New Onion

So, we’re seeing a public-private partnership to build large docks. Smells like an opportunity for more legal corruption.

Cross Island Marina will be built under a private-public partnership between the West End Development Company (Wedco) and South Basin Development Ltd….

“The multi-phased Cross Island Marina project will offer approximately 200 slips, along with support and club facilities. It will include a mix of slip sizes —100 to 250 feet and possibly in excess of 300 feet long — to accommodate both mega-yachts and those smaller in size. The marina will offer exceptional services for yacht owners, captains, crews and their vessels and it is anticipated that a large number of local yacht owners will take advantage of the new facility.

Here are my questions:
- Who is “South Basin Development Ltd.”? EVERY SINGLE SHAREHOLDER.
- Has the contractor been chosen? ie. is this just to keep Correia’s Gravy Train continuing after the cruise ship terminals and other Dockyard work is finished?
- Is it going to be public risk, private profit?
- Why would mega yachts come here to be serviced?
- Is there a shortage of slip space in Bermuda?
- How do the financials work? Who pays for what? How much will it cost?
- What local yacht owners (I can think of 5 “local” boats and some ferries that may be large enough to use such a facility)?
- Where are the people going to come from to run it/do the work?
- How will the average person be better off?

This smells like another hair-brained idea ripe for corruption and self-dealing. Convince me it’s not, given the history of government projects down there the burden of proof is on those claiming not to be crooked.

Looks like the Gazette is picking up on what some of us have been predicting… in 2007 I was bullish on the construction industry because I thought that increases in employment would continue and demand for housing would rise to a corresponding degree. The combination of term limits, tighter financing, and global recession has taken us toward the scenario that became more clear in mid 2008.

Overbuilding of commercial buildings is the culprit this time.

In July 2008 I wrote:

The next casualty if real estate goes will be the construction boom. Prices of construction have already risen substantially in dollar terms If the public’s ability to buy falls then builders will not be able to sell quickly, returns to speculative builders will fall, and some may lose money and those most dependent on leverage will fail while most slow down the pace of building. Then the workers building them may then be unemployed – the failure of education and lure of the drug industry have sent a large number of young Bermudians into the combination of drug dealing and construction work. They are going to be pissed off and the effects on Bermuda will be quite painful.

Denis over at 21square.com has also written about this.

Odds of a large hotel project are very low, although there may be a lot of cleanup work done at Morgan’s Point I think we can be sure that the ultimate beneficiaries will be the usual Friends and Family Plan members. At the same time, the overspending by government during the boom times and deficit spending to fund current expenditure has left the government unable to prudently pursue large capital projects now in a time of cheaper construction.

After my recent posts of relative skepticism about the Bermuda real estate market I think it’s worth outlining the bull case for Bermuda real estate. It can be located right here: Royal Gazette Employment Classifieds.

As long as the government continues to allow population growth then Bermuda’s economy will continue to grow largely independent of the rest of the world, and despite poor government (really terrible government could still cause a local recession/depression). However this population growth fuels the decline in standards of living as more of us are packed into condos/human filing cabinets, and spend more of our lives sitting in traffic. This population growth also shields government from responsibility and side effects of having a government producing large numbers of (mostly black, mostly male) people who are only employed because we are building as fast as we can to provide housing for the growing population, so as long as the government continues to keep the demand side for housing growing by allowing net immigration, and as long as they continue to artificially constrain the supply side through incompetent management of urban planning and building control, then we should see prices remain firm.

Of course, we are building a social house of cards by leaving the lower income Bermudians chronically under-housed, and by keeping prices and rents high are transferring wealth from the young and poor to older (mostly white) home owners.

Anyone who claims the PLP is the party of “social justice” is clueless.

Since Bermuda’s government is picking up on the American right-wing’s penchant for outsourcing of government functions it’s probably worth it to start asking the question: Are government contractors more efficient than the civil service?

From the Wall Street Journal opinion section a somewhat slanted view:

One fact about government outsourcing is settled: It sure doesn’t save money. A Washington Post reporter who scrutinized Katrina reconstruction contracts in 2006 found that “the difference between the job’s actual price and the fee charged to taxpayers ranged from 40 percent to as high as 1,700 percent.” To cover damaged roofs with tarps, certain contractors billed the government $1.50 per square foot of roof covered; some of the people who actually did the work got under 10 cents per square foot. Guess who kept the difference.

The issue in my books are incentives – what are the incentives we create when we contract out government functions?

Disclaimer: The following is speculative. I have no non-public information on current banking conditions whatsoever and am very likely wrong, or at least I hope the worst does not come true.

