The Reverse-Bill-of-Materials conundrum

This is a reverse-bill-of-materials moment for the economy. A BOM is usually intended to show what one needs to Build something, and often a BOM is largely composed of many 'kits' - sub-assemblies, and that recursion can go many layers down to arrive at the ultimate content. That's what makes such a nonsense of trying to, for example, derive a 'carbon footprint' for a finished product of any complexity - too many ultimate components and thus far too many assumptions needed.

A dis-assembling economy. OTOH, crucially has no BOM's which specify the componentry which will ultimately be affected. So the unravelling of entire sectors (events, festivals, tourism) is inherently unable to be predicted in the precision needed to direct remediable action or arrange substitutions.

That's what makes this whole thing so not-amenable to ordinary economic modelling. Because BOM's only work during Assembly, not for Demolition. Hence the headless-chicken circling seen from prognosticators of all stripes, and from not a few commenters right here on Interest.....

As a thought experiment, imagine an AirNZ engineer, a barista, and an RE salesbot (sorry, Personage). 

1. The engineer has two mortgages, two cars on HP, an overdraft and significant CC debt, but owns two residential rentals and is now jobless. 
2. The barista has zero mortgage and moderate CC debt, but a student loan and a small overdraft - little to no other assets beyond a motorscooter, and her boss has just announced a 3-day week. 
3. The RE bot has a thumping mortgage, no rentals, a large Amex balance, two leased vehicles and a few other toys/assets, and the firm has just cut the commission rate by 50%. 

Now, kindly predict the economic effects of this small sample's situation. Then multiply that by a million.....

And here's the real kicker. It's far, far easier to Demolish than to Build.....

Why house prices took off 2002-3

The graph of house affordability wonderfully clearly illustrates the way in which Ms Market end-runs stupid politicians.

The immediate cause of the 2002-3 jump in unaffordability was a choice by the newly elected Labour Gubmint to 'help' poor people into their homes. The Welcome Home scheme was a typical politician's gesture to cement its electability.

Unfortunately, this was achieved (to the extent possible - the number of WHL's eventually taken up is in the low thousands) at the much wider price - gently hinted at in this 2007 article http://www.stuff.co.nz/southland-times/news/34275/Southlanders-welcome-h... - of cementing in price floors all over the country.

As the article suggests but does not pursue, if a guaranteed loan (criterion for issue - can ya Fog a Mirror?) of say $100K is plugged into a market where low-end prices are well below that, then what's a vendor gonna do?

That's right, folks, tack a '1' in front of what they were asking for the shack in question.

And once ya starts this boondoggle a'rollin', it gathers speed (higher prices), it affects most of all the exact constituency it purported to assist (the poor Labour voter) and the only way out of the mess is to raise the value of the loans on offer. Which promptly sets off another round of asking-price inflation.

After all, what vendor is not going to sell for the available guaranteed-loan value plus a Modest Margin?

The secondary cause of the price inflation was the familiar one thrashed about on these here august pages for a decade: the dreadful co-incidence of spatial planning (supply limits) and more regulation (Building Act, revised in 2004, Elfin Safety mania). The planning debacle conferred a Planning Gain to developable land (paid for by the buyer, who else) and the Regulation mania increased construction costs substantially. But that only affects new builds - the price explosion I am focussing on here is for existing older stock.

A personal example will suffice - I would invite an Auckland example (where the whole thing has exploded most spectacularly) to sit alongside my experience.

We bought a shack in 2001 for my son, just around the corner, in an eastern suburb of Christchurch, for $47K. Yes, Virginia, prices like that for 'needing TLC' properties were not uncommon. We straightened it up (it had a pronounced lean to the Left as viewed from the front - ironic, innit) tarted it up with paint, ply, grass and improved the stormwater drainage plus added a foundation to replace the rotted stumps that greeted us. All Like-for-Like, all done by my son and yours truly, a nice if small unit (around 70-80 squares, we never did measure it up) basically in our spare time.

We spend around the same amount - $40-odd K - to achieve of all this, so it owed us perhaps $85-90K.

Then, mirabile dictu, the Welcome Home scheme came along.

Overnight, it was impossible in the whole of Christchurch to buy anything that did not start with a '1'. Vendors treated the WH scheme as a universal pricing signal.

