Tuesday, September 13, 2016

This Is NOT How To Finance Affordable Housing

Coming late to this particular party, but better late than never (excerpt):

Putrajaya allows developers to give housing loans

PETALING JAYA, Sept 8 — The Urban Wellbeing, Housing and Local Government Ministry today announced the introduction of an initiative that enables property developers to give out loans to buyers at an interest rate of between 12 and 18 per cent.

Minister Tan Sri Noh Omar said that the move is intended to assist Malaysians who are unable to get a full housing loan from banks or those who may only be given a partial housing loan….

…“Because sometimes the buyers, they don't get 100 per cent loan. Sometimes the bank only gives them a 70 per cent loan and they only have money to pay 10 per cent so the balance, the developer can give them a loan," he said during a press conference after officiating the 19th National Housing & Property Summit 2016 at the Sunway Resort Hotel & Spa….

…“This proposal is a win-win situation for both developers and house buyers. For the developers, this end-financing facility offers a second profit centre. First, of course, from the sales (sic) of these houses and second from the proceeds of the end-financing scheme that I am proposing,” he said during his speech.

He explained that all developers will be able to apply to the ministry for a money lending license beginning today in accordance to the Moneylenders Act 1951.

However the government’s award of such licenses will be dependent on a variety of factors, especially the company's financial standing.

He added that the scheme will not involve the central bank and will be wholly handled by the ministry.

I’m sorry, Tan Sri, but this sounds more like lose-lose than win-win. A lot has been said and written in the interim, so I want belabour the obvious points. Let me instead talk about the less obvious.

The first things that sprang to mind when I first read about this proposal were two well known and related theoretical principles in microeconomics – adverse selection and assymmetric information (aka the “lemons” problem).

Adverse selection happens when a policy, product or service attracts the very people most ill-suited to them. Assymmetric information describes a situation where one party knows more than the other, which causes a market failure. I’ll deal with the latter first.

Take a group of house buyers, with different capacities to pay. Banks sort these potential borrowers based on the information available to them – wages, employment status, bank account data, and in Malaysia, access to CCRIS. CCRIS lists all the credit facilities Malaysians have with the banking system and payment history, independently of what the borrowers declare. This reduces information assymmetry, so that banks can properly price their lending risks, or alternatively, the ratio of loan to value (LTV) they are willing to finance. The higher the risk, the higher the financing cost and the lower the LTV, and vice versa.

This makes for a relatively efficient market, but causes a social failure – those least likely to need loans are the ones who can access bank loans most readily and cheaply, while those who arguably need financing more are faced with steeper collateral constraints and dearer financing. Leaving that aside, pricing risk more accurately allows banks to minimise dislocations in the housing market (while maximising profits, it should be said).

Assuming this cockamamie scheme goes through however, developers won’t have anything like the advantages a bank would have. Developers won’t have access to CCRIS, won’t have the credit expertise to price loans accordingly, and won’t have the recovery mechanisms that banks have painstakingly built up over decades of institutional history and experience. As such, regardless of the actual risk involved, developer sourced loans will be more expensive than necessary, as the lending rates will have to take into account the larger information assymmetry involved.

That leads to point 2 and adverse selection: if banks are in fact pricing risks correctly (or at least, as correctly as possible), developer loans would by default attract those who have the least capacity to bear them. Banks don’t put low LTV ratios for fun, not when there’s a profit to be made; they lower them because they think the risk is higher. This creates an unavoidable spiral – developer loans carry higher interest rates because the risks are higher; but higher interest rates simultaneously increase the probability of those loans defaulting, which of course requires an even higher interest rate to offset the potential loan losses.

Which leads to point 3: If the banks become aware that some of their low LTV loans are going to see their collateral part financed by high interest rate developer loans, this would materially change their view of the risks involved. So what I think would happen would be that low LTV loans are likely to be ratcheted even lower (and the high-interest financing part get ratcheted higher), until banks give up lending to that segment of the market entirely. This is the law of unintended consequences – I do believe that providing high cost, easy access home financing will eventually effectively shut out low income home buyers from the formal banking system.

My last point before wrapping up: The only winners I see out of this proposal are property speculators. High leverage and high financing costs encourage short termism. Many people see housing as largely a human rights issue (true) and think that any price is worth the cost (false).

Let me break it down. Buying a house involves two components: the first is the flow of housing services over time (shelter), which is a basic human right. The second is an investment in an asset, for which you expect a return. For the latter, think about high income individuals buying homes at 4.5% and low income individuals buying homes at 12%-18%. The only way this would make any kind of sense would be if affordable house prices increased at a double digit pace.

