The Alchemist

July 28th, 2008 by De Onion

For the record – the real slowdown is just beginning.

From the New York Times:

Some suggest that the banks, spooked by enormous losses, have replaced a disastrously indiscriminate willingness to hand out money with an equally arbitrary aversion to lend — even on industries that continue to grow.

Some have suggested that Ewart Brown is a remarkable alchemist for his ability to make a Platinum era in tourism (he picked occupancy numbers from the week of the Newport Bermuda Race) from tourism numbers that most would consider to be more Talc than anything. I expect that if Brown continues to work his magic in tourism and if the US slowdown becomes a truly widespread credit bust then we could soon be in the “Peat” period of tourism. The only thing that will prevent that is if the government decides to use the taxpayers to subsidize large capital investments in tourism for the benefit of private developers… like the Southlands/Morgan’s Point giveaway and the Club Med giveaway. Either way, the people of Bermuda get screwed.

The coming debt crisis.

July 23rd, 2008 by De Onion

An interesting article in the paper today: Car sales concerns.

With car sales dropping 24 percent in May alone, dealerships said it was hard not to notice a lack of customers.

This is not only an indication of economic weakness, but it’s also going to show up somewhere else where it hurts. The government takes a large tax on every car sold. Fewer sales means less tax revenue.

Since our government has presided over massive increase in spending which have not been fatal thanks to almost matching gains in tax revenue, we can expect nothing good from the combination of poor financial control, economic slowdown, and a Finance Minister who would have been fired if she was a company CFO.

Edit: Changed the link from a duplicate of the car sales story to Bob Richards’ response to the audit.


July 17th, 2008 by De Onion

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?

Of Bears and Bankers…

July 15th, 2008 by De Onion

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).

Parties matter

July 15th, 2008 by De Onion

Many people complain that political parties are essentially the same – but there is a meaningful long-term difference. This book will be looking at the difference between economic performance of American Presidents.

Some say Reagan produced the fastest growth, or the biggest debt, others say it was Clinton. But for the most part, these often widely held and contradictory opinions are wrong. We take a look at what actually happened (and why) by looking the data on over 40 different series people care about from Ike’s term to the present. We use colorful graphs and a bit of humor, and we stick to the facts. We rank each president on a variety of issues. At the end of the book, we give you an overall ranking based on how each President did on all the issues we look at. Results will be surprising to many people. They will also be contentious. But most importantly, they are based entirely on objective data.

New blog…

July 13th, 2008 by De Onion

A new blog by Doug Decouto.

Welcome to the club.

Music festival…

July 7th, 2008 by De Onion

Other bloggers have already sounded off with their thoughts on the Music Festival.

I think the music festival spending is pretty minor in the context of the things to actually complain about, especially if it breaks even. In my view there are a few fundamental issues:

1. How do they not know if it will make a profit or not? They know what revenues will be, and should have a good handle on expenses, so why can they not make a financial projection?

2. The festival is only the latest in a long string of public works whose returns accrue primarily to the party insiders in the form of an image boost and direct payment of taxpayer money, and is borderline vote buying.

3. How many of those “overseas” tickets are actually Bermudians with foreign friends/families fronting for them?

For the record: I have a history of assuming mere poor decision making when the actual issue is abject corruption.

Short Bermuda?

July 5th, 2008 by De Onion

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.

Price indexing…

July 5th, 2008 by De Onion

Developing a price index for Bermuda real estate is far more difficult than in the United States because every home is a custom home. In the USA you will have quite literally identical houses being built all over the country so they’re really a commodity and easy to index. A Vexed says:

The article claims that the average cost of a single family home is now just under a million. Meanwhile a January 2007 article from the same agency put the price at 1.325 million. That implies the average sales price of Bermuda real estate has dropped by more than 25% in one year.

Before we get hysterical, we need to remember that because properties in Bermuda are all different, the median transaction price is not necessarily the same as the price change any given property from year to year. We can infer changes in the market’s demands, but because houses are not commodities, a decrease in year over year median price does not imply a falling market, and could instead reflect a smaller number of high-end transactions, or a larger number of low-end transactions.

A more careful and subjective analysis of comparative properties is needed to arrive at the actual year over year decline in what a property sold for last year compared to what it would sell for today. I believe that at present we can have some faith in the agency’s estimate of a flat market with longer time on market, from which we can infer that if time on market does not stabilise or fall then prices will decline and may have already, sales price data lags as properties that come on the market today will not sell for months.

Next up… lending.

Global health

July 4th, 2008 by De Onion

Here’s a neat interactive side by side comparison of healthcare systems internationally. Just something I stumbled across.

As I’ve said before – the only conclusion that an honest economist can make about healthcare is that one that is for fully private and for-profit is the worst possible solution and Japan, which from an economic perspective is one of the best healthcare providers is also the worst for the doctors. This is not a coincidence, and it looks remarkably like the Bermudian system.