We cashed the little house in for $123K and split the proceeds 50/50. This proves the point about screwing up the low-end market by a naive and economically dopey funding scheme.

Only 18 months prior, a deserving young FHB could have gotten it at auction for $47K - it was quite livable as is provided one trod lightly over the missing-stumps bit.

That difference - $47 to $123K or 161% in original cost - is exactly what the stoopid politicians wrought by introducing a massive re-pricing incentive. And, of course, offset by the improved condition that we provided.

And the real pity is that as noted, the pricing structure this triggered off was universal, whereas the WH Loan applied only to a comparative few.

If one had the figures and divided the overall price adjustment NZ-wide by the number of WH beneficiaries all time to date, the figure would shock and horrify - it is most probably in the hundreds of millions or even low billions per such WHL recipient.

Ms Market is a stern mistress.....

Hoose prices.

There is a Gordian knot here: a myriad of interlocking and mutually reinforcing factors. No use tackling any one alone.

• Zoning which by prescribing allowable uses, immediately causes price differentials either side of a squiggle on a map.
• TLA's benefit (with a time lag) in their revenue streams, as those squiggle-caused prices work their way into valuations. So are disclined to look any closer, let alone kill the Golden Goose which lays Rising Valuations.
• Any price rise anywhere (an outlier sale, a zoning change etc) immediately propogates to the locality: suburb, area, city, province in a diminishing ring of value effect as the circle gets wider.
• Any householder with suitably structured credit lines can cash up some increment of these value gains. Many do (ATM-bolted-to-house effect).
• Banks encourage this: more collateral = more credit availability = greater interest revenue streams.
• Land agents encourage the general rise in values: being commission-based, generally 2-5%, This promptly reinforces any general rise by cementing in recent-sales actual figures, on which everyone else in the loop relies.
• Builders benefit from higher prices for existing homes, as it allows them to build to the high end of the market. There's no profit in a 90-squares kit erection, compared to a 300 squares architect-designed mansion.
• Architects, now we mention them, are another Mr/Ms x% deal: the higher the general price level, the better their incomes get.
• Building suppliers, that cosy duopoly, benefit from the revamps, the new builds, and the ATM-on-house syndrome. New bathroom? Just draw down that revolving credit line and spend 'er at the nearest duopolist.
• ComCom is asleep at the switch, so there ain't no cavalry to ride in and Save anyone.
• Building regulation ( codes tightening, LBP's needed for practically everything, Elfin Safety up the wazoo on sites- it's a Very long list) all has Good Intentions, but a few grand here, a few grand there, pretty soon, it adds up to Real Munny. From the end customer's pocket, of course. That's what that there Credit Line is for.
• TLA's again, just to complete the loop (they, arguably, have set this whole mad shambles a-trundlin' down the track) clip the ticket to the tune of $75K per house/land package (Mike Greer, Press coupla years ago, Google it yer lazy sods). DC's fees, levies, consents, inspections. Nice racket.
• And all this is, of course wonderfully rounded off by the rise on average incomes which supports it all. Or not, as the case may be.

But when yez stands back and looks at the whole sorry picture, and asks oneself - Where ter Start? - well, it has to be said, there's no one action, no one sequence, and certainly no painless way to do much about any of it. And zero political will - there's too many voters would get badly burned - many of them the working class. After all, who puts up the scaff, staffs the duopolies, swings them hammers, transports stuff, induces hapless bank customers to extend their indebtedness, mines the steel, etc? S'not the 1%.

We'll just haveta let this runaway train hit the buffers at the end of the track.,

Because all tracks (Thomas excepted, perhaps) have Ends.

Ah, but When?

Christchurch - Strangled by CCC staff

The old, traditional delivery areas of Local Government - roads, bridges, hard services such as drainage, sewers, water - are doing just fine.

But the regulatory areas such as planning and consents are simply getting in the way of everything. Spatial Planning is a failed concept - the RMA was meant to gauge proposals by reference to their effects, not their zoning. But it was captured early on by the zonerators and old-school town planners, and has never recovered.

Arguably, this crew have, by strangling land supply and imposing lengthy, adversarial processes on developers, designers and builders, added multiple layers of cost to homes, businesses and the local economy.

