Tag: The Conversation

America’s rental affordability crisis is about to go from bad to worse

From The Conversation.

We just learned America’s rental affordability crisis is as bad as it’s ever been. Unfortunately, it’s about to get a whole lot worse.

The American Community Survey for 2014, released a few weeks ago, found that the number of renters paying 30% or more of their income on housing – the standard benchmark for what’s considered affordable – reached a new record high of 20.7 million households, up nearly a half-million from the year before. Despite the improving economy, the increase was nearly five times bigger than last year’s gain.

That means about half of all renters live in housing considered unaffordable. And the latest increase comes on top of substantial growth since 2000 that has seen this number climb by roughly six million households over the period, an increase of about 41%.

Worse still are the more than 11 million households with severe cost burdens, paying more than half their income for housing, up from seven million at the start of the century.

Having so many families and individuals struggling to pay their monthly rent is a clear cause for concern. Renters in this situation are forced to make difficult trade-offs to make ends meet, including opting for housing in distressed neighborhoods or in poor condition. In fact, in an analysis of consumer expenditure data we undertook at the Harvard Joint Center for Housing Studies, we found that renters in this situation largely accommodate their high housing costs by spending substantially less on such basic needs as food and health care.

This growing problem needs to be addressed because having a stable, decent home has been found to produce a wide variety of benefits, from better health outcomes to improved school performance among children. There is also growing evidence that providing permanent affordable housing for homeless individuals and families is much more cost effective than paying for temporary housing.

With the housing crash receding from the headlines and prices on the rise again, it is all too easy to believe that as the economy heals, the housing affordability crisis will naturally ebb without the need for greater efforts by our public leaders.

Unfortunately, this is wishful thinking.

US-Rentals-1

Prospects for improvement

The rising tide of cost-burdened renters has its roots both in the real (inflation-adjusted) growth in the cost of rental housing and in falling renter incomes.

Since 2001, the median monthly rental price in the US has climbed significantly faster than inflation, while the typical renter’s pretax income has fallen by 11%. These trends were evident even before the recession and housing bust, but have certainly been exacerbated by the economic travails since.

Now that the economy is nearing full employment and holding out the prospect of a rebound in incomes and construction of new apartments is reaching levels not seen since the 1980s, there would seem to be some hope that the extent of rental cost burdens would start to abate. But at the same time, there are also demographic forces at work that are likely to make matters worse.

The two fastest-growing segments of the population in coming years will be those over age 65 and Hispanics, both of which are more likely to experience cost burdens.

In collaboration with researchers at the affordable housing nonprofit Enterprise Community Partners, the Joint Center for Housing Studies set out to simulate future trends for cost-burdened renters based on our household projections for the next decade under different scenarios in which rents continue to outpace incomes, or, alternatively, where we see a turnaround in current conditions and incomes grow faster than rents.

As we document in our recent report, we found that demographic forces alone will push up the number of renters with severe rent burdens by 11% to more than 13 million by 2025, with a large share of the growth among the elderly and Latinos. That’s assuming incomes and rents both grow in line with overall inflation.

If we do get lucky enough to see gains in income outpace the rise in rents by 1% annually over the next decade, we would see a modest decline of some 200,000 renters with severe burdens. That’s some improvement but not nearly enough to appreciably change the current challenge. And this modest net improvement would mask a still-significant growth in rent burdens among Hispanics of 12%.

US-Rentals-2But alternatively, if rents continue to grow faster than incomes at a pace similar to what we see today, we could see the number of renters spending more than half their income on housing reach 14.8 million, an increase of 25% over today’s record levels. That would mean 31% of US renters – and most likely at least a few of your family and friends – would be desperately struggling to get by.

What can we do about it?

So what do we need to do to address this situation?

Since falling incomes are a key part of the problem, efforts to raise take-home pay will have to be part of the solution. Increases in the minimum wages will help to some extent. Improvements in education and job training that prepare people for decent paying jobs are also needed.

On the housing front, there is also a strong case for an expansion of assistance for the nation’s lowest-income households. About 28% of renters earn less than US$20,000 a year. At that income, monthly housing costs have to be $500 or less to be affordable.

The private market simply can’t supply housing at such low rents. Public assistance is needed to close the gap. However, at present only about one out of four households who would qualify for this federal housing assistance based on their income is able to secure one of these units. Unlike other programs in the social safety net, housing assistance is not an entitlement. And we simply don’t come anywhere close to fully funding housing assistance to help all those eligible.

The vast majority of those who are left out face so-called worst-case housing needs, paying more than half their income for housing or living in severely inadequate housing.

Solving the housing problem

There are two main ways in which we have extended housing assistance in recent decades: 1) by providing housing choice vouchers that subsidize monthly costs for homes the tenant finds in the private market or 2) by subsidizing the cost of new housing or the rehabilitation of existing housing with support of the Low Income Housing Tax Credit.

Both programs have their place. In markets where modestly priced housing in a range of neighborhoods is not in short supply, vouchers make sense as a means of taking advantage of housing that already exists. Vouchers also have the potential for giving greater choice about where residents want to live in a metro area.

The housing credit program also plays an important role in helping to preserve existing subsidized housing that needs new investment, in helping to turn around neighborhoods where new housing can have a positive impact and in adding affordable housing in neighborhoods where it would not otherwise be provided.

Still, both programs could benefit from reforms to ensure that funds are used efficiently and that the housing opportunities provided are not concentrated in distressed neighborhoods.

For example, the Department of Housing and Urban Development recently started a pilot program that factors the variability of market rental prices across neighborhoods into the maximum rent its vouchers cover. Currently, the limit it is set at is the same for an entire metropolitan area. The new approach would allow that limit to vary across neighborhoods, giving beneficiaries more choice in where to live and also keep HUD from overpaying in distressed areas.

There are also proposals for reforming the housing tax credit program to allow it to serve a broader range of income levels and make it easier for people to get aid in high-cost markets like New York, San Francisco and Boston, where rental burdens are increasingly a problem among moderate-income households and not just the poor.

The grass roots

Beyond these federal efforts, state and local governments also have an important role to play in fostering a greater supply of affordable housing.

In addition to providing public funds for this purpose, these levels of government set land use regulations and policies that have the potential to spur affordable housing production. But all too often, they deter affordable housing production through complex and costly approval processes as well as limits on the types of housing that can be built.

