The telco confusopoly

The one frustration that started me blogging more than three years ago was the confusing pricing practices of phone and internet service providers. It was quite obvious to me that their 'plans' where meant to be confusing to ensure the consumer could not easily identify the cheapest provider. Today, the Australian Communications and Media Authority (ACMA) has released a report that recommends improving price information for telecommunications contracts to avoid a 'confusopoly' (here).  Amongst other things -

The authority also wants to prohibit what it says are misleading advertising practices, such as the use of the term "cap" on mobile and broadband plans.

"It's not a cap, it's not a maximum, it's a minimum," Mr Chapman said

"We want to prohibit that unless its a genuine hard cap, so that if you exceed your limit the service ends or you get the opportunity to upgrade." (here)

Most recently I have been comparing mobile phone plans. Some of the cheap plans don't allow you to call 13, 1300 and 1800 numbers under the cap, and they all have different call rates, flag fall and penalties for exceeding cap limits. To actually compare providers you need to know your calling needs in advance and have the mathematical skills to run this call profile, and other scenarios, through a model of each available phone plan. Insanity.

As I previously wrote -

By consciously manipulating these two criteria of a free market [low barriers to entry and perfect, or at least good, information], all firms in the market are able to avoid a state of true competition that would produce the most efficient allocation of services, and are able to artificially inflate the value of the commodity, hence producing more profit for each firm in the market.

This is not meant to sound like a conspiracy, because indeed each firm does not need to meet in back rooms with the other firms in the market and all agree to limit customer information and the comparability of their products. They each simply need to aspire to the great marketing ideal of product differentiation, a concept that is fundamentally designed to artificially eliminate direct competition by removing direct comparability.
...

The power of product differentiation, through its ability to remove comparability and create an information gap to distort what could be a perfectly competitive market, can be demonstrated by the case of the term life insurance market in the US in the late 1990s. There was a mysterious and dramatic drop in prices across all firms that did not correlate to price drops in other forms of insurance, which themselves where steadily rising.

According to economist Steven D. Levitt, this can be attributed to the realisation of a perfect market through the power of the internet. Although term life insurance policies had been quite homogeneous before this period of time, the process of shopping around for the cheapest price had been convoluted and time consuming, whereas websites such as Quotesmith.com suddenly made the process almost instantaneous.

In just a few years, the value of the term life insurance market in the US had dropped by USD$1bilion because of the new found ease of comparability. What insurance firm would want this to happen? Even if you were a small player in the market, say a 1% market share, your turnover had just dropped by $10million. It is perhaps one of the great recent examples of the power of perfect competition in allocating resources efficiently, yet possibly one of the greatest blunders by the insurance industry.

I believe that the power of private enterprise is its innovative response to the financial risks it incurs, but with very simple regulation the innovative confusopoly, which comes at a cost to cosumers, can easily be avoided.  Indeed, most of the pushback against the telco confusopoly is from webpages which keep up-to-date tabs on plans from each service provider and enable you to take some rough guesses about future use and compare the cost effectiveness of each offering (eg here)

GDP down 1.2% for the March qtr

In the next 24 hours there will be a frenzy of economic commentary about the national accounts data and the importance of the last quarter's figure for the RBA board meeting next Tuesday.  My money is on no move by the RBA and more poor economic data this year.

For interest, below is the GDP per capita and Real net national disposable income per capita over the past deacde.  Notice the last few years (since end 2007) have been very flat for GDP per capita, and volatile but not really moving for net national disposable income per capita.

Brisbane and Perth housing slide continues

RP Data-Rismark released their dwelling price data for April today (here).  Brisbane and Perth are leading the price slide with Sydney and Canberra showing small gains.  This follows a stream of poor economic data recently.

I March 2010 I suggested that the next interest rate move by the RBA would be down.  I was wrong.  They increased another 75 basis points in total in their April, May and November decisions. 

My reason for suggesting they must move down is that the economy was much weaker than they anticipated, and the outlook far less bouyant.  Given this recent data one must think that their optimism is slowly fading.

2011 will be a very interesting year indeed. 

Learning to judge risk

No, this is not a post on financial risk. It is about child development and learning to judge risks yourself (a hot topic in my household).

As an economist parent this article, and the comments that follow, is very interesting. It begins...

Play equipment designed by  "safety nazis " doesn't allow children to learn from risk-taking, an expert has warned.

More kids aged two to seven were getting injured in playgrounds because they didn't know how to take calculated risks.

While it may seem obvious, learning to take risks involves... taking risks! There is an old saying that epitomises this attitude – if you want to learn to swim, jump in the water.

