Posts Tagged ‘Banks’


On Tomorrow’s Secret Meeting To Plot The End Of High Frequency Trading

The MasterFeeds: On Tomorrow’s Secret Meeting To Plot The End Of Hi…

Sharevar addthis_config = { ui_cobrand: “The MasterFeeds”}

The MasterFeeds


Excellent!!!!

Artist’s Rendering Of Larry Summers’ LinkedIn Profile

Artist’s Rendering Of Larry Summers’ LinkedIn Profile:

Share this|var addthis_config = { ui_cobrand: “The MasterBlog”}

________________________
The MasterBlog


Second Leg of Crisis Beginning: Hedge Fund Manager

Published: Tuesday, 31 Aug 2010 | 5:38 AM ET
By: Patrick Allen
CNBC Senior News Editor
September and October hold bad news for stock markets and banks remain overleveraged as we head into the second leg of the financial crisis according to Pedro De Noronha, the managing partner at Noster Capital in London.

“We are seeing one of the most challenging years for investors ever,” De Noronha told CNBC Tuesday. “Major investors are simply leaving the market. When it looks like markets are about to fall off the cliff they rally and vice versa.

“There are problems coming from the resetting of US mortgages and (the) euro area remains a big worry,” he said.
“Germany is unwilling to save any other European country,” De Noronha said. “Merkel used up lots of political capital saving Greece and she saved the Greek bond market in order to save the French and German banking system from more big losses.”
“There are four or five countries that have major structural problems that should not be in the euro,” he said. “I still have (yet) to see a politician who will shoot themselves in the head on austerity.”
“The Greeks have no choice but to cut, the others like Spain are not doing enough, I am with the ‘Austerian’ school and do not buy the Keynesian argument,” he said.
On Monday, Nobel-prize-winning economist Paul Krugman called for another big stimulus program for the US, saying “(e)verything is pointing to the need for more spending.”
Laughable Tests?
De Noronha said he is also very worried about the banking industry and is shorting five of the biggest bank stocks in Europe: UBS, Barclays cnbc_comboQuoteMove(‘popup_barc-ln_ID0EGGAC15839609’);[BARC-LN 308.30 5.90 (+1.95%) ] cnbc_quoteComponent_init_getData(“barc-ln”,”WSODQ_COMPONENT_BARC-LN_ID0EGGAC15839609″,”WSODQ”,”true”,”ID0EGGAC15839609″,”off”,”false”,”inLineQuote”); , Intesa Sanpaolo, Unione de Banche and BBVA.
“The recent stress tests made me laugh,” he said. “We only stress tested what the banks told us, I did not see anyone testing anyone until they had gone broke.”
“When I look at Tier 1 Capital ratios, I find things propping them up that are not assets that can be drawn on in a crisis,” he said. “The real capital 1 ratio of some major banks is just 1.7 percent and I am shorting five major European banks as a result.”
The majority of banks remain over leveraged going into what could be the second leg of the financial crisis, De Noronha added.

“The regulators used 6 percent as the threshold for defining the minimum capital ratios, but that 6 percent number includes non-cash assets such as deferred tax assets and goodwill,” he said. “If you use only tangible book equity the 6 percent of the biggest offenders turns into closer to 2 percent which implies a leverage ratio of 50 times. That is hardly conservative for current the current economic reality.”

On Tuesday, Credit Suisse took a different stance, boosting its rating on banking to “overweight” from “market weight,” saying that economic risks are “overplayed” and that “funding should be less costly than initially feared.”
© 2010 CNBC.com

Global Economy – Second Leg of Crisis Beginning: Hedge Fund Manager – CNBC

Share this|var addthis_config = { ui_cobrand: “The MasterBlog”}

________________________
The MasterBlog


>Oh, poor “Demonized Algos” !!!