With both demographic and economic trends likely to keep the number of cost-burdened renters at record levels for years to come, the issue is not going to go away. But we still lack the political urgency to take the steps needed to do something about the problem; housing affordability hasn’t even come up in any of the presidential debates.

It may be because it has historically been borne by the nation’s most disadvantaged families and individuals. But with the number of cost-burdened renters reaching highs each year, the challenge of paying the rent each month is becoming a significant concern for a broader swath of the country with each passing year.

It’s time our political leaders take notice and take action.

Author: Chris Herbert, Managing Director of the Joint Center for Housing Studies, Harvard University, Andrew Jakabovics, senior director for policy development and research at affordable-housing nonprofit Enterprise Community Partners.

The dark side of free markets

From The Conversation.

It is now not uncommon for 11-year-olds to be diabetic. I see one reason for it every time I check out at my local Safeway in Washington. The candy is right there at the cash register, waiting to be eaten.

But this does not mean that the manager of the store is mean or even irresponsible. If she has qualms about this practice, she would face a real dilemma: she needs to show a profit. The margins at supermarkets are tiny. No matter what her morals, she has almost no choice but to place those sweet impulse buys where customers can see them. In other words, there is an economic equilibrium in which businesses take advantage of every opportunity to increase profits. In such an equilibrium, the candy will be at the checkout counter.

Curiously, while economists understand each and every such instance where people are tempted to buy things that are not good for them, they fail to appreciate that this occurs because of a general principle of economics. They fail to understand that free markets, as bountiful as they may be, will not only provide us with what we want, as long as we can pay for it; they will also tempt us into buying things that are bad for us, whatever the costs.

Markets will deceive

Just as free markets can serve the public good “by an invisible hand” (as Adam Smith saw more than two centuries ago, and is the foundation of the field of economics), free markets will do something else. As long as there is a profit to be made, they will also deceive us, manipulate us and prey on our weaknesses, tempting us into purchases that are bad for us. That is also a fundamental feature of market equilibrium, in which supply and demand balance each other out.

My fellow economists, while they recognize such behavior in individual instances, fail to see this as a general principle. And thus a lot of bad things happen, such as the candy at the checkout counter. Most notably, we economists should have been a chorus warning of the financial crash of 2008. We should have recognized that people should not be buying overrated mortgage-based securities, nor should banks have been creating the insecure loans that backed them. Instead there were at most a few lone voices of protest. We should have been more skeptical.

But this is not just about economists and what we think, because through long chains of reportage and other channels (such as this one), what we say in our faculty lounges affects politicians and the public opinion more generally.

This failure to understand that markets have this downside is then passed on into policy more narrowly defined. The public fails to understand that in the economic equilibrium, if there is a profit to be made, someone will take it up, as long as it is legal and as long as there is no public protest against it.

The consequences of being a ‘phool’

Princeton University Press

A recent book we wrote called Phishing for Phools describes how the fundamental logic of economics, going back to Adam Smith, delivers this conclusion. That is, markets are not benign forces working for the greater good but instead are filled with businesses that “phish” by exploiting our weaknesses to get us to buy their products. We are the subjects of those phishes – the “phools” – when we fall for it.

The onus in the book was on us to show that temptations to make bad decisions really do significantly affect our well-being. Such a demonstration was surprisingly easy.

There are four huge areas of our lives – consumer spending, investment, health and politics – in which we are making decisions that no one (on reflection) could possibly want. Yet we make those decisions, and the free market provides them, just as bountifully as it satisfies our more benign impulses.

First, even in the US, as rich as we are by all historical standards, most of us go to bed at night worried about how to pay our bills. We are continually tempted, and have a very hard time sticking to a budget. Thus, the median American family has on average less than one month’s expenditure in its bank account; half of all US respondents in a 2011 survey said they would have a very hard time raising US$2,000 in a month’s time if an emergency occurred; and my rough estimate suggests that 20% of us will go bankrupt at some point over our lifetimes.

Second, there are financial booms and busts because stories – what we are saying to ourselves and what we say to each other when we make our decisions – spread like epidemics. Those stories lead people into bad investments, and then, when those investments go sour, there are declines in confidence that threaten the whole financial system. Humpty Dumpty has a great fall and only slowly is pieced back together again.

Third, regarding health, the market gives us tobacco, which, according to Centers for Disease Control estimates, is responsible for almost 20% of deaths in the United States. The pharmaceuticals industry sells us drugs with unknown long-term effects, which are sometimes severe. And Big Food serves us sugar and fat, so that two-thirds of Americans are overweight, with more than half of them also obese. The list goes on.

Finally, the political system in a democracy is like a market system: there is a competition for votes. But that too has a “phishing equilibrium.” To keep their jobs, politicians have to raise money from “the interests” and use it for TV ads that show what nice folks they really are.

Casinos are another example of how free markets tempt us into doing things we shouldn’t do. Reuters

Prosperity at a steep premium

Free markets may lead to prosperity, but they also deliver more than the unalloyed benefits ascribed to them. This unwillingness to acknowledge their dark side undergirds the basic fundamental thinking of economists and leads to bad government policies. A grownup’s view of the economy that incorporates the downsides of capitalism is a prerequisite for sane policy.

The economic system works as well as it does not just because of individual incentives, but also because a whole raft of individual heroes, social agencies and government regulation puts limits on this downside of markets to phish us for phools. Such policy is a balancing act, to filter out the bad sediment while allowing through the true benefits of free markets.

This view of a phishing equilibrium thus challenges current economic thinking in a new way. There is a huge payoff to incorporating it into our view of the economy. Just as we love our children, we should love free markets; but as with our children, it would be a mistake to think that they can do no wrong.

Authors: George A Akerlo, University Professor, Georgetown University; Robert J Shiller,Professor of Economics, Yale University.

Six reasons why China’s economy is weaker than you think

From The Conversation.

The UK has rolled out the red carpet for Chinese president Xi Jinping on his five-day official visit. He is being given the royal treatment, including a stay at Buckingham Palace, a ride in a state carriage along The Mall and several banquets. The trip will also include plenty of time with the British prime minister, David Cameron, who is keen to discuss the trade and investment that the UK hopes to secure from the visit.

