Tag: investing

Home, Expensive Home

The chart of the day comes from the excellent Vivek Kaul:

https://www.livemint.com/industry/buying-homes-why-tax-policies-need-a-tweak-11705234900028.html

What this shows us is that over the last sixteen years or so, there has been a steady increase in the percentage of home loans that have been given to the non-priority sector – that’s the blue line. These were at about 30% in 2007, and are at about 70% today. Obviously, the red line shows us that priority home loans have taken the journey in the opposite direction, falling from about 70% of all loans disbursed in 2007, to about 30% today.

What is a priority home loan, and what is a non-priority home loan?

Priority home loans are loans amounting up to Rs 35 lakhs in metropolitan centers, and up to Rs 25 lakhs in other parts of the country. There’s fine print, but for our purposes, this is a simple and good enough definition. Non-priority home loans, of course, are loans above these amounts.

Long story short, rich people are taking loans to buy homes, while poor folks, not quite as much. But why should this be so? Part of the reason, Vivek Kaul says, is incentives:

Tax policy in India incentivizes buying homes as an investment. Income earned from the salary or business income of an individual is taxed at the marginal rate of tax. The highest marginal rate of tax, even without taking the different kinds of surcharges for higher income into account, is 30%. At the same time, long-term capital gains made from selling residential real estate is taxed at 20% with indexation benefits being available. Indexation allows the consideration of inflation while calculating the price of buying a house as well as improvements made on it over the years, in order to calculate capital gains. Long-term capital gains on selling a home come into the picture if the period of holding between the buy date and the sell date is more than 24 months. This effectively means that the tax on capital gains (a form of income) made from buying and selling of homes, is significantly less than even 20% (it can be even lower than 10%). Plus, the holding period of two years is way too low

https://www.livemint.com/industry/buying-homes-why-tax-policies-need-a-tweak-11705234900028.html

When you buy a house and sell it, say ten years down the line, the gains you make on selling the house at a higher price are taxed at 20%, not 30%, as your highest income would be. Second, your gains aren’t taxed – your gains net of inflation are taxed. And so buying a house and selling it can be plenty darn profitable – a house isn’t necessarily a place to stay. It is, instead, an investment. Take away this incentive, Vivek Kaul says, and you might see the “demand” for housing come down.

Speaking of incentives, he also has an idea for increasing the supply of homes available in cities for renting:

At the same time, the government needs to encourage those who own homes, to not keep them locked and rent them out. On the tax front, this can be achieved by taxing rental income from homes at a lower tax rate. This will also discourage those landlords who insist that tenants pay them in cash (at least in part).

Of course, this will only be a very small step in making residential real estate in cities across India a little more affordable, given that the sector is too complicated and too convoluted to be set right only through incentives and tax policy.

https://www.livemint.com/industry/buying-homes-why-tax-policies-need-a-tweak-11705234900028.html

Incentives matter, and our current policy mix incentivizes the construction of, and the purchase of, unnecessarily expensive homes, but not for the purpose of staying in them. Vivek Kaul says that taking away the incentive of capital gains tax on housing, and introducing a lower tax rate on rental income could go a long way in terms of maki housing for affordable in India’s cities.

Now, homework:

Is this a good idea or a bad idea? Who will benefit by this, and who will be harmed by this? Who will support this idea, and who will protest such an idea? Which group is likely to be politically more active? What are the risks of implementing Vivek Kaul’s ideas? Try adding at least a couple more questions to this list, and then answering them. Some of these questions (and their answers) are already there in Vivek Kaul’s column, see if you can spot them!

Notes from Barry Ritholtz’s Interview of Mark Mobius

There have been three excellent interviews that I came across this week, and the next three posts are my notes from having read these interviews. The first one is Barry Ritholtz interviewing Mark Mobius.

First off, if you don’t know who Mark Mobius is, here’s some background. This is his Wikipedia page, this is his Twitter handle, and this is information about him from his own website.