And the tightening of residential construction certification (DBH's Licensed Building Practitioner scheme) is another well intentioned but costly exercise: consider that of the 90% of Chch houses which are fine to carry on living in, fully 2/3 were put up by (shock, horror) completely uncertified people! Gadzooks! How can they now live with themselves?

Against this background of staff who blindly pursue failed techniques, causing cost wherever they cast their gaze, impervious to the time value of money, secure in their little fiefdoms, and protected by layers of certification, professional guilds and stroppy unions, how is a call to 'unity' amongst Councillors going to make the slightest scrap of difference?

We're living 'Yes, Minister' - and compulsorily paying through the nose to fund this incredible debacle.

And folk wonder why the pedestrian option - vote with yer feet and escape the CCC and its parasitic staff - is increasingly attractive?

Why I quote Kipling

That article is, simply, what I believe. Takers in NZ outnumber and can thus outvote Makers, and this will not end well.

Because Makers are free to go Make someplace else; to Make less (just sufficient for their own sustenance - income equals expenses); or to stop Making altogether. In all three cases, tax revenues collapse, suddenly.

And, you cannot Make (coerce) the Maker to Make stuff. At least not in a country I'd want to live in.

Whereas Takers have irreducible, and often extensive, Needs.

This Mess We're In (with apologies to Polly Jean)

This (Gummint discovers that taxing property won't raise the dosh needed for tax cuts) all neatly illustrates the unfortunate corner that most western democracies have knowingly painted themselves into.

In handing out entitlements, perqs and goodies, in an implicit intent to buy their recipients’ votes, they have triggered the ‘endowment effect’.

Simply put, this means that you may not miss something you never had, but you’ll fight tooth and nail to preserve something you Do have, no matter how dodgy or corrupt the process of acquiring it was.

This ‘ratchet’ has now jacked most people’s hopes of continued income up, way, way past the point of sustainability. That is, we’re running out of Other People’s Money (the taxes paid by actual tax-producing enterprises and people).

I frankly don’t see any easy way out of this sort of boondoggle. The political way is blocked by the ‘entitled’, who will simply vote for the More Goodies Party if given the chance – what Mancur Olson calls ‘distributional coalitions’.

We see this oh so clearly by the Grey Mob’s fury over a few trips to Waiheke. ‘How Dare They!’ is the cry.

Bill E’s sober estimate of less-than-sufficient tax revenues is also no doubt an outcome of a ‘John Galt’ effect: you cannot force people who can control their net income, and therefore their tax liability, to Produce and be Taxed if they don’t agree with the uses to which said Tax is being put.

They will quietly arrange their production to suit their own need for income.

E.g. in most farming situations, the distinction between living expenses and small luxuries is quite invisible, and you can go fishing on the King Quad.

They will minimise the net income externally reported.

E.g. by a doctor not doing those few extra surgeries, or a consultant deciding that 24 billed hours/week @ $150 is enough, ta very much, and going golfing the other two days.

And of course in all these scenarios the tax liability (and national tax revenue) falls sharply.

Or, being smart, ambitious and mobile, they simply up stakes and leave.

I reckon that the Greek outcome is the most likely: as internal economic arrangements are so incestuous – a Gordian Knot, indeed – only the cold eye of external parties – bondholders spring to mind – has any power to force the needed changes.

Which changes are of course bleedingly obvious:

- arrange tax matters to minimise tax arbitrage
- remove welfare traps such as WFF and roll these into a finer-grained tax structure
- means-test universal benefits
- work for dole
- less Gumnut overhead

Then, and only then, does John Galt shuffle back to the pages of badly written if expository novels, because it would only then be clear to all Producers that their hard-earned Tax is not being misapplied to produce more underclass infestations, unintended outcomes, and perverse incentives.

The depressing if logical outcome of my estimate of the situation (and I see Mark H’s comment as a John Galt moment, too), is this:

There is no political way out of this. Because the distributional coalitions and the voices of the ‘entitled!’ are, taken together, a massive majority. And because (as I recall an ex Nat pollie telling us at an MBA briefing a decade and a half ago) MMP is a recipe for stasis – nothing much will change, because nothing much Can change.

So, chaps and chapesses (BH, you owe me a royalty for that term, BTW), don’t be going looking to Politicians of any stripe, to solve the pressing issues of our quirky little Isle.

And the follow-up, from comments which suggest marvellous ways to restructure tax:

JK and crew are castigated for an incremental/pragmatic approach, but political realities and the structures of MMP rule out anything else.