Britain’s pivot to China is largely based on its economic strength. And yet there is cause for concern. Having been the locomotive for global growth following the financial crisis in 2008, Chinese growth has now slowed and its economy is looking increasingly fragile. The latest GDP figures came in at just under 7%, significantly down from the astounding annual rate of more than 9% per year between 1990 and 2010.

Exports from China have declined, and exports to China must battle against the depreciating yuan. China’s slowdown has depressed global commodity prices, adversely affecting big exporting countries such as Brazil and Russia.

Some leading economists have been very optimistic about China. Nobel Laureate Robert Fogel published an article in 2010 that predicted that China’s GDP will grow at an average annual rate of more than 8% until 2040, when its GDP per capita would be twice that projected for Europe and similar to that in the United States. Fogel used a textbook method of analysis to predict an unrelenting upward path.

But as countries grow, their service sectors tend to increase as a proportion of output and employment. Rates of growth of productivity in services tend to be much lower than in manufacturing or agriculture. Hence, in any economy, growth rates are likely to slow down through changes in economic structure. There are several other reasons why China’s economic growth is set to stall.

1. Demographic shifts

China will experience an adverse demographic shift in the coming decades. Three decades of the one-child policy has reduced the number of adults of working age. The recent and ongoing relaxation of that policy, plus a big decline in infant mortality, increases the number of children. Older people are living longer, due to improved healthcare and reduced poverty. Hence the average number of children and old people, which needs to be supported by each person in work, is set to increase dramatically.

China’s population is ageing. Hung Chung Chih / Shutterstock.com

2. Chinese GDP per capita is still low

GDP is way below that of the US and other developed countries. World Bank Figures for 2014 put China’s GDP per capita at about 24% of that in the US. In the 20th century, only five countries managed to grow from 24% or less of US GDP per capita to 60% or more of US GDP per capita. They were Japan, Taiwan, South Korea, Singapore and Hong Kong. China still has a long way to go.

3. Lack of democracy

While there is some evidence that autocratic governments can help economic development at lower stages of development, particularly by promoting basic industry and infrastructure, there is strong evidence that democratic institutions are much more suited to higher levels of development. Notably, when Japan, Taiwan and South Korea reached about 45% of US GDP per capita, they were established or emerging democracies. A transition to a more democratic government may be necessary as China develops, but this would be very difficult to achieve – and could be highly disruptive.

4. Lack of openness

A democratic government is but one part of a constellation of vital institutions. As Nobel Laureate Douglass North and his colleagues have argued, dynamic modern economies need checks, balances and countervailing power to minimise arbitrary confiscation by the state. Legal systems have to develop significant autonomy from the political elite. In my book Conceptualizing Capitalism I show that absolute GDP per capita in a sample of 97 countries is strongly correlated with absence of corruption and openness of government. China is not an outlier in this test.

5. Problems with land and property rights

Unrest in the Chinese village of Shangpu was triggered over an unpopular land deal. REUTERS/James Pomfret

China’s population is divided into two classes. Chinese citizens are registered with either an urban or rural classification, depending on where they are born. Urban registrants have better education and health services.

Many rural registrants, meanwhile, have rights to the use of land. But these are often anulled after local party officials are bribed by business speculators and sell the land for profit. Frequent local protests result and the whole system of land use is in dire need of radical reform. Currently it fosters corruption and inhibits the skill development of half of the Chinese population.

6. Lack of homegrown talent

Although there are many small firms in China, there are still few mainland-registered large firms. Barry Naughton has noted that of the top ten firms in China exporting high-tech products, nine were foreign. Offshore registration is understandable, because fear of state sequestration persists in a country that did not recognise private property rights in its constitution until 2007. China’s financial system is very heavily concentrated in state hands, with punitive penalties on private lending.

Thus, there are weighty institutional and demographic drags on further rapid growth in China, especially as it enters intermediate levels of economic development that are ill-suited to the continuance of a one-party state. China can succeed, but only through massive and potentially destabilising reform of its political and economic institutions. We should not be surprised by even lower growth rates in the future.

Author: Geoffrey M. Hodgson, Research Professor, Hertfordshire Business School, University of Hertfordshire

Government to act against businesses exploiting credit card charges

From The Conversation.

The Turnbull government will ban businesses from charging consumers excessive surcharges on their credit cards, and move to inject more competition into the superannuation industry, responding to the Financial Systems Inquiry headed by businessman David Murray.

Under planned legislation, the surcharges will not be allowed to be more than the cost to the business of accepting payment by card.

The Australian Competition and Consumer Commission (ACCC) will enforce the regulations to ensure consumers are treated fairly and not overcharged.

The government is also promising action to improve the standards of financial advice, an area that in recent years has been subject to extensive malpractice and controversy, amid deep concern especially from retirees.

The government’s response to the Murray inquiry, which reported last year, was announced by Prime Minister Malcolm Turnbull, Treasurer Scott Morrison, and Assistant Treasurer Kelly O’Dwyer at a joint news conference. Most recommendations have been accepted, and several measures have been added.

The report and response cover the resilience of the financial system; superannuation and retirement incomes; innovation; consumer measures; and the regulatory system. Measures to improve the resilience of the banking system are already in train.

Turnbull said the surcharge issue “has been the subject of considerable consumer concern”.

“Quite plainly, where a merchant says if you use a credit card it’s an extra 2% or 3%, that carries with it an absolutely crystal clear, irrefutable representation that the merchant is seeking to recover his or her costs,” he said.

“In some cases they may be, in other cases they’re not.

“We think that consumers are entitled to a very fair deal here … in other words, to get exactly what they are being represented to be getting, which is an additional charge that recovers no more than the merchant’s costs.”

Morrison said that in some cases surcharges could be more than 10%. In future merchants would have to pass the “fair dinkum test” – “the fair dinkum cost of what someone is actually absorbing and passing on”.

To improve the financial advice industry, advisers will have to have a degree, pass an examination, undertake continuous professional development, subscribe to a code of ethics and undertake a professional year before they can advise clients. There will be some transitional arrangements as the tougher requirements are put in place.

“These higher standards will, for the first time, place financial advising on a similar footing to other professions and in doing so increase consumer trust and confidence in the sector”, the ministers said in a statement.

The Abbott government had its regulations watering down the Labor government’s more stringent rules thwarted by the Senate.

The superannuation measures are to improve competition, efficiency and transparency – which the government says will improve after-fee returns for fund members. The Coalition believes that industry funds have too much of an advantage under present arrangements.