Demonised ‘algos’ push the surge in FX trading

By Jennifer Hughes, Senior Markets Correspondent
Published: September 1 2010 00:04 | Last updated: September 1 2010 00:04

Since the infamous stock market “flash crash” of May 6, high-frequency, or algorithmic, trading has been unwillingly dragged into the political and regulatory limelight.
forex-trading-graphicSo far, however, attention has focused on the role of these high-speed traders in the equity market. Outside the glare of that publicity, it is less well known that on May 7, FX trading volumes reached records, straining the plumbing of these markets.
Some participants argue these strains were partially caused by algorithmic, or algo, traders.
Exactly how much of this can be attributed to algo trading is unclear. However, there is no question that high-frequency traders are a fast-increasing force in FX markets, which is sparking a fierce debate as to their value to the market.
On Tuesday, the Bank for International Settlements reported that average daily turnover in the FX market has jumped 20 per cent in the past three years to $4,000bn a day. Its survey was taken in April, so missed the May spike, which related to the eurozone sovereign debt crisis.
The BIS-reported gains were led by a near 50 per cent leap in spot trading – deals for immediate delivery – to $1,500bn a day. This jump was powered by increased activity from “other financial institutions”, a group that includes hedge funds, pension funds, some banks, mutual funds, insurance companies and central banks. This will also include algos.
While all categories of “other” could have increased their trading, it is likely a significant proportion was driven by algo traders, who favour the deep, liquid spot markets and particularly currency pairs such as eurodollar and dollar-yen, which between them account for 42 per cent of all currency trading.
The question for the FX market is whether high-frequency dealers improve the market by adding liquidity, or whether they are instead merely price takers who contribute little.
“Algos have been demonised, but they’re an important part of the growth story,” says David Rutter chief executive of Icap Electronic Broking, which runs EBS, the main FX interbank trading platform. “What we’ve found is that they add pressure at each price point so that instead of getting big price gaps on shocking news, trade is more orderly.
“With FX, there are a lot of other flows such as global trade, so there is good underlying liquidity that the algos can enhance.”
Algos initially appeared in FX markets almost a decade ago, attracted by the deep liquidity and increasing use of electronic trading. They were generally welcomed, particularly by banks looking to build their prime brokerage businesses. However many banks soon grew disenchanted when they found the fast-moving shops were profiting from banks’ own slow systems by exploiting brief, tiny price differences between rival platforms.
Some banks went as far as ejecting offenders from their platforms but banks’ views have since become more nuanced. They have generally reached an accommodation, helped by technological improvements which make it easier to monitor client dealings and offer client-specific prices.
“The facts are that algos have made the markets more efficient and have helped ensure there’s one virtual price,” says Jeff Feig, global head of G10 FX at Citigroup. “They do cause banks to be smarter and we’ve had to work harder to be more efficient, but that’s ultimately to the advantage of the end user.
“I think that to some extent, algos have pushed banks and the result has been enhanced transparency and increased liquidity.”
Algos mean many different things in the FX market. While high-frequency traders are the best known – typified by one senior banker as “five smart guys in a room in New Jersey,” – banks are increasingly adept at developing their own algorithms to make their internal FX deals more efficient. These “internalisation” trades too will have provided a boost to the BIS numbers.
Most players say algos are now a fact of life in currency markets.
Unlike the equity market, which is split into hundreds of stocks, they believe the FX world’s focus on a relatively small number of currency pairs means it would be far harder for a single group of participants to move the market significantly, intentionally or otherwise, as some watchers fear happened during the “flash crash”.
“Also trading can happen anywhere there’s an electronic execution system and a volatile market,” says Alan Bozian a former FX banker and now chief executive of CLS Bank, the FX settlement system. “The question is, which markets adapt well and I don’t think it’s necessarily the stock market.”
FX markets have proved generally good at adapting. Systems such as CLS, introduced years before the financial crisis, have helped minimise settlement risk and since May, participants have been working again to improve their processing systems to cope with increased volume.
Significantly, for a market that is very much built around a hub of big banks, the BIS report showed that, for the first time, interaction of the main banks with “other” financial institutions overtook trading between themselves.
This could be a pointer to the market of the future, where banks are likely to remain the hub, but as much for their trade processing abilities as for their liquidity.
This would allow the winners to build profitable volume without taking on huge trading risks – suiting the current regulatory mood.
“The banks want to continue being the price providers, but they’re getting much more interested in the infrastructure and improving that,” says Mr Bozian. This evolution is likely to apply to high-frequency trading too.
Mr Rutter believes algos are only in their “late teens” in terms of development. “The early algo trading was about super-fast dealing and chasing inefficiencies. That’s largely gone,” he says.
“Now its about math and science being thrown at the market – there’s a rich pool of data and I think we’ll see algos evolve so its not just about milliseconds, but about longer-term predictive math.”

