Why is SMRT Raising Fares?

Lost amid the Anton Casey mess was the announcement that SMRT would raise fares by more than 3% in 2014 and additional 3% in 2015.  With yesterdays announcement that SMRT profit had fallen by more than 40%, SMRT appears destined to take increasingly stronger steps to maintain profitability.  While people have understandably been upset by the fare increase, there appears to be a poor understanding of how this fits into the larger picture of Singaporean public finances and the Temasek portfolio.

  1. Transportation companies and especially public transport companies are notoriously unprofitable.  There is a reason there are virtually no listed public transportation companies and that is because they are unprofitable.  Throughout the world, whether it is North America, Europe, or even Asia (Singapore and Hong Kong excluded) public transportation companies like bus and rail companies do not make money.  Public transport train, subway, and bus companies from Japan to Germany are rarely profitable enterprises.
  2. SMRT is an immensely profitable firm.  Despite being in a difficult industry, SMRT has posted net profit margins of nearly 20% as recently as 2010 and even in its most difficult recent year still managed to post a net profit margin of 7.3% equaling $83 million SGD.  In other words, despite declaring a healthy net profit, SMRT has also declared its business model “unsustainable”.  This begs the question: what is driving the unreliability and financial problems at SMRT?
  3. SMRT is receiving subsidized profits via government funds.  Though most people are aware of the subsidized fares available to seniors and students, there are two much larger and less obvious ways the government subsidizes SMRT.  First, the Singapore government has been gifting buses to the SMRT most recently to the tune of $1.1 billion SGD resulting in an annual implied subsidy.    If we take a simple scenario assuming this money was loaned to SMRT over 10 years at 5% annual interest, this would necessitate annual payments of $142 million SGD.  Consider, that SMRT only recorded net income of $161 million in 2011 declining to $83 million for the year ending March 31, 2013.  It becomes obvious how important this implicit subsidy become to SMRT reporting yearly net profits around 10%.


Second, though there is no public statement about the agreement between SMRT and the government on the rail, subway, and light rail assets, given the generosity of the government to SMRT with regards to buses, it stands to reason that they are displaying a similar level of generosity with regards to rail assets.  The government of Singapore paid for out of public funds and built rail and subway lines and then reach an agreement for SMRT to pay the government for the use of these assets.  If the government is not charging SMRT a cost plus rate for the use of those rail assets, as is the most likely scenario, this represents an additional significant subsidy.  Given the large amount of money invested by the Singaporean government over time but the longer expected of life span of rail assets when coupled with the bus subsidy, it would be conservative to estimate an implied subsidy of greater than $200 million SGD annually to SMRT.  Given their recent net profit of $83 million and their $163 million in 2010, this implied subsidy represents between 125-250% of net profits.


  1. This matters because SMRT is a publicly traded firm and a portfolio company of Temasek.  SMRT is publicly traded and counts Temasek as its dominant shareholder.  Temasek repeatedly boasts its superior asset management in producing 16% annualized returns since 1974 and SMRT has produced consistently high rates of return producing an 18% net profit in 2010.  Given the close links between the government and Temasek, each has an incentive to ensure continued profitability even if that means the government gives money to Temasek managed firms so they can declare a profit.  SMRT is only making a profit because of government subsidies not due to superior management.  If the government wants to give money to SMRT for the purpose of maintaining service, this would be a reasonable use of public funds.  However, the government giving money to SMRT so it can declare a profit and increase the rate of return for government linked shareholders is nothing less than cronyism.

Let me strongly emphasize that given the difficult nature of the public transportation industry, I am not philosophically opposed to public private partnerships in this area.  However, it seems to be a clear conflict of interest and inappropriate for the government to be subsidizing the profits of a publicly listed firm that is owned by a government owned investment firm.  SMRT clearly has no profits without government subsidies and the subsidies should not be used to allow Temasek or other executives to meet profit or return targets for bonuses.

Chinese New Year News

Apparently, I am not the only one coming up with better estimates for the reality of Chinese data.  One Chinese academic says that if a more representative methodology is used to record home prices in China it may increase “housing market appreciation by more than 100%!”  It is also worth noting this is from the China Daily not a foreign publication.  These data discrepancies have caused one research firm to estimate Chinese GDP at 6.1% in the 4th quarter rather than the officially report 7.7%. More some other time on why China needs to maintain such rapid growth but it is interesting just how many people are pointing out the Dragon Emperor has no clothes.