The Royal Gazette picked up a real estate story… just in time for me to finish another – somewhat speculative piece about real estate markets of the future.

The value of a bond is dependent on the amount of the regular interest (coupon) payments and the prevailing interest rates. When interest rates rise the interest payment amount of a bond stay the same, but it’s possible to get new bonds that make a higher interest payment, so the value of the old bond falls.

So for real estate: if interest rates rise, the amount that can be borrowed falls for any given payment amount.

The more that debt is used as a tool to buy property, the more that property will behave like a bond, rising as interest rates fall and falling as they rise. With increasing use of 100% financing and other “innovative” financing methods this part of what happened in the United States. Incidentally, this is why we should be very wary of any government initiative that simply serves to increase the amount of debt that consumers are able to take on to buy a property, such as giving away down payments. They tend to raise house prices in the short run, but if house prices fall and someone has borrowed all the money to buy it then the lender has immediately lost money. If the lender is the government then it’s the taxpayer who is in trouble – which in the USA is exactly what will happen as the US government is ultimately backing much of the mortgage industry.

What I missed is that the lender’s use of Mark to market accounting adds another dimension to the dynamic. And was the driver of the first waves of the credit crisis. Banks are highly leveraged – they often have leverage of on the order of 15:1, which is to say they have large amounts of assets and debt that are based on a fairly small amount of equity. When the value of their assets falls they then have to reduce their lending or raise capital to return their leverage (which they call “reserve ratio”) to more normal levels. As the credit crisis continues it is now appearing quite likely that some major financial players will (or already have) reached the point where their liabilities (debts) exceed the values of their assets, making them effectively insolvent. The US Federal government is then going to start to take these risks onto its balance sheet – as has begun with Fannie Mae and Freddie Mac, both of which would otherwise be sliding into bankruptcy, and if the Fed is not able to stem the decline in confidence those two will in all likelihood be joined by a variety of other financial institutions.

Bloomberg link.

U.S. banks can lend $12 for every dollar raised through the securities, so $100 million of the preferred shares may become as much as $1.2 billion in credit, based on Basel I banking rules.

When prices fall, the bank’s risk of loss in a foreclosure increases. Under the old paradigm with a 20% down payment on a house, it’s rare for banks to take a bath and the bankers are far less sensitive to downturns in the real estate market. This has previously been especially true, where large down payments and substantial discounts on valuing rental income have kept Bermuda banks safe from market declines. However, with first time buyers in Bermuda now being offered the ability to borrow more than 100% provided they live in a property for period, the banks have essentially made an economic loss the instant they write these mortgages (they have origination expenses). Accounting rules determine if banks need to show a loss on their income statement/balance sheets, and so the dynamic in Bermuda may be different if the banks don’t need to start taking huge write downs when prices do start do decline.

The problem is that the sale price of real estate is dependent on the bank’s ability to lend.

*cue ominous music*

Once a bank starts to lose money as house prices decline and credit starts to be constrained then they can’t lend as much so house prices decline and credit becomes more constrained so the banks can’t lend as much so house prices decline… and so on. A vicious cycle. The newest and most greatest loan/value ratio mortgages lose money first – and as prices decline successively older vintage mortgage holders find themselves underwater.

That’s essentially what has been happening in the USA. As house prices have declined mortgage rates have gone up, reflecting the unavailability of credit, which has effectively increased the cost of ownership.

In the US (and to a vastly lesser degree in Bermuda) bankers have decided to abandon risk controls because they have been in an almost generation long bull market for real estate that began with the taming of inflation in the early 1980s and which last had a major shakeup almost 20 years ago. The world has changed and there’s a very real risk that the USA will face massive financial stress as layers of debt unravel, what began with sub-prime mortgages issued by 22 year old Las Vegas mortgage officers has now spread because the growth of the US economy has for most of the past 6-8 years been dependent upon debt creation. The crisis has the potential to be truly crippling for America as the US Federal Government is in terrible financial shape after years of neo-Keynsian policy under Regan and Bush II and may be unable to produce a policy response to restore confidence, which in a worst case scenario will result in a truly spectacular recession and possibly a depression.

In theory, we in Bermuda should have been taking note and creating a sovereign wealth fund during the boom times instead of abandoning financial control in the government and spending hundreds of millions of dollars on farcical projects, and we DEFINITELY should not be spending like drunken sailors now.

