Friday, December 19, 2008


Luigi Frascati, B.Econ

Thursday, December 18, 2008


A Crisis Of Competence

What public officials didn’t tell you about the recession – or refuse to admit.

One of the objectives of this blog, the Real Estate Chronicle, has been to share with readers throughout the time principles of economics and to lay the foundations for sound investment decisions. Although the focus of the Chronicle primarily reflects my chosen profession – real estate sales and investments – many of the economic principles enunciated herein are valid and applicable to other fields as well. In this respect and judging from the number of e-mails, comments and at times even criticism I have received over the years, I think I can affirm I have been successful at contributing my fair share to make people “know before they act”, at least those who have been steadily reading these electronic pages.

It is therefore with a great deal of apprehension that I now must bring forward to the attention of anyone willing to pay heed, the fact that it is becoming more and more evident we are living through a historical period of virulent incompetence in pretty much all levels of public administration, as well as among those who are at the helm of some of the largest and more powerful private and public enterprises. This is turning to be an epoch of errors of mastodontic proportions on the part of our government and business leaders, of wrong and at times unethical decisions and practices – whether made neglectfully or wilfully – and of self-serving application of economic and financial principles. All these, in turn, have caused and are causing a dramatic erosion of investors’ confidence, which is at the root of the present problems.

We all share some collective blame for allowing sub-prime lending practices to get out of hand, for continuing to consume far more than was responsible or reasonable, for not demanding that our elected officials ask tough questions and for embracing easy money. But I submit that we have done all this with the tacit consent of those in charge, who knew or ought to have known better, who had both a moral duty to warn the public about the consequences and a legal responsibility not to inflate expectations, who have elevated unsustainable consumption to the standing of moral value and preached that the more we spent the stronger our economies would become and, consequently, the better patriots we were. Politicians and business leaders alike encouraged the spending spree and absurd consumption on the rationale that “the merrier the people, the merrier the voters and the merrier the customers”. Likewise, the recovery plan involving massive spending they are now proposing, dubbed by some ‘The New Deal Redux’ , falls well short of its aimed objectives. It is at its best an economic exercise in futility, at its worst incompetence to the highest degree.

In the United States, the Federal Government has acted in a tradition of unwarranted market interference with "ad hoc" cash infusions which, far away from being well thought out, seem to have been drawn out of the hat. Take for instance the Bear Sterns merger with JP Morgan done with a helpline from Uncle Sam to the tune of USD 29 billion; or the AIG situation where the Feds have poured way over USD 100 billion. Then, of course, there is the ongoing Fannie Mae and Freddie Mac situation, which has led right into the core of the banking industry beginning with Bank of America, that walked into Merrill Lynch with the help of a USD 50 billion federal subsidy, the Well Fargo - Wachovia Bank USD 20 billion deal, the multi-billion dollar Washington Mutual rescue, all the way to Citigroup receiving a USD 306 billion bailout package. Not to mention the new 'rescue package' presently being worked out for the three automakers, which will be certainly followed through by the new Administration. All this has created and will continue to create the worst investment environment America has seen in recent years.

How many times does the Dow Jones need to be saved?

Banking analysts and public officials alike are quick to point out to the real estate bubble as the primary cause of all the economic turmoil. But in doing so, they conveniently omit the fact that they have been the very instigators of such bubble, by promoting and encouraging speculation in real estate, which ultimately caused prices to increase, thus producing more speculation and subsequent price increases until housing prices became so absurdly high that consumers either refused or could not afford to purchase, thus sending demand tumbling down. What’s more, officials of all political colors omit to point out that the present situation is a direct consequence of the biggest asset bubble in history: the stock market, the place where speculation is the norm. And that the economic decline began in the stock market well before it affected real estate. In fact, and contrary to what we all consistently hear, it is the stock market that has dragged down real estate and not the other way around.

A couple of years ago when both Alan Greenspan, the former Chairman of the Federal Reserve and David Dodge, the then Governor of the Bank of Canada were talking about "froth" in real estate, rather than putting pressure on lenders to tighten their credit standards, governments actually encouraged banks to lower the qualifications bar, on the political ground that ownership was a 'right' owed to and bestowed as upon each and every American, and as upon each and every Canadian. After all, so the rationale went, the higher the number of property owners the higher the number of property tax contributors. And banks, of course, merrily went along on the ground that the higher the number of mortgagees, the higher the interest income they received which, in turn, looked good in the balance sheets for when they traded their shares in the stock market. Not to mention the fact banks could go out and sell mortgages in packages to the highest bidder, thus furthering their profits even more. A course of action this first devised in Wall Street but more than happily followed by banks throughout Canada just as well.