The numbers change depending on what assumptions you make, but even with a bank LTV ratio of 70%, you’d need house prices to increase by 8%-9% per annum for someone with a developer loan to break even, not to speak of actually accumulating wealth. The only way low income households can get ahead in this situation is to flip their investment over the short term, while the leverage is still high and and their home equity is low. In other words, you won’t even need speculators or syndicates to ignite a house price bubble. Everybody will get into the game, because the incentives to do so are very strong. But this causes already unaffordable housing to become even less affordable.

I fail to see how this solves our housing problem.


  1. A tall order to service two loans on a piece of property.
    There's nothing to stop a developer and buyer from an agreement on the 20% difference in loan.
    #12-18% on 20% additional financing, the amount on default accumulate at tremendous pace on compound interest.
    The burden is on the shoulder of the buyer and instead of a nest may end up on the street.
    Property price trend upwards without fail. Desperate moves to rope in developers is a sign of Govt. concerns.
    With the asset as collatoreal the loans granted are relatively secured. Instead of developers, Govt should create a mechanism to bridge the gap in finance and stream the 20% difference into longer repayment period at much lower interest.
    EPF which holds much of the saving of potential buyers can be the conduit for such purpose.

    1. @Williamyapfc

      Your proposal is similar to what Singapore's CPF does. I'm not keen on it because of the same issues it causes in Singapore - people could end up having their retirement savings trapped in housing equity and won't have sufficient funds to actually live on.

    2. Proposing EPF as the conduit is for the sole purpose of bridging the 20% downpayment gap not the entire loan.
      Developers will be generous to accomodate the downpayment shortfall interest bearing gap. At 12-18% this won't pose a heavy burden since that portion could be deffered profits now bearing interest. Investment see returns.
      Companies operating procedures differ and different money lending postures can creep into the picture. Consequences?
      As you mentioned, the less qualified will suck the honey without due consideration.
      What happens on repayment default? For sure banks have locked in all clauses to secure the property. What about the developers who extended the bridge finance. They won't forfeit or write off their investment and in a short period at 12-18%, the compounded interest can exceed the bridged financial facility.
      Even banks do not have the financial muscle of EPF investing locally and abroad for the benefit of members. EPF can by itself or with other institutions be the instrument to bridge the deposit gap. Like in insurance they have a pool.
      EPF is not in the business of charity since they must reap dividends for members.
      Since the less qualified willingly cough out an extra 12-18% interest on the deposit debt, there can be a mechanism where banks provide the 90% and sell 20% of the deposit gap to a pool of investors.
      The repayment can be scheduled to extend a few years longer to accomodate the 20% sold relieving the less qualified's burden of trying to satisfy two creditors over a piece of property in the immediate execution of the loan agreement.
      Such arrangement can satisfy many parties involved.
      I disagree, your views on the S'pore CPF. Lifestyle differs. Value may be trapped in asset, but there's a choice to swap from a high value to a lower value asset and unlock the monetary potential. Seems the trend is the other direction. However, acknowledge the home owner trend there. A gathering of professional fine tuners seems appropiate.
      It must also be noted that once a viable financing scheme comes into effect, greed allow the escalation of pricing by a few to the woes of the populace.

    3. William,

      I'm still having trouble seeing how your proposal will work.

      The issue at heart is that regardless of who provides the financing, the people being targeted simply can't afford that bridge finance (yes, I understand it's only the difference between the LTV provided by the bank and the house price). That's why the banks are only providing 80% LTV or less to these borrowers.

      Whether you have EPF or developers or banks securitising that portion or extending the repayment period, the result will still be a higher default rate. Shifting the risk around doesn't solve the underlying problem. The Americans tried to solve that with CDOs, but they still got default rates in the double digits.

      The availability of financing is really a red herring. This whole mess really distracts from the real issues behind unaffordable housing, which are the structural problems in residential development and the crucial shortfall in housing supply over the past decade.

    4. When the market demand was for under 200K dwelling, why were approvals given for projects consisting so many units above that value demand. Where did it go wrong?
      Vehicle installment have repayment stretching many years making repayment easier. Likewise if housing also extend the stretched, repayment can be more affordable.
      This doesn't mean individuals automatically qualify. Joint income applications may just meet the financial requirement in the form of husband and wife or direct blood ties without opt-out option.
      Developer bridging loan scheme will really crush the shoulders of the purchaser.

    5. When the market demand was for under 200K dwelling, why were approvals given for projects consisting so many units above that value demand. Where did it go wrong?
      Vehicle installment have repayment stretching many years making repayment easier. Likewise if housing also extend the stretched, repayment can be more affordable.
      This doesn't mean individuals automatically qualify. Joint income applications may just meet the financial requirement in the form of husband and wife or direct blood ties without opt-out option.
      Developer bridging loan scheme will really crush the shoulders of the purchaser.

