How do we best manage our economic growth?

Please note: The following post has been composed on my mobile and as such please accept my apologies for the lack of typical exact quotes and links, as well as potential typos.

Buried within the "The leader-less opposition - what next for them" discussion over on Progressive Minds is a great few comments regarding concerns regarding controlling growth in Bermuda's overheating economy. It is suggested that growth can be controlled through manipulating the spending power of individuals. This writer however wonders if growth could be controlled through sound policy? Whether we could moderate over-employment and development, put a temporary halt on the influx of new business and better control the effects of inflation on those impacted by it most? Would such steps offer better management of our growth for the benefit of all Bermudians?

In his commentary on the Progressive Minds blog, Oscuro Branson seems to suggest that growth can and has been controlled through a reduction of the spending power of individuals through taxation, high housing costs and manditory pensions. He essentially suggests that growth in Bermuda is caused by an increase in consumer demand and which can be controlled by increasing consumption taxes (duty) on luxury items.

This writer would readily agree with Oscuro Branson's suggestions if Bermuda were a large country, however as a small island Bermuda's situation may be different. As Oscuro Branson notes, Bermuda has no ability to control money supply through central banking policy due to the lack of a central bank and pegged currency and thus growth must be controlled through other means.

Before studying how we could control growth, lets assess the problem to understand what we're attempting to solve. Growth itself is not a problem, however too much growth due to a lack of infrastructure and too much development causes over-employment, or a lack of available people in the workforce. Over-employment causes the importation of foreign workers to supplement workforce demands, which add strain to our infrastructure. This strain inherently causing inflation, a rising of prices on goods due to a devaluation of our dollar's purchasing power.

Housing is one example of strained infrastructure where demand has risen faster than supply causing increases in rent and home prices due to the influx of foreign workers. Subsequently, because Bermuda imports the majority of it's goods, the rise in foreign workers has also caused a rise in local spending and thus a rise in imports which has caused greater strain on our shipping, transport, storage and retail infrastructure. Being that our shipping infrastructure was originally designed for much less capacity, costs have risen to reduce the demand to cope with the difficulties of importation. This when combined with an increased number of individuals purchasing goods along with rises in housing costs, a fundamental need for all people, compounded with the snowball affect of rising cost of living causing prices to be hiked causes inflation to rise dramatically. This all occurs outside of external uncontrollable inflationary pressures such as the rising cost of oil and the rising cost of imported goods due to inflation in countries we trade with.

Being that we don't have a central bank and our currency is pegged, we cannot manipulate our lending rates to control money supply and thus control inflationary pressures. Instead can we turn to controlling inflation and over-employment through sound policy and well planned government spending?

In times of too much growth causing over-employment, should government be reducing and eliminating unnecessary capital projects thus reducing demands on the workforce that contribute to over-employment? Beyond this, because we are a small economy, can we more easily control the growth of new international business as well? Thus, could we put a temporary halt on the formation of additional exempt business (a soft close as has been written about previously on this blog) to also reduce the influx of foreign workers? A reduction of foreign workers would hopefully reduce demands on local sectors such as hospitality, retail and construction. All of this should also be considered when questioning plans for a raft of new hotels and their added strain on our workforce and infrastructure.

While this writer does agree with Oscuro Branson on increasing duty on luxury items (though moderately and reasonably), especially the suggestion to use it to eliminate our debt and build up currency reserves, this writer also believes in the allocation of some of that increased revenue, along with the reduction and reallocation of wasteful spending towards rebates and social services vouchers to distributed equally among all people as has been discussed previously in this blog's writings of a fairer tax system.

While this writer agrees with greater taxation on luxury items, he disagrees with utilizing a reduction in spending power as a specific solution for controlling growth as it has the potential to place greater strain on poorer elements of our society; those most affected by rises in inflation. Instead, could we control growth through sound policy by moderating over-employment and development, putting a temporary halt on the influx of new business and better controling the effects of inflation on those impacted by it most? Thus, is there a means by which we can better manage our growth for the benefit of all Bermudians?

A run on the bank

This can't be a good sign for the overall markets.  CNN reports that savers at Northern Rock, one of the UK's top five lending banks, have lined up for two days thus far attempting to empty their accounts after the Bank of England bailed them out due to issues with the credit crunch.