But it seems that Councils are not going to replace their plastic low velocity slippery slides and bouncy foam ground covers with splintered old wooden climbing frames in hurry. The experts still haven’t grasped the implications of their research. They conclude with the following advice.

To improve playgrounds, Ms Walsh suggested longer and bigger slides built into embankments to eliminate falls.

Also, smooth boulders for balancing, shallow ponds for exploring and plenty of vegetation to provide nooks and crannies for children to crawl around.

But if children learn from risk taking, shouldn’t they build high fast slides, with no ground protection and sharp jagged boulders for balancing and deep ponds for exploring?

In any case, the finger pointing at engineers and playground designers was thoroughly dismissed in the comments, with molly-coddling litigious parents copping a bit of heat.

Getting my head examined - a Chris Joye rebuttal

Don't get me wrong. I agree with Chris Joye on some things - lowering the inflation target (perhaps not right at the moment), pushing for a more streamlined NBN, and supporting Malcolm Turnbull's political ambitions.

But when it comes to the housing market the guy with all the numbers is happy to overlook the strikingly obvious and adores a verbal stouch with his foes - the group he calls 'housing nutters'. In fact he just recently recommended the following 

At the same time, anyone who claims that a 1% year-on-year retracement in dwelling values is a major asset-class event (cf. the share market frequently falling more than 5% on a given day) needs their head examined, with the greatest of respect. And I sincerely meant that latter caveat: you genuinely should seek medical advice if you are convinced that house prices are plummeting. 

Let's take his advice and examine what is in my head (noting that I don't believe a 1% year-on-year fall in national home prices in isolation is a concern). 

Joye often likes to draw attention to the low volatility of the housing market compared to the share market (eg here and here). But he neglects a few important differences. 

1. The housing market has at best monthly data only. Moreover each month's price data point is essentially an average. The share market would be far less volatile if you measured it that way and averaged away each month's price extremes. Not that volatility represent risk in any case. 

2. The share market is an equity market. If you want to compare like with like you need to compare the change in home equity to the change in share prices. If there is $1.7trillion in housing debt outstanding against $3.5trillion worth of housing, you can double any housing price change to calculate the change in equity of homeowners on average. Of course prices are set at the margins so perhaps for the price setting buyers and sellers the leverage, and importance of small price movements, is even greater. 

3. The negatively geared investor sets the market price (apart from the recent burst of FHBs). This means they are losing money every year. Any small decline in value decreases their equity substantially in addition to losses already incurred. 

4. The marginal homebuyer is heavily leveraged - 80% plus. This is not the case in the share market. Remember, leverage works to improve both gains and losses. 

5. The wealth effect is much stronger in the housing market than other markets, particularly due to leveraging and the sheer size of the asset compared to household incomes. 

6. Cost of home ownership is much greater than simply the interest cost. For most homes around 25% of the gross rent is spent on annual costs (refer to 3.) 

7. Housing market crashes, while they feel almost spontaneous, actually take some years to eventuate.

Irish housing - 5 years to fall 28%, or 0.41%/month

US housing - 6 years to fall 31%, or 0.38%/month

UK - 2 years to fall 21%, or 0.8%/month (and still 18% down from their peak 4 years later) 

8. Lastly, I feel sorry for anyone who shared Joye's property optimism and bought into the Brisbane or Perth property markets in the past two years.  While the share market hasn't been crash hot, 6% returns on cash has been pretty flash.

Anyway, if these notes are a sign of a mad man, well so be it ;-)

Wealth effect driven by the housing market

Leith van Onselen over at Macrobusiness has written a couple of very important and timely articles on the wealth effect. Put simply, the wealth effect is an increase in spending that accompanies and increase in perceived wealth.

In relation to housing, this paper suggests the wealth effect increases our propensity to consume by 9c per dollar of increased housing value (which is further supported here). So if the housing stock of Australia is valued at $3trillion (some say between 3.5 and 4 trillion), and market values increase 10% in a year, then we will spend on average 9% of the $300billion of new 'wealth', or $27 billion - with $6 billion of spending occurring prior to the end of the next quarter.

Importantly, this money is spent before it is earned by selling the asset. The easy access to home equity lending has been a contributing factor to the size of this effect, enabling households to spend their capital gains before they have been realised which increases their financial risk.

There are few readily available studies about the size of this effect in reverse, but if the same values hold in both directions we can look at some interesting scenarios.

If prices fall 2.5% nationally over a quarter then we lose $75billion of perceived wealth, with an immediate reduction in spending in the following quarter/half year of about $1.5billion and ongoing reductions in spending totalling $7billion

With about $1.7trillion of bank loans outstanding, that is about the same effect on spending as an increase in interest rates of 0.25% and keeping them there for two years (which will mean $4billion extra is spent on interest repayments per year). This of course assumes that house prices are not dramatically affected.  Indeed, if we consider that interest rate moves are likely to also bring down home prices, we can expect a much greater effect from the monetary lever.