I did raise the red flag several times in the past, to the extent that speculation was not synonym of investment. And in an article I authored, which is entitled “Speculation v. Investment” first appeared in this blog all the way back in December, 2005 when all outlooks were rosy and when nobody even remotely thought of economic slowdowns of any kind – much less of recessions – and which article nowadays can be found pretty much everywhere in the Internet, I did spell out that speculative ravages ultimately reveal themselves detrimental for the entire economy, especially when they involve large ticket items such as real capital assets. This is so, I stated, because the role of speculators in a free market economy is to absorb risk and add very little liquidity to the market place. Speculators, I contended, in fact reduce market liquidity by inflating prices which, particularly in the short run, reduce the pool of buyers thus hampering demand and reducing prices even further. Put differently, wealth dependence on speculation as opposed to production and investment, creates the illusion of prosperity.

In the last three months, it has finally become apparent that the economy has serious problems more than originally thought. Households both in the U.S. and now in Canada are indebted, the economy is stagnating, growth is forecasted in the red, and unemployment is edging up. Yet governments in North America, thanks in large part to the Obamania that is pervading the continent – if not the world - are proposing to spend with both hands in the months to come.

The truth - and this is what public officials from the right and especially those from the left won’t tell you - is simply that we are going to have to take it on the chin. There is no easy fix, no return to the days of plucking credit cards and of mortgages growing on trees, no Obamas out there to rectify the situation with the single stroke of a magic wand. Canada in particular is not “immune to the recession” like politicians and banking conglomerates here wanted people to believe, merely because we have all sorts of natural resources. If there are no buyers, we can ditch our resources. And buyers out there are dwindling. Here too people will lose their jobs, like it has already happened to countless individuals across the West. Obama cannot and will not help Canadians – the man has got his hands chockfull with Americans! Besides, I am not entirely convinced that the rooseveltian government spending propositions he is entertaining are the solution, nor am I convinced he’s got the money to carry them out.

Housing in Canada was and still is grotesquely overpriced, though prices are slumping. And albeit real estate is a localized business and varies from place to place, here in my hometown of Vancouver, British Columbia prices will continue to fall not “until June” like Premier Campbell wants you to believe (he’ll have to call elections within six months), but for the whole 2009 and maybe beyond. In time they will reach a level at which it will make sense for consumers to buy a home. These are painful and necessary realignments. However, when the market reaches equilibrium once again - and it will at some point in the future, given enough time to correct itself - then real estate will become once again the traditional, solid, no-frills investment the way it has been for decades before the onset of the new millennium.

When this happens, think twice before plunging your hard-earned money into the stock market once more. Given the choice between the purchase of a piece of paper representing the share into a far-away company over which there is no control, and the purchase of four walls and a ceiling that can be seen, touched and painted, be prudent and conservative and take the low-flying choice by going with real estate. Not to mention the fact that in times of financial straits real capital assets always hold at the very least a residual (land) value, as opposed to stocks that are not worth the paper they are written on.

I know, Donald Trump may not agree with all this, but then again I would not want to take at face value the expertise of someone who owes USD 390 million to Deutsche Bank by year's end - and who doesn't have it.

Luigi Frascati

Real Estate Chronicle


Sunday, December 07, 2008


Mr. Sore Loser

There are losers and there are sore losers.

The uncharacteristic turmoil of last week in the otherwise fairly tame Canadian political landscape gives us a taste of things to come. It was the Conservative government’s economic proposals of the week before that have provoked the full-scale rebellion of the opposition. Presenting the fiscal update in the tradition of a government that has valued cautious, prudent spending over grand bailouts, Finance Minister Jim Flaherty offered a relatively frugal stimulus package to boost the ailing Canadian economy, refusing thereby to follow the footprints of the American Congress and the Barack Obama Administration to come.

But the real spark that has incensed the Liberals – and most specifically their leader, Stephane Dion – was Mr. Flaherty’s announcement of cuts to a public fund for political parties. This cut was not entirely unforeseen following the Democratic Party’s own tally in the United States that Barack Obama’s election cost some USD 730 millions, and considering that in the wake of the general economic slowdown that has affected and is afflicting all Western governments to various degrees, the general idea is to reduce what is aptly termed "spending waste" – especially political spending waste.

