10-STEP FORMULA: Dr Ernest traces the path of how countries and individuals can ruin themselves financially
In my previous two articles (NST RED 13th and 20th July 2012), I examined the causes and events that led Malaysians to be caught in the “Malaysian Property Dilemma”. Like the situations in Ireland and Spain, the phenomenal increase in property prices in Malaysia during the past three years is fuelled, in part, by the abundance of bank loans with extended (30 years) repayment periods that are made freely available to those who apply. This surge in the availability of bank loans with easy repayment periods almost overnight created a new and aggressive group of property-hungry Malaysians i.e. Generation-Y, the newly graduated and newly affluent young Malaysians in their 20s and 30s.
Prelude to financial ruin: In my previous article (NST RED 27th July 2012), I concluded Malaysian property sellers are also caught in a Property Sellers Dilemma. They cannot afford to sell! They also cannot afford not to sell! It has happened before in 1997/1998. It can happen again if no action is taken. How long can the twin dilemmas of the Malaysian Property Dilemma and the Property Sellers Dilemma continue before we find ourselves in a Property Market Crash?
In my previous article (NST RED 17th August 2012), on behalf of the thousands of Malaysian families now drowning in their housing loan debts or barely keeping their heads above water, I appealed to the Prime Minister to intervene to have Bank Negara Malaysia impose a Malaysian-wide Housing Loan Repayment Moratorium to be implemented by Malaysian banks for a duration of between three and five years.
The path to financial ruin: Are we Malaysians and is Malaysia on the path to financial ruin? Are we heading to where the likes of Greece, Ireland, Portugal and Spain are: National Financial Crisis and even possible National Financial Ruin?
The path to National Financial Ruin (for the Country) and Personal Financial Ruin (for the Individual) is a well-trodden path walked by many who had gone before: Nick Leeson (Singapore Derivatives), Lehman Brothers (USA Investment Bank), Barings Bank (United Kingdom Bank), Greece, Ireland, Portugal and Spain to name but a few.
Let us now follow the movements of these financially troubled entities on their journey along the path to Personal and National Financial Ruin.
Step No. 1: Idea for a Bank facility (loan) or project
When a country’s economy is good, for the individual citizens, there is an incentive to spend and indulge. Like the citizens of Ireland and Spain, they would embark on spending sprees to buy cars and properties they do not need and cannot afford and in places they hardly know.
As for companies, including property developers, they will waste no time in pandering to the desires of these newly affluent consumers. They will expand and diversify.
For Governments like Greece, they quickly embarked on massive infrastructure and capital works projects building roads and highways leading to nowhere. All these economic activities are embarked upon in the name of wealth creation.
With stable political environment, little thought is given to possible political instability in the future. Where did these newly affluent consumers, companies and Governments find the money to spend? From the Banks.
Step No. 2: Need or speculative venture?
Do you need the new car and the new house? Can you comfortably afford to pay for that detached house in Damansara Heights, Kuala Lumpur?
Do we need another 100-storey office tower generating another 3 million sq ft office spaces for KL when as at June 2011, we already have 81 million sq ft of offices with another 25 million sq ft of office spaces already in the pipeline and scheduled to come on-stream by 2015 when KL will by then have a total of 106 million sq ft of office spaces?
To understand the supply and demand situation of commercial spaces in KL, I will quote (edited) from an online news portal statements made by property professionals in Malaysia as follows:
“Total office space supply in the Klang Valley stood at 80 million sq ft at the end of 2010 and 80.8 million sq ft at the end of the first half of 2011. It was estimated that an additional 25 million sq ft of office space would come on stream in the Klang Valley by 2015; excluding mega projects such as the Naza group‘s KL Metropolis development, Warisan Merdeka Tower and the Tun Razak Exchange (formerly known as Kuala Lumpur International Financial District)”. - Christopher Boyd of CB Richard Ellis on 1st November 2011
“By 2014, the Klang Valley will have 53 million sq ft of retail space in 149 malls and hypermarkets. However, only about 43 shopping centres and hypermarkets out of the existing 133 (or 30 per cent) were performing well”. - Allan Soo of CB Richard Ellis as quoted on 1st November 2011
“A BIG pipeline of commercial properties in and around the city centre itching to be launched over the next decade or so is stoking concerns by the day. Will there be sufficient demand for all these buildings?”
“Close to half of the TRX real estate project will comprise office buildings. The project comes along at a time when many other mammoth commercial projects such as the re-development of the 926 hectares Rubber Research Institute (RRI) Malaysia land in Sungai Buloh and
Permodalan Nasional Berhad’s proposed 100-storey Menara Warisan Merdeka are poised to take off”. - The Star Online 11th August 2012
“As it is now, there is already an oversupply of commercial properties in and around the city centre”. - Lim Eng Chong of Henry Butcher Malaysia as quoted on 11th August 2012
“The take-up rate for office buildings which are being built and will be completed this year stands at below 50 per cent. This is for commercial properties in and around the city, but the same scenario exists further away from KL, such as in Cyberjaya; there is already an oversupply situation” - James Wong of VPC as quoted on 11th August 2012
In the light of the findings of property professionals in Malaysia, who are experts in their own fields, on the supply and demand situation for commercial properties in the Klang Valley, does Malaysia need and can we actually afford these mega projects?
