Sunday, February 12, 2012

Volume 4 Issue 6: Intelligent Investing

EPF Housing Idiocy

In many ways, I have begun to feel tired whenever I hear people preach to me that investing in property is the way to go. They tell me that house prices will never come down. I wish I could carry this blog post around with me and smack it into their faces every time they tell me that house prices will never come down.

But today's post is about something bigger than this. Recently, we are hearing all about the government trying to boost home ownership by borrowing money from the EPF and then grant loans to people who ordinarily would not be able to get loans from commercial banks. The immediate response by the public was to shudder in fear for the loss of their EPF money. What an insane and reckless move by the EPF to effectively lend to borrowers who are "subprime". So, the EPF had to come up with a clarification that the money is actually only loaned to the government, not to the subprime borrowers. As if this would make the whole issue OK.

There are so many things wrong with this proposal.

Default Rate

According to this article, this is what Raja Nong Chik, the Federal Territory Minister said:
Raja Nong Chik had said the loan was secure as it is guaranteed by DBKL, a government agency, and the EPF will earn 5.5 per cent interest per annum in repayments made by the 20,000 new homeowners. 
The Umno senator had said he expects “not more than 10 per cent will default”. 
He added: “The loans are backed by City Hall which has RM1 billion in reserve. You cannot doubt City Hall.”
A 10% default rate is insane. It is like a slap in the face, and then some. No bank will accept a 10% default rate on its books.

Interest Rate

Why is EPF earning a 5.5% interest? The government can go into the market and issue bonds at 4+%. Here is a chart showing the indicative yields as of December 2011:

A 20-year bond currently yields about 4.1% per year in the market. That is a difference of about 1.4 percentage points. Bear in mind that this is a 20-year bond. So if the government borrows RM300 million at 5.5% for 20 years, it will have to repay RM875 million (assuming its zero-coupon) in December 2031. If the government were to issue a 20-year zero-coupon bond at the current market rate of 4.1%, it will ONLY have to repay RM670 million, a huge difference of RM205 million. Of course it is not zero-coupon but using the difference in yields to maturity, you get a rough idea of how much money the government is actually wasting unnecessarily by tapping on the EPF funds.

Effectively, this is actually just subsidizing the EPF contributors. It is basically taking the money from the government's pockets and then putting it into EPF's. While the goal was to "help" the poor buy houses, the government is actually only helping the "not so poor" (which are the EPF contributors). Most of the hardcore poor people do not even contribute to EPF. So who is this actually helping?

And it doesn't help that Raja Nong Chik keeps mum about the rationale of the scheme:
Raja Nong Chik however declined to comment about this as well as why the government did not just use federal funds to finance the loan scheme. 
“Direct that question to the EPF,” the minister told The Malaysian Insider. 
The EPF clarified on Thursday it is in talks with a government agency to provide loans to city renters to buy homes but that the deal has not been inked. 
It also said that the terms involve lending an initial sum of RM300 million to the federal government through a special purpose vehicle linked to the Federal Territories Foundation (SPV FT Foundation), and that the firm will act as the middleman to grant the home loans to potential home buyers. 
Prime Minister Datuk Seri Najib Razak said last week the use of RM1.5 billion of EPF funds in the home loan scheme will not be detrimental to EPF contributors. 
This, he said, was because the amount needed to finance the loan scheme was not big compared to EPF’s funds. 
Raja Nong Chik gave a guarantee earlier that the government would safeguard workers’ interests, saying the deal ensured 5.5 per cent annual returns for the EPF.
Now it just appears more and more like the government is subsidizing the EPF. I think the EPF is running out of investment ideas and is simply unable to generate the "high" returns that it once did. If the EPF is unable to generate any meaningful returns to beat inflation, then it just means that it won't be able to pay out to the increasing number of retirees in the years to come.

This could mean that the government will have to keep pushing up the retirement age further and further, not that that is a bad thing.

House Prices

Another worrying thing that Raja Nong Chik said was this:
“The fact is that the low-cost property value, which Raja Nong Chik claims to be worth double or triple the selling price, has nothing to do with the issue of ‘sub-prime’,” the trio said in a statement today.
In case that was misquoted, here is another source, but this time, said by Najib:
“If at all there are loan defaulters, the houses can be sold for a much higher price,” he told reporters after a meet-the-rakyat session in Rhu Rendang yesterday.
Something clearly does not make sense here. First of all, the houses are supposedly worth two to three times more than what is being sold to these people. Who is subsidizing that? Even after the subsidy, why can't these people afford the houses? Or is it because the actual selling price is over-inflated?

Why are these so-called low-cost houses worth so much more than what they are being sold for? What will stop these people from actually selling off these houses at market prices after they are bought? Of course, you can put a 5-10 year moratorium on the deal, but still it is not that long.

What about the allocation mechanism of this scheme? Since only 20,000 people are going to be awarded this subsidy, what happens to all the other people who are left out? Is it the most effective way to allocate RM300 million?

On top of that, the math does not make sense. On average, each person would only receive about RM15,000 of loans if RM300 million is allocated to 20,000 people. What is one supposed to do with that kind of money? You can barely buy a car, let alone buy a house.

There are really so many things wrong with this deal that it is probably doomed to fail even before it begins. I have only skimmed the surface of the problems and I am sure that when the full details are released, there will certainly be more worms in the can.

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