Flippers
I moved from New York to Pittsburgh in 2004 to start my fellowship in Transplant Surgery. While I was looking for an apartment to stay in, I received advice from friends and colleagues: "buy a house instead of renting. Instead of paying rent, you can pay EMIs on the house and when you move, you can sell the house for more than you bought it for. The price of property always goes up." Fortunately I did not heed the advice and we know what happened in 2007-2008.
It has long been thought that the reason for the financial crisis was banks giving loans to people who could not afford the properties they were buying with the loans. Bank employees received incentives according to the number of loans they could negotiate. It was in their interest to negotiate loans for more and more people and when they ran out of people with good credit histories who could afford to pay back the loans, they turned to people with poor credit histories who could not. Incomes were falsely stated and many people who could not afford them ended up with homes they had no business thinking of buying.
The banks were well aware that these loans were risky (sub-prime) and they packaged them with other things and sold them as 'financial instruments' or investments all over the world. The rating agencies which should have flagged up the risks were in cahoots with the banks and many of these atrocities were rated highly.
Eventually, the inevitable happened. People who could not afford the properties they had bought began to default on the loan payments. The banks moved to repossess and sell these properties to recover their loans. Partly because of an unrealistic building boom driven by the surge in home ownership and partly because of repossessed properties returning to the market, the unthinkable happened and the cost of property began to drop.
Now people who had been reassured that "the price of property always goes up" found that even if they sold their homes, they would still owe the banks money and would have to continue to make payments on their loan. Many of them became bankrupt. Meanwhile the people to whom these loans had been sold (disguised by Wall Street) were beginning to realize that the AAA investments into which they had poured all their savings were melting away or were entirely worthless. Iceland became bankrupt. Retirement funds in Ireland disappeared.
People bought less. Jobs decreased. The global economy went into a depression which it is only just emerging from.
A recent article suggested that the problem may have been due to something other than poor people buying homes they could not afford.
https://finance.yahoo.com/news/house-flippers-triggered-us-housing-175705459.html
They found that it was house flipping speculators who inflated the housing bubble to such massive proportions. These were relatively wealthy people who would buy a property they did not need, solely with the aim of selling it at a profit. People who are moving want to sell their house. They do not necessarily want to spend months waiting for the best offer. They want to move and buy a home in the city to which they are moving. They end up selling to such a speculator. Now the speculator can wait for 6 months trying to sell the house at a markup.
However, in an economy in which property prices are coming down and there is a large volume of unsold inventory of new houses, the speculator is unable to dispose of the property.
Much the same thing is happening in the real estate sector in India, particularly in the NCR region. Noida, Greater Noida and Gurgaon have seen massive construction activity spurred on by what the builders thought was an infinitely expanding market. Prices were unrealistically inflated by 'flippers' buying from builders and selling to second generation buyers at markups of 20% or more. Much of these transactions happened in black money.
When you buy a property and sell it for more, you are not actually adding value to it. The net transaction is transfer of money from the second buyer to the 'flipper'. The system breaks down when people stop buying property. Of course demonetisation added a jarring shock to the property market which may just have tilted the balance towards the collapse.
The bankruptcy of Jaypee Infratech is a symptom. Builders overextended their credit and are now left holding unsold inventory and no longer have cash to complete building projects they have started.
I see no way this collapse is going to stop before making a major impact on the economy. It will slow down when property prices reach relatively realistic levels and plateau when the unsold inventory is sold. That will take many years.
It has long been thought that the reason for the financial crisis was banks giving loans to people who could not afford the properties they were buying with the loans. Bank employees received incentives according to the number of loans they could negotiate. It was in their interest to negotiate loans for more and more people and when they ran out of people with good credit histories who could afford to pay back the loans, they turned to people with poor credit histories who could not. Incomes were falsely stated and many people who could not afford them ended up with homes they had no business thinking of buying.
The banks were well aware that these loans were risky (sub-prime) and they packaged them with other things and sold them as 'financial instruments' or investments all over the world. The rating agencies which should have flagged up the risks were in cahoots with the banks and many of these atrocities were rated highly.
Eventually, the inevitable happened. People who could not afford the properties they had bought began to default on the loan payments. The banks moved to repossess and sell these properties to recover their loans. Partly because of an unrealistic building boom driven by the surge in home ownership and partly because of repossessed properties returning to the market, the unthinkable happened and the cost of property began to drop.
Now people who had been reassured that "the price of property always goes up" found that even if they sold their homes, they would still owe the banks money and would have to continue to make payments on their loan. Many of them became bankrupt. Meanwhile the people to whom these loans had been sold (disguised by Wall Street) were beginning to realize that the AAA investments into which they had poured all their savings were melting away or were entirely worthless. Iceland became bankrupt. Retirement funds in Ireland disappeared.
People bought less. Jobs decreased. The global economy went into a depression which it is only just emerging from.
A recent article suggested that the problem may have been due to something other than poor people buying homes they could not afford.
https://finance.yahoo.com/news/house-flippers-triggered-us-housing-175705459.html
They found that it was house flipping speculators who inflated the housing bubble to such massive proportions. These were relatively wealthy people who would buy a property they did not need, solely with the aim of selling it at a profit. People who are moving want to sell their house. They do not necessarily want to spend months waiting for the best offer. They want to move and buy a home in the city to which they are moving. They end up selling to such a speculator. Now the speculator can wait for 6 months trying to sell the house at a markup.
However, in an economy in which property prices are coming down and there is a large volume of unsold inventory of new houses, the speculator is unable to dispose of the property.
Much the same thing is happening in the real estate sector in India, particularly in the NCR region. Noida, Greater Noida and Gurgaon have seen massive construction activity spurred on by what the builders thought was an infinitely expanding market. Prices were unrealistically inflated by 'flippers' buying from builders and selling to second generation buyers at markups of 20% or more. Much of these transactions happened in black money.
When you buy a property and sell it for more, you are not actually adding value to it. The net transaction is transfer of money from the second buyer to the 'flipper'. The system breaks down when people stop buying property. Of course demonetisation added a jarring shock to the property market which may just have tilted the balance towards the collapse.
The bankruptcy of Jaypee Infratech is a symptom. Builders overextended their credit and are now left holding unsold inventory and no longer have cash to complete building projects they have started.
I see no way this collapse is going to stop before making a major impact on the economy. It will slow down when property prices reach relatively realistic levels and plateau when the unsold inventory is sold. That will take many years.
Greed has become systemic.
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