Step No. 3: Availability of cheap loans
The dire situation that thousands of Malaysians now find themselves to be in is due primarily to their easy access to Housing Loans with banks offering them up to 95 per cent of their Purchase Prices (not necessarily their actual values) and with repayment periods of up to 30, 40 or even 50 years.
Easy access to high margin Housing Loans with long repayment periods is not necessarily a good thing for Malaysians. Do you agree with this statement? Let us look at what happened in Ireland and Spain:
Spain: House ownership in Spain is above 80 per cent. The desire to own one‘s own home was encouraged by governments in the 1960s and 70s, and has thus become part of the Spanish psyche. As feared, when the speculative bubble popped, Spain became one of the worst affected countries. Spain has been the European country with the sharpest plunge in construction rates. So far, some regions have been more affected than others (Catalonia was ahead in this regard with a 42.2 per cent sales plunge while sparsely populated regions like Extremadura were down a mere 1.7 per cent over the same period). Banks offered 40-year and, more recently, 50-year mortgages.
Ireland: The property bubble in the Republic of Ireland was an unsustainable bubble in the price of real estate from the 1990s to 2008. The fall in domestic and commercial property prices contributed to the Irish banking crisis. As of February 2012, prices continued to fall. House prices in Dublin are now down 56 per cent from its peak and apartment prices down over 62 per cent. House prices have so far returned to pre-2000 levels. Mortgage approvals have dropped to 1971 levels.
An International Monetary Fund (IMF) report in 2000 contended that Irish property prices were almost certainly heading for a collapse in the medium term, since “no industrial country in the last 20 years had experienced price increases on the scale of Ireland without suffering a subsequent fall“.
There had also been reported cases of mortgage fraud where borrowers overestimate their income to enable them to borrow more. There is a worry that these people could fall into serious debt if Ireland had a property crisis like that in Britain in the late 1980s. This experience has resulted in the sub-prime residential mortgage fallout in the United States.
Many bank economists, media commentators, estate agents, property developers and business leaders went on record to state their belief that the Irish property market was healthy, and that any decrease in house prices was indicative of a soft landing only.
As of November 2011, prices continued to fall. House prices in Dublin are now down 51 per cent from its peak and apartment prices down over 60 per cent. House prices have so far returned to year 2000 levels.
Step No. 4: Inadequate feasibility studies with poor risk assessments
Malaysian banks, before they lend money to developers and house purchasers totalling in the millions of ringgit, should first carry out “Feasibility Studies” and they should investigate the viability of each potential project as well as all the options available.
I am informed that not many banks in Malaysia carried out detailed and exhaustive “Feasibility Studies” and they did not thoroughly investigate the viability of each potential project as well as all the potential risks involved with the project.
If Malaysian banks had in fact carried out these detailed and exhaustive “Feasibility Studies” and if they had in fact thoroughly investigated the viability of each potential project as well as all the potential risks involved with the project, Malaysia would have been spared the thousands of abandoned housing projects that dot our landscape throughout the country. Thousands of Malaysian families would have been spared the emotional anguish and trauma and financial pains of having to continue to pay the banks for the Housing Loans already released to these developers and yet not having the houses they purchased.
Such unfortunate consequences that these Malaysian families are now having to bear, to a large extent is due to Malaysian banks’ failure to undertake in an organised way appropriate risk assessment and their failure to identify all the risks and not evaluating all the risks accurately, both qualitatively and quantitatively, even when these risks have been identified.
Due to their poor risk management procedures, Malaysian banks, after having identified these “risks”, did not deal with these risks in an adequate way. The result: Disasters occur and we find ourselves burdened with the many abandoned housing projects.
Step No. 5: Banks not properly managed
In this respect,I am happy to note that Malaysian banks are generally well and properly managed. Our Central Bank, Bank Negara Malaysia also has a tight rein and control over Malaysian banks.
This situation unfortunately cannot be said of banks in the US and even in Europe. The BBC on 24th August reported via Internet news that HSBC, Standard Chartered and several European banks have been under investigation by US regulators such as the Treasury Department‘s Office of Foreign Assets Control, the Federal Reserve, the US Senate‘s Permanent Subcommittee on Investigations, and Manhattan District Attorney, Cyrus Vance.
Step No. 6: Premature project commencement
Starting projects before funding for the whole project has been negotiated and agreed upon with the banker is a dangerous and at times a disastrous venture. Similarly disastrous for both the bankers and developers is the habit of Malaysian developers of not carrying out “Market Studies” to ascertain the level of demand (actual demand) for the products and properties that are being developed and expected to be sold in the Malaysian property market place.
