India’s Big and Messy Real Estate Ponzi Scheme, Just Got Messier



Over the last few years, many real estate companies across the country, particularly in Delhi and the National Capital Region (NCR), have taken money from home buyers and not been able to deliver promised homes on time.

Some of these companies have also taken loans from banks and defaulted on those loans as well. Basically, these companies have taken money from home buyers, they have also taken loans from banks, and still been unable to deliver the promised homes. In some cases, real estate companies have already booked sales on homes they are yet to deliver.

The question is where has this money gone?
I think there are two answers to the question. 1) Promoters of real estate companies have siphoned off a part of the loans they took on from banks and the money they took from buyers. 2) This money has been diverted for other uses, like completing previous projects and buying more land (or to put it in real estate parlance for building a formidable land bank).

Banks are now looking to recover their bad loans from real estate companies. And at the same time, the buyers are also hopeful that someday their dream homes will be delivered to them.

There are several interesting issues that crop up here:

a) It is now more or less clear that the real estate companies had been happily running a Ponzi scheme. A Ponzi scheme is basically a financial scam in which investors are promised very high returns. The money being invested by the second set of investors is used to pay off the first set. The money invested by the third set of investors is used to pay off the second set and so on. A Ponzi scheme runs until the money being invested in the scheme is greater than the money that is going to redeem the investment of the early investors. The moment this reverses, the scheme collapses.

The real estate companies essentially followed this model. They announced a new real estate project and then raised money against it. This money was then used to buy more land or simply siphoned off. Then a new project was announced. The money raised against the new project was used to complete the earlier project. Of course, I am simplifying things a bit here, but that was the basic modus operandi.

The key in this method of selling homes was the ability to keep launching new projects. Over the years, as real estate returns fell, the ability of real estate companies to launch new projects came own drastically. Once this happened, they couldn’t raise enough money to complete their existing projects. And this led to many buyers being left stranded in a rented home.

b) The inability to deliver on promised homes along with low returns has put off people from investing in real estate. The falling interest in owning real estate becomes clear from the savings figures as well. As per the recently released annual report of the Reserve Bank of India, in 2012-2013, savings in physical assets made up for 14.4 per cent of the gross national disposable income (GNDI). By 2015-2016 this had fallen to 10.7 per cent of the GNDI. GNDI is a concept similar to GDP which also takes remittances from abroad and food aid into account. India’s GNDI is around 1.03 times its gross domestic product.

c) A bulk of the buyers had bought homes by taking on home loans from banks. They are currently paying EMIs against these loans. They are also paying a rent to live in the homes that they currently do. Given this, they are monetarily stretched. Further, they are paying an EMI for an asset which they haven’t got as yet and will probably never get in the form they had originally envisaged.

d) When prospective buyers take a home loan from a bank, the home they are buying is the collateral or the security against the loan that is taken. In many cases, the real estate companies have offered these homes against which home loans had already been taken, as a collateral to the banks, and taken on more loans. So, the buyers have been taken for a ride here. Also, the question is how have banks allowed dual financing on the same asset?

It is worth remembering here that many real estate companies which have defaulted on banks loans and delivering homes, worked on a pay as you build model. This basically meant that these companies got paid in instalments from the buyers at every stage of construction.

Hence, the homes were technically owned by the buyer (or to put it more specifically the bank from which the buyer had taken on a home loan) and could not have been offered as a collateral, without the consent of the buyer. Nevertheless, that seems to have happened. This is something that the banks need to explain. (In case you want to understand dual financing in even more detail click here and here).

e) So, where does that leave the buyer? Recently, bankruptcy proceedings have been started against Jaypee Infratech which took money from more than 30,000 buyers and did not deliver on the promised homes. At the same time, it has defaulted on bank loans. The Supreme Court has stayed these proceedings.

The Bankruptcy and Insolvency Code in its current form does not leave anything for the buyers. The buyers are not on the list of entities that will be compensated for payment of what is due to them once the company is liquidated. From the legal point of view this makes sense given that the money that the buyers had handed over to the real estate companies was basically an advance and not a loan. But then given that thousands of families are involved, should only the legal view prevail is a question even though tricky, worth asking.

Of course, the bureaucrats who wrote the bankruptcy code did not take the real estate sector and the way it operates, into account. This is something that the government should hopefully correct for in the days to come.

f) Suggestions are now being made that like the banks, the buyers should also be ready for a haircut (i.e. be ready to accept a part of the money they had invested with a real estate company to buy a flat and not the entire amount). The trouble with this argument is that for the banks, the bad loans of real estate companies are just a part of their overall bad loans. For the buyers, the money they invested with real estate companies was probably the biggest investment they ever made and if they have to take a haircut on it, they will probably never recover financially from it.

