Friday, May 14, 2010

An ancient parable with modern characters

A dear friend of mine, Kiran Sreedharan, pointed out a great piece by Aadisht Khanna. AK says that this old  parable of "the weaver and chariot maker is one of the Panchatantra stories that usually doesn't make it to primary school textbooks or Amar Chitra Katha, mostly because it's full of sex, war, and moral hazard".
Like most really great stories, this one is a cutting commentary on recent events in the US financial markets, and rip-roaringly hilarious because it is so true. Only, we are looking at that truth through the goggles of an old parable. 
Aadisht writes a very interesting blog at  However, in my view, this ancient parable with modern analogies is something that puts most of his blog entries in the shade. 
PS: 8 Mar, 2011
This page seems to have moved, but I found the same parable here. Obviously, this is an un-attributed lift, because this blog entry is dated after the date of this blog entry of mine. 

Thursday, May 13, 2010

Another Great Feature from Google Labs

The guys at Google are really something.

Now, it is an app still in the Labs stage (i.e., pre-beta) that I noticed today. It is called Google Public Data explorer. What it does is that it brings Economics and Macro-economic indicators alive.Way, way beyond what any spreadsheet applications have done. This feature currently works on specific datasets that Google has compiled. I am sure that the next step will be to allow you to upload your own datasets and use the same engine to animate the stuff.
Take for example this picture.  It clearly shows how hypocritical the developed countries are, when they refuse to talk about sharp reduction in emissions, and expect countries like India and China to commit to emission reduction. See their per capita profligacy over the last few decades by clicking on button below the graph. The underlying data is from the World Bank.
Take this picture, that shows how the preparation for the Olympics and the huge increase in steel manufacturing in China made for a sudden acceleration of China's absolute CO2 emissions.
Macro-economics and statistics will never be the same again.
I salute Google. This would be a godsend for researchers and for number-crunchers in companies, once it graduates to allowing us to upload and analyse our own datasets. No more huge money to be spent on data mining and analysis software. 

PS: Those of you who read this and some of the other entries on my blog are invited to comment  on the entries they have a thought to share, and to subscribe to the blog feed. I promise interesting posts, and not too many of them. Nice to know that someone is reading all this!


