time to put up. They remain in existence for 20-40 years through various repairs, upgrades and changes of use. However they are there and whoever owns them, for the building is there for the very long term.
When demand rises the industry does not immediately respond with supply. It is inelastic. Slow to respond as surplus space is absorbed and prices rise. When yields are acceptable development starts. This goes for any interest rate. However lower interest rates improve the yields and the likelihood is that industry kick starts earlier.
With a development taking 6-24months, especially using brick and mortar, there is a considerable lag from “go ahead” to completing the sale with the owner taking possession.
Demand drives and leads the market. It dictates prices for existing stock and the nature of the new, frequently custom designed buildings. So supply follows and provides buildings to suit demand.
Once a building is up it is going to be there for a long time even if demand falls. The existing supply of buildings remains constant (slowly diminishing over a very long time) but immediate supply, through the building industry, is hit hard and fast leaving approvals on hold, sites abandoned etc.
Building Demand
Demand is dictated by affordability. This is a mix of the construction cost of the building and cost of money (interest) to give a full combined cost. With people borrowing to buy this comes down to monthly cost for the majority of buyers.
Since buildings and needs for buildings are diverse the “design and locations” are part of the demand structure for buildings. When the specifications of a building are no longer needed the demand for it no longer exists and it is obsolete. When the monthly cost of a building becomes comparatively expensive, the demand for that building drops. This can be caused either through price increases or competitive buildings being priced lower. In apartment towers, malls this is visible through vacancy rates.
Interest
2.5% interest over 25 years means that interest makes for 46% of a monthly repayment. Increase interest to 3.5% over 25 years increases the interest portion to 58% of monthly repayment. On a loan, moving from 2.5% to 3.5% means an overall increase in monthly repayments of 12%. As home repayments are a huge proportion of a family’s budget an increase can have a detrimental impact on a family’s welfare.
For a business or family with a set budget an interest rise means buying or moving to lower cost premises.
Home Mortgages
A home loan takes up a significant proportion of a family’s take home pay. It is safe to say that interest hikes place a heavy burden on a family. A mortgage is virtually fixed on the basis of purchase price. As the value of a property drops then the owner is left increasingly exposed.
How big are mortgages? Most people choose to suit their life style and earning capacity. Smaller the mortgage the better, however if there are no properties within their range and their social structure they will buy, reluctantly, up a level. This means that prices are higher and building supply following slowly. However this means a higher vulnerability. With a solid banking system these risks are covered by, mortgage refusal, repossession and higher rates.
The cost of a home is significant for anyone and more significant the lower your income. There is a point that they are not normally affordable or low earners are too higher risk. We start venturing into the world of Subprime.
Banks are involved in most buildings and building deals. Some homes are paid off with a value that can be used to raise funds or other benefits by accommodation or rental incomes. If sold often there is a new mortgage raised for the new buyer with the seller taking credit in a bank or financial fund that in turn invests in property.
When it all goes mushy the banks loose repayments, their repo values drop and their asset values drop affecting pensions etc. The properties are still there and as the market recovers the losses are made good with the increase in property values and revival of the building industry.
Most government spending tends to have a very watered down effect on this sector. Their most effective tool is the prime rate that can affect the affordability of property and curb or stimulate demand.
Subprime
They often rent. They also want homes of their own. So subsidisation and rent control come first to mind. They are a mix of high risk people, some disadvantaged, some poor credit responsibility.
However high risk, subprime, loans are available so some, many, buy a stake in the property market. Using what they would normally pay in rent to a landlord they are able to escape the instability of renting. In a stable market the banks get higher interests to cover higher default rates. In growing markets the banks win and the disadvantaged win with increasing property values.
The Subprime clique creates a new sector of demand on the market. Those from lower income areas don’t do much more than reduce a heavy demand for subsidised rentals in an over subscribed market.
In a period of poor market demand they soak up much of the under-utilised existing supply and boost the economy.
Many move into the existing first rung home ownership. In doing so there is a social migration and they increase the demand on this level. Prices rise as availability remains short term static. Then many of the first rung move up a rung with their slightly better buying power, or having already paid off much of their mortgage. They now have a higher mortgage and a lower resilience. This shift occurs slowly up the ladder lessening as it rises. It also triggers the supply for the building of flats and housing complexes are put up that reduces the pressure higher up the ladder.