Frugality, however, is not a term in Mr. Dion’s vocabulary if the end result affects his political agenda and own personal goals and ambition. The main reason for the anger of the liberal leader was the elimination of federal political subsidies, as this would have disproportionately worsened the financial situations of the opposition parties compared to the Conservatives; the Conservative Party received 37 percent of their funds from Crown funding in 2007, the NDP 57 percent, the Liberals 63 percent, the Green Party 65 percent and the Bloc Québécois 86 percent. Recent polling by Ipsos-Reid found that 61 percent of Canadians wants political subsidies eliminated.

Labeling the removal of public funding to parties as an “attack against democracy”, the opposition threatened to topple the weeks-old government: they would vote against the fiscal update, the defeat of which would be considered a vote of non-confidence in the newly formed Conservative minority government that would bring it down. And this notwithstanding the announcement by the Conservatives on November 29, 2008, that the plan to eliminate the political party direct subsidy would be dropped. And, of course, Stephane Dion would be appointed “interim”Prime Minister until the time he would resign as Liberal leader this coming May.

As it turns out, Governor General Michaelle Jean has agreed to “prorogue” the current session of Parliament until January 26, 2009 at the request of Prime Minister Stephen Harper. To “prorogue” parliament means to discontinue a session of parliament without dissolving it. Various prorogation scenarios were possible: one was a long-term prorogation, lasting up to a year, while another was a short prorogation period lasting a few weeks to a few months. Each would delay any parliamentary activity regarding bills, hence a motion of non-confidence could not be registered and the Conservative government would continue.

The economic implications of all this political drama are huge, especially as they relate to big ticket items such as real estate.

For one thing the very idea of national unity has been damaged, with Westerners who were never favorably disposed to the Liberals accusing them of trying to dislodge their Conservative government, and with Quebecers feeling that they have no business in governing Canada. And this does not reverberate well internationally at a time when large capitals are already looking upon North America as a dismal place to invest.

This theme was re-affirmed by Gordon Campbell himself, the liberal Premier of British Columbia, who has spoken out against the coalition stating that if their gamble fails, Canada's economic worries will become significantly worse as a result. And Campbell’s own worries in British Columbia would head south considerably, in light of the fact that the Premier will have to call the provincial elections within the first half of 2009 and seeing as to how the left-leaning New Democratic Party (NDP) is already leading the Liberals five points in provincial polls. An NDP win would be a disaster for real estate, recession or not.

And then an un-elected “coalition government” headed by Stephane Dion as interim Prime Minister would certainly be put under question by both Canadians and foreigners alike, considering Mr. Dion’s track record as leader of his own political party. Stephane Dion’s leadership quality have been already challenged and put to a test, having just led his own political party to one of the worst electoral defeats ever. And this too would not bode well with investors, especially foreign.

Besides, to see a Stephane Dion sitting in as an un-elected Prime Minister smacks too much of politics Venezuelan style. Anytime Canada’s political stability is diminished both domestically and abroad we all stand to lose in the international arena politically and ethically as a nation, as well as in the economic arena. Canada is too dependent upon its reputation as one of the best places on Earth to conduct business to afford ‘coup d’etat a la Dion’, and in light of this Mr. Dion has done a great disservice to the country.

Real estate specifically, as among other business, stands to suffer from the reverberations of all this political drama. The capital appreciation we all have enjoyed this past few years is the direct, proximate result of the international image of Canada as a politically stable society and a serious and resourceful economic partner. This in turn has attracted foreign investments and capital that have contributed to the unprecedented development of various sectors of the economy with real estate in the forefront.

We can hardly afford now to have politicians the likes of Mr. Dion satisfying their own political ego and ambitions by putting their own interest and personal agenda over and above the national interest.

Luigi Frascati

Real Estate Chronicle


Wednesday, December 03, 2008


And The Real Estate Board Says ...

A lesson in Marshallian economics.

The most recent bulletin released by the Real Estate Board of Greater Vancouver (REBGV) has stirred up a lot of apprehension in the Lower Mainland on the part of Sellers and Realtors alike. Sellers are clearly concerned by what they perceive as a drop in value of possibly their most treasured asset. Realtors, on the other hand, are fearful of the decline in sales with the corresponding decline in commission earnings. Following is the full, integral text of the REBGV Release, with highlighted in red the parts that seem to be causing a great deal of anxiety and widespread concern just about everywhere.


Slow home sales create window of opportunity

VANCOUVER, B.C. – December 2, 2008 – November reductions in home sales and prices have helped improve affordability in Greater Vancouver. However, November also saw a corresponding decrease in the number of new homes coming onto the market.

In its most recent statistics release, the Real Estate Board of Greater Vancouver (REBGV) reports that
residential property sales in Greater Vancouver declined 69.7 per cent in November 2008 to 874 from the 2,883 sales recorded in November 2007.