“FT” and “Financial Times” are trademarks of the Financial Times. Privacy policy | Terms

FT.com / Currencies – Demonised ‘algos’ push the surge in FX trading

Sharevar addthis_config = { ui_cobrand: “The MasterFeeds”}

The MasterFeeds


Richard Russell’s Daily Letter

August 9, 2010 — Headline from page one, New York Times, Aug. 7: “Nation Lost 131,000 Jobs As Governments Cut Back. Hiring By Private Sector Anemic in July.”

Headline from the Weekend Investor section of the August 7 Wall Street Journal“How To Beat Deflation. Strategies to Protect Your Portfolio From and Take Advantage of the — Dreaded ‘D’ word.”

The specter of deflation is cropping up in many media outlets today. In fact, I’d say that deflation talk has almost become popular. The key question is this — Fed Chief Bernanke is obviously reading and hearing all about the “coming deflation.” What will Bernanke do about it? I think he will fight deflation with all the weapons at his command. And Bennie has a lot of weapons, least of which is printing “money.”
………………………………………………………..

The air is filled with rumors and contrary opinions, so many that it is literally impossible to follow them all. Some of the opinions and views have such earth-shaking implications that it’s difficult to ignore them. But as my subscribers know, we’re not a news site, and we don’t invest or divest based on the news of the day.

A few examples — I just finished my friend, John Mauldin’s always excellent column (how does he travel continuously and write the column?). Rather than paraphrase what John is writing, I’m including an actual segment from John’s latest column —“Main Street may be about to get its own gigantic bailout. Rumors are running wild from Washington to Wall Street that the Obama administration is about to order government-controlled lenders Fannie Mae and Freddie Mac to forgive a portion of the mortgage debt of millions of Americans who owe more than what their homes are worth. An estimated 15 million U.S. mortgages are implicated.”
Russell Comment. Would Obama actually do this? My answer is that Obama and his buddies are so frantic to get the economy moving again that they would be willing to try anything.
Beyond mortgages, Americans are so loaded with debt that maybe the next Obama step would be to forgive ALL personal debts in the US. Better still, why not return to the year of Jubilee and cancel out ALL world debts (I don’t think holders of US Treasuries would go for that one).
The current issue of Barron’s is fascinating. The inimitable Alan Abelson notes that stocks are not cheap. Alan asks, “Where is it written that a market that in a not too distant-past values stocks at 60 time earnings, can’t value them, if the outlook sours, at six to eight times earnings?”
Russell Comment — Yes, I have noted that the big booster in bull markets and the big killer in bear market is the change in price/earning ratios, rather than the actual change in earnings.
But here’s what I really want to talk about. From the cover page of Barron’s — “Why the Fed Will Soon Print $2 Trillion.” The related major article is entitled, “Time to Print, Print, Print,” and is written by Jonathan R. Laing. The author believes that the Fed has only one way to go, “Quantitative easing,” and maybe printing another $2 trillion of fed notes (dollars). Laing concludes, “so it’s more than likely that the big artillery of quantitative easing will be unleashed to push the economy out of its despond. It’s high time to get out the money-printing machines. Damn the risks of triggering a bit of inflation and some modest investment bubbles. The alternatives are far worse.”
Then (believe it or not) in the same issue of Barron’s we see an article by my old friend, Robert Prechter, the guru of the Elliott Wave thesis. Robert explains how a great contraction in credit and debt will bring about deflation. Robert notes that the amount of dollar-denominated debt worldwide is some $57 trillion. . . The already-issued debt and potential debt is poised to overwhelm the possibility of management monetization. The Fed’s assets amount to $2.3 trillion, a drop in the global debt bucket.”
Robert concludes his frightening article as follows — “If you are positioned for more inflation — as the vast majority of investors are — you are likely to find yourself on the wrong side of the monetary bet. Positioning for deflation simply means avoiding traditional investments, especially risky debt, and maintaining maximum safety in cash equivalents, held in the safest institutions. If you shed market and institutional risk, you can sail through deflationary times unscathed.” 

