Friday, 4 December 2009

Bubble trouble?

Letter to South China Morning Post:
I agree with Tom Holland (“Bubble muddle ”, Dec 04): keep the government out of bubble-busting.
The IMF has cast its fierce and basilisk eye on our equity and property markets and determined that they are developing bubble-like tendencies.  It then proposes “remedies”.  Quite why the IMF should have any credibility after the fiascos of its interventions in South America in the eighties and the Asian Financial crisis of the nineties, is beyond me.  Countries did best which did the opposite of the IMF credit-tightening prescriptions in those crises.  In the Hong Kong property market, counter-cyclical attempts at control by the government have been shown time and again to lag so badly that they exacerbate downturns and magnify upturns.
Memo to Chief Executive Tsang: listen to the wise advice of Mr Holland, not that of the pointy-heads at the IMF!

Full text below as may not be available online:

By: Tom Holland, Dec 04.

The International Monetary Fund is worried about Hong Kong.
Yesterday it warned that "strong capital inflows and the resultant large liquidity overhang in the financial system could potentially lead to rapid credit growth, fuelling asset markets and creating macroeconomic volatility". In other words, its analysts believe bubbles are developing in Hong Kong's stock and property markets.
The fund is so concerned it called on the government to adopt "countercyclical regulatory action to mitigate the asset price cycle".
In plain English, that means it thinks the government should act now to pop the bubbles before they form. It even suggested five possible policy measures officials could employ.
The IMF's stance is hardly likely to win it many friends among Hong Kong's people, who tend to be rather more sanguine about the idea of stock and property bubbles. If anything, most rather relish the prospect as an exciting opportunity to make lots of money.
Cheung Kong (SEHK: 0001) executive director Justin Chiu neatly summed up the prevailing attitude a couple of weeks ago. "I don't really mind a bubble as long as it doesn't burst," he told a real estate conference. "If I drink champagne, I don't like to drink flat champagne." The government, he implied, should butt out and let market forces take their course.
Our increasingly interventionist officials are unlikely to heed his advice. Chief Executive Donald Tsang Yam-kuen and others have vowed action to deflate any emerging bubbles. No doubt the government is already studying the IMF's policy proposals.
For the property market, the fund suggests requiring banks to hold more capital against their mortgage books to cool off the home loan market. Alternatively, regulators could force banks to increase their loan loss provisions during the upward leg of the cycle in order to curb their lending.
The government could also cut the permitted loan-to-value ratio on mortgages, or tighten lending procedures and standards. And, finally, it could step up land sales to increase the supply of flats coming onto the market.
If there were a bubble, it is unlikely any of these measures would have more than a marginal impact. Hong Kong banks already hold more than enough capital, so increasing ratios would have little effect. And considering that default rates remained below 2 per cent even in the depths of the property market crash 10 years ago, provisions already look adequate.
Lowering the minimum loan-to-value ratio from an already conservative 70 per cent wouldn't achieve much either. At around 64 per cent, the average ratio is well below the minimum anyway. Meanwhile, bank credit procedures are already considered fairly tight.
Finally, increasing land sales might work in the long run. But given the extensive lead time on new developments, it wouldn't do much to let the air out of a bubble in the short term.
The truth is, however, that there are no bubbles, either in the stock or property markets. The equity market has risen strongly over recent months, but as the first chart shows, the price to book valuation for the Hang Seng Index is bang in line with its long-term average and far below the bubble levels that developed in 1999 and 2007.
True, price-to-earnings ratios may look a little elevated right now, but given expected earnings growth of 20 per cent or more next year and the low cost of capital, analysts believe current valuations are fully justified.
Nor is there any sign of a bubble in property. Prices have risen this year, but as the second chart shows, affordability looks reasonable by historical standards. Certainly, it is way below the heights reached in the 1997 bubble. What's more, with some 50,000 flats sitting empty, there is no obvious shortage of supply.
And as the third chart illustrates, there is no evidence of a bubble-like rise in transaction volumes. The number of property deals has actually been declining for the last few months - just like the number of mortgage approvals - as buyers have baulked at the higher prices.
So although as the IMF says there is plenty of liquidity around, we needn't worry too much. Even if stock and property markets gain by another 20 per cent next year, it will be a long time before we have to begin taking its bubble warning seriously. And even then, there won't be much Hong Kong can do about it.