  1. Mark has worked at a talent agency, has worked as a communications teacher, a political consultant and has sold Snoopy merchandise in South Asia. Doing a variety of things in your career is a plus, not a minus! Or that, at any rate, is how I interpret this.
  2. And on a related note, being exposed to a variety of cultures, especially when you’re young, is also a good thing. He speaks about the culture shock of having visited Japan on a scholarship after getting his Master’s degree, and towards the end of the interview, he also speaks about his recommendations yo young folks starting out in investing. His first piece of advice? Travel!
  3. Mark has been to a 112 countries (!), a point that comes up in the podcast, and I found myself wishing that Barry had asked him a question (or two) about getting a feel for a new place. What do you look for in a new neighborhood, or a new city? What thumb rules has Mark developed for figuring out a city from the point of view of the quality of its administration, where to eat, how markets work over there, law and order and so much more.
  4. “Don’t just speak to top management” is excellent advice, and applies to much more than just financial investing. Get a sense of the place (any place!) by talking to everybody, and if possible, speak to top management last.
  5. Nothing beats actually visiting a company before investing, and it is best if you do that yourself. Travel, meet people, ask interesting questions, and keep doing that for as long as you can is excellent advice, always. Read (kind of) more about it here.
  6. As a student of finance, reflect on the part of the interview where Mark Mobius talks about the importance of well developed equity markets, the need for liquidity and private equity investments as an alternative.
  7. “One thing you’ve got to realize is that the world has changed to the extent that a lot of the emerging markets growth is now in the United States, because U.S. companies are manufacturing and selling and buying from emerging countries.”
    What is the appropriate unit of analysis for international trade, international finance and international investing? Why?
  8. Airlines and time-zones helped Mark Mobius decide where to base himself. Looking for underrated factors while making decisions need not be restricted to just financial investing!
  9. The reflection on China and Venezuela, and the impact that government policies (or even strong leaders) can have on domestic firms is worth reading and thinking about.
  10. Maybe I’m too much of an economist, but I don’t get the deflation is actually a good thing argument. More reading and thinking to do!
  11. And finally a book recommendation: about the history of double entry book-keeping. Note that the transcript donesn’t link to the book that Mark is talking about, so I may well be wrong about the hyper-link.

Understanding Arbitrage

Part 1 and Part 2 here. I’d recommend you read those before you start this one.

Now, what if at the end of the academic year, you find yourself without a job offer? We all hope and pray that this doesn’t happen to anybody, but the sad reality is that there will always be such cases.

What could be done?

What I am about to describe doesn’t actually happen in any college that I know of, but it helps me build my story, so let’s go with it for the moment:

What a university could do is that it could hire the services of a placement agency. Said placement agency would take on the responsibility of getting these students placed in one firm or the other. These wouldn’t be glamorous jobs, of course, and they wouldn’t be high-paying ones. But hey, at that stage, any job offer is a good offer – and you could always try and shift as soon as possible into a better job, no?

The placement agency wouldn’t do this for free, of course. The college would have to pay the placement agency for each student placed.

Here’s the interesting part, though. It is quite likely that the placement agency would be taking a fee from the firm in which this student got placed. That is, the placement agency gets a fee from the college, but it also gets a fee from the firm.

(There are variants, of course. But we’re talking Zomato, Uber, Dunzo and old school real estate agents and all that. Middlemen, essentially. The equilibrium of who pays, and how much, and why are all excellent questions for an intermediate micro class.)

So what is the placement agency doing? In the language of the financial markets, it is engaging in arbitrage. Arbitrageurs make markets more efficient, by connecting supply and demand. The type of supply and demand that wouldn’t have been able to connect otherwise.

The student that didn’t get placed, and the firm that wanted a new employee hadn’t been able to meet so far, and the placement agency facilitated this deal. We’re talking economics, of course, and the placement agency therefore deserves a fee for providing this service.

This fee can be collected in two ways. First, the way that I just described above: take a flat fee from both sides of the transaction. Or, think of a bank. What does a bank do? It connects people who are willing to loan money to people, with people who are looking for a loan. The bank acts as the middleman, and offers a lower rate of interest to depositors. It also charges a higher rate of interest to people who want to take a loan.

Why do people say a currency is stronger or weaker than another one just by looking at the exchange rates? - Quora
Original Image here

This is known as the bid-ask spread. The middleman bids a lower rate while buying, and asks for a higher rate while selling.

An efficient market is one in which there are no arbitrage opportunities. Or in the language of the economist, an efficient market is one in which there are no search costs. It’s mostly the same thing. I have fixed deposits in the bank that pay me a painfully low rate of interest. In my neighbourhood is a person who has taken a loan from the same bank in which I have my fixed deposit. She is being charged an eye-wateringly high rate of interest.

In effect, I am loaning my money to her. Because I do not know of her existence (nor she of mine), we both use the bank to “complete” the transaction. The difference between the rate of interest I get and she is charged is what pays for the rent of the bank, its employees salaries and so on.

(By the way, what if the bank gives out a new loan to another person before my neighbor has repaid hers? Leverage!)