Russell Comment — Whew, how’s that for a scary contrary opinion? Robert believes that way to safety in a deflation is to have cash, and lots of it. My concern with this approach is that I question the safety of the US dollar (and all fiat money, for that matter). So in an all-out deflation, Robert Prechter will be sitting in all cash or US Federal Reserve notes. But the dollar is collapsing, and with a US that is deflating, none of our foreign creditors will want dollars (in fact, they will be trying to get rid of dollars). With fiat money in retreat all over the world — and currencies devaluing against each other, the world’s peoples will turn to the only money they can trust — gold. I’m aware that Prechter believes gold will be heading down in a deflation, I disagree.

I was there during the Great Depression, and I can tell you nobody at that time had dollars. But if you did have dollars they were trusted and they were considered as good as gold. Today, it’s different. The very validity of the dollar is in question.

By the way, Prechter believes the Dow will end its bear market at a value of 400. If so, Prechter is looking for a calamity comparable to the Great Depression of the 1930s. 

Russell response — I distrust all scenarios and predictions, although I read ’em all and find many of them fascinating. In the end, I only trust the wisdom of the stock market. I haven’t liked the recent action of the stock market, and I’ve advised my subscribers to get out of stocks. From our standpoint, when it comes to news events, our main interest is not in the news, but in the stock market’s reaction to the news.

The stock market will tell its story as we go along and in its own good time. Our job is to ignore all opinions and forecasts and to follow the stock market and believe what it’s telling us.

Gold has advanced seven days in a row, and should be ready to back off a bit. The many arguments and rumors regarding gold are almost deafening. I don’t give a damn what the gold bulls or the gold bears say, I follow the price action as best I can. Often, the best test — is what an item can or can’t do. On the latest correction, gold held 1100 — bullish. Can Dec. gold climb into the 1300s, which would be a record high? That’s what I’m waiting to see. By the way, gold may be forming a head-and-shoulders bottom. More technicals — the 200-day moving average for Dec.gold is at 1155.10. The 50-day MA for Dec. gold is at 1215.90, which is bullishly above the 200-day MA. If Dec. gold can close above 1215.90, that would be a bullish development.

The Federal Open Market Committee meets tomorrow. Will they hold interest rates at zero and will they accelerate their printing? If they do, it will put pressure on the dollar and it will be bullish for gold. If they boost interest rates, expect gold to correct.

TODAY’S MARKET ACTION:

My PTI was up 7 at 6117. The moving average at 6095, so my PTI is bullish by 22.
The Dow was up 45.19 to 10698.75.
Transports were up 59.09 at 4516.35.

Utilities were up 1.30 to 395.02.

NASDAQ was up 17.22 to 2305.69.

S&P was up 6.15 to 1127.79.

September crude was up 0.78 at 81.48.
Total Volume on the NYSE and associated exchanges was 3.43 bn.

There were 2199 advances and 830 declines on the NYSE.

There were 305 new highs and 15 new lows
The Big Money Breadth Index was up 4 at 807.

Dollar Index was up 0.26 at 80.67. Euro was down 0.49 at 132.25. Yen was down 0.60 to 116.48. Currency prices as of 1 PM Pacific Time.

Bonds: Yield on the 10 year T-note was 2.82. Yield on the long T-bond was 4.01. Yield of the 91 day T-bill was 0.14%.

December gold was down 2.70 to 1202.60. September silver was down 0.23 to 18.24.

My Most Active Stocks Index was up 2 to 200.

GDX was up 0.02 to 50.19.

HUI was down 0.22 to 459.72.

CRB Commodity Index was down 0.12 at 274.59.

The VIX was up 0.40 to 22.14.

Late Notes — Dow up 45, Trannies up 59, Utes up almost 2. It’s increasingly more difficult to be bearish on this market when my PTI remains bullish. It was up 7 today to 6117, making my PTI bullish by 22 points. As for the “internals,” well you heard the PTI report. NYSE breadth was good, 2199 issues higher, only 830 down, 305 new highs and 15 new lows. Up volume on the NYSE was an impressive 71% of up + down volume. 

Dollar Index was up 0.26 to 80.67. Are there too many bears on the dollar. When the shorts overdo it, you know what happens — the item goes UP. Bonds were slightly lower. Dec. gold was down 2.70 to 1202.60, but still holding above 1200. Tomorrow Bernanke and the gang meet for the Fed Open Market Committee, and everybody is waiting breathlessly to hear what the gang comes up with. 