Sub prime thoughts

What impact has the Bear Stearns fallout had on the overall markets?  What positions did it have?  Could it's fallout be any kind of indication of what will happen as other sub prime resets occur?  What are the answers to these questions and how will the markets fare in coming months?

Here's a chart (via Google Finance) of Bear Stearns Companies Inc. (BSC) over the last 6 months compared to the S&P 500, the Dow and the Nasdaq. 

Note the timing of how the fallout of the two Bear Stearns hedge funds relates to the falls in the market?  How much lost investor confidence was tied to the Bear Stearns collapse?

How much were these funds worth?  Reading Bear warns loans have little value suggests:

The Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage fund reported $638 million of investor capital and gross long positions of $11.15 billion in the first quarter.

The Bear Stearns High-Grade Structured Credit Strategies fund had $925 million of investor capital and gross long positions of $9.682 billion through March 31.

Does this put the positions of these two funds somewhere near $20 billion dollars?  How much of this was poorly managed and locked into sub-prime loans that began defaulting due to rising interest rates?

Let's reexamine that chart of the adjustable rate mortgage reset schedule from my post Subprime fallout.

 

How long does it take for the resets of mortgage rates to subsequently start impacting the ability of people to repay their loans?  What percentage of sub-prime credit borrowers would have put themselves in this position financially?  How long can they live before their loan is defaulted if they're over stretched?  How does the $20 billion positions of the two Bear Stearns hedge funds compare to overall exposure of mortgage rate resets?  How many companies could have similar poor exposure?  How much of an impact will we see if there has already been $160 billion in resets and there is much more to come?

Unfortunately, there are many unanswered questions.

Subprime fallout.

Will the fallout of subprime loans be the catalyst to push the United States economy into a recession in the coming months?

As my interest in studying the markets grow, I've taken to writing a little bit more about my limited understanding of them.

One of the theories I'm following is what impact the fallout of subprime mortgages will have on the overall markets.  It suggests that in a lending boom, banks run out of people to lend to due to low interest rates encouraging a large number of people to buy, so they start giving out subprime mortgage loans.  Due to the lower interest rates, variable rate mortgages are attractive because they are offered at a much lower rate than fixed.  What the common individual with poor credit and limited financial knowledge doesn't account for, however, is that variable rate mortgages reset after two years and the interest rates can rise considerably in that time, as they have in the last couple years. 

Above is a chart garnered from a blog called At These Levels, though modified to indicate present standing in July.  What the above chart indicates is the amount, in billions, of resets of varying types of adjustable rate mortgages.

What is important to understand is that when someone with bad credit and limited financial understanding is given a loan (often when they cannot actually afford it), they may stretch their budget further than they will be able to manage when their rates reset.  So, now that interest rates are much higher and resets are occurring, people are suddenly watching as their low mortgage payments turn into high ones.  This can cause strain and for many is unsustainable, so people start dumping their homes on the markets in order to recover any possible value prior to being foreclosed on.

People begin missing their payments as they try to sell their homes.  Being as interest rates are higher, it becomes harder to sell homes and thus supply quickly outstretches demand and the inventory of unsold homes begins to rise.

 

Graphic  courtesy of WSJ online

The money to fund these loans comes from banks who acquire the money through selling bonds or bond based funds.

So, you buy a bond (guaranteed specific investment return) and the bank turns around and uses that money to give out subprime loans.

Many resets happen do to interest rate increases.  People with bad credit who are living paycheck to paycheck are now stretched and can't meet their payments.  Mass sales of homes begin to happen as people try to beat foreclosures.  Housing bubble bursts (as it has been doing) and the banks start foreclosing.  Banks can't sell homes at previous value to recover and end up with losses as they are in the banking business, not the housing business.

Assets listed by banks in the form of mortgages given out on the basis of securing bond based portfolios begin to look overpriced because homes no longer carry the value they once did and many are being forced to foreclose.  This causes the banks to then have to revalue the assets of the funds they offer which causes them to be revalued for lower than they were previously reported.   This results of this revaluation is said to be coming for the 3rd quarter in September.