Real estate agents made the real estate market more efficient than it would have been otherwise, but their margins were so high, that Magic Bricks, and Housing.com and their ilk had a reason to enter and promise lower commissions. So also Uber, so also Airbnb, so also (think about it) Amazon.

Perfect competition, which we learn about in microeconomics, is best thought of as an always ongoing process, not as a static equilibrium. One aspect of which is better, more efficient arbitrage. That’s not how the textbooks do it, and more’s the pity.

Anyways, arbitrage is a good thing, because it makes markets more efficient in two ways:

  1. It makes trades happen that wouldn’t have taken place otherwise
  2. Competition between arbitrageurs drives the “market-making” fee downwards, making more trades happen at cheaper rates.

A truly efficient market is one in which there are no further arbitrage opportunities, and market-maker fees can’t possibly be any lower. No, as it were, dollar bills lying in the streets. See if the joke now makes sense.

So, over the past three days, we’ve learnt about the following:

  1. Forwards markets
  2. Hedgers
  3. Speculators
  4. Arbitrageurs
  5. Efficient markets

Next week (for there is only so much finance we can take at a time) we’ll get back to trying to understand finance, beginning Monday.

Optional homework: watch (and try to make sense of) Arbitrage. And if you want an example of how to write well, read this review of the movie – whether you watch it or not.

What is leveraging?

You may want to give this a read (if you haven’t already) before starting in on today’s post.

In my fourth semester while I was a Masters student at Gokhale Institute, I took this paper called Econometrics-II.

Let’s just say that it wasn’t the best decision ever. The paper was theoretical, abstruse and full of jargon, even by the standards of academia. And because it was my fourth semester, we weren’t exactly a motivated bunch. Placements had happened a little while earlier, you see, and the fourth semester was essentially us killing time until we joined whichever company we had been placed in.

And the combination of a difficult paper and a lack of motivation is a dangerous thing. By the time I and the rest of my batch trooped in to the examination hall for writing this particular paper, we knew it wasn’t going to be a pleasant experience.

And as it turned out, even adjusting for our expectations, it was a truly difficult paper. By the time we left the examination hall, all of us felt that there was a very real chance we wouldn’t pass this particular paper.

The trouble was, I had already entered into a forward contract with a firm to sell my services to them, five hours a day, eight hours a week. My services, that is, as a Masters student.

I had promised, in other words, to sell them something I didn’t possess: the services of a person with a Masters degree.

I was, in other words, leveraged.

What is leverage? The technical term is slightly different than the context in which I am using it over here, but I was in effect betting on the fact that I would be a Masters student by June 2006, in the month of January 2006. And I had promised (in January 2006) to deliver to the firm a service I didn’t have in my possession at that point of time.

To use the language we learnt about yesterday: I had shorted my services, when I didn’t actually have what they wanted.

The firm that had decided to hire me had also used leverage. It had promised to deliver (had sold) to its client a team of analysts. These analysts (one of them being me) would be ready to start work in 2006. So if you think about it:

  • the client was going to pay money to a firm…
  • …assuming that the firm would have a team ready to go in June 2006.
  • The firm, in turn, had assumed that the person they had hired in January 2006 would actually be a Masters student come June 2006.
  • And the student had blithely assumed that Trix-II (which is how all students at my college referred to that horrible paper) would be dealt with one way or the other.

When this last assumption breaks down, so do all the others, causing a chain reaction of sorts. In financial markets, this chain reaction can grow monstrously large, with extremely unpleasant consequences.

<Cough> Subprime <Cough> Crisis <Cough>

When a bank assumes:

  • that a loan that it has made will be repaid, with interest…
  • …and uses those presumed profits to buy an asset…
  • …and uses that asset as collateral to buy something else,
  • exactly the same thing is happening!

When the first loan ain’t repaid, bad things happen.

So is leveraging bad?

As I said yesterday, it depends on whom you’re asking. The student in question is unlikely to view leveraging as a very bad thing. That’s what got the student the job!

The firm will have a rather more bleak view of the affair, but so long as they can find a replacement easily enough, this won’t be an out and out disaster.

In the case of financial markets, leveraging is a (really big) problem when the losses are systemic. That is if all graduates from all colleges suddenly flunked in one year, they’d all be in trouble. As would the firms that had decided to hire them. As would the firms who had hired these firms. And so on.

But as today’s post hopefully makes clear, leveraging itself isn’t bad, so long as it isn’t overused, and that too systemically.

This is a rule that gets broken in a rather prominent fashion every now and then in financial markets the world over, with the attendant mess gaining a lot of attention.

But leveraging itself? It’s used all the time, and by all of us, one way or the other.