The Supreme Court now needs to decide whether the buyers are financial creditors or not. This is a tricky question, which I shall elaborate on later in the days to come.

g) In all this, the real estate promoters seem to be having the last laugh. A part of the money they borrowed from banks and took from real estate buyers, has been tunnelled out. It is hardly likely that the bankers will be able to go after their other assets (i.e. the land bank they built by tunnelling out money) in order to recover their loans. Hence, they have clearly managed to limit their losses.

In fact, in a fair world, the balance sheets of these real estate companies would have been subjected to forensic accounting in order to figure out where did the money go. But the bankruptcy code has no such provision. If it did that would inevitably delay the resolution process.

And this brings me back to the point that I keep making for all my readers who forever seem to want solutions to all problems; everything in India does not have a clear solution.

Of course, now the central government will have to get involved if this issue has to be sorted at any level. I only hope that they try and arrive at a private sector solution and the taxpayer money is not used in any form. Already, a section of the real estate sector is talking about a government bailout. If the builders in India don’t have money, who does?

To conclude, the mess in the real estate sector in India is an excellent example of what follows when a Ponzi scheme goes bust. And as they like to say in Hollywood films, you ain’t seen nothin’ yet. Keep watching.

The column originally appeared on on September 11, 2017.

10 things you should know about the American debt ceiling

ObamaVivek Kaul 
The American government is staring at a big problem ahead. Come October 17, and it will hit the debt ceiling set by the American Congress. If this happens it will have global implications. Given that, it is important to understand what the debt ceiling really means and how it can impact the whole world.
So what is the debt ceiling?
The American government, like almost every government in the world, spends more than what it earns. The difference between what it spends and what it earns is met through borrowing money. There is an overall limit to the amount the American government can borrow. This limit is currently set at $16.69 trillion.
So what will actually happen on October 17?
The American Treasury Secretary Jack Lew (equivalent of the finance minister in India) has said that on October 17, the Treasury department will run out of the extraordinary measures it had put in place to ensure that the government doesn’t cross the debt ceiling of $16.69 trillion. 
Since May 2013, Lew has taken a number of extraordinary measures, like delaying pension fund payments, to ensure that the government expenditure remains under control and hence, the government does not cross the debt ceiling.
So the American government will run out of money on October 17?
The answer to this question is not very clear. Lew has said that as on October 17, the government “
“will be left to meet our country’s commitments at that time with only approximately $30bn.” And this amount will not be enough to meet expenditures of the government, which on certain days can be as high as $60 billion. He has not clarified the exact expected expenditure of the American government as on October 17. Hence, we don’t know if the American government will run out of money on October 17.
So when will the American government actually run out of money?
There are various estimates going around on this. Most analysts agree that the government won’t run out of money on October 18, and will keep chugging along for a brief while. The Bipartisan Policy Center expects this date to be anywhere between October 22 and November 1. 
As it points out “Updated data on Treasury cash flows through the first week of October show that the range for the Bipartisan Policy Center’s (BPC) X Date – the date on which the United States will be unable to meet all of its financial obligations in full and on time – has narrowed to between October 22 and November 1.”
Economists at JP Morgan have come up with a more precise date of October 24th. 
As an article on points out “They (i.e. the economists at JP Morgan) write that it is “extremely unlikely” the Treasury will be able to make it’s payments more than a few days after the 24th, and that the Treasury would most certainly have to default on some payments by November 1st, when large outlays for Social Security, Medicare, retirement benefits for military and civil services workers, and interest payments are due.”
So what will be the impact of this?
The expenditure of the American government will be greater than its income. Until now it has been able to borrow money to finance the gap. It won’t be able to borrow anymore. Given that, it will have to cut down on its expenditure.
AsEric Posner writes on “If the debt ceiling is not raised, and the executive branch stops borrowing, the government will need to cut spending by about 15 to 20 percent—or almost 40 percent of spending on everything (yes, Medicare and defense) other than the interest on the debt.”
The impact of the cut in expenditure will be immediate. As Henry J Aaron writes in The New York Times “A decision to cut spending enough to avoid borrowing would instantaneously slash outlays by approximately $600 billion a year. Cutting payments to veterans, Social Security benefits and interest on the national debt by half would just about do the job. But such cuts would not only illegally betray promises to veterans, the elderly and disabled and bondholders.”
Other than having economic consequences, this cut in expenditure will also have social consequences. As Mark Blyth writes in 
Austerity – The History of a Dangerous Idea in a slightly different context but still applicabl in this case, “Seventy-two percent of the working population(in America) live paycheck to paycheck, have few if any savings, and would have trouble raising $2000 at short notice. There are, as far as we can tell, about 70 million handguns in the United States. So what would happen if…no paychecks were being paid out?”
Hence, cutting expenditure can have dramatic social and economic consequences.
So why is the American government doing nothing about this?