    6. @William

      BNM issued a press release yesterday on your idea of extending loan tenures:


      Basically, it doesn't really work. The difference I think is that because the loan tenure is so short for car loans, increasing it has a dramatically larger impact on monthly installments. To achieve the same reduction in monthly installments as going from 5 years to 9 years for cars, you'd need to go from 35 years to 63 years for housing. That's not practical, unless you're thinking of multi-generational housing loans.

      On where did it go wrong, it's a long story, and not entirely the fault of developers. They were just responding to changes in the regulatory and cost environment. Fixing this will be complicated and politically difficult.

      Lastly, I have to disagree with one of your earlier comments:

      "Property price trend upwards without fail."

      No, they don't.

      That ignores for example, what happened in the mid-1980s and after the Asian Financial Crisis, as well as more isolated price movements, such as in Johor over the past two decades. We've seen that globally as well, for example in the US, Spain and Ireland (among many other countries).

    7. #Hisham
      My comments are as a concerned citizen without the actual economic knowledge to compare historical statistics of the past and neither am I involved in banking or housing.
      It is commendable that BNM review the loan tenure. If you read into my thoughts, I raised the subject of joint application for eligibility in the form of husband and wife or direct blood ties.
      The direct blood ties is the form of parent and family at the initial stage or evolve the scene bellow.
      A husband and wife purchaase is a clearcut case. What is the lifespan to complete the monthly installments if you say 35-63 years.
      Persume a couple in their 30s' slogging for the next 30 years. The ability to command an income may have degenerated or in suspect zone after 30 years or may have passed away which is very unfortunate if it happened earlier.
      However after that period the chidren have grown up generating income to carry on the responsibility.
      There is no way they will surrender the property unless they really cannot afford.
      It is for the children, the property decision was made. Involves new document in the future but can solve the burden of 2 seperate loans where even the question of eligibility arise not to mention servicing even one part of the installment.
      Given your reasoning, you may not agree, yet you haven't made any proposal.
      Delay costs are a further loss to developers in servicing interest payments benefitting banks only.
      Unsold homes also affect both developers and bankers affecting the overall economy.
      It is better to solve part of the problem rather that an ambitious one shoe fits all.
      Even if developers reduce price forfeiting their profits and banks interest rate are reduced,but without long tenures, it is not a struggle but more a killer blow.

    8. #Hisham
      Just read the BNM report regarding finance not a problem.
      Extra cost is the cost of money and the individual himself evaluate whether it is worth stretching the tenure paying extra for the cost of funding.
      The age of 25 as a start point is more of theory and not realistic because at that age, a career just started and very few exercise the saving discipline at that point in life. At that age, to commit to a major investment with a big lump sum downpayment is the forte of only a minority.It will be interesting if statistic of 25 year olds with 300K loans available.
      30 is a more realistic figure where the loan tenure will exceed the income generating years.
      Serving the loan is in doubt at the retirement age when the principal loan has already been exceeded. This is where the blood ties can continue in what you say is multi generation loan of Japan.

    9. @William

      1. I don't agree with multi-generational loans because you are saddling children with debt for an asset that may or may not keep its value. It's one thing to save for the children, it is another to put them under an obligation they did not consent to. Moreover, Malaysians are having fewer children, and a significant number will never even marry (marriage rates are currently just 60%, and divorce rates are nearly 20% and climbing). Multi-generational loans are not a viable solution.

      2. Loans for construction purposes is just 3% of total loans. Mortgages are 30%. Bailing out developers should not be a policy option, and poses no risk to the banking system. Making sure housing loans are sustainable on the other hand is absolutely critical.

      3. You might like to read my latest opinion piece:


  2. What on earth is the Minister thinking?

  3. Capped at 12% means 0-12%, not 12-18%.

    1. @Unknown

      Absolutely. But given the dynamics I described in the post, we can infer a few things:

      1. A developer loan will always charge a higher rate than the prevailing bank lending rate;

      2. At the very least, it would be at least equal to (but not less than) what banks would grant for unsecured personal loans, since developers would face a higher information asymmetry than banks do and would need to be better compensated as a result;

      3. With banks knowing that the gap between their low LTV loans could be financed through higher rate developer loans (thus increasing the potential default rate), low LTV loans from banks would also be more expensive and/or harder to source, which would require developer loans to charge higher still;

      4. All this leads to higher default rates, since higher interest costs would reduce the ability of households to service both loans;

      5. Which leads to higher rates again, for both banks and developers to break even.

      Ordinarily, with asset backed credit like this, I would expect fairly low lending rates. However, since this scheme allows people to bypass the more stringent credit standards established by banks, I'd think we'd see pricing somewhere between personal loans and credit cards.