I have been happily minding my own business in Costa Rica, off to Alberta for a bit of marketing, then Spain, where I am now. So I check in to the internet this weekend, no worries, the Dow is unchanged, politics as usual, whooops! A $700 billion bailout?? That´s more condos than I can build and sell for the rest of my life! Unless, that is,our politicos blunder (again), inflation ramps up and that starter unit goes for a cool $billion. Oh man, I hope I am wrong about this.
And what exactly are our leaders proposing? Destroy the remaining banks, best I can tell. And here I was, all smug, in a third world country that has sidestepped problems mostly by having an underdeveloped banking system that wouldn´t know a CDO squared if it found it in a crossword puzzle.
So where is the blunder? Step one. (Those who can analyze do, those who can´t, number.) Make banks mark to market the value of their assets. So, if the market panics for a quarter, your bank is insolvent. Step two. Invent a race to the bottom, a reverse auction ( I promise you, I am not making this up), where the most desperate bank wins the right to sell its riskiest assets to us, the U.S. taxpayers, at the lowest price, in competition with other banks. Step three. By the end of the following quarter, use this price to mark to market the portfolios of all banks and other financial institutions, making more of them insolvent. Repeat.
The fact is, the AIG loan of last resort solution was the right one. Can´t borrow money? OK, we provide liquidity, but make it a loan, make it secured, and expect to be repaid. If some banks go broke because of their bad assets, so be it, but not because of illiquidity. Meanwhile, the ones that will survive with time, but suffer from a liquidity problem today, can get their liquidity as loans, yes, from you and me, the lender of last resort. Financial markets unfreeze. Stronger regulation, including forbearance where prudent, gives technically insolvent banks the time to work their way out of trouble, while taking down the hard cases. Kinda like the 80´s.
During the last financial crisis, the Resolution Trust Corporation took over the assets of insolvent S & L´s, auctioned them, and minimized thetaxpayer´s loss. But the key was, insolvent S & L´s were allowed to go bust without being mindlessly marked to market, laid low by bad assets rather than by bad accounting. This new combination of mindless accounting and a mindless reverse auction gives pause. But, I fear, pause is not in the cards six weeks before a general election. Hopefully, this is Bush´s intelligence test for McCain and Obama, and one of them will pass the test.
Here is what I wrote for Chicago Title´s Latin American magazine in a more innocent time (July). For those not interested in Costa Rica, you can stop here.
Friends who learn that I left for Costa Rica looking for adventure three years ago and never came back eventually get around to asking me if the Costa Rican real estate market is still going up in spite of the subprime mortgage meltdown in the U.S. And, if it is, how can that be possible?
On December 14, the Wall Street Journal reported on a phenomenon that those in the know have found out first hand. “The housing slump has sent many Americans shopping south of the border.” Existing-home prices... are still climbing in much of Latin America and the Caribbean. ... In San Pedro, Belize, the average price of a 2,200-square-foot home was $697,500 in September, up 18.6% from a year ago, according to a study by Coldwell Banker; the price of a similar property in San Jose, Costa Rica, was up 20.7%, to $389,900, the study said.” What? In the face of massive publicity in the U.S. concerning the U.S. subprime mortgage meltdown? House prices falling? Foreclosures rising? Gloom and doom.
Let’s start by stating the obvious (it makes things so much easier). A subprime borrower is not now, and never was, a good candidate for buying a vacation or retirement home overseas. Ouch. We sympathize with the plight of subprime borrowers, but, no, here in Costa Rica we do not feel your pain. If you are successful enough to be planning your vacation or retirement haven overlooking the Pacific Ocean, you are successful enough to have sidestepped the problems caused by overextended finances.
What about financing? In the United States, the mortgage market went from being incredibly permissive to incredibly tight in two short years. From fantastic to terrible. In Costa Rica, the mortgage market has gone from worse to bad. Yes, you read that right. Not bad to worse. Costa Rica is only now starting to develop modern home lending practices. Who knows, in another couple of years, they might even be good (which will lift prices). There is always a bull market somewhere (credit to Jim Cramer). What is happening in North America are government policies that look to favor Costa Rican real estate values.
Costa Rican real estate deals are transacted in U.S. dollars. Inflation traditionally has been high when measured in the local currency, the colon. In 2007, according to official government statistics (http://www.inec.go.cr/) Costa Rica’s general price inflation was 10.81%. Construction cost inflation (for construction of houses) was slightly higher, at 11.48%. The main newspaper, La Nacion, calls for 15% construction price inflation this year. In the face of all this local inflation, U.S. dollar price inflation historically has been low, because the Costa Rican government supported a creeping devaluation of the colon against the dollar.
No more. Since 2007 the colon has remained within a narrow band against the dollar, sometimes up, sometimes down. What does this mean for a North American investor? Just this. In order to purchase the same construction one year from now, it is prudent to count on annual construction cost inflation of 15%, plus or minus. And this does not take into account inflation in land prices, driven by the same inflation forces, plus supply and demand. No wonder, then, that prices were up 20% in 2007,according to the WSJ article.
Does this make sense? We have been there before. When general price inflation is high, like in Costa Rica, real estate is a terrific asset class. In inflationary times, you want to own real estate. And since real estate prices move in five to seven year cycles, you don’t want to bargain hunt by buying too early in a falling market like the U.S., you want to buy in a rising market like Costa Rica. There is always a bull market somewhere.
But what about the Canadians to the north? Cold, dark, long winters. Ehh? A strong economy. Crazy real estate prices. The Canadian dollar is up 50% against the U.S. dollar over the past five years. Whoaa. Cheap U.S. dollars. Bargain time in a rising market, sipping a cold one while watching the hot January sun set into the Pacific Ocean.
At The Oaks Tamarindo, my luxury condominium project cum nature preserve located within 10 minutes of Costa Rica’s best beaches, and only 48 minutes from the international airport, savvy North Americans have snapped up units at prices under $200 per square foot, compared to around $500 per square foot back home. Ecologically planned, built to the highest North American standards, with the best of Costa Rica waiting just outside their door. Phase one? Sold. Phase two? We sold 34 units this year, almost all to U.S. and Canadian citizens, only 14 units remaining. What subprime mortgage crisis? Ask the author about phase three. Or selected opportunities. email@example.com.