November 23, 2017

The Intertemporal Structure Of Preferences

A report from the Malay Mail Online in Malaysia. “Haphazard construction of new property without regard for market forces was the reason for the existing oversupply of real estate, said an industry group. The Association of Valuers, Property Managers, Estate Agents and Property Consultants in the Private Sector Malaysia (PEPS) said this when expressing support for the government’s decision to suspend approval for property valued above RM1 million. It said Bank Negara Malaysia has demonstrated that there was currently RM35 billion of unsold property of various types in the country, and that more effort must be made to ensure these are taken up before more are constructed.”

“‘PEPS views the causes of property market overhang to be developers’ indiscriminate building of properties, a lack of market studies and financial feasibility studies being carried out prior to building, no coordination on planning among local authorities and indiscriminate approvals. Other causes include the delay in gazetting of local plans that leads to uncontrolled development and higher cost as well as artificial demand created by members of the public for fear of losing out on choice properties,’ it said in a statement.”

From Free Malaysia Today. “The Consumer Association of Penang (CAP) has criticised the government for only recognising now what it had highlighted 28 years ago on the housing situation in the country.CAP president SM Mohamed Idris said it was good that the government had finally decided to freeze luxury property developments from Nov 1, 2017 due to a glut of such properties. According to reports, Second Finance Minister Johari Ghani had announced that the freeze will affect high-rise condominiums, shopping malls and commercial units.”

“‘CAP had warned of this scenario 28 years ago in our book ‘Housing for the People’. However, it fell on deaf ears till now,’ he said, adding that he had repeated the message many times since then. ‘The crux of the housing problem is that the country’s building resources were channelled not towards where people’s housing needs are, but towards where the market which could pay was.’”

“‘Such a problem has been manifested nationwide, leading to an over-production of unusable expensive properties that a large segment of the Malaysian population cannot afford. For example, the term ‘affordable housing’ is grossly misleading because it can range up to RM400,000 per unit,’ Mohamed said. ‘We have to consider that this serious housing policy flaw, resulting in a glut of unsold property units, can drive developers, the banks and the country to financial ruin.’”

From The Malaysian Insight by Carmelo Ferlito. “I read the recent article by Sheridan Mahavera, ‘No sign of housing market crash, say economists,’ in which some of the thoughts I expressed in an interview with Free Malaysia Today are reported. I need to clarify both my thoughts and what I believe to be some misunderstandings regarding the concept of crisis, crash and bubble. In particular, the first lines set the article’s tone and they open doors to misinterpretations.”

“Mahavera writes: ‘House prices are not expected to fall sharply next year, said economists who disputed speculation that the property market will crash due to a glut.’ These lines linked market crash and sharp price fall as if they were the same thing; such an approach to business cycles is misleading. From the perspective of economic theory, they are two distinct phenomena: a crash is an eventual consequence of a previous boom and its roots need to be found in the dynamic of the boom; the price fall is an eventual consequence of the crash, but its magnitude (sharp, light, …) depends on a series of factors that need to be closely analysed.”

“The appearance of an economic boom is always related to a modification in the intertemporal structure of preferences, and it is always related to a specific industry, whose expansion dynamics will drive upward the general economic system. Entrepreneurs’ mood is lifted up by positive profit expectations, usually focused on a specific industry, which recently was the property sector for the Malaysian case. It is therefore crucial to emphasize the central role of expectations as the driving force behind entrepreneurial preferences.”

“The signals an economist should look at are related in particular with the fact that the first wave of investments is always followed by a secondary wave of imitations and speculations. The pace of economic growth becomes particularly sustained when the primary wave of entrepreneurial investments is joined by a stage of secondary growth encouraged by the instincts of imitators in search of profit and driven by ‘fashion’.”

“Why are imitations inevitable? It is easy to imagine how the success of entrepreneurial initiatives is readily followed by imitators looking for success within what at first sight always seems to be a period of growth destined never to end.”

“Like the primary wave of investments, the second wave is generated by profit expectations, particularly the expectation that the current situation will not change. From a quantitative point of view, moreover, imitation (secondary) investments might even be greater than the first cycle of investments since they involve a larger number of individuals, whose expectations are ‘over-excited’ by the boom.”

“The positive sentiment, that becomes ‘incandescent’ at the end of the primary expansion stage, also plays a role in regards to the action of banks. In fact, precisely because of what happens during expansion, it is highly likely that banks make available ‘virtual funds’ that are not backed up by real savings, driven by expectations that the adaptation of consumer preferences (further saving) cannot but occur, precisely because of the enthusiasm generated by the boom.”

“It is well known that prices raise during a boom and tend to decrease during a crisis. But we do not have to mistakenly identify the crisis with the price fall itself. They are two separate phenomena, the second being a consequence of the first one.”

“A similar mistake is done by some economists when they identify overproduction as a crash, when instead it is an eventual consequence. Therefore, while we can imagine that the present dynamics in the property market in Malaysia will bring out a crisis (though a precise temporal estimation is a job for fortune tellers and not for serious economists), the potential effect on the price system cannot be precisely identified.”

“In fact, a big part of the final outcome will depend on subjective reactions by market actors. Will they expect a short and limited crisis? Or a long and widespread recession? The individual mood will play a big role in the developing of the crisis itself. People owning houses for investment might decide not to sell, expecting a positive upturn soon; or they might be caught in panic and running for liquidating their assets. These two different behaviours will have different consequences on price movements, while the crisis itself will remain as a matter of fact.”

“Finally the response from government, Bank Negara and the credit system will play another pivotal role: if these institutions will try to support the industry via credit expansions, the crisis will turn to be longer (like it is happening in Europe now) and the price fall will be hidden by centrally led inflation, setting the stage for fake recovery and a subsequent deeper crisis. On the contrary, if market forces will be let free to allow the production structure to realign itself to the new scenario, the price shock would be stronger, the crisis shorter, and the new economic fundamentals more sound and stable.”

“In conclusion, the analysis of the peculiar moment experienced by the property market in Malaysia can be successfully carried out only if supported by an understanding of the cyclic dynamics which characterize capitalistic development. Cycle stages and price movements are linked but distinct phenomena; while we can see a crisis coming, the subsequent price movements cannot be uniquely identified a-priori.”