As must be clear by now the consequences of the American government hitting the debt ceiling and not being able to meet its expenditure, will be disastrous. Given this, why hasn’t the government done something about it? Why haven’t they increased the debt ceiling?
The answer lies in the fact that the two houses of the American Congress are currently in a logjam. The House of Representatives is dominated by the Republican Party and the Senate is dominated by the Democratic Party. And both the parties are refusing to talk to each other. The Republicans believe that fiscal profligacy of the American government has gone on for too long and needs to be reined in.
In fact, many Republican Congressmen are not concerned about the debt ceiling at all. 
As Senator Richard Burr recently said I’m not as concerned as the president is on the debt ceiling, because the only people buying our bonds right now is the Federal Reserve. So it’s like scaring ourselves.”
So are Republicans right on only the Federal Reserve buying government bonds?
This statement has been true in the recent past. The Federal Reserve of United States, the American central bank has been printing money to buy American government bonds. This helps the government finance its fiscal deficit. Fiscal deficit is the difference between between what a government earns and what it spends.
But Burr’s statement does not take into account the fact that foreign countries hold nearly $5.6 trillion of American government bonds. In comparison, the treasury holds bonds worth $1.93 trillion. These bonds were issued by the American government to borrow money to finance its fiscal deficit.
Interest on these bonds needs to be paid. Also, maturing bonds needs to be repaid. The American government has reached a stage, where it pays the interest on bonds as well as repays maturing bonds, by raising money by selling new bonds and taking on more debt. Any decision to stop paying interest on bonds or default on maturing bonds, will lead to a global financial crisis. As Posner writes “ If he(i.e Obama) stops interest payments, the United States will default. This will not only raise interest payments—costing taxpayers hundreds of billions of dollars—but could spark a financial panic like the meltdown of 2008.”
The US government bonds are the ultimate risk free asset. If the government defaults on interest payments and/or principal repayment, then investors all over the world are going to exit all kinds of financial markets. No wonder China which holds more than a trillion dollars of American government bonds is worried. 
The Chinese Vice Finance Minister Zhu Guangyao recently said “We naturally are paying attention to financial deadlock in the U.S. and reasonably demand that the U.S. guarantee the safety of Chinese investment there.”
So that brings us back to the question why aren’t Republicans and Democrats talking?
This basically boils down to the fact that Republican Congressmen seem to be confident that the government is in a position to work its way around the debt ceiling. As Senator Orrin Hatch recently said “I think the administration could work on who gets paid and who doesn’t in a way that would pull us through.”
It is easy to ask the government to prioritize payments, but anything done around those lines could have serious legal implications. It needs to be pointed out that there are no legal provisions to decide which expenditure should be cut first. “There is no clear legal basis for deciding what programs to cut. Defense contractors, or Medicare payments to doctors? Education grants, or the F.B.I.? Endless litigation would follow. No matter how the cuts might be distributed, they would, if sustained for more than a very brief period, kill the economic recovery and cause unemployment to return quickly to double digits,” Aaron points out in 
The New York Times.
The politicians on both the sides are also taking it easy because the markets haven’t reacted to this lack of communication between the two political parties on the debt ceiling. As Senator Hatch put it “I don’t think the markets have been spooked so far, and I personally believe that if they realized there was a legitimate attempt to make the government work, they would be less likely [to be spooked].”
So why haven’t the markets reacted?
The debt ceiling has been in place since 1939. And since then the American Congress has raised it numerous times to allow the government to borrow more. As an article in the Christian Science Monitor points out “An overall cap on federal debt has been in place since 1939, and Congress has raised it numerous times since then. The Treasury Department counts 78 times since 1960.”
What has happened 78 times is also likely to happen one more time.
This explains why the various financial markets in America and around the world continue to remain stable and are not taking into account the possibility of another crisis. As Bill Gross manager of the world’s biggest bond fund, told Bloomberg Television “The odds of a default are “a million-to-one” as the Treasury Department will be able to take other measures to ensure it is servicing the country’s debt.”
Hence, the market is currently expecting the Republicans and the Democrats to sit down and solve the problem before October 17.
So will the markets continue to remain stable?
That’s a tricky question to answer. The closer we get to October 17 without any solution in sight, the more the stability of the markets will be threatened. In fact, if the American stock market falls it might even get the Republicans and the Democrats to start talking. As John Cassidy of The New Yorker magazines writes on his blog “If the market fell by, say, three or four hundred points for three days in a row, and then lurched down another eight hundred points, or even a thousand points, the effect would be salutary. How can I say that? Tens of millions of Americans would grow alarmed about their 401k plans. On Wall Street, there would be margin calls, liquidity runs, and other disturbing developments that inevitably accompany market breaks. Rumors would start to spread about the health of various financial institutions. You don’t have to subscribe to a tail-wags-the-dog view of finance and politics to believe that this would lead to a rapid change of thinking, and of behaviour, in Washington.”
This will get the two sides talking on the debt ceiling for sure.