My pen-pal, the one and only Dennis Gartman notes that the M-2 is diving and that the adjusted monetary base has gone nowhere for the last nine months. John Williams reconstructs the broad M-3 money supply and shows that it is diving. So what’s going on — is the Fed playing games with us? Can the market and the economy go up without a rising money supply?

Never mind, we go by the action of the market, and so far, the action has been OK, although a bit ragged. 

See you tomorrow, with diamonds hidden in my hair — wait, Faye just cut most of my hair off. I’m walking around with a buzz cut, can this be me?

Adios,

Russell

Expensive stones, most of them over one billion years old.

With the advent of GIA (Gemological Institute of America) certificates, diamonds are becoming a leading safe-haven item. You can send a diamond to the GIA and get a recognized certificate showing the cut, carat, color and clarity of your diamond. Seasoned buyers will not buy a diamond without a GIA “cert.” These certs have finally put diamonds in a different category. You can now buy a diamond a receive (with a cert) a close approximation of what the stone is worth.

India is fast becoming the center of diamond cutting and trading. The best diamonds have come from the Golconda area of India. The Golconda diamonds were “whiter than white.” By the way, the Golconda mines are exhausted. The lower the nitrogen content of a diamond, the whiter the stone is. Golconda diamonds have a nitrogen content of 2% to down to 1%, making them the whitest of all diamonds. Actually, a few other diamonds sport this low nitrogen content, and despite the fact that they don’t come from India, they are still called Golconda diamonds. Only about 1% of all diamonds are classified as Type IIA or Golconda diamonds. These special diamond bring huge prices. For instance, a well-cut internally flawless Type IIA diamond of 5 carats may sell for over one million dollars. 

As a rule, white diamonds are judged on their whiteness — the whiter, the better. Colored stones are judged by the depth of their color and the evenness of their color throughout the stone. 

Diamonds as a safe haven have one big advantage over gold. Millions of dollars worth of stones can cross a border hidden in a tiny packet or sewed into the lining of your pants. And with the advent of GIA certs, you can be reasonably assured of what they are worth. High-grade stones are so hot today that dealers have been calling retailers and asking them if they have any overage in their diamond inventory. There is almost no bargain diamonds for sale today. The best deals are seen when a professional outfit buys a diamond from a private party, a party that knows nothing about the value of their diamond. 

Thus you see ads in the newspapers as follows: “We want your gold and jewelry and particularly your diamonds. Nobody pays higher prices than we do.”

________________________
The MasterBlog


Blackstone’s Byron Wien Singlehandedly Refutes The Double Dip, Hilarity Abounds
To all the bulls out there, we have a Wien-er just for you. In an essay that is basically a sequel to last week’s job application in a second-tier position in the administration by a Moody’s strategist and a Princeton economist (yes, yes, we know… oxymorons), the BlackStone head of something, Byron Wien, says the fututre for the market, the economy, and pretty much everything else is brighter than a nuclear bomb (incidentally one going off today would likely send the market into the greatest melt up in history). 


Lest there be any confuction what Byron’s view is: “My view is that the economy is going through a temporary lull and business conditions will improve later this year and in 2011.” At least Wien is honest: “In preparing this essay I used research from Goldman Sachs, Lord Abbett, Credit Suisse and International Strategy and Investments for arguments on both sides of the double-dip issue.” Mmhmm – that some serious “both sides” source list. And the piece de resistance: “The factors that argue against a resumption of the recession are the strong liquidity position of corporations which have 6% of their assets in cash, a level not seen since the 1960s, and the fact that both housing and autos are at low levels of production and not likely to drop further.” 


Over the weekend we will present an extended analysis finally putting to rest the inane argument that corporations are flush with cash: while true on a gross basis, the net level of cash vs debt, and especially vs equity, is at one of the worst levels in history. This ongoing childish avoidances of the liability side of the corporate balance sheet must stop and someone has to finally shut up these so called sophisticated economists and their endless lies.  


