Hype and Easy Credit – a recipe for disaster, or just a logical correction?

South Africans are finally beginning to concede that a recession may just be on the cards

President Kgalema Motlanthe has even used the word depression, and our pundits seem a little less certain that our current account surplus will protect us, or that our tight credit policies and our non-dollarised economy will cushion the blow.

The reports coming from the rest of the world certainly do not support cheerful optimism.

Britain has already acknowledged that it is in a recession, and that it stares deflation in the face.

Standard & Poor issued a statement earlier this week that $2.1 trillion of debt is coming due in Western Europe over the next three years in severely dysfunctional markets where borrowing costs have already jumped 225 basis points since August 2007.

The United States is far worse off than Europe (in October alone its economy shed 240 000 jobs), and its own analysts are saying not even Obama can stave off the collapse of an empire showing all the signs of collapse; an economy based on speculation and sentiment in the form of derivatives (far removed from the tangibles of manufacturing), catastrophic debt levels, extreme economic inequality and a costly military which has overreached itself.

The heir apparent to the throne of world leader, and economic bellwether, is China, and China is crashing.

Since the credit crisis began China’s GDP has slowed from 12 percent to 9 percent, its stock market is down 60%, Chinese banks are facing a liquidity crisis (with bad debt sitting at 6 percent ($171-million) of total advances factory owners are abandoning and simply walking away from their factories, and the real estate market is in deep trouble.

Sovereign credit default swaps spreads are widening as central and other banks lose faith governments’ abilities to bail out their own economies.

The International Monetary Fund’s forecast for the world economy next year is a major contraction of the rich economies of North America, Europe, and Japan “for the first time since the Second World War.”

The upshot is likely to be what conspiracy theorists say was the whole point of manipulating , exploiting or even engineering of the current crisis: A new world order.

These are not the words of ITInews. “Gordon Brown calls for new world order to beat recession,” was the headline in the Telegraph on Thursday.

British Prime Minister Brown was calling for the creation of a “truly global” society ahead of this weekend’s G20 summit, saying the current “economic downturn” is the perfect opportunity to “thoroughly reform” international financial institutions.

For months now the writing has been on the wall. The IMF is in for some heavy-duty retooling in the interests of “greater international transparency” in banking practices for instance.

In South Africa key sectors are shedding thousands of jobs, 32000 at Longmin (mining) alone, with the motor industry expected to make a major announcement soon, following warnings by McCarthy CEO Brand Pretorius that rationalisation and retrenchments have become increasingly likely in the motor-retail sector.

The housing market is a good place to start taking a measure and the best place to start is with an owner.

John Turner (not his real name) got into financial difficulty recently and had to sell his house – an investment in an area undergoing gentrification - urgently.

He was hoping for a R1-million. He got R390 000 (granted he was forced to sell urgently.)

Last week a Sunday newspaper reported that the number of South African homeowners who have defaulted on their home loan repayments has rocketed to nearly 100, 000 since June as debt starts to overwhelm them.

Alliance Group had auctioned more than 1500 repossessed homes since January.

According to First National Bank, the monthly repayment on a R1.1-million home loan over 20 years had increased from R10982 in June 2006 to R14893 at the current prime rate of 15.5%.

Absa blamed rising inflation and interest rates, as well as the implementation of the National Credit Act (NCA).

The morning ITInews interviewed RealtyWize principal Clyde Young there was a story in the local newspaper about real estate agencies going to the wall in record numbers (in Britain they’re being shut down at the rate of 150 a week.)

Young is a realist. “No-one’s buying,” he tells me.

Bluntly, Young tells me there was absolutely no reason why South African property prices should have skyrocketed the way they did in the past few years.

“There was no change in the asset value. Nothing was added to the property other than an increase in the price.”

He sees the hand of the banks, but is not certain to what end.

“You know how you can tell things are bad,” he says.

“Usually the banks give people a month or so if they’re in arrears with their bond. Not this month. A date late and they were on the phones saying: ‘When are you going to make the payment?’

Young believes the banks have been manipulating house valuations for years and that prices were vastly overinflated based on nothing but sentiment.

Lew Geffen is one of South Africa’s leading property experts.

He recently set the cat among the pigeons by sending out a memo to his agents (he heads Lew Geffen Sotheby’s International Realty) saying the property market was worse off than the banks were leading us to believe, and to expect another 25% drop in prices over and above the dip already being experienced. (Absa for instance, is predicting 5% drop.)

Negative equity is building up in the market as house values decline beyond the price at which they were bought.

In a tough market, banks are demanding higher deposits, and consumers already reined in by the National Credit Act are finding it virtually impossible to secure a bond. Hardest-hit are first time buyers who can’t raise a deposit.

Geffen says while the banks are being truthful in their estimations, it is a skewed truth.

“They are taking the whole market into account, putting sub-economic housing in with luxury housing, which makes the numbers so general as not to be accurate,.