The article originally appeared on on October 9, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

‘In the global beauty contest, the US Dollar is the least ugly candidate’

Central banks around the world seem to have only one solution for every problem that the various economies have been facing: print more money. And a large portion of this money has been used to prop up banks and financial institutions that would have otherwise fallen and shut shop by now. “It is unfortunate that nobody is allowed to default these days, because all these bailouts are only adding to the inflation menace and the ongoing money creation is confiscating the purchasing power of the public,” says Puru Saxena, the founder and CEO of Puru Saxena Wealth Management. Based out of Hong Kong, Saxena is also the editor and publisher of Money Matters, a monthly economic newsletter. In this interview he speaks to Vivek Kaul.
In a recent column of yours you said “the world’s stock and commodity markets are defying all logic and advancing in the face of adverse economic conditions”. Why has that been the case?
All asset prices are determined by the risk free rate of return and by suppressing interest rates near historical lows, central banks in the developed world have engineered this rally in risky assets. When it comes to investing, monetary policy trumps economic fundamentals and cheap credit triggers a rally in stocks and commodities. This is why, despite sluggish economic growth in the US, Wall Street has been rallying for over 3 years. Conversely, despite good economic growth in India, due to monetary tightening, Indian equities have underperformed over the past year!
Do you expect this trend to continue?
As long as the Federal Reserve keeps interest rates at historical lows, the uptrend on Wall Street is likely to continue. Of course, the bull market will be subject to periodic corrections, but the primary trend should remain up. In our view, the next bear market on Wall Street will arrive after several months of monetary tightening by the Federal Reserve and we are at least 3 years away from this scenario. After all, Mr. Bernanke has pledged to keep short term rates unchanged until at least December 2014, so there is clear visibility for another 2 and a half years.
In Europe, the attention seems to have shifted to Spain. I was reading somewhere that the assets of the three biggest banks of Spain are at $2.7trillion or around twice the size of the Spanish economy. And the banking sector in Spain seems to be in a pretty bad shape. How do you see that playing out?
Spain is in real trouble, but the politicians will probably not let it default. So, either the European Central Bank will bail out Spain or it will continue to provide cheap loans under its LTRO(long term financing operations) scheme. It is unfortunate that nobody is allowed to default these days, because all these bailouts are only adding to the inflation menace and the ongoing money creation is confiscating the purchasing power of the public. Already, the Federal Reserve and the ECB have provided trillions of dollars of loans to hundreds of banks and this trend should continue for the foreseeable future.
What are the other dangers that you see the European markets throwing up in the days to come?
Many European nations are essentially insolvent and they cannot repay their loans in today’s money. So, unless they are allowed to default, the central banks will probably continue to bail out all the distressed bondholders and banks. The truth is that the central banks do not want anybody to default because the losses will be catastrophic for the financial institutions; so they are shoving even more debt down the throats of these heavily indebted nations! It is easy for us to see that more debt cannot solve a debt crisis but this is the strategy the central banks have come up with and we all have to live with the consequences.
The European Central Bank seems to be going the Federal Reserve way. The Federal Reserve in 2008-2009 seemed to have been rescuing banks and companies, the ECB is rescuing countries? Aren’t some of these countries like Italy and Spain are too big to bail-out?