Feel free to print out two copies of the attached Wien essay: we hear his work “product” is much better in two ply format.
  h/t FMX Connect

View article…


CAIXIN ONLINE
Aug. 3, 2010, 8:30 p.m. EDT

Fear empty flats in China’s property bubble

Commentary: Even worse than price bubble is quantity bubble of vacant flats

By Andy Xie
BEIJING (Caixin Online) — How many flats in China are sitting empty? The media recently floated a story — denied by power companies — that 64.5 million urban electricity meters registered zero consumption over a recent, six-month period. That led to a theory that China has enough empty apartments to house 200 million people.
Statistical transparency is lacking in this area, so the truth about empty apartments remains under wraps. Publishing accurate data should be of the highest priority, since the size of the nation’s unused apartment stock is perhaps the most important measure of the extent and seriousness of China’s property-market bubble. Indeed, it’s a grave concern for policy making, since unpublished data may indicate not only a price bubble but a quantity bubble burdening the market.
ABOUT CAIXIN
Caixin is a Beijing-based media group dedicated to providing high-quality and authoritative financial and business news and information through periodicals, online and TV/video programs.
Get the Caixin e-newsletter
Real estate is prone to price bubbles because unique factors restrict its supply response. Inflated prices have been the mark of most modern-day property bubbles. Price bubbles occur frequently and can last a long time.
In the 1980s, Tokyo saw a tremendous rise in property prices not in tandem with supply. The Hong Kong property market experienced a similar phenomenon in the 1990s.
One reason for limited supply is that property development is subject to government regulations, especially local rules. Established communities usually restrict building heights and density, for example, making it virtually impossible for mature communities to increase supply quickly. London, which is now experiencing a price bubble, and Tokyo in the past are cities that tightly control building heights.
Second, infrastructure development takes time and is always relative to land availability. Even in an island-city such as Singapore, land can be reclaimed from the sea at low costs, pointing to the correlation between land and infrastructure. But when property prices are high, and even when money is available for infrastructure development, one should be cautious about plunging in for fear that property prices could later fall. Thus, even over extended periods of time, property supplies may not respond to price increases.
Hong Kong doesn’t have height restrictions like London or Tokyo. Nor does it have infrastructure or land shortages. But a government policy limiting land supply created scarcity before 1997, setting the stage for a bubble. The subsequent catalysts for higher prices were loose monetary conditions imported from the United States through Hong Kong’s currency peg to the dollar. Even though prices were rising, the government chose not to increase supply, leading to a price bubble.
Thus, demand for property also rises under eased monetary conditions, and climbing price momentum attracts speculative demand. If monetary conditions remain loose for a while, credit access can sustain this kind of speculative demand. This points to a need for the Chinese government to adjust its property-market policies as well as interest rates to reduce speculation and steer the market out of a looming bubble crisis.
It’s been said many times that China is experiencing a nationwide urban property price bubble. High prices in major cities where most of the country’s property value is concentrated cannot be explained rationally.
Rising rents are a little easier to explain, however, even in the face of empty flats everywhere. Some blame intermediaries for ramping up the market, but this explanation is hard to stick in China’s fragmented intermediary real-estate industry. Instead, inflation expectation is probably driving current rent increases: Property owners anticipate spending more in the future remodeling flats to compensate for renter wear-and-tear, so they charge higher rents now to plan for higher costs.