The Productivity Commission will be asked to develop and release criteria to assess the efficiency and competitiveness of the superannuation system. It will “develop alternative models for a formal competitive process for allocating default fund members to products”.

The government says it will work with industry to provide retirees with more flexible and reliable retirement income products and “to extend the choice of fund arrangements to more employees as recommended by the inquiry”.

Last month legislation was introduced to alter super funds’ governance arrangements, requiring at least one-third of trustee boards to be independent directors, including an independent chair.

Morrison said the government was putting “Australians in the driver’s seat of their own money and no-one else, and that’s as it should be.

“It does end the closed shop when it comes to mandatory superannuation contributions and how they are directed off into funds, and it will give Australians greater choice about where they invest their own money for their own retirement.”

Morrison described the Murray report as “a common sense report. It has common sense recommendations, a health check on where our financial system is at.”

In terms of the financial system itself, it makes it stronger by embedding deeper protections within the system, whether it’s on capital adequacy, improved governance and standards right across the system and empowering our regulators to be able to enforce the protections that are in that system, protect consumers and Australians and our economy at the end of the day.

“It does provide Australians with greater choice and greater control over their own money, whether it’s their superannuation or anything else.”

Turnbull acknowledged work done by former treasurer Joe Hockey and former assistant treasurer Josh Frydenberg but stressed “this response is a response of the Turnbull government to this inquiry”.

Author: Michelle Grattan, Professorial Fellow, University of Canberra

Super members the winner in sensible financial inquiry response

From The Conversation.

The government has accepted virtually all of the recommendations of the expert panel behind last year’s Financial System Inquiry. Clearly we can argue about some, and people would prefer to pick and choose depending on their predilections, but rather than allow the reform process to be unpicked by stealth, the government has opted to support its experts. That is a welcome change.

The inquiry had three main issues to deal with: the safety of our banking system in the light of the global financial crisis, the increasing importance of the superannuation industry to our financial system as a whole, and how new technologies and related innovations might impact the system. While the banking issues are well understood the other two pose new challenges for Australia.

Inquiry chair David Murray and his colleagues focused heavily on superannuation. This is appropriate since the superannuation sector is now a major part of the financial system. By the time of the next inquiry it may even manage more assets than the banks.

The one recommendation which was rejected by the government in its response to the inquiry, Recommendation 8, was intended to limit the ability of superannuation funds to borrow. The FSI approached this as a prudential issue, worrying about potential risks from leverage within the superannuation sector. The government has rejected the argument saying it may be an important issue in the future but is not now, preferring to monitor what is happening rather than prohibiting it.

The choice not to reject any other recommendations on superannuation is far more important.

The government supports the FSI’s concerns about the efficiency and competitiveness of the superannuation system. It has charged the Productivity Commission with reviewing the current system and suggesting ways in which the system might be made more competitive. This will be a major challenge of the superannuation sector and involve them in a lot more policy analysis over the next couple of years.

On the management of retirement income streams, the approach is more nuanced. It will require funds to develop products and then leave members with the right to choose between these new products and their current choices. The approach will be fleshed out as part of the two ongoing reviews in the area.

Industry funds will struggle with the next two recommendations: on choice of fund and on governance.

The government has committed to extend choice of fund by removing the deemed choice provisions of some industrial agreements. This does seem sensible policy although it will be criticised. Since most people have choice of which funds their savings will go into, it seems inappropriate to lock other people into a restricted set. It is hard to argue that having more choice will hurt anyone and it could lead to greater competition between funds.

The issue of strengthening governance is also going to be disputed but should be inoffensive. Rotating directors and having independent directors are normal requirements in the corporate world and, with many funds managing tens of billions of dollars in savings, it seems sensible to allow funds to find the best directors possible. It may also be easier for independent directors to recommend the amalgamation of funds which is badly needed and should produce significant benefits for savers.

Can the government make the superannuation more competitive in the expectation that it will produce better outcomes for savers? Clearly the answer is yes. The superannuation system has evolved over time, driven by rules and by changes in rules. Its size is a product of rules and regulations. Steps to make the system more transparent, to allow greater choice, and to enhance the professionalism of management can all be expected to produce better outcomes for savers.

The politics of the government’s response is sensible. The Productivity Commission will be cheering. It will have a whole new stream of work and be brought back into the centre of government policy analysis. This is a very healthy development.

Author: Rodney Maddock, Vice Chancellor’s Fellow at Victoria University and Adjunct Professor of Economics, Monash University

Rising mortgage rates – is it time to refinance your home loan?

From The Conversation.

Last week, Westpac hoisted its lending rate by 20 basis points in a bid to recover the costs of recent capital raisings. There is speculation other banks will follow. Australia’s non-bank lenders could be winners from such a scenario – but the choice may not be as simple as the lowest interest rate.

The outcome of the Financial Systems Inquiry

The background to Westpac’s move lies in recommendations by the Financial System Inquiry that the capital base of Australian banks should be increased to an “unquestionably strong” level and that there should be a narrower gap in different mortgage lending requirements between institutions.

As a result Australian banks have considerably increased capital levels this year by approximately $16 billion.

However, higher capital levels and bank stability may come at additional costs, even if trade-off theory suggests greater bank and system resilience would normally equal lower funding costs. That’s because bank investors have high dividend expectations, so this means the costs of boosting capital may be passed onto borrowers.

Capital levels are likely to increase further as regulators seek to narrow the gap between the practices of the big banks and smaller lenders, and amid their increasing concern at Australia’s house prices. In particular, large banks are expected to increase capital required under their internal risk weighting models for mortgages.

Will non-bank lenders grow their mortgage books?

Non-bank lenders provide mortgage loans with comparable features but unlike banks are exclusively funded from wholesale markets and not from consumer deposits.

As a result, banks face minimum capital requirements enforced by the Australian Prudential and Regulation Authority to protect depositors, while non-bank lenders are unregulated and may more freely choose their funding mix and hence have lower funding costs.

This often implies lower capital ratios for non-banks than banks. Raising capital levels for banks only may have an impact on the balance between bank and non-bank competitors.

The following chart shows the counts and total assets of banks and non-bank lenders in Australia over time:

Total assets of non-bank and bank lenders provided by Australian Prudential Regulation Authority, http://www.apra.gov.au

The size of non-bank lenders ($120 billion) is much smaller than the size for bank lenders ($3.8 trillion) and has shrunk in relative terms over the past years. This may suggest that Australians fail to really consider this sector to finance their homes despite competitive mortgage rates from non-bank lenders.