If the revaluations are bad enough, investors then lose confidence in the markets and start dumping their stocks in hopes of taking profits from the recent bull markets.  What happens when investors flood stocks on the market?  Over supply, less demand.  We then find ourselves in a situation where we're either approaching a major correction in the markets or the beginning of a recession as the combination of the poorer segments of the economy are now budget stretched and the higher segments lose a fair bit of their gains in the markets, people flee to safer investments as overall spending in the economy grinds to a halt.

Of course, I really know very little about the markets and these are just ideas formulated on a very basic understanding so I'd welcome input from those out there who are a bit more knowledgeable than I.  Looking back on it now, I wish I'd taken economics as my first year elective in university as opposed to psychology.

Archive Entry: Bermuda as a business

This entry comes from a post made on my now defunct former blog back in June of 2006.

I read an article on heartbeatnews.com on Bermuda tourism the other day that contained a few very interesting statistics.  Apparently, in 2005, we had the highest level of visitors in 2005 with a total of 521,043 arrivals by air and sea.  Air arrivals reached 269,587, down marginally.  Cruise arrivals rose by 20% to 247,259.  Tourism earned a total of $448 million with an estimated $39 million in revenues coming from cruise visitors.  It then pointed out that this is less then 10 percent of overall spending.

Let’s take a moment to think about this for a second.  Cruise arrivals accounted for nearly HALF of incoming visitors yet earned us less then 10 PERCENT!?!  Looking at Bermuda as purely a business, I'd have to say I really don't like those numbers; this venture doesn't seem profitable at all.

Let’s compare Air earnings to Cruise shall we?

 

Cruise:

$39 million / 250,000 = $156 a person approximately

 

Air:

$409 million / 270,000 = $1515 a person approximately

 

So using these numbers, let’s assume we invest $50 million into tourism hoping to revitalize it.  I’ll suggest a couple projects which that money could be used to boost numbers on one side or the other.   For Cruise, let’s assume we use it to construct new docks and for Air, say a conference center.

So let’s figure out how many more people we need to bring in to recoup that cost for our people.

 

Cruise:

            $50 million / $156 = 320,000 people approximately

 

Air:

            $50 million / $1515 = 33,000 people approximately

So, if we wanted to recoup our investment, how much of a gain in each industry will we need to see?

Cruise:

            Over 1 year:  (320,000 / 250,000) x 100 = 128% increase

            Over 5 years:  (320,000 / (250,000 x 5)) x 100 = 26% increase

 

Air:

            Over 1 year:  (33,000 / 270,000) = 12% increase

            Over 5 years:  (33,000 / (270,000 x 5)) x 100 = 2.4% increase

I’m no rocket scientist, nor am I a CEO of a super rich reinsurance company, but to me, if Bermuda were my business, it would seem that it would be a hell of a lot better to invest my money in Air and not even bother with Cruise.  That’s not even considering the costs in terms of the people that flood our beaches, our roads, contribute to waste and take up spots in valuable activities that should instead be going to air visitors who earn us a good deal more?

If someone would be so kind, please explain to me why we’re even remotely considering building new docks for super ships as part of the waterfront revitalization plan?  Why are we also planning to destroy our heritage so that town cut can be widened?

Hell, if you can tell me that, perhaps you can also tell me why we’re even bothering to compete with the sun and fun tourism industry in the first place?  Our peak season is the Caribbean’s off season and frankly 4 months of sun worthy weather just doesn’t cut it in terms of competition.

If it were up to me, I’d be chasing the business rewards, international conferences, trade shows and incentive planning industries instead.  We are after all an international business center.  We also happen to be a short hop from the east coast, and businesses just happen to have the money to spend where “discount tourism” just doesn’t cut the mustard in comparison.  On top of that we’d get free advertising in terms of inviting more business to locate here, if we so desired to let them, that is.

Why is targeting business an easier sell?  Businesses give expense accounts to their traveling employees.  Foreign companies are taxed on profit so if you can write off expenses and lower your profit; you don’t get taxed on it, and happier employee’s too boot.  What better way to reward your workers then sending them to a conference in beautiful Bermuda?

I just don’t understand it why Vegas needs to be the only place where all the big conferences go.  Wouldn’t people enjoy coming to a destination like Bermuda?  Perhaps if we build a conference center or two, pandered to the industry a little, and capitalized more on our location, location, location… tourism wouldn’t be such a dead industry and we’d actually be running a profitable business.