Quantity pump

What especially distinguishes China’s property bubble, however, is an unprecedented amount of living space. This huge stock of empty flats equals the nation’s quantity bubble.
Quantity bubbles are less common than price bubbles, and they don’t last as long. Rising supply usually exerts downward pressure on prices, although an influx of money can hold up prices even when supply is rising.
A price bubble can damage an economy in three ways. First, it usually leads to a banking crisis. As the market trades at ever-higher prices, buyers borrow more against the same property. Banks that maintain the same lending cushion with, say, a 30% down-payment rule suffer losses when prices fall below that level. A banking system in crisis cannot lend normally, and the economy suffers collateral damage due to dysfunctional banking.
Second, the wealth effect leads to excessive consumption during a bubble. The payback weakens an economy for several years.
And third, bubble-induced demand distorts the supply side. When inflated industries go down with a bubble burst, it takes time for other industries to rise in an economy in their place.
A quantity bubble is sometimes a construction bubble, and it fizzles out when a building cycle turns over, crashing prices as soon as new supply becomes available. This is what happened to a commercial property bubble in the United States in the late 1980s, triggering a bank crisis when it burst and prompting the Federal Reserve to maintain a loose monetary policy that helped the banking system heal.
Quantity and price bubbles may grow together. Southeast Asia, for example, experienced a quantity-cum-price bubble that lasted several years in the 1990s. As regional currencies were pegged to the dollar, loose monetary conditions were imported from the United States, fueling a property bubble. Due to few restrictions on urban development, rising prices led to massive increases in supply. Liquidity inflow fueled speculative demand. But when U.S. monetary policy tightened, the market crashed and triggered the Asian Financial Crisis.
The latest experience in the U.S. market was mainly based on a price bubble, although some cities such as Las Vegas and Miami saw quantity bubbles as well. The U.S. government quickly recapitalized its banking system, limiting the direct effect of the banking crisis on the economy. Current weakness can be explained mainly by the wealth effect and employment losses in bubble-inflated industries.
When Taiwan experienced a price-cum-quantity bubble in the late 1980s, analysts determined the number of empty flats by obtaining electricity meter data from the power supplier, leading many to conclude that about 15% of all flats were empty. Today, some analysts are trying the same tactic in China. But Taiwan’s housing conditions are less complex. Getting to the core of China’s data requires more calculating.
Housing types, for example, must be considered. China’s urban housing stock is mainly split between old, public housing built for company or government employees, and some 60 million units of private housing built over the past 10 years. Property developers are now building about 20 million private flats, and local government-owned land banks may be good for another 20 million to 30 million.
About 1 billion square meters worth of public housing (or about 14 million, 70-square-meter units) have been torn down, leaving about 9 billion square meters of this type of living space nationwide.
Moreover, companies and government agencies are still building apartments for employees. This practice has slowed but remains significant in many cities even today. It’s hard to tell how many of these newer flats are out there.
There are similar unknowns about dormitories, such as factory dormitories that house workers from rural areas who migrate to manufacturing regions. Most of China’s more than 200 million migrant workers may be living in such dormitories.
Not all commercial property is market-driven, since certain people with connections or other advantages may own rental apartments that tend to have high vacancy rates and should be taken into account when calculating market excess.
Another consideration is that massive quantities of housing have been springing up in rural communities near major cities. And when farmland is rezoned for urban development, the region’s housing starts falling into the urban category.

Numbers crunching

Although China’s new property sales topped 14% of GDP in 2009, the data is confusing. Maybe it’s confusing by design, since firm figures on total urban housing stock are hard to find. My guesstimate is that China’s total urban stock is around 17 billion square meters, plus or minus 10%.
One useful figure for analysts is China’s living space per capita. Surveys in most cities suggest the average living space is between 28 and 30 square meters per person. We don’t know which population segment these surveys cover; they certainly don’t include migrant workers. And we don’t know if empty flats are counted.
Based on this limited data, however, we can confidently conclude that China does not have a housing shortage. Moreover, its per-capita living space is higher than in Europe and Japan. Indeed, if we adopt Japan’s standard, China already has sufficient urban housing space for every man, woman and child in the country.
Far more important than general data, however, are the housing figures pointing to a huge quantity of empty flats apparently being held only for speculation.
In a normal market, the vacancy rate should be equal to the number of households relocating, times the average transition period, plus newly formed households times the average purchase period. For example, a vacancy rate of 1.5% could accommodate a market in which 6% of households relocate every year, and the transit time is three months. If new household formation is 3%, and the average period for a property purchase is six months, this factor requires a vacancy rate of another 1.5%. The total normal vacancy rate should be 3%. This figure includes the new properties ready for sale.
Although the government doesn’t publish vacancy data, I think the vacancy rate for the nation’s private, commercial housing stock is between 25% and 30%. That’s at least double what’s required in a normal market. The gap between what’s needed and what’s available can be viewed as speculative inventory. The value of this inventory held by speculators is probably around 15% of GDP. It’s being kept on ice, just as copper and other commodities are hoarded in anticipation of rising prices.