Some time ago Bank of Bermuda head Phil Butterfield remarked in his sweeping style that “We have never lost money on Bermuda mortgages.” Sorry Phil, you have lost money on mortgages before and you’re about to again. However, the margins are so large on Bermuda mortgages that we probably don’t have to fear the kind of financial mass destruction that is happening in the United States (all bets are off for Bermuda banking if some major insurers go bankrupt, the government starts talking about exchange control, and a hotel or two closes at the same time).

I wrote this in the middle of June and never finished it… but with tourism arrivals down substantially and real estate showing weakness, it’s relevant but half baked.

For the first time I am seriously considering viewing Bermuda as a short.

Since even before 1998 people have been thinking that Bermuda is going to hell in a handbasket and those people have thus far been wrong.

Ewart and the boys are betting the farm on tourism. This is a mistake because our biggest source of tourists – America – is rapidly finding out that living a life of inflating standards of living through using debt creation to create disposable income is a temporary strategy at best.

The prices of those fractional units at most of the new hotel developments (that are in effect selling Bermuda permanently to foreigners) rely on people being willing to borrow money to afford to buy them. In many cases this sort of “real estate” investment has by accident been a low-cost way for people to make a speculative play on real estate continuing to go up in price (which really means that some other sucker comes along willing to borrow more to buy it). The last sucker has already bought at the inflated price.

If the transmission mechanisms that flow low interest rates out to consumer borrowing begin to function properly (the very low fed rates at present generally cause mortgage rates (over 6%) much lower than we see in the market today), then we can expect interest rates to begin to rise and if inflation continues to be an issue then you can bet interest rates will rise dramatically, causing a rise in the US dollar which will eliminate one of Bermuda’s tailwinds making us a less expensive place to do business than Europe/UK. If we do not offer a compellingly better business environment, then this loss of cost competitiveness could hurt Bermuda business substantially.

It is never a good idea to bet against Bermuda – for all our failings we have some of the best and the brightest in the world working to make this place great. They just do it behind the scenes and despite the politicians basking in the limelight.

From The online Royal Gazette.

“We talked about Bermuda. He was interested in how we were doing in tourism and understood our rationale for rebuilding tourism and not having a one-legged economy.

Essentially shows one thing: The Premier, the President, or both do not understand international business.

As I have said before, we do not have a one-pillar economy, not even close. We have insurance/reinsurance, investment management, trusts & fiduciary services, and a number of others. Each of them is a completely different industry and each of them is highly efficient at bringing in revenue from overseas into Bermuda and depositing it into our economy in the form of salaries, rental payments, services, taxes, tourists, etc.

Each of these international industries can offer Bermudians completely hilariously high salaries in comparison to competing jurisdictions and other industries. If we do things right then these salaries funnel through to the service sectors and keep our blue collar workforce enjoying a good standard of living and unlimited opportunity for their children. Why? Because Bermuda has a sustainable competitive advantage of being a historically stable, well-run country with a legislative framework far more nimble than large countries (although a number of countries are gunning to take us down).

All of our pillars are suffering from the bad behaviour of Dr. Ewart Brown and his cronies and the utter mismanagement and corruption that is their standard operating procedure.

Unknown to most voters, and despite the politician’s best efforts to derail international business, in the background the machinery of the Bermuda regulatory system continues to do an acceptable job of keeping legislation up to date without the clown show of some of our competing jurisdictions.

For those not watching, the United States is quite likely in the early stages of a pretty massive economic shift and decline as they cope with the outcomes of a sales and consumption culture that emphasised selling rather than real value-added, as well as consistently living beyond their means as both individuals and a government. We in Bermuda have most of our white collar workforce in generally real productive occupations… however, we are living beyond our means as a government and are beginning to see some real sales culture and American style spin. This will end badly for Bermuda if we do not keep our eyes on honest accountability and using true objective feedback.

It’s important to remember that the reason that International Business has not left as many predicted after the PLP win in 1998 in a large part because the PLP has by and large not followed through on promises at all… in an area.

Can we please stop repeating the mistruth that IB will leave… they’ll only leave if the PLP start doing what they say they’ll do, since the PLP will never be honest or competent we have little to worry about (except declining quality of life due to constant mismanagement, something that BeachLime touched upon that I want to write about at length later…).

Just a note.

If the potential US recession and the disaster that will be policies like work permit time limits, workforce Equality Act, and Goodwill Plus coincide then Bermuda could very easily face a serious problem.

If we want to control population, house prices, and foreign housing ownership then let’s control them with proactive policies and honest measurements, not driving up the cost of doing business so much that salaries don’t rise… and believe me, many of Bermuda’s brightest, hardest working, and most educated don’t feel welcome in the radical PLP’s Bermuda and will quite easily find work overseas.