The change process, crudely put, is Unfreeze Existing/Change/Refreeze New.

Your proposals are for the middle bit.

Hitting a wall of some kind (bond-buyer revolt, sovereign debt default, Repo Man, bankruptcy) would seem now to be our best hope for getting the Unfreeze. After that, Change can happen.

But wishing this in public on all of us is, shall we say, Not a Good Look.

So we carry on, just kicking the can down the road. And, some of us, quietly preparing for a harsher, colder world.

Standard and Poor's Moment of Truth

The headline really says it all, no? And, dear reader, it's not from a lone blooger in his attic. It's from Dow Jones.

All of us who have wondered, for three years now, just how it is that credit can be freely given for crap furniture ("Buy now! No repayments until your 3-year-old kid graduates Medicine school!"), let alone actual Houses, are receiving an answer from the financial universe.

It's all Smoke and Mirrors. It is financial junk. And it is tanking. Sinking, Flushed, Round der Bend.

Already there is a domino effect in the US:

- Home Depot (fond memories: I bought two Bostitch nail guns there for amazing low prices, and despite some TSA headscratching, got them back to NZ in checked baggage) has announced an earnings downgrade

- Builder D R Horton has orders down 40% and inventory piling up. (Although just how new houses can 'pile up' does make one stop and think. Maybe they just stack them with big forklifts, like containers?)

- Re-rating of sub-prime debt instruments (the now infamous CDO's) is rampant, and guess what they will find - more junk and crap, everywhere they look. As Dr Housing Bubble notes, there's over a trillion US in mortgage re-sets a-comin round the bend.

So the question for NZ is - how soon before the US mortgage train wreck grows wings and flies the Pacific to land here? Oh wait, Bridgecorp was evidently into non-prime-mortgages too. As I seem to have voiced before, it would be schadenfreude if it weren't My country, too.

If I was working for one of the crop of recently opened appliance stores, I'd be polishing my CV. Because it's just amazing what you can do without when you put your mind to it. And vanity spending is the first to, er, vanish.

Boy, am I glad I downsized mid last year.

Update: 20 Jul 2007.

A good summary of the mechanisms behind CDO's and the other financial instruments which are presently in trouble. The obligatory quote:

'Bundling mortgages into asset-backed bonds and then agglutinating those bonds into collateralized debt obligations sliced into different flavors of risk always smacked of a sophisticated pyramid scheme.'

That's right folks - a pyramid scheme.....

Housing Bubble

A useful post here from another bubbular location: Southern California (SoCal, for short).

What can happen there can happen here, too. The post is quite good on the accelerated effects of information flow about housing, and the relationship between credit card debt and higher mortgage payments as fixed-rate or sweetheart deals reset to mrket levels.

In the '80's, Muldoon borrowed and hoped. We have lived through what it took to get us out of that hole: the best part of 20 years of work and better productivity.

And now, two aspects of the zeitgeist are putting us back in a similar hole:

1 - a Gummint hell-bent on buying enough votes for the next election, via various income redistribution schemes. Personal Tax cuts? Nah, Nanny knows best, you lot will simply add demand to the economy if we let you actually keep your own money. Speak for yourself, Michael bloody Cullen: I would pay down what minor debt I may have, and put the rest into Aussie shares and another super fund.

H L Mencken had it right in the '20's: an election is 'an advanced auction of stolen goods'.

And we are about to find out the hard way, yet again, that you cannot redistribute yourself rich.

2 - There is undoubtedly a local housing bubble. When it corrects, from a point where house price to income levels are around 5-7 i.e. unsustainable, to a level of say 4, look out below. 4/5 is $100,000 on a $500,000 home: a $100K loss. But 4/7 is $300,000 on a $700,000 home, and there's plenty of those just along my own street. So if you are one of the Feckless Many who have ratcheted up their debt anywhere north of 75% of current house valuation, you're gonna be hurting soon.

In effect, in the '80's, Muldoon borrowed and hoped at a public-sector level.
But in the aughties, borrowing and hoping is a private-sector pursuit.

And as the poster points out, in an environment where news and sentiment get around at the speed of light, that 'when', as in when the correction happens, might be a lot sooner than you would like.

SoCal catches the flu, we all cough.