The building industry moves up a notch and this boosts the economy so that more people that can afford housing in an upward spiral. Interest rates often dip. Increased incomes boost funds from banks and pensions that are thus invested in more expensive, though rising value properties.
This also creates more demand on first rung level so that more disadvantaged are earning enough to climb onto the first rung to repeat the cycle with bank loans expanding accordingly.
This is a win-win and double win situation. Yet this, unchecked is a bubble, an artificial demand because there comes an equilibrium of more people sitting, some on a higher rung, on the ladder whose bottom rung is wobbly and centred on the lower income areas.
The Pitfall
The world goes through cycles. The dips clean out the inefficient and the booms create growth. Excessive cycles the dips clean out more than the inefficient and the booms create inefficiency.
So even in dips the Subprime sector takes a knock but the costs attributable to risks were covered by higher interest rates. There has always been a very small, high risk/return market. However this grew to being significant and unsustainable.
Given a hard knock, in an over exposed market, the demand for buildings falters, meaning that the demand for new buildings brakes that much harder. The drop in demand creates a negative spiral steeper than the upward spiral. The lower down the ladder the harder the brakes go on. Too fast and the building industry implodes.
So many more people are home owners than should be and yet even more people are financially exposed. They face reduced incomes. The large stock of existing homes means that supply remains medium term constant against a short term drop in demand causing disproportionate price drops. These price drops are likely to mean that too frequently the loan>market value of a property. This value has gone, but where? This value is the price for the market carrying those long term unviable home owners.
The property markets drop taking with them the values of investment assets of banks and funds.
Subprime is not a long term lending option without some system of bailout. Short term or a few carefully controlled long term home owners.
C.R.A – Citizen Reinvestment Act
This is legislation implemented by President Carter’s Administration. It was in reaction to the inability for many lower income families to access home finance and being unable to own their own homes and raise their standard of living.
http://www.federalreserve.gov/dcca/cra/
http://en.wikipedia.org/wiki/Community_Reinvestment_Act
American history is rich with thrift banks and their failures. Financial Discrimination has been removed in legislated steps, sexual, racial and with the CRA the basis of redlined (high risk) neighbourhoods. Removal of most of the discrimination is understandable and beneficial to financial institutions. However there was a solid reason to discriminate against the lower income as they were not likely to be able to repay their loans.
The idea was that the community in which a financial institution was present had to provide service to the disadvantaged in order for the community in order for rating approval. In short the C.R.A provided the community the leverage to delay and halt the efforts of banks to merge or expand until they had agreed to lower their credit standards
The idealistic implementation of the C.R.A has considerable merit, placing home ownership to the disadvantaged. Many people achieve fully paid off home ownership strengthening communities and economies. The application of the CRA is prevalent in poorer areas and has had a positive effect in these areas but leaving them exposed to being hit them harder in downturns.
There is a legal caveat:- banks should not expose themselves to undue risk. This is a serious piece of “damned if you do, damned if you don’t”.
These community demands are not matched by other socio economic factors that could underpin the C.R.A in those communities. As the C.R.A affects a critical portion of the property sector the role it plays in the economy is significant. So it became a history of simple bullying to provide for high risk subprime loans in a barely disguised social levy.
Summation
The current crisis has been blamed on the financial sector. To a large extent this is true through the gearing of sub-prime through the system. A strong revisiting of circumstances to avoid repeats is required. However the practice of funding high risk and underprivileged “home owners” using higher rates, boosted the demand side in a ripple effect up the property ladder over stimulating supply and creating an unnatural boost to the economy. The supply lagged and prices were generally a few notches over the top so it meant that too many more “home owners” had increased exposure and supply caught up.
When an existing, sensitive property market has a very weak high risk foundation that is more likely to fail. When things go wrong the drop is further and harder with it being more likely to shake off more “home owners” from the property ladder. This foundation needs to be secured. Not left to falter again.
When it all went mushy the under regulated banks loose repayments, their repo values crashed and their asset values crashed crippling banks and pensions etc. The properties are still there with an over supply so that the full revival of the building industry simply is not going to happen for some time and pull the economy up.
Having extracted a huge cloaked and inefficient tax that has assisted in the demise of institutions the Government now part owns it, through bail outs.
The C.R.A has been noted, against firm denial, as a factor of this current crash. Direct hard-line evidence is lacking, however as a large factor of the subprime it is a strong factor in influencing the demand led building and property industry that affects every part of the economy.