Sunday, May 09, 2010

Residential Property: Time for a Simple Reform

Recently, I visited an exhibition organised by an builders' confederation (MCHI) in Thane, where I live. I was struck and amazed by the unfairness that the industry has been able to visit upon buyers. The biggest unfairnesss is the increase in the rates. A year ago, apartments were available for Rs. 3,200-3,500 per sq ft in a then newly developing locality west of Ghodbunder Road. At that time, people wisely shook their heads and said that the rates were too high and hence the time was ripe for a "correction".  Now the rates ranged from Rs.4,900 to Rs.5,900 in the same locality, an increase of 53 to 84% in just about a year. What is this because of? There is no word I know which describes the opposite of "correction", except "correction" itself. Be that as it may. Let me now list the "unfairnesses" that the typical home buyer labours under.
  1. Most of these rates apply to buildings that have just been "launched" -- which means that not even a hole has been dug. In some cases, even the permission to start construction work (which comes after several clearances) may not have been received. Deliveries are rarely promised before June, 2013 for such apartments. This means that any money paid by a buyer to the developer represents risk capital. If for some reason, the builder does not deliver the apartment, the investor will be left holding the can; and civil rights are notoriously difficult to assert and execute in Indian courts in anything less than a whole generation. 
  2. The buyer is "allotted" a cube of space in the air called a proposed flat. He cannot transfer that right to the apartment without  the developer's consent. The typical developer will not allow the transfer, and if he deigns to allow it, he will charge a hefty sum, enough to make the sale much less worthwhile to the hapless buyer.  Or, he will offer to repay the sum paid less a small percentage. If the buyer accepts it, the builder will line up another such buyer at a rate much higher than the "booking rate" paid by the earlier buyer, justified by market conditions and the fact that the building construction has progressed considerably. Push a builder on why he does not allow such transfers before possession, and he will say that he cannot allow them to "spoil the market" thereby giving away that the market is nothing but a cozy cartel or oligopoly.
  3. Instalments have to be paid as and when slabs are cast, and with 30 and 40-floor apartment blocks coming up nowadays, 2% to 3% of the agreed total consideration comes up for payment every month or two months, reaching 80% of agreed consideration when all the slabs are cast. This stage is reached faster if the building is not so tall. Non-payment or slightly delayed payment would visit the buyer with an interest burden. Consider this: a typical buyer who funds 20% of the consideration on his own and 80% through a home loan has to pay up 20% immediately (i.e., 100% of his own contribution before initial excavation) as this is a normal rule with lending institutions and another 60% using loan disbursements, whereas the builder has incurred only 20% to 30% of the total cost of construction. While one may make an allowance for some reputed builders, there is nothing to stop builders from diverting the resultant temporary cash surplus into other projects, or land acquisitions. The temptation is very high -- after all, he will be using zero-cost funds and the risk will substantially be borne by the buyers who have no alternatives. 
  4. Now look at the builder's position. He has collected 80% of his money but has yet to spend 70% to 80% of the cost of construction. He has already used up the cash -- and will have to generate liquidity to finish the remaining work. What is his incentive to do the remaining work and deliver on the promised date, when it means that he now has to cough up more than he has collectible?  Every delay works to his advantage. Small wonder that most builders fail to deliver as per first promised schedule. 
  5. Now look at our typical buyer's position. He is living in a rented house. As soon as loan disbursements begin, he is keen on reducing overall interest costs, so he agrees to start paying his EMI (or pre-EMI) to mitigate borrowing costs. He then (let us say) gets married to a working girl whose earnings also come in handy. The marriage took away whatever financial cushion he still had remaining. And he (and his newly wed wife, too) have to pay (for 18 months to 36 months) a loan instalment in addition to the rent -- which, if they can afford it, leaves them with even less money in hand. Despite education, and despite well-paying stressful jobs, they are living from hand-to-mouth, with too much of month left at the end of their money. And then, after paying all his life's savings and incurring a huge debt burden, when the slabs are fully cast, they both are in the weakest bargaining or negotiating position that they will ever be in -- much worse than at the start. What's more, he does not even know the other people who share his plight, because only the builder knows who else has bought apartments. Add to this mix an implacable builder who does not recognize the concept of fairness, and you have a buyer who is extremely angry, but totally vulnerable and soft-as-putty. He does not have any money left to launch a legal fight, and the agreements are worded totally in favor of the developer, he discovers too late. At this point, it only needs an event like a job loss (which would not have been very stressful if he still had his savings, and was not servicing a home loan) to push him beyond the brink.
  6. If property prices are under downward pressure while construction is in progress, the builder is cool: his costs are already covered; and the  buyers are already locked in at the old price. He will have a few flats unsold, but if he does not need the money, he won't sell in a depressed market. His locked in buyers too, cannot sell without his okay. So the market price never really falls, and buyers at lower levels will not find builders willing to sell very easily. 
  7. If property prices rise, it is even better. Delaying delivery will make existing buyers desperate. Some will have reached the end of their financial tether, and become willing to sell out at much less than current market prices. The builder only switches the old buyer with a new one, who is willing to pay a much higher price. 
How can the situation be remedied?  There is a crying need for One Simple Reform: Ban builders/ developers from selling apartments or shops till they are ready to be occupied, and till an occupation certificate certifying that the entire building is fit and ready for occupation, has been received from the Municipal Corporation.  Indeed, they should not be allowed to even issue allotment letters or collecting advances linked to blocking of a specific apartment, shop or office. No document should be recognized as a sale agreement unless it is stamped and registered, and this cannot be back-dated. How will this help?
  • Builders/ developers will be keen on completing construction and making the property ready for possession because their own money is locked in till that happens.
  • Their traditional source of funding, prospective buyers, will dry up. So will "investors" who get in with the builder and get out with the builder, because they cannot get anything but a stated rate of return, and will be much more uncomfortable without a valid letter of allotment.
  • If the project gets "stuck", then the risk is entirely on the builder because he has his own and borrowed money invested, and the longer it takes, the higher the cost of funds.Also, the builder will be under much greater pressure from lending institutions who have (hopefully taken) collateral securities and who have the financial muscle to take control of the project, if needed, and sell the unfinished project to another bidder. Individual flat buyers will never be able to do that.
  • Prospective buyers will not become lightning rods for risks of this business because they cannot invest early. They can only buy ready flats, so they won't get "stuck".
  • The negotiation balance will be much less lop-sided, because prospective buyers can dangle full immediate payment as a carrot, and can demand better rates because the average builder is under much higher pressure to sell. 
  • Builders will be unable to overextend themselves to buy land because cost-free and risk-free funds to create land banks will disappear.
  • If property prices fall, some builders who have unsold, ready flats will be unable to bear the financial burden of waiting through the downward cycle of prices, and will be forced to sell at lower prices.
Along with this simple reform, there should be stringent punishment and fines (collected on behalf of those who have funded him) for those breaking this rule, and provisions for handling the interests of buyers who are already stuck" with a particular builder. A real estate regulator should be set up (could be additional powers to SEBI itself).
I know that there will be enough naysayers who will object to this simple reform and dub it simplistic and unrealistic, but in my view, problems resulting from this would be manageable.