Tourism may look good now, but where will we be in a few months?

While the Premier may be 'excited' by the increase in number of tourists visitors, I still remain unconvinced that this year will be a good year for tourism.  In the past I have written about the potential for the new US passport regulations to have an impact on our tourism industry.  Another issue that may have impact on this years tourism season are Ajustible Rate Mortgages and how they have affected the US housing market causing a reduction in tourism spending this year.

Today, there was an interesting post on one of my favorite economics blogs - http://bigpicture.typepad.com - that was suggesting potential tertiary market impacts caused by the slowdown in the housing sector.  One potential slowdown that was listed was airlines, which got me thinking further about travel.

Back in Feburary I wrote about the potential impact rising interest rates may have on the housing market.  This being that many Adjustable Rate Mortgages were given out by lenders when interest rates were low and now that interest rates have risen, those attractive low rate adjustable mortgages have turned into high rate ones which have stretched the budgets of many beyond their expectations. 

This stretch has caused many to begin to try to put their homes on the market in hopes of selling prior to foreclosure.  This also means that the budgets of many individuals who rely on such mortgages are now stretched further then they once were.  When an individual's budget is stretched, they're more likely to cut out luxuries such as fancy vacations to destinations such as Bermuda (especially when adding the hassle factor of not having a passport) in favor of cheaper vacations.

Will the downturn of the American housing sector have a negative impact on our tourism market?  Perhaps.  Is it a good idea to get Bermudians all riled up in believing that tourism is going to be great this year?  Well I suppose an election is just around the corner.

Where's the Beef?

I've taken a moment to review this year's budget statement.  To my dismay this years numbers are in a different format then last years.

Last year's numbers from the 2006/07 Bermuda Government Budget were given in tabular chart form, comparing not only the projected estimates for 2006/07, the 2005/06 original and revised estimates and the 2004 actual numbers.

This year, while the budget summary has some nice colorful pie charts, the budget itself is lacking in the format that made last year's easy to read and comprehend quickly.  Instead it lays out the numbers in paragraph form.  This can make it harder to read because it isn't as easy to lookup and compare the data from this year to previous years.

Example:

"Mr. Speaker, Government proposes to collect total revenues of $917 million in
2007/08, about 7 per cent higher than the revised revenue estimate of $856 million for
2006/07."

Compare that to the chart on the right from last year, which not only provides the estimate of $835 million, but also the revised 2005/06 number of $798 million, the original 2005/06 of $750 million and the 2004/05 of  $782 million.

Without these numbers it's hard to see how things have changed from a big picture perspective because it's compare each source of revenue.

"Customs duties are expected to contribute $247 million towards the total revenue
estimate in 2007/08. Following consultation with representatives of the Bermuda Tour
Boat Owners Association, Government has decided to amend certain tariff items to
provide greater assistance to these businesses including duty-free fuel, a reduced rate on
spare parts and an amendment to an existing concession to allow sales of existing vessels
to overseas purchasers without a claw-back on the 10 per cent duty concession."

What this doesn't tell us is what the final numbers for 2006/07 were for customs duties.  I have to search to find

"For 2006/07, customs duty is expected to be some $10 million higher than the original
estimate of $225 million"

Elsewhere in the document, the government suggests:

"This Government listens and seeks to address the concerns in a prudent but peoplefriendly
manner."

I would like to ask where I need to go to collect a copy of the budget represented in tabular form like last year because I would like to get an accurate and fair idea of how our money has been allocated?

Studying the impact of interest rates on the trends in the US housing market

Disclaimer:  I have zero knowledge of nor expertise in the fields of economics or real estate.  The following is simply a summary of my own thoughts regarding trends in the housing market and what little I've learned of how to follow them.

Back in university, a friend of mine who was studying economics told me about a paper he was working on.  The subject of the paper was how when interest rates rise, people on variable rate mortgages have the level of their monthly payments rise and subsequently have a tougher time meeting them if they've overstretched their budget.  Subsequently some of those who are struggling to live paycheck to paycheck foreclose.  For each foreclosure, banks take on losses that they want to recover from quickly so they turn the homes over to the markets.

