Category Archives: Banking & Finance

The wrong end of the stick

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In some UK forums recently I have taken part in discussions where the someone is fixated on a specific aspect of real estate investing and they are missing the bigger picture.

The first revolves around the ability to buy a property at a discount (buying wholesale might be the USA phrase) and rather soon after resell or obtain financing at the full market value. Lenders in both the UK and the USA tend to avoid using the paper value if the last sale is less. They will use the lower of the value or sale price for up to 6 months in the UK or even 12 months in the USA.

In the other conversation, we are entering the murky waters of the definition of money, franctional reserve banking and the idea that there is a comspiracy between some big banks. Even if we complete avoid the more wacky ideas, the idea that anything at the macro level impacts significantly the success of a real estate investor’s deal is odd. Deals are done one deal at a time and very much concerning a specific property. If you get a great deal on a house, it does not matter what is going on at the macro level. Yes, interest rate trends and other things have a bit of an impact. Still, your ability to negotiate has more impact that what the Fed or the Bank of England thinks about the source of money and interest rate trends.

Any comments?

Oh, sorry for the late publication. Travel related. Likely to impact the next post also. I will be back in London in about 12 hours.

Bubbles & Banks – Krugman

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Bubbles and the Banks
January 8, 2010
NYTimes.com
Paul Krugman wrote recently that his upcoming columns in the NY Times will be focusing on banking reform. He starts by asking a question:

“What should reformers try to accomplish?”

He starts out by making an observation.

“A lot of the public debate has been about protecting borrowers.”

“But consumer protection, while it might have blocked many subprime loans, wouldn’t have prevented the sharply rising rate of delinquency on conventional, plain-vanilla mortgages. And it certainly wouldn’t have prevented the monstrous boom and bust in commercial real estate.”

“Reform, in other words, probably can’t prevent either bad loans or bubbles. But it can do a great deal to ensure that bubbles don’t collapse the financial system when they burst.”

Think about it. One of the top economists in the US is stating that you can not prevent bad loans or bubbles. We have to accept that both will happen and it is not practical to create regulations to stop either condition.

A bit later in the article Krugman compared the dot.com meltdown when the losses experienced by stock investors was largely the same in magnitude as the losses that have happened as a result of the housing meltdown. If both events were equal in magnitude why the difference in terms of the impact to the US economy?

“The short answer is that while the stock bubble created a lot of risk, that risk was fairly widely diffused across the economy. By contrast, the risks created by the housing bubble were strongly concentrated in the financial sector. As a result, the collapse of the housing bubble threatened to bring down the nation’s banks. And banks play a special role in the economy. If they can’t function, the wheels of commerce as a whole grind to a halt.”

“Why did the bankers take on so much risk? Because it was in their self-interest to do so. If the concentration of risk in the banking sector increased the danger of a systemwide financial crisis, well, that wasn’t the bankers’ problem.”

So what is the solution Krugman is proposing. He only provides the high level as the real details will be shared in future columns. Below is a quick summary of the main points.
“The test for reform, then, is whether it reduces bankers’ incentives and ability to concentrate risk going forward.”

“Transparency is part of the answer. Before the crisis, hardly anyone realized just how much risk the banks were taking on. More disclosure, especially with regard to complex financial derivatives, would clearly help.”

“Beyond that, an important aspect of reform should be new rules limiting bank leverage.”

I am not a fan of Krugman when it comes to the more populist or political points of view. I do think he clearly articulates some of the key issues using language many can grasp. As a way to get a dialog going Krugman makes it pretty easy.

-John Corey