That’s why house price falls of just a few percent can cascade into a crash so easily.

I would suggest the reason the wealth effect in relation to housing is much higher than found elsewhere is that many people who benefit/lose from house price changes are highly geared, which increases/decreases their equity more quickly for a given price change.

On this note I would add that you can’t directly compare share market volatility to house price volatility, since the share market is an equity market. To make a direct comparison you need to compare the volatility of the equity component of the housing market with share market, or the volatility of the share market value plus the value of debts held by those listed businesses to the housing market.

Peter Schiff predictions

Peter Schiff was ridiculed for years when he predicted that the US housing bubble and credit binge would result in a massive asset price bust and recession.  You could describe his economic philosophy as Austrian, and as the recent Keynes and Hayek rap video explains, the bust is a direct consequence of the boom, not some seperate economic event that can be avoided through government intervention.

In this early 2009 video Schiff predicts the collapse of the US dollar and makes some very astute observations that may resonate with Australians.  Enjoy.

1980s Texas Housing Bubble Myth - A Reply

Recently the debate on the price impacts of planning regulations has been a hot topic here and elsewhere. Leith van Onselen at Macrobusiness is one of the more sophisticated proponents of supply side impacts on home prices and recently responded to a comment of mine about Houston Texas. My comment was that if Houston is an example of how responsive supply can help cities avoid house price volatility, why did Houston experience a house price bubble in the 1980s?

Leith argued that Houston's apparent price bubble was a mere blip on the grounds of price to income multiples. In his typically evenhanded fashion Leith also notes many of the demand side factors at play during that time— the oil boom, liberalisation of loan standards, and population growth. He brings together these points with the following conclusion.

What makes Texas’ home price performance in the early 1980s particularly impressive is that prices managed to remain relatively stable in the face of significant demand-side influences that should have caused home prices to rise significantly and then crash.

An additional point is made that Houston has managed to avoid the 2000s property bubble infecting most of the US and much of the world.

My reply.

Houston prices declined around 40% in real terms following the 1982 market peak—that is indeed volatile—and it took 15 years for prices to recover in nominal terms.  The Case-Shiller 10 city index has dropped by a similar amount since the US peak in 2006 (30.5% nominally). So much for the volatility aspect.

But why do prices in Houston still appear so dramatically affordable when compared to incomes?

One major reason is the relatively high property tax rate.

Property tax rates in Houston more that doubled from 1984 to 2007 becoming one of the highest rates in the US. Depending on your area you can pay between 2-3% of your properties improved market value in annual State taxes, while the US National average is 1.04%.

One would expect areas with higher property taxes to have structurally lower prices, reduced price volatility, and much lower price to income ratios.

An illustrative example is shown below. The three comparisons are intended to roughly represent the early 1980s, the early 2000s, and today. The Houston property tax rates increase from two to three percent, while the comparison taxes increase from half to one percent. Interest rates also represent mortgage rates at the time.

From these examples we can see that from just this single factor, the property tax differential, we should expect prices in Houston to currently be structurally around 30% lower than national averages (more on the impact of the property tax differential here).

An important factor at play in this example is that at lower interest rates a fixed percentage property tax leads to greater price differences. Therefore, over time, we would expect Houston to home prices to be a smaller fraction of comparable homes elsewhere as the property tax differential has a greater price impact at lower interest rates. Remember that in the table above, rents and returns are the same for each comparison - only the tax rate is different.

Of course, this does not mean that housing is lower cost. It just means that the cost of housing is borne by annual tax obligations rather than capitalised in the price. A far better comparison of whether housing is structurally cheaper in Houston would be to compare quality-adjusted rents to incomes over time and across cities.

Perhaps once the property tax differential and other demand-side factors are properly considered we will see Houston's supply-side impact on housing prices diminish to zero.

Lastly, I would add that the memory of such a deep and prolonged property price slump would be motivation enough to dampen speculative housing demand in Houston. Who in their right mind would bid up prices in Houston knowing that increased tax liability and the history of dramatic losses on the property market?

Evidence of supply-side effects on home prices remains elusive.  

A sign of desperate times?

Saw this advertisement today in the Financial Review.  I haven't seen anything like it before but it reeks of desperation.  Is it some kind of joke?

I like the first part of the fine print "Real Estate agents tell me I can get $2.1million for my luxury home but..."

Rent seeking behaviour - scare campaigns

From the Hungry Beast