There are many reasons for this – convenience may be one of them as banks are able to offer a larger product range and cover most financial needs of consumers, and consumers prefer to bank with a single institution.

The small size is a great disadvantage as relative fixed costs are higher for small firms than for the major banks.

Should you choose a bank or non-bank to finance your home?

Consumers seeking mortgage finance for a property – either a new borrowing or refinancing of an existing loan – can choose between a large number of banks and non-bank lenders, along with hundreds of loan products.

Comparison websites generally rank lenders and products according to the most obvious criterion – the interest rate. Non-bank lender often provide the cheapest terms. But the lowest rate loan is not necessarily the best loan.

The choice between bank and non-bank lender can be important if you want to use an offset facility. Offset facilities are not always included and they can expose borrowers to lender risk.

Having savings in an offset facility means that in effect the lender owes you money. Banks are much less risky in this regard because they benefit from government guarantees as well as greater scrutiny that are tied to the bank status.

Non-bank lenders are excluded from such guarantees and furthermore may have a greater exposure to market instability.

During the global financial crisis non-bank lenders (especially overseas firms) that were funded through capital markets, rather than customer deposits, were challenged as wholesale funding markets dried up. Some failed and total volumes shrank between 2009 and 2013 (see chart above).

Still, it is likely that more Australians change to non-bank lenders in the future. Changing a lender is easy as mortgage brokers often provide the legwork, plus exit fees have been considerably reduced since new laws came into effect on 1 July 2010 limiting mortgage exit fees to the lender’s losses directly connected to the borrower exiting the loan early.

Are non-bank lenders dangerous to our system?

Low volumes mean non-bank lenders are currently of no systemic concern to the economy and regulators. However this may change in the future as volumes shift and grow for non-bank lenders.

New market participants enter as new non-bank loan platforms are developed. One example is internet-based peer-to-peer lending.

Australians may adapt to this new regime and take on new technologies offered and seek the lenders providing the cheapest funding. Consumers generally do not care about the lenders’ own funding and may arbitrage the differences in mortgage rates by shifting the business from regulated banks to unregulated non-banks.

A concern may arise if non-bank lending is successful and to become a large player that is systemically important. In such a scenario the government would be well advised to consider regulating the industry.

Such regulations may include minimum lending and funding standards with the mission to protect de facto consumer deposits via offset accounts and to ensure the credit supply in economic downturns when wholesale funding markets are constrained.

We may be some time away from such a scenario in light of the increasing dominance of bank lenders.

Author: Harry Scheule, Associate Professor, Finance, UTS Business School, University of Technology Sydney

If you think your emails are private, think again

From The Conversation.

When you type up a racy email to a loved one, do you consider the details private?

Most of us would probably say yes, even though such messages often end up filtered through intelligence agencies and service providers.

On the other hand, as the digital world becomes more personalized, consumers have begun to accept, appreciate and apparently request relevant connections between their online behavior and displayed advertisements.

It’s fairly commonplace now. Type camping gear into your browser, and for the next few weeks you’ll see online ads for shoes, stoves, shirts and even fashion accessories, all specially designed for camping.

But when you send an email to a family member, or when you receive an email from a friend, do you expect the same type of follow-on advertising as you do from internet searches?

Or do you expect some different level of privacy simply because the information is cloaked in an email?

That’s the issue at stake in a pending lawsuit against Yahoo! Inc.

The case against Yahoo

Plaintiffs filed an email privacy lawsuit against Yahoo in the US District Court for the Northern District of California under several privacy laws, including the Stored Communications Act (SCA) – a federal law that prohibits an email service provider from knowingly divulging to any person or entity the contents of a communication while in electronic storage.

Under the SCA, an email service provider may, however, properly disclose the contents of such communications with the lawful consent of the originator or an addressee or the intended recipient of such communication.

Earlier this year in May, Judge Lucy Koh granted plaintiffs’ request to proceed in the lawsuit as a nationwide class action.

Class actions allow plaintiffs with identical or similar claims to come together as a group in one lawsuit against a common defendant, rather than each plaintiff bringing his or her own individual lawsuit against the same defendant. Typically, many of the claimants would not have the resources to pursue their individual claims for oftentimes relatively modest economic damages. A class action allows them to pool their resources, hire attorneys on a contingency basis to limit or eliminate plaintiffs’ out-of-pocket expenses and seek potentially larger awards than would likely result from a series of individual lawsuits.

Koh is the same judge who denied class action certification in a similar email privacy case against Google last year. The key difference, as Judge Koh noted in her May ruling, is that the plaintiffs in the Yahoo case sought to include in the class of plaintiffs only non-Yahoo Mail subscribers, while the plaintiffs in the Google case tried to include subscribers as well.

This is important because of the issue of notice and consent: did non-Yahoo Mail subscribers have notice of (and thereby consent to) Yahoo’s publicly disclosed policy of scanning, and possibly sharing, emails simply by corresponding with a subscriber?

Given the express language in the SCA that lawful consent of the originator or an addressee or the intended recipient of such communication is sufficient, and given Judge Koh’s prior ruling that Yahoo’s terms of service establishes consent of the Yahoo Mail subscribers – the answer appears to be yes.

In its request to the Ninth Circuit Court of Appeals for permission to appeal Judge Koh’s class action order, Yahoo argued in part that the court improperly decided that the issue of consent could be analyzed within a class action. Yahoo argued that since consent is an issue that is specific to each potential plaintiff’s behavior and action, it would not be appropriate to examine it on a “class” basis, but rather it should be looked at on an “individual” basis. Yahoo’s request was denied without discussion. A preliminary trial date for the Yahoo case has been set for February 8.

Can we expect our emails to remain private? Yahoo mail via www.shutterstock.com

Consumer expectations of privacy

At first blush, it’s tempting to say that emails are different from online behavior and internet search histories, and therefore deserve a heightened level of privacy. An email, like its offline counterpart US mail, is personal, private and akin to a confidential one-on-one conversation written with a specific recipient in mind.

