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And so the cycle turns…as it has always done

Posted by on Nov 12, 2015 in 18 year real estate cycle |

In July, German lender, Commerzbank, sold two commercial real estate portfolios for around $2.9 billion. You can read about this here. It’s not a particularly remarkable story but I am bringing it to your attention because it’s an important part of the 18 year cycle, particularly the first half of the cycle – the de-leveraging process. Note some of the key facts in the article – all classic elements of the cycle: The bank had to be bailed out by the German government with an $18.2 billion emergency investment at the height of the financial crisis in 2008/09. Note that this is the same German government that has since been criticizing peripheral Eurozone countries about their profligate lending. In fact, at the start of the GFC, German banks were more highly leveraged than banks in the US, UK, Spain, Ireland…or even Greece. The bank is selling off part of its commercial real estate loan book, which it describes as “non-core” assets – compared to its “core” ones – which are the loans it supplies to businesses looking to expand, invest, create jobs do all of the things that generate economic growth This will help the Bank meet new banking regulatory requirements (Basel III) under which the Bank needs to hold more capital relative to its assets. It recently raised $1.4 billion by issuing more shares to further meet such requirements. Note that the discount (that is the amount by which the sale price is below the outstanding value of the loans) on the portfolios being sold is only 3% – this is significant because this means that the value of the real estate has recovered to levels seen when the loans were made, prior to the financial crisis. Pay attention to articles like these. This is the cycle in action. Banks can only really start to lend to the economy properly once they have got rid of the loans they made in the prior cycle. It takes several years for banks to do this, because they need to see a recovery in the underlying value of the real estate so that they minimize losses and because they have a lot of real estate on their books. And they have to find buyers – the more the better to generate competition and increase the sale price (which also takes time). Many of these assets are now being snapped up by other banks and institutional investors. It is only once this unwinding/de-leveraging process has completed that banks can focus on their “core” activities, which is lending to businesses that generate wealth within the economy. The article notes that Commerzbank is a “key lender to the small and midsized companies that make...

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Would you like to work only 15 hours a week?

Posted by on Nov 6, 2015 in 18 year real estate cycle |

In 1930, as the world toiled through the Great Depression, John Maynard Keynes wrote an essay, Economic Possibilities for our Grandchildren, to allay people’s fears about their economic future and, as he so eloquently put it to take wings into the future” in order to ask: “What can we reasonably expect the level of our economic life to be a hundred years hence?” In other words, he was peering into a crystal ball to imagine what things would be like in 2030. As an aside, reading this essay is a little like going back and watching Back to the Future II, in which Marty McFly is transported to the future….to our very own 2015. It’s interesting to see all of the technological progress they envisaged for October 2015. Some of it was way off (hydrating pizza?) but in other ways it was quite accurate (3D movies at the cinema; video chatting with several people via computer). In his essay, Keynes made two famous predictions: that the world in economic terms would be eight times better off (projecting into the future the growth rates from the early part of the 20th century). And that this would mean that his grandchildren would only have to work 15 hours per week. I mention this now because a famous UK economist, Tim Harford, author of The Undercover Economist, revisited Keynes’ famous speculations in the Financial Times. Here is what he had to say: Keynes was half right. Barring some catastrophe in the next 15 years, his rosy-seeming forecasts of global growth will be an underestimate. The three-hour workday, however, remains elusive. Harford then goes on to explain why this might be the case. He puts it down to two main reasons: We like to work hard. We like to earn more than our neighbours so we can spend more than them. There may be something in this. But please note – he misses the main point. (As an aside, I’ve given up expecting such figures to “get it”). The fruits of economic development always increases the price of land, which far outstrips the growth in wages. This is called the Law of Economic Rent. This is an invariable, immutable and permanent law of economics. Write it down. Commit it to memory. This is what drives the cycle. Increased rents attract capital; and then invite speculation as people chase something for nothing. In economies (such as ours) where the rent is privately captured, those who own the rent can work less and less – because as the economy grows the value of the rent increases. But those who earn wages will see much less growth – while the rent (or mortgage payments) they will have to...

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