“The truth is that the market is down quite radically and it’s coming down from a very high threshold. The market was pumped up by up to 54% and money was freely available. In terms of the banks’ policies they were giving out money left, right and centre.

“This led to a 54% rise all based on hype and easy credit. We’re now suffering the hangover from that period. Now there’s a lot of fat in the market and it’s going to lose that fat. It’s going to be very difficult.”

Geffen says the market is down between 17 and 20% - on the back of a 50% drop in volume - and estimates the “fat” in the market at about 35%.

“People are mesmerised by what’s going on. They’re not in a buying mood and if money becomes more expensive there will be more screws on the public and the situation will be made worse. The rest of the world’s decreasing interest rates and we’re increasing them. We’re out of alignment and its pulverising people.”

Geffen says the market will obviously recover in time. The big winners will be those with cash.

The banks, he points out, will not suffer. They’ll be tightening up on credit, as their own access to capital is squeezed.

Others, like Herschel Jawitz, insist the drop is bottoming out but admit that the bottom end of the market and first-time buyers are out of the game.

John Loos is FNB’s property economist.

ITInews asked him whether the market was being talked up artificially and whether the likelihood of a recession or depression was being soft-pedalled.

“No I wouldn’t agree. I don’t think there’s any evidence of anything being withheld. SARB data paints a grim picture on the durable consumer side as well as residential mortgage industry, two of the hardest hit.

“June mortgage loans are down by -35.5% year-on-year and NAAMSA’s new vehicle sales which are very much up to date (2 days after month end) paint the same picture. There are lags in the official stats but they haven’t changed in recent years.

“So no, while conspiracy theories make for a good story I have no reason to believe that there is any cover up domestically. Official stats have lags, but the lags haven’t changed in recent years in what would look like an attempt to cover things up.

“We don’t obviously know yet what GDP data will say but plenty of other publicly available data tells a bleak picture, while on the other hand I think it is realistic to believe that CPIX inflation should start declining , given global commodity prices falling. So I think the bulk of the picture is there for all to see if they want to see it.

“But what we don’t know, is how bad the US financial sector crisis really is, and I wouldn’t be surprised if a lot of information in that regard is being withheld from the world. That’s got nothing to do with our authorities, but it can affect us big time.

"I think we know that the Yankees haven’t been exactly honest about what has been going on in their financial sector, so I don’t know whether to believe them going forward. That’s the unknown factor, and the worse it gets (than anticipated) the worse our economic situation could become,” he said.

He said he believed house prices would deflate further through to about the second quarter of next year, whereafter rate cutting was expected.

Property economist Erwin Rode, CEO: Rode & Associates, disagreed with the view that the true nature and depth of a depression rather than a recession was being withheld from the South African consumer in order to avoid a panic.

“It looks progressively more likely that we might be heading for a recession but certainly there is no evidence yet that SA is heading for a depression.”

He agreed the housing market was still overvalued, and the correction that started at the beginning of this year would last “many years indeed”.

“I do not see it as a crash like in the USA, but rather a long period of little nominal capital growth, certain less than the inflation rate, for say five to seven years. But expect capital values to decline by 5% or so next year.”

This price correction, he said, was necessary for salaries to catch up with house prices. “It will be a process of many years, not a happening.”

Banks are finding harder to raise capital because their traditional sources of capital in Europe have dried up as governments rush to prop up their own economies.

ITInews asked Leon Barnard, Standard Bank’s director of personal and business banking products what effect a loss of liquidity was having on banks’ ability to finance housing.

He said Standard Bank was highly capitalised with excess capital after the sale of a 20% stake in the bank to ICBC last year.

There had been marginal tightening in credit policies at Standard, he said, but lending was still occurring.

“The Standard Bank median house price index recorded a decline of 2.5% y/y in October, following a rise of 3.6% y/y in September. It is anticipated that house price growth will be negative over the short and medium term.

Over the short term, economic conditions are expected to deteriorate further, but South Africa’s intensifying economic slowdown and the positive developments on the inflation front for early next year, suggest that we could be at a peak in the monetary policy tightening cycle.”

He said the residential property market was expected to improve meaningfully only once fundamental drivers such as disposable income and interest rates improved and households felt more comfortable with their debt levels.

This was unlikely to happen before late 2009 or early 2010.

What effect did Standard foresee on the low incoming housing market particularly?

“The lower end of the housing market is still proving to be resilient to current market conditions. While the housing market in general has seen a bit of stress on it, the same cannot be said for the prices and real volumes of low cost houses.

“Demand has always outstripped supply in this sector. However, the full picture is not as rosy as that. Underlying economic conditions coupled with high interest rates, high inflation and decreased household disposable income has made this market quite challenging.”

So, essentially, depending on whom you speak to:

  • The property market is the victim of malinvestment driven by a fundamental misreading of the market or a deliberate manipulation.
  • “What goes up must come down.” The bubble has burst and the market is correcting.
  • Things are not as bad as they seem; and
  • Things are far worse than they seem.

Article by: Lloyd Coutts - www.itinews.co.za