So far, nothing has been ‘too big to bail out’! Already, the ECB has extended over $1.4 trillion of loans under its LTRO scheme to several hundred banks and if need be, it will probably create more currency units to bail out its banking cronies. If the situation becomes desperate, then, we may even get fiscal integration within the Euro zone but we don’t think that the establishment will let the Euro fail.
In all this talk about Europe, attention seems to have shifted away from the problems in the United States, which is where it all started. How good or bad is the scene there?
Although the economy is struggling in the US; things are much worse in Europe. Fortunately, the US is in the enviable position of being able to print its own currency at will and this is a luxury which the distressed European nations do not have. Under a crisis scenario, the US can always create even more dollars out of thin air and repay its creditors, but this is something Greece, Italy and Spain cannot do! Moreover, despite having a federal debt to GDP ratio of over 100%, the US still controls the world’s reserve currency and this is a big advantage.
One talk in the market seems to be that the Federal Reserve Chairman Ben Bernanke will initiate QE III given that Presidential elections are scheduled this year. Several Federal Reserve Chairmen have in the past have run easy money policies to help the incumbent US President who is running for the election again..
In our view, Mr. Bernanke will only initiate QE3 after a big dip in the CPI. Currently, the CPI is hovering around 2.7% and it is conceivable that QE3 will be announced when the CPI dips to around 1-1.5%. With the CPI close to 2.7%, we believe that Mr. Bernanke will find it difficult to unleash more stimulus.
You have maintained for a while that world’s developed nations are all bankrupt. In fact in a column last year you wrote “Let’s face it; many of the world’s ‘developed’ nations are insolvent and the writing is on the wall. Either these indebted states will default or they will try and inflate their currencies into oblivion.” How do you see this scenario playing out?
Given the developments of the past 3-4 years, it is clear that the policymakers do not want to see defaults. So, they have chosen the monetary inflation route and this is destroying the purchasing power of currencies all over the world. As a result of massive money creation, currencies are being debased and prices are rising all over the world. In fact, inflation is surging in most nations and people are struggling to make ends meet. In the US alone, the Federal Reserve has created trillions of dollars to bail out the banks and the ECB has also created and loaned out over US$1 trillion to hundreds of banks over the past six months! Never before in history have we witnessed such monetary inflation in so many nations and nobody really knows the consequences of this strategy.
“When the interest payments on US debt become painfully high, Mr. Bernanke will be called upon to unleash the hyperinflation genie.” This is something you wrote last year. When do you see this happening?
As long as foreigners are willing to invest in US Treasuries and demand for US government debt is high, hyperinflation will not occur. However, if one day, bondholders stop financing the US deficit and they stop buying US Treasuries, then Mr. Bernanke will have no other option but to use the printing press to purchase US Treasuries. Already, the Federal Reserve is a very large player in this market but if other investors flee this market, then out of desperation, we may experience hyperinflation in the US. Fortunately, there are no signs of that happening anytime soon as demand for US Treasuries is still strong.
Many pundits in the last few years have forecast the crash of the dollar. The biggest among them being Pimco’s Bill Gross. But that hasn’t happened. Every time there is a slight hint of some new trouble, money rushes into the dollar. How do you explain this?
In the global beauty contest, the US Dollar is being perceived as the least ugly candidate! This is why the US Dollar has not collapsed against major world currencies, although it has depreciated gradually over the past decade. If you review the world today, Europe is a mess and Japan is still struggling. So, apart from the US Dollar, we don’t really have very many choices! In the developing world, no nation wants a strong currency and countries such as China, India and Brazil are all engaged in competitive currency devaluations. Under this scenario, the US Dollar cannot really crash against other currencies because either they are equally bad or they are being held down on purpose.
What is your prognosis on gold?
Gold is in a multi-month consolidation phase and currently, it is trading under the 200-day moving average. So, in our clients’ portfolios, we do not have any exposure to gold at present. In our view, QE3 will be required to trigger the next big rally in gold and until then, prices are likely to drift lower. Furthermore, after 11 years of gains, investors should be mindful of the fact that gold is no longer cheap and the bull market is now in its mature phase. Thus, owners of gold should be very cautious and consider booking their profits on the first sign of trouble.
What about India? Which are the sectors and stocks you are positive about?
It appears as though India’s monetary cycle has peaked for now and further rate cuts should assist the Indian stock market. Usually, there is time lag between monetary easing and its effects on the economy, so in our view, the Indian stock market may not take off for another few months. Nonetheless, we remain optimistic about Indian stocks and continue to like those companies which earn high rates of return on shareholders’ equity.
(The article originally appeared in the Daily News and Analysis on May 21,2012.
(Vivek Kaul is a writer and can be reached at [email protected] )