Learning To Tie The Policy Hands

In recent weeks, it has become clear that the red-hot property market has made the government uncomfortable, even as ministers strenuously deny any plans for demand-side intervention. Instead, 'non-interventionist measures' such as releasing more information and ramping up land sales have been mooted.

Two fundamental rules are generally accepted in the formulation of good economic policy. Firstly, less discretion may be better, especially in circumstances where policy conflicts might arise. Secondly, too much change in policy might not be optimal when there is a high level of uncertainty regarding policy outcome.

Set in this context, one could postulate that the recent escalation of property prices might have been avoided if policies had been more consistent and if policy-makers had less discretion to tinker with the market situation as it evolved.

Macroeconomic Stability versus Reserves Protection

To advance the argument, let me propose that the two main roles of the government are: (1) a macro manager of the economy (2) a custodian of our national assets.

Boom and bust cycles create real adjustment costs for the economy. Over- or under-valued asset prices result in the misallocation of resources for the economy. It is therefore natural that the economy's macro manager be concerned about asset price bubbles and busts.

What about the government as a custodian? During downturns, asset prices are low. Selling land (or other national assets) during these periods would attract low bids, which would be tantamount to diluting the country's reserves. As recent as two years and half years ago, the government was still refusing to release land that did not match its reserve price [1]. Conversely, during a market boom, the custodian has the temptation to sell as much land as possible so as to boost reserves.

Trouble is, there is a lead time of 12-18 months from the release of land, the completion of bidding, and finally to the launch of a project. After the launch, it is another 2-4 years before the project is completed. All in all, it takes around 4-5 years from the release of land to when the housing units are finally made available to the market. The property market works in these very long cycles, which to a large extent explains why the pipeline of housing supply often does not coincide with demand.

Given this lag structure in supply, the release of large amounts of land during a boom could potentially store up for a bust later. Releasing land now does nothing to address current shortages. By the time the completed units become available 4-5 years into the future, the market would have presumably corrected itself. The glut of housing units then simply accentuates the down cycle. As mentioned, current shortages could have stemmed from the reluctance to sell land at lower prices earlier in the cycle [2]. The policy reaction of the custodian can therefore come into conflict with the macro-manager.

Use of CPF and Pro-Cyclical CPF Contributions

Let me turn to the use of CPF for private housing purchases. Those who understand finance will know that there is effectively a call option with the deferred payment scheme. With deferred payment, only a 10 per cent down payment is required to purchase a property with no further payment required until TOP. A 30 per cent appreciation in property prices therefore translates into a 300 per cent capital gain (before factoring in cost).

In mid 2005, the government further relaxed the use of CPF for housing purchases, reducing the cash up front from 10 to 5 per cent. It marked the start of the current property boom. Though the policy change looked minor, its effect was not trivial. In essence, cash needed up front was in effect reduced by 50 per cent. A little cash with deferred payment now allows one to take a speculative position into the market upside. Since speculators often need to cash out before TOP, should we be surprised that the number of sub-sales is increasing? As the government ramps up land sales today, should we not be worried about what would happen to the market when the large number of units reach TOP in a few years time?

Even though CPF is meant for the long-term objectives of retirement and housing, contribution rates are almost always used to adjust short-term business costs. The government as even used it as a signaling device to manage business costs [3]. Employer's CPF contributions are often cut during recessions and subsequently restored during booms. The use of CPF contribution rates as a tool to manage short-term business cost adds another reinforcing factor to the cyclicality of the housing market. CPF contributions are a pro-cyclical source of liquidity in the property cycle.

Unexpected Policy Changes and Timing Difficulties

Discretionary policies often have unintended consequences. Take the sudden hike in development charges recently as an example. The increase in development charges, which is effectively to an increase in land cost, should actually cause prices to go up (not down). Though the policy rational was explained, the market perceived the move as a government reaction to rising property prices. As the market now cannot discount further policy changes , it becomes more erratic even as the government works to stabilise it.

The concession on stamp duties, introduced during the downturn to stimulate the property market, were suddenly removed a couple of months ago. The market can only speculate on what the government will do next to cool the property sector

Often, it is difficult to get the timing of discretionary policies right. The anti-speculative measures of 1996 came on the eve of the Asian Financial Crisis. Instead of a property market correction, we witnessed a multi-year rout. The recent DC hike also came just before the stock market correction. In volatile trading, property and bank stocks have fallen sharply. Policy makers, often compelled to act at the peak of the cycle to check asset prices, can end up correcting too much too late.

Now, this is not to say that one should not be concerned about sharp asset price appreciation. How to identify an asset price bubble, let alone deal with it, remains a fiercely debated question among academics and policy-makers [4] alike.

Clearly, the best policy would be to prevent an asset bubble from forming in the first place. To achieve that would require more consistent rather than discretionary policy. As an example, a less discretionary land sales or CPF policy might just go some way towards achieving this.

Tying of the Hands

Unpredictable policy changes, even those made with the best of intentions, must count as a risk factor to citizens, investors and businesses. As with so many things in life, even U-turns are sometimes necessary when unforeseen circumstances arise. But economic cycles are just that - cycles - periods of ups and downs. Good policies, particularly those that influence the long-term competitiveness of the economy like CPF, housing and land policies, require some consistency and predictability. Too much discretionary control could end up compromising long-term objectives. Some credible hand-tying could actually be good in the long run.


Footnotes

1 "Singapore won't release any land sites on confirmed list in 1H2005" Channel NewsAsia, 7 Dec 2004. "The Singapore government has said it won't release any land sites for private residential, commercial and hotel developments through the confirmed list in first half of next year. Sites would only be made available for sale via the reserve list. . . . The government offers land for sale through a confirmed list and a reserve list. Under the reserve list system, the government will only release a site for sale if an interested party submits an application to have the site put up for tender with an offer of a minimum purchase price acceptable to the government."

2 "Sale of Exec Condo Halted as Home Price Slide" Straits Times 26 June 2004. "A slide in prices of private homes in recent years has prompted the Government to refrain from offering any executive condominium (EC) building site for sale for the rest of the year."

3 "CPF Changes a Bold Signal to Investors" Straits Times, 3 Sep 2003. "Acceptance of tough new moves proves Singaporeans' adaptability and shows 'we have a great people', says PM Goh"

4 The former Federal Reserve Chairman Alan Greenspan noted just how difficult it was to check asset price bubbles. The current chairman Bernanke essentially supports this view, but many economists remain highly skeptical about this 'do-nothing' approach. Many economists now blame Alan Greenspan for cutting interest rates too aggressively post dot-com bubble, creating a potentially more dangerous housing bubble in the process