The coming S$270 billion bailout

There are very few cars in the second-hand market more than five years old. Given that cars have to be either scrapped or exported when they reach ten years of age, there are probably too few buyers for such cars, in the absence of which it is extremely difficult to discover a market price for them.

The ten-year rule is related to the fact that Certificates of Entitlement (COE) have a life of ten years, though strictly speaking, the rule is separate from COEs. COEs, as most Singaporeans know (but foreign readers may not) are auctioned rights to own a vehicle. There’s a limited annual supply as determined by the government based on road and parking space capacity, adjusted by the number of decommissionings occurring simultaneously.

In the second-hand car market, prices move inversely with the age of the car. The older the car, the lower the price. Another way of saying it is that the price moves more or less in tandem with the declining number of years left in the COE until somewhere around the halfway mark, when the price falls off the cliff. Old cars cost more to maintain in addition to having fewer years left.

Most of us would say that such price trends reflect a perfectly rational way of assessing value.

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Public housing in Singapore is also governed by its own kind of “COE”, though we call them title deeds. They have a life of 99 years. The oldest flats, built in the 1960s, are now approaching 50 years in age.

However, Singaporeans have totally different expectations about value. We expect it to go up as the termination of the lease approaches. Cabinet minister Lim Swee Say assured Singaporeans that this is in fact government policy as well, in a Chinese-language debate with other political parties televised on 3 April 2011. Using a translation provided by Donaldson Tan of the NewAsiaRepublic website, this is what he said:

The PAP’s view and approach on housing policy consist of 3 points. The first point is that home ownership is the cornerstone of the housing policy.

The second point is there must be gradual appreciation in property prices. Why is this important for HDB price to appreciate gradually over time? Consider the hypothetical situation of a Singaporean who bought a HDB flat for $200,000. In 20 years time, would he benefit if the selling price is less than the price he bought today? If the Opposition thinks depreciation of HDB price is good, it can use this point as a platform to fight for more votes.

— Lim Swee Say, as translated by Donaldson Tan. Source link.

It is inconceivable for this government to allow the values of public (“HDB”) flats to decline, when through law people are forced to set aside a big part of their incomes in the Central Provident Fund (CPF) and then encouraged to commit a huge part of their existing and future CPF savings to pay for a flat. The flat effectively becomes the primary form of saving for retirement. Yet, the asset is a declining lease.

The brick and mortar aspect of it too can barely be expected to survive 70 years let alone 99. The perennial complaints of spalling concrete should tell us that our HDB flats are not in the same league as Egyptian pyramids when it comes to withstanding the ravages of time.

It’s as if every citizen is encouraged to put his savings into a longer-term COE+vehicle with the government promising one and all that COEs will increase in value as its lifeterm decreases and the vehicle becomes a boneshaker. Where is the logic in this?

There seems to be widespread delusion about what the HDB market is really all about. We call it “property” and, fooled by language, we think the market has the properties of property. It does not. In a classic property market, the asset changing hands is a freehold title to physical piece of land. Land has a natural scarcity; the title is in perpetuity. Neither of these critical attributes apply in the HDB market. It is certainly not in perpetuity, nor is there any natural scarcity.

The title is, in a sense,  to a slice of air for a delimited length of time. How many slices can there be? As many as a government wishes to create by fiat, and technically possible by advancing construction technology. It is theoretically of infinite quantity. There is no natural scarcity, only man-made (and therefore man-reversible) ones.

And yet, buyers bid higher and higher. Of course, the hope is that after they have purchased the flat, the market price will go yet higher and they will manage to cash out before the market comes to its senses and, recognising reality, crashes.

What did I just describe? A bubble. And like all bubbles, it will burst.

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Let me make a digression and talk a little about SERS. These initials stand for “Selective En-bloc Redevelopment Scheme”, under which the Housing and Development Board identifies certain old blocks of flats and buys them back from leaseholders. The Board then tears down the blocks in order to build new, taller blocks on the same site, increasing housing density. At this point, let me point out that this process exactly illustrates what I said above: The government is able to create new quanta of “property”  by slicing up more blocks of air; it only proves my point that there is no natural scarcity.

Unfortunately, my block has not yet been identified for SERS, so I don’t have detailed and personal experience how it works. But I have two friends who have benefitted and from them I understand that the process involves the government buying back the leasehold based on market value. The purchase price can then be used towards the price of a new flat somewhere close by. If the new flat’s price is more than the old flat’s market value, you will have to top up the difference.

The thing to examine closely is the market value of the old flat. As I described above, it is based on mass delusion. This means the first people who enjoy SERS will get a bubble-based valuation for the old flat. Once the bubble bursts the remaining people will find their old flat’s market value crashing. To get a new flat to stay in after being evicted by SERS, you will basically have to pay all over again virtually the full price of a new flat.

And the bubble has to burst. At some point, people are going to say: Oh, your block is nearly 80 years old and your lease has only 22 years left, no way I will even consider buying your flat, just like how cars with less than five years left on their COEs don’t find much of a market.

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However, the government has given an implicit promise to sustain a rising value of HDB flats, as you can see from Lim Swee Say’s words above. It will be political suicide to let prices crash because people’s retirement savings are tied up in the value of this make-believe asset.

When the crash looks like it will happen, the government will likely step up SERS, making themselves the biggest buyer of HDB flats in order to reassure the market when all other buyers are fleeing. Then when market valuations are pointing south, the government is likely to establish a floor valuation (i.e. decoupling it from the fast-sinking free market price), to reassure existing leaseholders that they will get more or less the expected value of the flat based on previous bubble delusions. Effectively, the government will be forced to underwrite near-worthless “assets” and bail out citizens whose nest-eggs are evaporating.

What is the cost of that bail-out to come? It’s hard to say because we don’t know what stratospheric prices HDB flats will have reached. But if we assume today’s average price of about $250,000 per typical flat, and add a bit more, say to S$300,000, and multiply this with the present stock of over 900,000 flats, it comes to S$270 billion.

Like most big numbers, it’s hard to visualise S$270 billion. But we can compare it to the annual gross domestic product of Singapore, which is S$304 billion. Yes, that’s 90 percent of our present GDP.

Still hard to visualise that? Let’s take the experience of another small country. Soon after the Irish government was forced by circumstances to take on the debts of its overextended banks in the wake of the 2008 financial crisis, it found its commitments too heavy to bear. The country, facing bankruptcy, had to run to the International Monetary Fund for a bailout, in the process of which, severe austerity measures had to be implemented. What was Ireland’s commitment to its banks as a percentage of the country’s GDP that precipitated the crisis?

Irish Central Bank Governor Patrick Honohan said total loan losses at the country’s lenders, including foreign-owned banks, total at least 85 billion euros, about half of GDP.

— Bloomberg News, 21 Nov 2010, Ireland Seeks Bailout as ‘Outsized’ Problem Overwhelms Nation. Link.

Half of GDP was enough to break Ireland.

There will be a difference, of course. Unlike the acute crisis that Ireland faces, buying back a stock of flats over an extended period of time makes it a chronic crisis. But don’t kid ourselves, going broke slowly is still going broke.

You might say, what does it matter to me personally so long as I get back the value of my flat? Yes, you will get back its value, e.g. all S$300,000 worth of it. Except that when Singapore is considered broke internationally, you will have in hand 300,000 scraps of banana money.