Starting projects well before pre-let contracts are negotiated and agreed upon with between the developers and their potential tenants may prove to be disastrous ventures. The findings of James Wong of VPC that “the take-up rate for office buildings which are being built and will be completed this year stands at below 50 per cent” bear witness to these disastrous consequences.
Step No. 7: Change to a hostile economic or political environment
When the National Economy and the Regional Economy collapse, most economic activities will come to a stand-still. Bank Loans already approved will be frozen and in many cases, withdrawn by the banks. Following closely on the heels of such developments, foreign exchange rates will fall; if the Developers have borrowed from Foreign Banks, their Loan Repayments will rise.
Confidence for further investments as well as of potential users of facilities including hotels, sports stadiums, offices and shopping malls will drop resulting in many empty and unoccupied hotel rooms, office suites and shopping mall retail outlets.
Such hostile economic environments will shake confidence in the share markets, leading to massive sell-outs of shares that in turn lead to drop in share prices (values), ultimately leading to the collapse of companies, even long and well-established ones.
When such adverse economic environments are compounded with political unrest caused by, for example, the dismissal of the Prime Minister and his Government or scandals associated with a government official can cause more turmoil and instability to the nation.
Sounds familiar? Remember the 1997/1998 Asian Financial Crisis?
Step No. 8: Loss of market confidence
Remember the aftermath of the 1997/1998 Asian Financial Crisis? Share prices and values of companies fell. There were fewer new tenants and many existing tenants did not renew their tenancies. Many companies either went bankrupt or were drastically shrunk in size and business resulting in many of their employees and workers becoming unemployed. With such massive retrenchments of workers and employees, an “Economic Tsunami” swept through the nation causing great instability.
To stem the outflow of funds, the Government increased interest rates with dire consequences for the domestic economy. The few remaining companies and manufacturing facilities still standing were forced to close as they could no longer pay their Banks the increased interest.
In spite of the Government’s efforts to stem the outflow of funds, international currency speculators continued to attack the country’s currency until the Government was forced to devalue the local currency with more dire consequences for the domestic economy.
Imports became more expensive and businesses with foreign loans were now forced to close because they could no longer keep up with the payments to their Foreign Lenders.
The net result: More unemployment.
Remember Thailand and South Korea? This was what happened to these two countries and their citizens.
Step No. 9: Loan repayments increase
Before and during the Asian Financial Crisis, the Governments of Thailand and South Korea borrowed heavily from foreign lenders and their companies also did the same. Consequently the Governments and businesses of Thailand and South Korea had to pay heavily for these foreign loans due to the greatly devalued Thai Bhats and Korean Wons.
I remember reading in the newspapers during the height of the 1997/1998 Asian Financial Crisis that patriotic South Korean Citizens lined up at their Central Bank in Seoul to hand over their personal jewelleries to help their country, South Korea meet its obligations to foreign lenders.
When Governments like Thailand and South Korea borrowed heavily from foreign lenders to pay for Capital Projects, when their economies took a dive and their currencies were devalued, they will have to pay more for the Foreign Currency Loans with money that they do not have.
Further when Governments and businesses did not carry out detailed and exhaustive “Feasibility Studies” and if they did not thoroughly investigate the viability of each potential project as well as all the potential risks that they may be exposed to including political, currency and economic risks, they are creating an environment for a “Perfect Storm of Disasters”.
Step No. 10: Finished project income failure
Even against all odds, the National Government managed to raise all the money needed and finally completed the projects like Greece’s massive infrastructure and capital works projects building roads and highways leading to nowhere. These projects were started 10 years ago in the 2000s.
Fast forward to 2012, where is Greece now? They could not find the money to pay their lenders for the loans given to Greece 10 years ago. Greece is now nearly a bankrupt country.
Spain also finds itself in a similar situation. More than 10 years ago, Spanish developers went on a rampage to build and build houses and Spanish citizens, with an abundance of bank loans, went on to buy and buy. The Provincial Governments, to compete for “Investments” into their local areas went on to build and build infrastructures with borrowed money.
Fast forward to 2012, where is Spain now? Spanish developers could not find the money to pay their lenders, Spanish buyers and the Provincial Governments of Spain could not pay their banks.
The consequence: The Federal Government of Spain has to go to the European Union and borrow heavily to pay the debts of Spanish developers, Spanish house buyers and Provincial Governments of Spain.
What will happen to Greece and Spain? Will they face financial ruin?
Conclusion: Are we Malaysians and is Malaysia on the path to financial ruin? Are we heading to where the likes of Greece, Ireland, Portugal and Spain are: National Financial Crisis and even possible National Financial Ruin?
Malaysians, you be the judge.
This column is endorsed by the National House Buyers Association of Malaysia (HBA) to educate, inform and empower house buyers in Malaysia.