And recent lawsuits underscore this temptation. A new case filed a few weeks ago in California federal court alleges that Twitter is “eavesdropping” on users’ private messages in violation of federal and state privacy laws. Another suit filed earlier in September in the Northern District of California alleges that Google unlawfully diverted non-Gmail users’ email messages to extract content.

But one of the key issues in the case against Yahoo is whether email users – specifically those who do not subscribe to Yahoo Mail – consented to Yahoo’s publicly stated policy that emails sent through its service are scanned and analyzed by the company.

Yes, Yahoo’s publicly available web pages, including the Yahoo Mail page, disclose its scanning practices and the possible sharing of email content with third parities, yet the plaintiffs argue that before sending an email to a Yahoo user or before receiving an email from a Yahoo user, they were not given notice of that policy and therefore did give their consent to it.

The plaintiffs’ argument, while superficially plausible, will be a challenging one to make. Companies such as Yahoo and Google have long provided notices and disclosures to consumers, yet consumers rarely read privacy policies or terms of use.

So given this persistent choice either to not read or to disregard privacy disclosures, can plaintiffs (whether as individuals or as a group) really object to scanning emails for targeted advertising – whether they’re subscribers or not?

Leaving aside the issue of consent for the moment, is our online behavior or our internet searches really any less personal – or any less private – than the content of messages sent by users of a free email service that publicly discloses that their emails will be scanned and possibly shared with third parties?

No, they really aren’t.

As The New York Times noted in April 2014 in Sweeping Away a Search History:

Your search history contains some of the most personal information you will ever reveal online: your health, mental state, interests, travel locations, fears and shopping habits. And that is information most people would want to keep private.

Given the intensely private nature of internet searches and email messages, it’s hard to think that consumers would somehow expect more privacy in one than in the other, especially when they use Yahoo Mail, Gmail or other services that users know rely on advertising to support the product. And neither should we expect complete privacy if we use a paid email service to send a personal message to a user of one of the free services.

Realistic levels of privacy

It’s clear from Judge Koh’s earlier rulings that Yahoo users do not have a right to privacy in the messages that they send to or receive from a Yahoo email user given the respective terms of service governing Yahoo Mail.

But do the non-Yahoo users who willingly sent an email to a Yahoo account holder (and presumably received some) have a right to privacy when the account holder has none?

The plaintiffs allege that Yahoo intercepts and scans subscribers’ incoming and outgoing emails for content, including the content of emails to and from nonsubscribers. The plaintiffs further allege that Yahoo copies the entirety of such emails and:

extracts keywords from the body of the email, reviews and extracts links and attachments, classifies the email based on its content[,] … [and] subjects the copied email and extracted information to additional analysis to create targeted advertising for its subscribers, and stores it for later use.

Plaintiffs allege that Yahoo intercepts, reads and learns the content of non-Yahoo subscribers’ email communications without the non-Yahoo subscribers’ consent. The plaintiffs say such conduct violates the California Invasion of Privacy Act (CIPA). Judge Koh certified the nationwide class action with regard to the SCA claim and a California-only subclass with regard to the California state law claim under CIPA.

Unlike the Google case, in which Koh denied the plaintiffs’ request for class action certification, the alleged privacy claims in the class action against Yahoo are no longer for money damages (since plaintiffs abandoned their claim for money damages when they moved the court for class action certification). Rather, it is about asking the court to determine that Yahoo’s acts violate the SCA and, if so, that Yahoo be prohibited from engaging in that practice in the future.

The plaintiffs won a short-term victory in achieving class action certification, but this bigger issue over whether they can object to the scanning process – based on a right to privacy – given Yahoo’s disclosure of its scanning and possible sharing practices and given that they chose to send and/or receive an email to a Yahoo user, is far from being decided in their favor.

And they’ll have a tough road ahead making their case, because an important lesson we’ll all learn eventually is that email privacy can sometimes be a digital paradox.

Author: Lydia A. Jones, Adjunct Professor of Law, Vanderbilt University

VW is not alone: how metrics gaming is commonplace in companies

From The Conversation.

The Volkswagen “dieselgate” story, in which the company helped their cars pass emissions tests under special conditions that they later failed when the car was driven normally, is not an isolated incident – there has long been a culture of gaming metrics in the automotive industry and other sectors do it too.

Metrics are shorthand for good performance – they focus the mind of the setter and the tested and are costly and embarrassing if targets are missed. So why take the risk?

This gap between the rhetoric of good practice and the reality falling short in manufacturing has been noted elsewhere. And research I co-authored back in 2004 showed how another car supplier which had multiple sites across the world gamed the standards placed on it by customers. Winning business depended on performing well on various measures, with the company’s customers assessing each delivery of parts on quality, cost and whether it was on time and in full. One of us spent six weeks in two different sites carrying out participant observation. We found that the company gamed the system rather than admit issues with performance, presenting an image of good practice which was a facade.

Quarterly or biannually, customer procurement staff visited the supplier and undertook a complex evaluation process of the company we studied and the rest of their supply base. The quality and delivery performance over an extended time period was assessed as were cost increases, manufacturing and the supply chain capabilities and staff performance. League tables were produced and further business was awarded on good performance, or business was lost if the supplier scored badly.

The customers wanted to trust the supplier manufacturing process. This meant believing it was capable of producing good parts and meeting variations in demand. We found three examples of gaming to meet process measures.

1. Presenting a smooth-running operation

The semblance of high quality at every stage of the manufacturing process gives an indication to customers of the eventual product quality. It is common practice for suppliers to provide statistical process control charts where samples of car parts are checked to see if they match up to various metrics. Ideally, all the machinery and equipment should be measured and in control so that it does not produce bad parts. In our research, the supplier sent the charts taken from places in the process they knew were performing best, not a general sample and most certainly not from areas that they knew would make the graphs look bad.

2. Hiding stoppages and delays

The second measure was about stoppages or downtime in the process. Minimising unexpected breakdowns or downtime in the manufacturing process is key to being seen as a capable supplier. In order to achieve this, the best manufacturers plan maintenance periods where the line is stopped deliberately to service machines.

When the supplier process we studied stopped unexpectedly, management immediately reallocated the time to “planned maintenance”, so they met the downtime target and looked like an advanced manufacturer to the customers.

3. Minimising the appearance of waste

A good manufacturing process does not produce much wasted product. On the factory floor the designated container for our study company had an acceptable level of scrap product, which was measured and recorded. Material which could have been counted as scrap was disposed of via conveyor belts intended for other purposes. We even found that it was placed in employee trouser and coat pockets to be hidden and taken out the factory, so that waste targets were met.

