Risks and Opportunities – II
Given the likely difficulties of owners to successfully make interest payments in the overall environment of likely rising mortgage payments, and because curtailing investments in T-bills from banks could lead government for printing money, that will only compound the situation by increasing aggregate demand and causing demand-pull inflation, and in turn more jacking up of mortgage rates. At the same time, rising inflation in itself will cause significant increase in the costs of production inputs — labour wages, cement and other raw material prices, electricity tariffs, among others — resulting in difficulties arising in payments being made to various providers of raw materials and services for the Scheme. All of the above could set in another situation of ‘circular (or revolving) debt situation’ in the housing and the financial sector; difficulties in making payments between owners, banks, and industry related with the housing sector.
Moreover, since these are mortgages with little deposit or equity expected of the owners — and in some cases no equity provided by people living below the poverty line — the loan to value ratio (LTV) generally would be on the higher side; close or equal to 100 percent for many of the owners. That would basically mean that the banks would likely raise the risk premium component in the overall mortgage rate, especially in those cities or areas where the price or value of land (on which houses are to be built) is quite volatile. As a baseline, the government would have to fix the real estate market before getting on with the Scheme, so that prices are not influenced by speculative elements, including by some elements likely from the opposition political parties giving air to such speculation by making their own investments for the purpose of derailing this flagship Scheme of the government.
If, at all, price of land falls for example or is very low to start with, even lower than the amount of mortgage — which it could be given while land is pricy in bigger cities, the same is not true for many a smaller cities — then the banks could enter into a regime of negative equity (that is LTV ratio of more than 100 percent). This could be a risky situation for the financial sector, especially when the government has announced creation of a housing authority, which if also assumes a banking role as a subprime lender of mortgages then the repeat of the Global Financial Crisis of 2008 could happen for Pakistan- a big storm in a bowl.
If, at all, price of land falls for example or is very low to start with, even lower than the amount of mortgage — which it could be given while land is pricy in bigger cities, the same is not true for many a smaller cities — then the banks could enter into a regime of negative equity
During the 2008 Crisis, one of the outfalls was that while the banks were bailed out of by governments using tax money, yet the owners of households were not supported. The government would find it very difficult on both counts — since tax money is insufficient for meeting necessary public expenditures let alone bailing out banks or owners, and printing of money will only complicate the existing macroeconomic issues — not to mention the pressures of the IMF programme to stop government from doing it; where the programme may go off-track all together — and also because government will not have much money to give in case of a negative equity situation, that is government will have little to offer beyond the money obtained from selling land.
This would likely leave many of the owners in precarious situation, since while some of them benefit from the low-end employment opportunities that the Scheme will provide for earning money, but since no special purpose vehicles (SPVs) are being created by government for the owners overall from which could generate sustainable income stream for them to make interest and the left-over mortgage payments (over and above the value of land). Moreover, they will be vulnerable to interest rate volatility situation if that mode is after all kept in the mortgage agreement.
This is indeed a very weak point in the whole Scheme — how to put the households on a sustainable income generating scheme for allowing them to successfully make all the interest payments and whatever left of the principal, and at the same time to have the capacity and willingness to retain the house once after it is completed and all payments have been made. A likely scenario in case the households do not have a path planned in parallel of the Scheme out of their vulnerabilities/poverty by the government, would be that they may after all sell the house for money, to those who can afford, in turn returning to populate slums again but this time with money in hand to spend! Also, this would increase income inequality all the more because now the people who were doing well but did not have low priced land and house to buy, to have both and in turn move up the scale of living standard.
In another case, if the government is unable to assist owners in making interest payments, and also the value of land drops below the mortgage value, then these poor and vulnerable people to start with, will now find themselves also indebted. Hence, it is important for government to plan employment opportunities for these households, and also create SPVs, like for example creating a mutual fund of these owners and making their investments in stock exchange or government bonds, so that interest payments are linked with returns from these investments, and also to come on a sustainable path out of poverty.
To really pull the people out of poverty, it is better that government rather than implementing this Scheme, would fix the real estate, financial, and labour markets, and all this private sector credit is diverted towards investing in more important sectors like education and health, and in a greater welfare programme, so that the impact of all of this combined would mean that people would be made capable of earning a livelihood and make savings, and have correct price signals and capacity to make a house themselves. This would also not put undue pressure on the banks to commit to risky mortgages, which as the above analysis indicates, very likely could be.
If at all subsidised houses are to be provided by the government to the poor and vulnerable, then it would be better to create them in a ‘special economic area’, whereby along with providing land for houses is provide area and more finances for creating employment opportunities in the shape of for example (a) establishing cottage industry and small and medium enterprises, (b) creating schools and hospitals for people to invest in their capacities and earnings, (c) leasing agricultural land and also allowing use of such land as lying vacant with the government to be overall used for agricultural production activities by these households. All these avenues will build the capacity of people to come on an income generating stream, and to have capacity to pay for houses, and to invest in their overall capacities and better life.