In an economy where interest rates are high, people are less likely to want to buy homes due to the high costs.  With extra homes being dumped on the markets by banks, it adds to the supply which outstretches demand and causes the market to become over saturated.  This causes the value of homes on the market to decrease.

Certainly I'm no expert on economics nor real estate, but as someone who wants to make the absolute most of the money I earn, I took heed of his suggestion.

As can be seen by the graph on the right, there was a higher percentage of customers behind on their payments after the last interest rate increase.

Over on the big picture there's a couple great posts that are of considerable interest.  One on housing price risk and and the other demonstrating a heatmap of US foreclosures.  The graphic on the right was from one of these articles.

Another interesting graphic is one that shows home prices by appreciation as diagramed by region.

Originally sourced from: Census Division, % change over previous four Qs (as of Q3 '06)

This graphic demonstrates the trend in the last 20 years and showcases the negative appreciation across all regions.

Comparing these charts to the last 20 years of the federal fund rate as evidenced by the graph below obtained from wikipedia.

It is interesting to note that in many cases, housing markets depreciated when interest rates went up in 1998 and failed to gain considerable ground throughout the downwards rate trend leading into 2002.  By 2003, with really low interest rates, all markets in the graphic above showed signs of appreciating up until rates began increasing in 2005 where another major downward trend began.

 

 

 

 

 

 

 

 

 

 

 

 

 

Thinking back to the comments made by my friend, what he described may have been on point. 

The first thought that may comes to mind is that these individuals who have outstretched their variable rate mortgages may be able to refinance.  However, as is outlined later in the housing price risk article, some variable rate mortgages carry a prepayment penalty which many may not be able to afford.

If this creates a trend that continues, it could cause housing values to continue dropping and an overall devaluation of the market.  How long this trend shall last is unknown, however there may be some who are able to capitalize on the depreciation in the housing market and pick up homes before the markets reappreciate in the distant future.

Of particular further reading on the subject is one blogger's perspectives on the forecasting by lenders of how how the fed's will change interest rates. 

I'm slowly learning more of the principles of economics.  One such example is the zero-balance of the economy.  Those who live paycheck to paycheck deep in debt are the ones who end up foreclosing while those who have the savings and solid financial foundation are able to capitalize on those losses to purchase a house for less then it is worth given the flood of foreclosures.

For those jumping on the new 100% financing offered by Bermudian banks to Bermudians, you should ask yourself what the potential is that the property you're purchasing could at some point depreciate.  If this was to occur, would you be able to cover the losses in the equity value of your home that you actually never had?

$15 million for football?

Are you kidding me?  Last year it was $11 million on cricket and we all witnessed how well that turned out.  I must be reading this incorrectly.  Are we honestly going to spend $15 million on football?

Don't get me wrong, football is a much loved Bermudian sport that needs the support of the country, but I do need to ask about the motivations behind throwing a large amount of cash behind another professional sport when there may be more important things we should be focusing on.

Should our government not be focusing more of their efforts and $$$ on education?  I don't just mean improving the system for future students but also fixing the horrible mess that has been made of my generation.  Certainly my generation has gotten the short end of the stick.

There is one perfect example that springs to mind that will help illustrate my point.  While at recruit camp, we had regular evening lectures to learn various topics.  In one such lecture on the combination of making schooling more accessable to recruits, one recruit asked if it was possible for him to attain his GED through the program.  This may have been something whose responsibility was passed off to the National Training Board, however what concerned me was that this recruit was requested later in the presentation to stand up and read a slide.  It surely was an embarassing scenerio for the individual as he struggled to read many of the words and did so at a snails pace.  It was such an abysmal performance that one could do nothing but feel very sorry him and feel enraged at the system that was supposed to educate him to enough of a level to survive in our society.  While he is just one example, there were many others who showed signs of being very poorly educated.

The regiment education program is a good first step, but the approx $100,000 of funding is pennies in comparison to $15 million.  Especially when many recruits arn't even capable of performing at the college level considering they missed out on the basics.

If government is interested in preventing "young people from getting mixed up in crime and drugs", the first step should be to ensure they are educated well enough to afford themselves a future.  Spare funding should be put towards helping all of those who have fallen through the cracks of our failed system.

Bermuda has failed my generation.  Football is all fine and nice, but we should be focusing more heavily on core issues not just paying idle lip service to them.