Buyers would visit and audit the supplier, so the supplier was well practised at turning the factory floor into a stage where ideal manufacturing practices were displayed and performed during the visit. Examples include the accident reporting chart beginning after the last accident, records of employee skills being up to date, even if the employee went on the course a long time ago and might not be able still to perform the tasks in question. Machines were hidden, cleaned and floor spaces painted, all to create the impression of a competent organisation which lapsed as soon as the buyers left.

The major car manufacturing customers were not above gaming measures themselves. When an employee was honest with a customer about having problems with an aspect of the process they were told to “move the curve up” on the chart, rather than investigate the root cause and improve the process. Perfectly good batches of parts were rejected one week then accepted the next so that customer stock levels met their target.

A Volkswagen car during a test at a technical and testing centre. Reuters/Dado Ruvic

Beyond the car industry

It would be wrong to just demonise VW and the car industry. The downside of having measurement and metrics on performance is a far wider phenomenon. I have witnessed similar processes in the food sector and it seems very similar to the distorted affect of performance measures at the failing Mid-Staffordshire hospitals and even in football. People focus on the measure, not the wider good the measure was intended to represent. Plus, the setters of the measure are equally culpable.

I respectfully disagree with Edward Queen’s article on The Conversation, which makes the case for teaching business students better ethics – this is too little, too late. The problem is far wider and systemic.

Trying to meet measures with no extra effort is considered an ethical activity in many organisations and rewarded at annual appraisal time – another example of targets shaping performance. The attractiveness of metrics lies in their appearing to give managers control; the problem is that they cannot cover all aspects of performance and leave scope for short cuts, interpretation and gaming – by every party involved.

Returning to the car industry, it’s worth paying heed to the ideas of management expert W Edwards Deming. His ideas are widely attributed to be responsible for improving the reliability and quality of cars and achieving market dominance for companies who followed them. He believed that organisations should not be run on targets, quotas, or objectives, as they are usually a distraction from improving processes. In the case of VW and the car industry, the overarching goal is to lower emissions, which is a far riskier option to ignore in the long term.

Author: Lynne Frances Baxter, Senior Lecturer in Management Systems, University of York

Will Cameron’s 200,000 starter homes really help solve the housing crisis?

From The Conversation.

British prime minister, David Cameron, has pledged to turn “Generation Rent” into “Generation Buy”, by building 200,000 affordable starter homes for under-40s by 2020. The price of the starter homes will be capped at £250,000 (£450,000 within London), and buyers will not be able to sell the properties on for five years. While the prime minister’s announcement will help address the UK’s chronic housing shortage, it is also likely to have unintended consequences.

We really ought to be building 240,000 new homes each year in England alone, if we are to meet need. Currently, we are only building about half of that amount. In fact, it was as far back as 1978 when we were last building the numbers of new houses we need today.

Challenge accepted

Minister for Housing and Planning Brandon Lewis recently said that building 1m new homes in the life of this parliament would be a good achievement. But, welcome as those homes would be, they are still fewer than we need.

The real challenge is to rebuild the construction capacity that we lost after the credit crunch, when many small and medium sized builders went out of business and many skilled construction workers left the industry as house prices fell and small builders found it hard to raise finance. So building more homes will involve boosting the number of small- and medium-sized construction firms, as well as skilled labour – all of which will take time and money.

As though the challenge of building a million homes wasn’t enough, we also need to ensure these homes are spread across all tenures: we need homes for private and shared ownership, newly built and professionally managed private rental homes and affordable rental homes. The prime minister’s announcement of additional starter homes is a useful contribution to meeting the gap between what we need and what we are currently building.

But these homes are to be secured by relaxing planning obligations for developers. Herein lies the potential for unintended consequences.

Over the last two decades, planning obligations have proved to be a very useful way of securing funds for infrastructure – such as open public spaces, schools, roads and public transport – and new affordable homes, including shared ownership and affordable rental homes.

Local authorities can use planning laws to negotiate with developers to incorporate affordable homes into their projects, and contribute toward the local infrastructure needed to support the new residents they attract. Over the years, large sums have been secured for infrastructure and affordable homes. Developers obviously incur costs when making these provisions. They ensure they can afford these extra costs by paying less for the land they buy than they would have done, if they did not have to comply with these obligations.

Prices for land tend to rocket when planning consent is granted, and it has long been regarded as reasonable for some of this potential increase to be diverted to fund infrastructure and affordable homes. Crucially, planning obligations have enabled private funding to replace publicly funded grants to housing associations, while maintaining the output of new affordable rented homes.

What’s the catch?

Now, developers will be required to provide starter homes at a discount, instead of contributing to infrastructure and affordable rental homes. This trade-off could mean that new starter homes are built, but the supporting infrastructure isn’t. It could also prevent communities from securing the new affordable rental and shared ownership homes they need. This will be a critical loss, especially since the latter have proved an effective way of helping low-income earners to get a foot on the “housing ladder”.

And while financial institutions are keen to invest in newly built privately rented housing, the scale of this activity is still modest and will not be adequate to meet the gaps in rented housing provision in the immediate future.

Perhaps the government has yet to unveil plans to increase public funding for infrastructure and to provide additional grants to build new affordable rental homes. But this seems unlikely, given the cuts to public spending we’re expecting, as we await the outcomes of the public spending review.

What we need, in addition to the government’s aspiration to build 1m new homes by 2020, is clarity about all the resources to be provided. This will allow the house-building and construction industry to gear up with confidence, and aim to reach that target across all tenures. Starter homes will help – but they shouldn’t come at the cost of schools and affordable rental homes.

Author: Tony Crook CBE, Emeritus Professor of Town and Regional Planning, University of Sheffield

How governments are helping big companies pay less tax

From The Conversation.

Corporate tax policy says more about power than anything else. Corporations seek to minimise the tax they pay – and, while governments ordinarily try to maximise their revenues, in the case of transnational corporations (TNCs) they also understand that they have to tread carefully. Governments have come to accept that they hold fewer and fewer cards as capital has become more mobile.

They’ve worked on their electorates in order to drive this message home. During the early period of the 2010-2015 coalition, George Osborne and David Cameron set out their own views by stating that they needed to ensure: “that the way the tax system operates for UK headquartered multinationals does not inhibit commercial business practices or make them unattractive to international investment”.