So indirectly the C.R.A is very significant, in terms of the property ladder it is the wood rod at it’s base.
So what are the options?
There is the opportunity of targeting the disadvantaged to boost flagging property demand in some areas. Put in a mixed package of redevelopment & rejuvenation it can boost local economies, employment and communities.
Getting rid of subprime will hurt the disadvantaged. C.R.A using subprime as a solution is not long term sustainable, never was. It has had significant benefit and should be part of a larger package that underpins the ability of the C.R.A homeowner to sustain repayments and lower the risk.
The communities should be using C.R.A to support urban renewal, not just upping the value of existing entry level properties, with a mixed effect. By taking older, rented run down properties up to standard, community social liabilities are reduced and replaced by assets. At the same time they will be generating income streams for the communities.
This would require the community working with government to get those buildings and properties purchased and set aside for C.R.A class purchase. The funds for buying the building being returned to govt coffers as the mortgages come through. A system that can be repeated pushing back the redline boundaries into a smaller and smaller area.
Leave it in isolation to market forces the irregular and exaggerated cycle will repeat itself new bank regulations or not. So while the banks are being increasingly regulated so should the application of the C.R.A. The new legislation is in place, with the current President as a past player in A.C.O.R.N I don’t hold much hope that this issue is truly tackled.
Without the communities and Government underpinning the Bank’s C.R.A obligations it will happen all over again in different and exciting ways.
In searching I have come up with considerable denials that C.R.A was responsible for the Sub-Prime crisis. Ahh – no it isn’t, certainly not directly. However it was part of the dance and partly responsible for a Black Tie event turning into an orgy.
When considering that the economy is built on several foundation stones that include the mix of legislation, property development (that is tightly intertwined) with the financial industry we can note that none stands alone. One may lead, but not without the willing approval of the others.
Property and legal systems are very much part of the crash, the legal systems were relaxed far too much and there has been much hustle and bustle putting in place legislation to prevent a repeat of this. This quietly acknowledges that the legal system played a part in the problem.
The property industry has a significant proportion as “homeowners”, the “homeowner” sector formed a bubble that popped. The “homeowner” sector includes a significant amount of disadvantaged C.R.A members. The following work is about the C.R.A and it’s place in the building and property industry.
Importance of the Building and Property Industries
The building industry provides employment for a considerable proportion of the workforce. These people in turn provide purchasing power into the market. The building industry buys in a large proportion of the nation’s production promoting other industries.
This industry provides premises for business, industry and families. This occurs through the provision of new and refurbished premises.
Thus industry, businesses and homes can maintain standards and when the economy expands it can provide more space.
Property is an asset used as security for funding new industry and home loans. This is a powerful tool for economic growth. The lack of this tool is evident in many nations with poor property rights.
The building industry is a major economic indicator, and I believe a foundation stone of any nation’s economy. The multiplier effect means that any government spending/cuts into this sector has a high ratio geared effects on the economy thus it is a valuable fiscal tool.
Supply of Buildings
Buildings take time to put up. They remain in existence for 20-40 years through various repairs, upgrades and changes of use. However they are there and whoever owns them, for the building is there for the very long term.
When demand rises the industry does not immediately respond with supply. It is inelastic. Slow to respond as surplus space is absorbed and prices rise. When yields are acceptable development starts. This goes for any interest rate. However lower interest rates improve the yields and the likelihood is that industry kick starts earlier.
With a development taking 6-24months, especially using brick and mortar, there is a considerable lag from “go ahead” to completing the sale with the owner taking possession.
Demand drives and leads the market. It dictates prices for existing stock and the nature of the new, frequently custom designed buildings. So supply follows and provides buildings to suit demand.
Once a building is up it is going to be there for a long time even if demand falls. The existing supply of buildings remains constant (slowly diminishing over a very long time) but immediate supply, through the building industry, is hit hard and fast leaving approvals on hold, sites abandoned etc.
Building Demand
Demand is dictated by affordability. This is a mix of the construction cost of the building and cost of money (interest) to give a full combined cost. With people borrowing to buy this comes down to monthly cost for the majority of buyers.
Since buildings and needs for buildings are diverse the “design and locations” are part of the demand structure for buildings. When the specifications of a building are no longer needed the demand for it no longer exists and it is obsolete. When the monthly cost of a building becomes comparatively expensive, the demand for that building drops. This can be caused either through price increases or competitive buildings being priced lower. In apartment towers, malls this is visible through vacancy rates.
