Large scale failure

When we are confronted with a potentially large failure which seems to come out of nowhere, our natural reaction is to avoid it at any cost. For example, the response to the recent Global Financial Crisis (GFC) was “unprecedented” and “aggressive” (http://georgewbush-whitehouse.archives.gov/news/releases/2008/10/20081014.html) with an incredible overall cost of over US$11 trillion and climbing (http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5995810/IMF-puts-total-cost-of-crisis-at-7.1-trillion.html) that will unlikely be recovered in our lifetime.

The reality is that the underlying causes of the GFC of excessive borrowing and risk taking were very similar to the Great Depression, the 1980s Saving & Loan debacle and the 1987 Wall Street crash. This serves as a reminder that large failure is inevitable – after all, the law of averages means that many times, outcomes will fall short of our expectations.

So if it is going to happen anyway, why don’t we confront potential large failure more openly with a more measured plan - or at least try to lessen the impact of failure before it becomes a problem? In part it is because a big failure and it's impacts are not something we like to be reminded of, let alone think will affect us. Many of us like to talk prospects up, even more so when things have been going well for a very long time. And we definitely don't want to leave a legacy of failure, so we will do all we can to at least defer the failure.

To me there seems to be a large gap in honestly discussing potentially large failure throughout the business cycle, This has become even more important given community reliance on large, global businesses. Failing to plan means paying substantial costs to avoid failure when there seems to be no other choice.

It is easy to find information about the numerous cases of business failure throughout history. Even Wikipedia has a list (http://en.wikipedia.org/wiki/List_of_business_failures). Although the reasons for failure become repetitive, it helps give a sense of what failure looks like, and reminds us that many failed businesses were once successful

To reduce the chance and impact of large scale failure, basic risk management can be followed. At a minimum this means establishing independent checks and balances and paying staff for long term performance rather than short term risk taking. Independent verification of activities remains the responsibility of a small, unappreciated minority of the business world, such as auditors and regulators. In boom times, these people are labelled as negative and any suggestions of better protecting the system are usually ignored or attacked (http://www.washingtonpost.com/wp-dyn/content/article/2010/03/18/AR2010031805370.html). But when boom turns to bust, we ask why these same people didn’t pick up the causes of the failure (http://seekingalpha.com/article/96955-bank-crisis-where-were-the-regulators). Instead of pointing fingers, we should insist on a stronger level of independent oversight of large businesses, both from within a company as well as outside from community representatives

If all else fails (no pun intended), an orderly run-off plan needs to be instituted to manage the community impact of failure rather than just stump up cash to deal with it another day. Unfortunately, from the GFC we have set a dangerous precedent where governments will prevent large scale failure through buy-outs and guarantees – this reaffirms the idea that failure should be avoided at any cost and that there are no consequences today of taking high risks.

Letting AIG or Citibank fail in 2008 would have probably resulted in a long, protracted depression for the Western world. But it would have reminded us that failure is inevitable, and that excessive risky actions do have consequences and exacerbate the impact of failure. Perhaps a large scale failure will remind us of the importance of caution, skepticism and austerity – all of which seem to have no place in modern life.

What housing shortage?

I have been reading/watching with interest recent coverage on Australia's reported shortage in housing, identified as a key reason for the recent and projected increases in Australia's house prices and reduced affordability.

Many commentators report much of this information as fact, despite it usually being provided by industry groups or construction/building businesses. On top of this, many local papers report information provided by local real estate agents, again verbatim, which is likely to be biased towards presenting an upbeat, optimistic view of the housing market.

Some examples of the reporting on the relationship between housing prices, housing shortages and population growth -

http://www.smh.com.au/business/housing-shortage-to-quadruple-hia-20100318-qgzu.html

http://www.smh.com.au/business/sydney-house-prices-tipped-to-push-higher-20100311-q0em.html

http://www.dailytelegraph.com.au/money/money-matters/sydney-the-city-of-broken-dreams-as-mortgage-stress-mounts/story-fn300aev-1225833209356

http://hills-shire-times.whereilive.com.au/real-estate/story/prepare-for-year-of-the-investor/

The general feeling is that there is an impending housing shortage crisis/disaster - so families have to "get in on the action", the effect of which is to keep pushing prices up.

But a look at the underlying ABS data on population growth tells a somewhat different story.

For example, there was an approximate 79,000 increase in the population of NSW for the year ended 30 June 2008 (http://www.abs.gov.au/ausstats/abs@.nsf/Products/3218.0~2007-08~Main+Features~New+South+Wales?OpenDocument#PARALINK3). Looking behind this data (see the spreadsheets in http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/3218.02007-08?OpenDocument), this 79,000 increase is roughly split as follows - Inner Sydney (17,000), Greater Northern/Coastal Sydney (4000), Greater Western/Southern Sydney (26,000) and Greater NSW (32,000).

This information tells us that most NSW house price growth should be in the Greater Western/Southern Sydney or Greater NSW area (these areas appear to account for about 70-75% of the population growth in 2008).

But NSW government housing data (http://www.housing.nsw.gov.au/About+Us/Reports+Plans+and+Papers/Rent+and+Sales+Reports/) shows that across NSW there was an annual reduction in housing prices to June 2008. For the year to June 2007, NSW population growth was 88,000, 67% of NSW population increase was in Greater Western/Southern Sydney or Greater NSW area, and prices were flat in some areas and marginally increasing in others.

It is true that the same housing data also shows house price increases to June 2009, and this does coincide with higher population growth in NSW (up to 115,000 although no regional data is available).

The problem with the population growth argument is that it ignores the obvious - it is likely (based on the experience of the USA, UK, Spain and Ireland) the current housing boom is in part driven by historically low, emergency level interest rates, easy credit, progressive reductions to income tax rates over the last few years, the first home buyers grant, and of course, investment speculation. And maybe the reason we are hearing so much about a housing shortfall is that it aligns to particular groups interests e.g. real estate agents, housing industry groups, construction business and the government (as a way of explaining away an asset bubble).

I think that more responsible, objective reporting by the media is in order to start challenging the information they are given - particularly if we want to avoid going down the calamitous property markets of the UK, USA, New Zealand, Spain and Ireland, where the same types of media reporting justified the booming markets until they fell apart.

And reflecting on it, what does a housing shortage actually mean? Is it that people are choosing between becoming homeless or buying a house? Not likely. People will (and are) renting instead of buying - and financially it is getting to the point where that makes more sense than buying a house. Maybe that will be the start of the bubble deflating.