Residential benchmark prices, as calculated by the MLSLink Housing Price Index®, declined 12.8 per cent between May and November 2008, amounting to an 8.3 per cent year-to-date price reduction for detached, attached and apartment properties in Greater Vancouver between November 2007 and 2008. In May 2008, the overall residential benchmark price was $568,411, compared to $495,704 in November 2008.

“Times of turmoil, from which we always emerge, offer excellent opportunities to buy quality real estate,” says REBGV president, Dave Watt.“For those whose personal finances allow them to get involved, there are opportunities in today’s housing market that have not been seen in many years.

“The local real estate market is not immune to the current economic challenges globally; however, Canada’s disciplined lending structure has kept the mortgage landscape steady in these uncertain times.”

New listings for detached, attached and apartment properties declined 10.8 per cent to 3,012 in November 2008 compared to November 2007, when 3,377 new units were listed. Active listings in November declined 4.7 per cent to 18,348 from the 19,257 active listings in Greater Vancouver in October 2008.

Sales of detached properties in November 2008 declined 69.8 per cent to 322 from the 1,067 units sold during the same period in 2007. The benchmark price for detached properties declined 8.6 per cent from November 2007 to $666,525.
Since May 2008, the benchmark price for a detached property in Greater Vancouver has declined 13.6 per cent.

Sales of apartment properties declined 67.9 per cent last month to 410 compared to 1,276 sales in November 2007. The benchmark price of an apartment property declined 8.6 per cent from November 2007 to $342,315. Since May 2008, the benchmark price for an apartment property in Greater Vancouver has declined 12.2 per cent.

Attached property sales in November 2008 decreased 73.7 per cent to 142, compared with the 540 sales in November 2007. The benchmark price of an attached unit declined 6.4 per cent between November 2007 and 2008 to $426,287. Since May 2008, the benchmark price for an attached property in Greater Vancouver has declined 11 per cent.

In light of the foregoing figures, which are all but rosy, it would seem to be somewhat anachronistic for REBGV President Dave Watt to talk about "excellent opportunities to buy quality real estate", many of which opportunities have "not been seen in years". Afterall the bulletin speaks of a fall in residential sales to the tune of almost 70 percent for this past November compared to a year ago, as well as of a 13 percent decline of the benchmark price from May to November. And yet if there is one person who would wholeheartedly agree with what would appear to be at first glance Mr. Watt's somewhat optimistic stance, this person would be none other than Alfred Marshall, one of the founding fathers of modern-day Economics.

Prof. Marshall (1842 – 1924) was the first to attempt to explain price behavior within the context of the equilibrium between supply and demand in competitive markets. More specifically, as it relates to inefficient markets, the Marshallian Curve describes how prices vary as a result of a balance between product availability at each price (supply), and the desires of those with purchasing power at each price (demand). A market is defined as "inefficient" when prices of traded assets do not reflect all information about those assets. As such, prices are subject to variations depending upon information that is unknowable at the time the price is set - just like real estate.

Price elasticity of demand is measured as the percentage change in the level of demand that occurs in response to a percentage change in price. In general, a fall in the price of a good is expected to increase demand for that good. More specifically, price elasticity is said to be high when a small increase in price causes demand to fall substantially. An increase in price arises also in the situation wherein the general value of the commodities in an instant segment market falls. Thus, entering a market at a price level that is not in line with market value for similar goods causes demand for that particular good to drop, if its price level is even only slightly higher than the general market value. Lesser demand, of course, causes a fall in price for that particular good which, in turn, has the proximate effect of increasing demand, all of which, therefore substantiates Dave Watt's statement as it relates to the opportunities available in the present market.

Alfred Marshall, during his tenure at the University of Bristol in England, opined furthermore on the concept that consumers attempt to equate prices to their marginal utility, defined as the measure of happiness or satisfaction gained by consuming goods and services or, in the case of real estate, capital assets. Given this measure, one may speak meaningfully of increasing or decreasing utility, and thereby explain consumer behavior in terms of rational attempts to alter prices. Hence, as the pool of buyers dwindles, sellers must apply leverage on the perceived value of the interest in land they are offering , that is alter their utility so as to motivate buyers to purchase. Which, in turn, helps to consolidate the market. And this, of course, explains how real estate, among other markets, always rebounds from times of turmoil, as Dave Watt announces.

Thank you for the lesson in Capitalism, Mr. Watt.

Luigi Frascati

Real Estate Chronicle


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