Trade and competition rules mean that some of the traditional methods of protecting businesses – the imposition of tariffs and the allocation of business subsidies – have been challenged. In such an environment, governments have looked for new inducements to maintain existing, or capture new, business investment and corporate taxation has offered new opportunities in this regard.

The key developments in national tax policies begin to make a lot of sense against this background, especially when we factor into the mix higher public debt levels and large national deficits. Governments have seldom been as desperate to capture the revenues owed to them and close the various tax avoidance schemes that prevail. International interest in corporation tax peaked in the aftermath of the post-2008 economic crisis. And the manner in which the UK Parliament’s Public Account’s Committee, chastised some of the largest and most successful companies for tax avoidance caught many, including the companies involved, by surprise. Parliament wasn’t supposed to talk to major corporations in this way.

We shouldn’t separate the investigations of the Public Accounts Committee from the context of the crisis. For a brief moment at least, major corporations were on the back foot. Public trust in big business – and in the banks in particular – was at an all-time low. The government had an opportunity to tackle the problem of corporate tax abuse and of closing the substantial deficit. However, many governments also recognised that, in the area of tax, they had to act multilaterally in order to ensure that they didn’t simply scare off investors to more favourable tax regimes. And it is out of this that international initiatives, including the OECD’s Base Erosion and Profit Shifting initiative (BEPS), have evolved.

Pay little pay late

The basic strategy for most corporate tax avoidance is simple: TNCs seek to design their businesses so that they pay as much income as possible in countries where taxes are low and as many costs as possible in jurisdictions where the statutory tax rate is high. Low standards of transparency in corporate financial reporting, differences in what should be included in estimates and disagreements over the meaning of corporate tax avoidance have produced varying estimates. The UK government estimates that the difference between the amount of tax expected and the actual amount paid was £4.1 billion in 2010/11 (the most recent estimation year available), although independent estimates put the figure at around £12 billion.

Avoidance stems from a similar set of pressures to corporate tax competition: corporate lobbying and structural pressures on successive governments to induce businesses to invest. These same drivers have created a vast range of broadly defined tax benefits – which increase the opportunities for tax avoidance and help to lower the effective tax rate.

Google denies trying to disguise the way its business operated to minimise its tax bill in the UK. Nick Ansell / PA Archive/PA Images

Findings from the UK have revealed the fuzziness of the rules regarding corporation tax. Creativity in the interpretation of tax rules is embedded in the institutional processes used to develop them. Large accountancy firms second staff to the Treasury to provide advice on formulating tax legislation so that when they return to their firms, they have inside knowledge of how to identify loopholes in new legislation and advise their clients on how to take advantage of them.

Playing the system

The ability of firms to interpret tax rules creatively also reflects the imbalance of resources between accountancy firms and tax authorities. In 2009, the four major accountancy firms alone employed nearly 9,000 people and earned £2 billion in the UK and as much as US$25 billion globally from their tax work; an estimated 50% of their fees now come from “commercial tax planning” and “artificial avoidance schemes”. In 2012, HMRC reported that it had 1,200 staff overseeing 783 large businesses, in respect of which £25 billion in tax was potentially outstanding. There are now around four times as many staff working for the accountancy firms on transfer pricing alone. And even where companies have been accused by HMRC of having underpaid taxes, the outcome has tended to be a negotiated settlement – an unequal process given the different resources available to the two sides and governments’ need to create a pro-business environment.

The potential weaknesses of co-operative approaches are illustrated by the UK’s Disclosure of Tax Avoidance Schemes (DOTAS), which requires companies engaging in tax avoidance to disclose their avoidance activities to HMRC which, in turn, rules on their legality. If legal, the tax avoidance scheme can be used for financial gain until HMRC acts to close the loophole that makes it possible. Unsurprisingly, DOTAS has had little impact on the use of aggressive schemes, largely because HMRC lacks the necessary resources to take effective pre-emptive measures.

Cosy deals

It isn’t just companies that governments are doing battle with over taxation, it is also other states. Apple has negotiated a special tax rate with the Irish government, resulting in its affiliates paying 2% or less since 2003. Starbucks has also apparently reached a similar “secret” deal with the Netherlands tax authorities. Amazon’s tax deal with Luxembourg is so generous that the European Union is currently investigating it as potential state aid to the company.

George Osborne wants Britain to have the lowest corporate taxes in the G20 by 2020. Anthony Devlin / PA Archive/PA Images

Evidence of bespoke tax deals reached between corporations and governments throws into question the very sustainability of the corporate tax system and raises serious questions about the alignment of government and corporate interests and its effects on tax revenues and public spending in future. It also raises questions about the lengths governments will have to go to in future to entice companies to invest and suggests that international agreement on corporate tax competition may be further away than is presently thought.

The key question is whether BEPS will reduce corporate tax avoidance. The OECD, upon releasing its final report, stated that the new tax agreement will increase the corporation tax take and restore trust in the fairness of tax systems. But there is still a long way to go before the BEPS reforms can really be considered to offer a way of tackling tax avoidance.

Country-by-country reporting, for example, will provide country-level disclosures that are unlikely to be transparent and readily available in anything like the format required to facilitate true international cooperation to act on tax avoidance. Moreover, while the rules about taxing economic activity are clearer, there has been no movement on the taxation of corporate subsidiaries so that they will still be treated as independently trading entities. This will do very little, therefore, to eradicate tax avoidance through transfer pricing.

Of course, no international agreement will reduce the pressure, much of it self-imposed, on governments to compete vigorously with other governments in the area of taxation. The UK government has a clear strategy to compete in such terms and has laid out its own stall by setting one of the lowest rates of corporation tax in the OECD.

There is nothing surprising about the fact that corporations should seek to minimise their tax bill. What is more surprising and worrying is the extent of the problem and the fact that governments also appear to be colluding in the practice. The battleground is no longer between corporations and governments, but between governments and governments, each one keen to attract new private sector investment with increasingly attractive inducements to companies to facilitate such investment. With all this going on, the big transnationals may be excused for thinking that such permissiveness is simply part of the overall package of inducements.

 

Authors: Kevin Farnswort, Senior Lecturer, Social Policy, University of York; Gary Fook, Corporate Criminologist, Aston University