Wednesday, May 05, 2010

Not a good time for any stock market

Airline and automobile industry have always been GDP multipliers. That is because of the huge direct and indirect employment they generate, both upstream (component and ancillaries manufacture, assembly, services) and downstream (sales, service/ maintenance, spares, travel and tourism) besides the airline manufacturers and operators themselves. When any of these industries get hit, the economy gets multiple hits.

Of the two, the airline industry is more vulnerable to random hits, because of the global nature of their operations. Not only are they buffeted by almost every risk there is, including terrorism, hijacking, fuel price and availability risk, currency fluctuation/market volatility risks, political and taxation-related risks, etc., but they are also vulnerable to Mother Nature – sudden “clear air turbulence”, volcanic ash, storms, lightning and bird strikes, storms, besides risks arising out of mechanical, electrical, hydraulic and electronic failures, Air Traffic Controllers' errors, pilot error, irate governments who impound planes to score political points, militant cabin crew and pilot unions, irate customers demanding refunds and free accommodation, careless loaders, .... the list is endless. There is no other industry I can think of, that has such a profusion of risks to contend with every single day. Of course, the insurance industry is a close second.

The automobile industry is already doing very badly in all countries save China and India, thanks to the 2008-9 meltdown and recession, and these two markets are becoming hyper-competitive, thinning the margins and making the business environment even more difficult for all players.

When both these industries are doing badly, it is well nigh impossible for any economy to grow, especially in developed countries where markets are already very developed, saturated and competitive. Add to this fiscal profligacy of successive governments and you have a great recipe for financial disaster. This is what Europe and the Euro area is facing today.

With growth rates of all these economies being in the low single digits where positive, and negative in most places, it does not take much to knock an economy, and by extension, due to globalization, an entire region, off-balance. The recent volcanic ash episodes have paralyzed much of Europe, especially the UK for upto a week. Given that a week is almost 2% of a year, loss of such a level of business more than once in a year is a luxury that any European country can ill-afford. We are already into the second bout of airport and airspace closures, and Katla, the bigger next-door volcano, has yet to erupt! Add to it the cost and turmoil of elections (in the UK), fiscal profligacy (Greece, Spain and Portugal) and strikes and unrest (Greece) and it would be a very credulous person who would bet on the European economy growing over the next two years.

Because of the very interconnected nature of markets, it takes seconds, not years, for any contagion, whether of optimism or pessimism, to travel across the globe. So brace yourself for stock market failures. This contagion will definitely travel to India, for no mistake of it own, except Indian markets' connectedness with world markets and contagiousness of investor sentiment.