Interest
2.5% interest over 25 years means that interest makes for 46% of a monthly repayment. Increase interest to 3.5% over 25 years increases the interest portion to 58% of monthly repayment. On a loan, moving from 2.5% to 3.5% means an overall increase in monthly repayments of 12%. As home repayments are a huge proportion of a family’s budget an increase can have a detrimental impact on a family’s welfare.
For a business or family with a set budget an interest rise means buying or moving to lower cost premises.
Home Mortgages
A home loan takes up a significant proportion of a family’s take home pay. It is safe to say that interest hikes place a heavy burden on a family. A mortgage is virtually fixed on the basis of purchase price. As the value of a property drops then the owner is left increasingly exposed.
How big are mortgages? Most people choose to suit their life style and earning capacity. Smaller the mortgage the better, however if there are no properties within their range and their social structure they will buy, reluctantly, up a level. This means that prices are higher and building supply following slowly. However this means a higher vulnerability. With a solid banking system these risks are covered by, mortgage refusal, repossession and higher rates.
The cost of a home is significant for anyone and more significant the lower your income. There is a point that they are not normally affordable or low earners are too higher risk. We start venturing into the world of Subprime.
Banks are involved in most buildings and building deals. Some homes are paid off with a value that can be used to raise funds or other benefits by accommodation or rental incomes. If sold often there is a new mortgage raised for the new buyer with the seller taking credit in a bank or financial fund that in turn invests in property.
When it all goes mushy the banks loose repayments, their repo values drop and their asset values drop affecting pensions etc. The properties are still there and as the market recovers the losses are made good with the increase in property values and revival of the building industry.
Most government spending tends to have a very watered down effect on this sector. Their most effective tool is the prime rate that can affect the affordability of property and curb or stimulate demand.
Subprime
They often rent. They also want homes of their own. So subsidisation and rent control come first to mind. They are a mix of high risk people, some disadvantaged, some poor credit responsibility.
However high risk, subprime, loans are available so some, many, buy a stake in the property market. Using what they would normally pay in rent to a landlord they are able to escape the instability of renting. In a stable market the banks get higher interests to cover higher default rates. In growing markets the banks win and the disadvantaged win with increasing property values.
The Subprime clique creates a new sector of demand on the market. Those from lower income areas don’t do much more than reduce a heavy demand for subsidised rentals in an over subscribed market.
In a period of poor market demand they soak up much of the under-utilised existing supply and boost the economy.
Many move into the existing first rung home ownership. In doing so there is a social migration and they increase the demand on this level. Prices rise as availability remains short term static. Then many of the first rung move up a rung with their slightly better buying power, or having already paid off much of their mortgage. They now have a higher mortgage and a lower resilience. This shift occurs slowly up the ladder lessening as it rises. It also triggers the supply for the building of flats and housing complexes are put up that reduces the pressure higher up the ladder.
The building industry moves up a notch and this boosts the economy so that more people that can afford housing in an upward spiral. Interest rates often dip. Increased incomes boost funds from banks and pensions that are thus invested in more expensive, though rising value properties.
This also creates more demand on first rung level so that more disadvantaged are earning enough to climb onto the first rung to repeat the cycle with bank loans expanding accordingly.
This is a win-win and double win situation. Yet this, unchecked is a bubble, an artificial demand because there comes an equilibrium of more people sitting, some on a higher rung, on the ladder whose bottom rung is wobbly and centred on the lower income areas.
The Pitfall
The world goes through cycles. The dips clean out the inefficient and the booms create growth. Excessive cycles the dips clean out more than the inefficient and the booms create inefficiency.
So even in dips the Subprime sector takes a knock but the costs attributable to risks were covered by higher interest rates. There has always been a very small, high risk/return market. However this grew to being significant and unsustainable.
Given a hard knock, in an over exposed market, the demand for buildings falters, meaning that the demand for new buildings brakes that much harder. The drop in demand creates a negative spiral steeper than the upward spiral. The lower down the ladder the harder the brakes go on. Too fast and the building industry implodes.
So many more people are home owners than should be and yet even more people are financially exposed. They face reduced incomes. The large stock of existing homes means that supply remains medium term constant against a short term drop in demand causing disproportionate price drops. These price drops are likely to mean that too frequently the loan>market value of a property. This value has gone, but where? This value is the price for the market carrying those long term unviable home owners.