Watch out

We should fear China’s quantity bubble. And we should be terrified by the potential for a massive amount of new, speculative inventory that could come on line this year and next.
Right now, tight credit is holding back the market, and supply is piling up on the developer side as inventory. The government’s tightening squeezed buyers of second and third homes, and transaction volumes across the country collapsed. What I’ve learned from intermediaries is that most property demand now falls into restricted categories, i.e., speculative.
It’s reasonable to assume, therefore, that the supply would be close to 15% of GDP in value this year and in 2011. That’s because when the policy is relaxed — as most expect — speculation will probably revive and lead to a doubling in the total value of speculative inventory.
Chances are good that policy makers will indeed relax policy. In some cities, banks are already loosening a bit. A key reason is that local governments have a lot of debt — commonly five times more debt than revenue — and could get into financial trouble without a decent level of property transactions.
Local governments in China depend on real-estate deals for revenue and could default if the market falls too far. Thus, the central government may loosen policy to help the locals without making a formal announcement. Such a change of heart would ease short-term government difficulties but double the trouble down the road when the property bubble bursts.
So even if China’s stock of empty flats is only half that recent estimate of 64.5 million, it would still be equivalent to 20% of all urban households. That’s higher than Taiwan’s vacancy rate at the peak of its bubble. Moreover, as credit rules are loosened, the stock could rise to more than 30%.
China’s housing oversupply isn’t surprising. Excess supply reflects the under-pricing of capital, and China’s system is structured to increase supply quickly. But rising prices alongside rising vacancy rates are surprising. Normally, speculators are spooked by high vacancy rates. But China’s phenomenon is unique for at least four reasons:
1) A sustained negative real interest rate has led to a falling demand for money and rising appetite for speculation. Greed and inflation fears are working together to form unprecedented speculative demand for property.
2) A massive amount of gray income is seeking safe haven. China’s gray income of various sorts could be around 10% of GDP. In an environment of rising inflation with a depreciating dollar — the traditional safe haven — China’s rising property market is becoming a preferred place to park this money.
3) Few people in China have experienced a property bubble. The property crash in the 1990s touched a small segment of society, such as foreigners and state-owned enterprises. Geographically, it was restricted to the country’s freewheeling zones in Hainan, Guangdong and Shanghai. Most people didn’t even know there was a property crash. This ignorance has led to a lack of fear that’s now turbo-charging greed.
4) Speculators think the government won’t let property prices fall. They correctly surmise that local governments rely on property deals for money and do all they can to prop up prices. But their faith in government omnipotence is misplaced. At the end of the day, the market is bigger than the government. The government can delay, but not abolish, market forces. Nevertheless, faith in government is replacing fears of a downside, and speculative demand will continue to grow as long as credit is available.
In other parts of the world, central bank attitudes toward real-estate speculation are changing. Israel’s central bank just raised its interest rate, specifically citing a need to fight a property bubble. Property prices in Israel have risen 20% in the past 12 months. India, Korea and Taiwan are raising interest rates out of concern for inflation and speculation as well.
China’s problems are much bigger than what’s found in these economies. But keeping interest rates low will only worsen the nation’s bubble problem. Periodic credit tightening and crackdowns on speculation won’t work because they are not taken seriously and never last.
China’s latest property-market tightening appears to have been improvised. Of course, any buyer discrimination policy is complex, hard to implement and creates excessive market volatility. Now, if special-interest pressure leads to a change in policy, speculators would be further emboldened, and the excess would multiply, making the eventual adjustment so much more painful.
Raising interest rates, however, would cool speculative demand gradually, avoiding market disruptions. At this point, a rate hike would be the best policy option. But a delay in raising interest rates would only cause a surge for the stock of empty flats and inevitably lead to collapse.
Long range, a policy of sustainability would require resolving local government financial problems by increasing non-property revenue sources or limiting expenditures. Currently, the investment-led growth strategy that’s been adopted by all local governments inevitably leads to maximizing revenues from land sales. So unless limits are put on this strategy, the property market will function abnormally.
Property taxes could play a significant role in revenue streams. In many countries, property taxes support local governments and public services. China should adopt the same model, while also restricting fiscal spending.
The bottom line is that China urgently needs a coherent property strategy. The massive overhang of empty flats should goad policy makers to act now. If the government eases rules for the property market before adopting a coherent policy, though, a crash could bring down the economy for an extended period.
One only needs to glance at modern-day price and quantity property bubbles around the world to understand the stark consequences. What’s happening to the U.S. economy now is a prime example, and it should be lesson for us. Otherwise, China’s economy will look like America’s. See this commentary on Caixin Online.




%d bloggers like this: