John Kay

Real estate prices are not just about corruption; they are also about affordability


India-Real-Estate-Market

Last week, Suraj Parmar, a leading Thane builder committed suicide. In his suicide note Parmar talked about the corruption in the system. A report in The Indian Express quoted V V Laxminaryan, the joint commissioner of police of Thane, as saying: “The suicide note speaks of several problems that Parmar was facing, including difficulties in obtaining approvals and the stop-work notices issued to him. The note goes on to say that several people were repeatedly demanding bribes, that he had already paid them a lot in the past but that their demands were still continuing and it had become too much for him to deal with.”

Corruption in real estate at the government level has always been an issue. But now if builders are to be believed it has reached never before seen levels. As Niranjan Hiranandani, director of Hiranandani Group told NDTV.com, after Parmar’s suicide: “In the last couple of years, I think corruption is over but extortion has started. So, I think what was unbearable to the builder was the fact that there was no corruption in that sense of the term, but it had gone far beyond corruption levels that have ever happened.”

A June 2011 news-report in The Economic Times gets into the details of the issue. In Maharashtra, which happens to be the biggest real estate market in the country, a builder typically needs around 60 approvals to construct a property. Of this, 50 approvals need to be taken from the municipal corporation where the property is being built.

The Economic Times report then goes on to quote Pune builder Kumar Gera, as saying: “These clearances should not take more than three months…But in most states, it takes anywhere between one year and four years. And they add 20-30 % to a builder’s project cost.”

This is, in turn, passed on to consumers who want to buy homes. As a report in the Daily News and Analysis points out: “At every step, there is a price to be paid to obtain necessary clearances. The ‘Golden Gang’, a group of corporators and civic officials, calls the shots and builders are bound to cough up exorbitant sums to avoid harassment. This expenditure, so to speak, is then passed on to home buyers. That explains why real estate in Mumbai, Thane and Navi Mumbai is so prohibitively expensive.”

In fact, as a real estate consultant told The Economic Times: “Builders don’t just pass it on…They often add to it big time.” So builders add their own corruption premium to the price of homes they sell.

Most builders use corruption in government and increasing input costs to explain that the price of homes won’t fall anytime in the near future. Take the case of cement, a major input into building homes. As a recent newsreport in The Economic Times points out: “Cement prices have jumped 20-40 per cent over the past two months in top cities despite demand from the real estate industry, which is its largest buyer, being low.”

In this scenario the price of homes won’t fall, say builders. But this logic just takes into account the supply side of the equation. It only talks about the builders who supply homes and the costs they have to incur. What about the end consumers who want to buy these homes?

As John Kay writes in an essay titled Guess Who’s Come to Dinner which is a part of the book Everlasting Light Bulbs – How Economics Illuminates the World: “But surely people can’t spend an increasing proportion of their incomes on housing.” The affordability of homes also needs to be taken into account.

Also, owning a house is just not about putting up a down-payment, taking a home loan and paying the builder. There are other costs involved as well. Hence, as Kay puts it, it is important “to focus on the costs of house ownership rather than the cost of houses.”

Given this, affordability isn’t just being able to pay the price of the house. There is more to it than that. As Kay writes: “Mortgage repayments [home loan EMIs basically] are only a…part of the cost of buying a house: you have to pay for repairs and maintenance, heat and light, property taxes.” Then there is the cost of moving in, the cost of setting up the place, and so on.

In a scenario where home prices are anyway high all these costs make the entire cost of owning a home even more expensive. So, the point that builders make about their inability to cut prices doesn’t have any meaning. They can build homes and sell them at prices they think are right, but the question is will there be any takers at that price? And the answer is clearly no.

In any market there are always two sides – demand and supply. And that is a basic point that our builders need to remember. So, they can continue holding on to their prices, but at those prices there will be not much demand for homes. As Kay writes in another essay titled A Fetish for Manufacturing: “The rewards of different activities [are] detached from their position in the hierarchy of needs. You only [get] paid for producing goods that people [want].”

Kay makes another interesting point, which I would like to talk about here. As he writes: “In classic bubbles – from tulip mania to the dot.com frenzy – people bought things, not for their intrinsic worth, but to sell on to others at a higher price. That rarely happens with houses.”

This is not true in the Indian context. Homes in India have “not” always been bought “for their intrinsic worth” but they have also been bought “to sell on to others at a higher price”. And that clearly is not happening anymore. Over the last few years you would have been better off letting your money sit idle in a savings bank account rather than investing in real estate. Given this, the interest in owning real estate has come down. That is clearly visible from the huge number of unsold homes across cities as well as fall in the launch of new projects.

As Kay writes: “As in every asset market, short term price movements are driven by beliefs, not underlying realities.” The underlying reality is that at these prices it does not make any sense to invest in real estate. But the belief that real estate prices always go up is still reasonably strong. The question is for how long will the belief remain strong?

I think we are half way there.

The column originally appeared in The Daily Reckoning on October 15, 2015.

Why smart people fall for Ponzi schemes

ponzi
Sometime back a friend called and had a rather peculiar question. He wanted to know how he could go about stopping one of his friends from peddling a Ponzi scheme.

This was a rather tricky question. Just explaining to someone selling a Ponzi scheme that he is selling a Ponzi scheme, does not really work. The first question I asked my friend was how was his friend doing in life? “He is doing well for himself,” said my friend with a chuckle. “He works in a senior position with a corporate and has managed to sell the scheme to at least ten people in the housing society that he lives in.”

“If he is working at a senior position, why is he doing this?” I asked my friend, and immediately realised that I had asked a rather stupid question. “I was hoping you would be able to answer that,” my friend replied.

This column is an outcome of that conversation.

Over the last ten years of writing on Ponzi schemes I have come to the realisation that many people who sell and in the process invest in Ponzi schemes are not just victims of greed or a sustained marketing campaign, as is often made out to be.

There is much more to it than that. Many individuals selling and investing Ponzi schemes (like my friend’s friend) come from the upper strata of the society, are well educated and know fully well what they are doing. In case of my friend’s friend he was selling a multilevel marketing scheme for which the membership fee is more than Rs 3 lakh. So, the scheme is clearly aimed at the well to do.

On becoming a member you are allowed to sell products, some of which cost as much as a lakh. Of course, you will also be making new members as well. The bulk of the membership fee paid by the new members you make, will be passed on to you. Hence, the more people you get in as members, the more money you make. Selling products is just incidental to the entire thing, given that a membership costs more than Rs 3 lakh.

This is a classic Ponzi scheme in which money being brought in by the new investors (through membership fee) is being used to pay off old investors (who had already paid their membership fee), with the business model of selling products providing a sort of a façade to the entire thing.

So, the question is why does the smart lot fall for Ponzi schemes? As John Kay writes in Other People’s Money—Masters of the Universe or Servants of the People: “Even if you know, or suspect, a Ponzi scheme, you might hope to get out in time, with a profit. I’ll be gone, you’ll be gone.”

People feel that the money will keep coming in. Or what the financial market likes to call ‘liquidity,’ won’t dry up. And this is the mistake that they make.
Kay defines liquidity as the “capacity of the supply chain to meet a sudden or exceptional demand without disruption…This capability is achieved…in one or both of two ways: by maintaining stocks, and by the temporary diversion of supplies from other uses.”

Kay in his book compares the concept of liquidity to the daily delivery of milk in the city of Edinburgh in Scotland where he grew up. As he writes: “In the Edinburgh of fifty years ago fresh milk was delivered everyday…At ordinary times our demand for milk was stable. But sometimes we would have visitors and need extra milk. My mother would usually tell the milkman the day before, but if she forgot, the milkman would have extra supplies on his float to meet our needs. Of course, if all his customers did this, he wouldn’t have been able to accommodate them.”

What is the important point here? That people trusted the milkman to deliver every morning. And given that they did not stock up on milk, more than what was required on any given day. If the trust was missing then the system wouldn’t have worked.

Take the case of how things were in the erstwhile Soviet Union. As Kay writes: “In the Soviet economy there was no such confidence, and queues were routine, not just because there was an actual insufficiency of supply – though there often was – but because consumers would rush to obtain whatever supplies were available.”

And how does that apply in case of Ponzi schemes? As I mentioned earlier, the individual selling Ponzi schemes feel confident that the money will keep coming in. Those they sell the scheme also become sellers. And for the Ponzi scheme to continue, the new lot also needs to have the same confidence.

In the milk example shared above, if people of Edinburgh had started hoarding milk, the liquidity the system had would have broken down. The confidence that milk would be delivered every day kept the system going. Along similar lines, the confidence that money will keep coming into a Ponzi scheme, gets smart people into it as well.

Of course, this confidence can change at any point of time. And if a sufficient number of people stop feeling confident, then the scenario changes. The money coming into the Ponzi scheme stops and the moment the money coming into the scheme becomes lesser than the money going out, it collapses. So that’s the thing with liquidity, it is there, till it is not there.

In my friend’s friend case, members down the line would stop making more members. Also, members who had bought the membership from my friend’s friend are likely to turn up at his doorstep and demand their money back.

And given that he has told membership to many people in his housing society, he can’t just get up and disappear, given that he is essentially not a scamster. He is a family man with a wife, children and parents, who stay with him.

Hence, he will have to refund them, if he has continue living in the housing society in a peaceful environment. How will he do that? Let’s go back to the definition of liquidity as explained above. Liquidity is maintained by “by maintaining stocks, and by the temporary diversion of supplies from other uses.” So my friend’s friend can pay up from the money he has already accumulated by selling these Ponzi schemes. If that is not enough, he can dip into his savings. And if even that is not enough, he can hopefully take the money being brought in by the new members (if at all there are people like that) and hand them over to the members demanding their money back.

Of course, by doing this he will only be postponing the problem, given that he would have to later deal with the new members.

Long story short—he is screwed!

The column originally appeared on The Daily Reckoning on Oct 13, 2015

Experts are bad at forecasting: Remember this, next time you see a forecast

forecast
If I ever have the time, the money and the resources, I would like to carry out an experiment. Every day on business TV channels, experts offer their forecasts on stock prices, commodity prices, the direction of the economy, politics of the nation and so on.

There are other experts making forecasts through research reports. As the British economist John Kay writes in Other People’s Money: “Most of what is called ‘research’ in financial sector would not be recognised as research by anyone who has completed an undergraduate thesis.”

Getting back to the topic at hand, I would like to figure out how many of these forecasts eventually turned out to be correct. So, if an analyst says that he expects the price of HDFC Bank to cross Rs 1300 per share in a year’s time, did he eventually get it right.

Also, I would like to figure out whether the “so-called” forecasts were forecasts at all, in the first place? Saying that the HDFC Bank stock price will cross Rs 1300 per share, but not saying when, is not a forecast. As Philip Tetlock and Dan Gardner write in their new book Superforecasting—The Art and Science of Prediction: “Obviously, a forecast without a time frame is absurd. And yet, forecasters routinely make them.”

When it comes to the stock market, there are two kinds of experts who come under this category of making a forecast without a time-frame attached to it. One category is of those who keep saying that the bull market will continue, without really telling us, until when. “Predicting the continuation of a long bull market in stocks can prove profitable for many years—until it suddenly proves to be your undoing,” write Tetlock and Gardner.

The second category is of those who keep saying that the bear market is on its way, without saying when. “Anyone can easily “predict” the next stock market crash by incessantly warning that the stock market is about to crash,” write Tetlock and Gardner.

The broader point is that no one goes back to check whether the forecast eventually turned out to be correct. There is no measurement of how good or bad a particular expert is at making forecasts. I mean, if an expert is constantly getting his forecasts wrong, should you be listening to him in the first place.

But no one is keeping track of this, not even the TV channel.

As Tetlock and Gardner write: “Accuracy is seldom even mentioned. Old forecasts are like old news—soon forgotten—and pundits are almost never asked to reconcile what they said with what actually happened.” And since no one is keeping a record, it allows experts to keep peddling their stories over and over again, without the viewers knowing how good or bad their previous forecasts were.

“The one undeniable talent that talking heads have is their skill at telling a compelling story with conviction, and that is enough. Many have become wealthy peddling forecasting of untested value to corporates executives, government officials, and ordinary people who never think of swallowing medicine of unknown efficacy and safety,” write Tetlock and Gardner.

In fact, in the recent past, many stock market experts were recommending midcap stocks. After the Sensex started crashing the same set of experts asked investors to stay away from midcap stocks as far as possible.

There is a great story I was told about an expert, who was the head of the commodities desk at one of the big brokerages. He was also a regular on one of the television channels as well. This gentlemen kept telling the viewers to keep shorting oil for as long as prices were going up and then when the prices started to fall, he asked them to start buying. This was exactly opposite of what he should have been recommending. Obviously anyone who followed this forecast would have lost a lot of money.

I can say from personal experience that predicting the price of oil is very difficult, given that there are so many factors that are at work. As Tetlock and Gardner write: “Take the price of oil, long a graveyard topic for forecasting reputations. The number of factors that can drive the price up or down is huge—from frackers in the United States to jihadists in Libya to battery designers in Silicon Valley—and the number of factors that can influence those factors is even bigger.”

Nevertheless, the television appearances of the commodity expert I talked about a little earlier, continue. And why is that the case? Tetlock and Gardner provide the answer: “Accuracy is seldom determined after the fact and is almost never done with sufficient regularity and rigor that conclusions can be drawn. The reason? Mostly it’s a demand-side problem: The consumers of forecasting—governments, businesses, and the public don’t demand evidence of accuracy. So there is no measurement. Which means no revision. And without revision, there can be no improvement.” And so the story continues.

One would like to believe that forecasts are made so that people can look into the future with greater clarity. But that is not always the case. Some forecasts are made for fun. Some other forecasts are made to fulfil the human need to know what is coming. Some other forecasts are made to advance political agendas.

And still some other forecasts are made to comfort people “by assuring [them] that their beliefs are correct and the future will unfold as expected,” Tetlock and Gardner, point out. Now only if it were as simple as that.

In fact, Tetlock spent close to two decades following experts and their forecasts. In the experiment, Tetlock chose 284 people, who made a living by predicting political and economic trends. Over the next 20 years, he asked them to make nearly 100 predictions each, on a variety of likely future events. Would apartheid end in South Africa? Would Michael Gorbachev, the leader of USSR, be ousted in a coup? Would the US go to war in the Persian Gulf? Would the dotcom bubble burst?

By the end of the study in 2003, Tetlock had 82,361 forecasts. What he found was that there was very little agreement among these experts. It didn’t matter which field they were in or what their academic discipline was; they were all bad at forecasting. Interestingly, these experts did slightly better at predicting the future when they were operating outside the area of their so-called expertise.

It is well-worth remembering these lessons the next time you come across a forecast. And that includes the forecasts made in The Daily Reckoning as well.

The column originally appeared on The Daily Reckoning on October 7, 2015

Why we buy lottery tickets

lotteryThe funny thing about memories is that we remember what we remember. And those memories may not always be a true reflection of how things may have originally happened. What we live with are our versions of how things may have really happened. And this we tell ourselves is the truth.

One abiding memory that I have from my childhood is that of my father buying lottery tickets. I don’t remember how often he did it. Neither do I remember how long he did it for. But I do remember that there was a time when he used to buy lottery tickets regularly. And in my version of this memory, I remember him beaming on days he used to buy a lottery ticket. He looked genuinely happy on those days.

And all these years later, I wonder why he smiled on the days he bought a lottery ticket, given that he never really won anything. Of course, I did not understand the reason back then, but now with some understanding of why people behave in a certain way, I do.

As John Kay writes in Other People’s Money: “A lottery ticket, which millions of people buy each week, is a wager. Cynics have advised that you would do well to buy your ticket at the last minute, because otherwise the probability that you will die before the draw is greater than the probability that you will win the headline prize.”

Jokes apart, why do individuals actually buy lottery tickets, given that the probability of winning the big-prizes on offer on any lottery, is very low. Only a few people out of the millions who buy lottery tickets regularly, are likely to win the top prize.

Psychologist Daniel Kahneman explains this in Thinking, Fast and Slow: “The possibility effect…explains why lotteries are very popular. When the top prize is very large, ticket buyers appear indifferent to the fact that their chance of winning is minuscule.”

The point being that unless you buy a lottery ticket you have no chance of winning. As Kahneman points out: “A lottery ticket is the ultimate example of the possibility effect. Without a ticket you cannot win, with a ticket you have a chance, and whether the chance is tiny or merely small matters little. Of course, what people acquire with a ticket is more than chance to win; it is the right to dream pleasantly of winning.”

And that I guess explains my father’s beaming face every time he bought a lottery ticket. In fact as Kahneman puts it: “Buying a ticket is immediately rewarded by pleasant fantasies…The actual probability is inconsequential; only the possibility matters.”

In fact, promoters, companies and governments (as is the case in India and other parts of the world) which sell lottery tickets, understand this fact very well. As Kay writes: “Promoters have learned through experience how to design an attractive lottery product. A few very large prizes establish the dream. A large number of very small prizes encourage customers to maintain the belief that ‘It could be you’.”

This structure of the lottery also explains why people keeping going back to buying tickets even though their chance of winning the big prize is close to zero. As Kay points out: “When lottery patrons lose, as they mostly do, they can sustain the dream by promising themselves that they will buy a ticket again next week. ‘It could be you’ was the well-judged slogan with which Britain’s national lottery was launched.”

So, the story and the hope of winning a big lottery continues among millions of people all over the world. And it is hope which makes a dull and dreary life, liveable at the end of the day. If that means buying a lottery ticket, then so be it.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared in the Bangalore Mirror on Oct 7, 2015

What business news channels have in common with Chacha Chaudhary


Chacha_Chaudhary_with_his_dog_Raaket
I normally don’t watch business news channels given that I find them quite flaky and get put off by their lack of depth. Nevertheless, these days with nothing better to do while having lunch, I sometimes do end up watching these channels discussing the vagaries and the volatility of the stock market.

And one of the things I have noticed is that the anchors as well as the stock market experts who offer their opinion on these channels speak with a lot of conviction and confidence. They appear to be in control of things. They appear to know what is happening, when the world around them is probably going crazy. We never hear them use words like probably, maybe or phrases like I don’t know. Further, they seem to have this uncanny ability to understand and explain something just as it has started to unravel. Their story telling abilities are simply terrific.

The uncanny ability of these anchors and experts to explain things at the speed of thought reminds me of a thought bubble in the Chacha Chaudhary comics, which used to say: “Chacha Chaudhary ka dimaag computer se bhi zyada tez chalta hai (Chacha Chaudhary’s mind works faster than a computer).” These anchors and experts are perhaps the Chacha Chaudharies of this day and age.

How is such speed possible? If the anchors and experts are so much in control and seem to have so much insight with such clarity, why are they not making money out of it? Why are they offering their advice for free on TV?

As the British economist John Kay writes in his new book Other People’s Money—Masters of the Universe or the Servants of the People?: “We deal with radical uncertainty through storytelling, by constructing narratives…The reality of market behaviour…relies on conviction narratives – stories that traders tell themselves, and reinforce in conversation with each other. Such narratives are the means by which we cope with radical uncertainty – the unknown unknowns that characterise… business and securities markets.”

The anchors and the experts appearing on business news television are in the business of telling us stories, which offer an explanation for why the market moved the way it did on a particular day. These days the most offered explanation is that economic jitters in China caused the stock market to fall. But this explanation is always offered after the stock market has fallen. No anchor or market expert ever says: “The stock market will fall today because there is economic trouble in China”.

As Kay writes: “The ‘explanations’ provided…by…market commentators…are little more than rationalisation of the noise generated by…market volatility.” And given this, it is worth asking that how useful is it for investors to listen to these explanations and make investment decisions after that.

Bob Swarup calls this phenomenon the illusion of explanation. He defines the term in his book Money Mania as: “Believing erroneously that your arguments…explain events.”

Further, how is it that the anchors and the market experts have an explanation for everything that happens in the stock market? And what is even more surprising is how they are able to come up with explanations so quickly. As John Allen Paulos writes in A Mathematician Plays the Stock Market: “Commentators…provide a neat post hoc explanation for every rally, every sell-off, and everything in between…Because so much information is available—business pages, companies’ annual reports, earnings expectations, alleged scandals, on-lines sites and commentary—something insightful can always be said.”

Over and above this there are many data releases which can also be used to come up with explanations. These data releases include inflation as measured by the consumer price index and the wholesale price index, index of industrial production, export and imports numbers, bank credit growth, and so on. And if all this does not fit into a convincing narrative you can always blame the Reserve Bank of India for not cutting interest rates.

Investing in specific stocks is not easy as it is made out to be by business news television. In fact, what anchors and market experts specialise in is making things simplistic rather than simple, given that they have limited time at disposal to say what they want to say. In this situation, where everything has to be said in thirty seconds to a minute, it is hardly surprising that things ultimately become simplistic. And this is clearly not good from an investor point of view.

What works for these anchors and experts is the fact that while coming up with explanations and predictions, their past record is not available for examination.

As Jason Zweig writes in Your Money and Your Brain: “Whenever some analyst brags on TV about making a good call, remember that pigs will fly before he will broadcast a full list of his past predictions, including the bloopers. Without that complete record of his market calls, there’s no way for you to tell whether he knows what he’s talking about.” This is a very important point that needs to be kept in mind when listening to anchors as well as experts on television.

Also, it is worth remembering here that which way a stock market will go is impossible to predict regularly on a day to day basis.  Nassim Nicholas Taleb in his book The Black Swan—The Impact of the Highly Probable lists a certain category of experts who tend to be…not experts. In this list he includes economists, financial forecasters, finance professors and personal financial advisers.

As he writes: “Simply, things that move, and therefore require knowledge, do not usually have experts, while things that don’t move seem to have some experts. In others words, professions that deal with the future and base their studies on the nonrepeatable past have an expert problem…I am not saying that no one who deals with the future provides any valuable information…but rather that those who provide no tangible added value are generally dealing with the future.” Given this, the stock market experts clearly have an expert problem.

Hence, the next time you switch on your television to try and understand what is happening in the stock market, do remember all that has been pointed out above.

Happy investing!

The column originally appeared on The Daily Reckoning on September 25, 2015