The property markets drop taking with them the values of investment assets of banks and funds.
Subprime is not a long term lending option without some system of bailout. Short term or a few carefully controlled long term home owners.
C.R.A – Citizen Reinvestment Act
This is legislation implemented by President Carter’s Administration. It was in reaction to the inability for many lower income families to access home finance and being unable to own their own homes and raise their standard of living.
http://www.federalreserve.gov/dcca/cra/
http://en.wikipedia.org/wiki/Community_Reinvestment_Act
American history is rich with thrift banks and their failures. Financial Discrimination has been removed in legislated steps, sexual, racial and with the CRA the basis of redlined (high risk) neighbourhoods. Removal of most of the discrimination is understandable and beneficial to financial institutions. However there was a solid reason to discriminate against the lower income as they were not likely to be able to repay their loans.
The idea was that the community in which a financial institution was present had to provide service to the disadvantaged in order for the community in order for rating approval. In short the C.R.A provided the community the leverage to delay and halt the efforts of banks to merge or expand until they had agreed to lower their credit standards
The idealistic implementation of the C.R.A has considerable merit, placing home ownership to the disadvantaged. Many people achieve fully paid off home ownership strengthening communities and economies. The application of the CRA is prevalent in poorer areas and has had a positive effect in these areas but leaving them exposed to being hit them harder in downturns.
There is a legal caveat:- banks should not expose themselves to undue risk. This is a serious piece of “damned if you do, damned if you don’t”.
These community demands are not matched by other socio economic factors that could underpin the C.R.A in those communities. As the C.R.A affects a critical portion of the property sector the role it plays in the economy is significant. So it became a history of simple bullying to provide for high risk subprime loans in a barely disguised social levy.
Summation
The current crisis has been blamed on the financial sector. To a large extent this is true through the gearing of sub-prime through the system. A strong revisiting of circumstances to avoid repeats is required. However the practice of funding high risk and underprivileged “home owners” using higher rates, boosted the demand side in a ripple effect up the property ladder over stimulating supply and creating an unnatural boost to the economy. The supply lagged and prices were generally a few notches over the top so it meant that too many more “home owners” had increased exposure and supply caught up.
When an existing, sensitive property market has a very weak high risk foundation that is more likely to fail. When things go wrong the drop is further and harder with it being more likely to shake off more “home owners” from the property ladder. This foundation needs to be secured. Not left to falter again.
When it all went mushy the under regulated banks loose repayments, their repo values crashed and their asset values crashed crippling banks and pensions etc. The properties are still there with an over supply so that the full revival of the building industry simply is not going to happen for some time and pull the economy up.
Having extracted a huge cloaked and inefficient tax that has assisted in the demise of institutions the Government now part owns it, through bail outs.
The C.R.A has been noted, against firm denial, as a factor of this current crash. Direct hard-line evidence is lacking, however as a large factor of the subprime it is a strong factor in influencing the demand led building and property industry that affects every part of the economy.
So indirectly the C.R.A is very significant, in terms of the property ladder it is the wood rod at it’s base.
So what are the options?
There is the opportunity of targeting the disadvantaged to boost flagging property demand in some areas. Put in a mixed package of redevelopment & rejuvenation it can boost local economies, employment and communities.
Getting rid of subprime will hurt the disadvantaged. C.R.A using subprime as a solution is not long term sustainable, never was. It has had significant benefit and should be part of a larger package that underpins the ability of the C.R.A homeowner to sustain repayments and lower the risk.
The communities should be using C.R.A to support urban renewal, not just upping the value of existing entry level properties, with a mixed effect. By taking older, rented run down properties up to standard, community social liabilities are reduced and replaced by assets. At the same time they will be generating income streams for the communities.
This would require the community working with government to get those buildings and properties purchased and set aside for C.R.A class purchase. The funds for buying the building being returned to govt coffers as the mortgages come through. A system that can be repeated pushing back the redline boundaries into a smaller and smaller area.
Leave it in isolation to market forces the irregular and exaggerated cycle will repeat itself new bank regulations or not. So while the banks are being increasingly regulated so should the application of the C.R.A. The new legislation is in place, with the current President as a past player in A.C.O.R.N I don’t hold much hope that this issue is truly tackled.
Without the communities and Government underpinning the Bank’s C.R.A obligations it will happen all over again in different and exciting ways.
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