From departing Fitch Chinese shadow banking expert Charlene Chu comes this beautiful tidbit regarding asset management and bad loans:

The fundamental question with these asset-management companies is where are they getting the money to do their business. We can see on the asset-management-company balance sheets that much of their funding is coming from banks, so they are borrowing from banks to buy bad debt from banks. In that scenario, there isn’t any true risk transfer the way there was in the previous bank bailout when the financing for the nonperforming loan carve-outs came from the government. Instead, what we have is bad loans moving from banks’ loan portfolios into their interbank portfolios as a claim on an asset-management company. Over the short term, this disguises the bad debt situation. But over the longer term, if asset-management companies can’t repay their borrowing from banks, then bank capital is still at risk of loss….Fundamentally there needs to be a deeper recognition that most of the challenges facing the financial sector, including the liquidity issues we see at the moment, are related to asset quality problems. That’s regardless of what the nonperforming loan data say. The market recognizes that; that’s why the banks are trading at such low valuations.”

While credit problems loom in China, there are also larger underlying pressures to the real economy.  One of the biggest is wage pressures.  According to this Financial Times article Chinese “factories made clothes at half the cost of its facilities in Malaysia and Thailand but that gap has since disappeared.”

China wants to start policy think tanks which invites the obvious question: don’t you need to be able to think to have a think tank?  Jailing professors for pushing the government to require officials to disclose their personal wealth isn’t radical stuff, unless you have something to hide.

Update:  According to Goldman Sachs the Chinese banking regulator has issued a warning on all loans made to coal miners.  Remember, it is a Shaanxi coal miner that triggered the first wealth management product that defaulted which is currently under negotiations with investors.


Is Singapore Headed to an Iceland Style Meltdown: Part II

In Part I of this series, I provided an economic philosophy for the prediction of financial crises or bubbles where I point out that it is incredibly problematic  to try and predict them.  We can see risks but predicting a financial crisis is something very different.  There is an old joke that says God invented economists to make astrologers respectable.  The point being that it is important to have an enormous amount of humility when prophesying about what is to come.

I believe words matter in writing as they state our intended meaning.  Jesse Colombo when writing about Singapore did not write that Singapore real estate is overvalued; he did not write that credit has expanded rapidly in recent history; he did not write that Singapore is a major investor in the region holding potentially overvalued assets.  Jesse Colombo asked whether Singapore is going to suffer from an Icelandic style meltdown.  Therefore, the question before us is whether Singapore will suffer a financial crisis similar to Iceland.  To answer this question, it is important that we have small understanding of the Icelandic financial crisis.

Prior to the 2008 global financial crisis, Iceland banks and investment firms began to accept deposits and borrow from foreigners to subsequently purchase foreign denominated assets.  When money markets seized up in 2008 and short term credit became unavailable to even the most credit worthy firms, Icelandic banks became unable to roll over their borrowings or repay foreign creditors.  To provide some perspective, Iceland’s external debts were nearly 7.5 times GDP and total banking assets were 11.1 times GDP.  External debt amounted to 160,000 Euros per citizen of Iceland.  Due to the collapse of the three major banks, the stock market declined more than 90%.  The declining currency cause a surge in inflation above 12% for two years straight and interest rates topped out at 18%.  The government budget went from essentially balanced to a deficit of 9% of GDP and the unemployment rate more than quadrupled.  The point here is that this was not a small economic correction but one of the most sudden and largest, in relative terms, financial crises in human history.  Therefore, what are the risks that Singapore will suffer from a similarly large and wrenching financial crisis?

Before, I begin to answer that question, I want to emphasize three things.  First, I recognize many of the same risks cited by Mr. Colombo.  The risks due to home value prices and the rapid expansion of credit to cite just a few are legitimate concerns, though I believe that these risks are enormously overstated.  However, the question is not whether these risks are elevated but whether Singapore will suffer an Icelandic style financial crisis.  Second, given that the analysis in question was filled with lots of well cited data, I will not revisit each point and will also assume everyone has already read the piece in question.  Instead, I will show what I believe I more important facts to consider.  Third, I will not address many related questions that could and should be asked here about policy responses or whether these things are good or bad for Singapore.  I will only focus on whether these factors will lead to an Icelandic style financial crisis.

  1. Singaporean external debts are elevated but not excessive.  One of the most common threads between financial crises are significantly elevated levels of external debt and increasingly short term debt.  Now as I noted philosophically previously, just because those two factors exist does not mean a financial crisis is imminent.  Singapore currently has an external debt to GDP ratio of 4.1 well below the Icelandic number of 7.5.  What is just as important is the composition of that external debt is its composition.  Most of that is in banking deposits.  As Singapore has become an offshore banking center and many corporations and wealthy have moved to Singapore, they have similarly brought financial assets.  The large majority of external debt is in the form of banking currency and deposits.  Iceland was never a banking center providing a large range of financial services to a region or wealthy population.  With 1 in 10 Singaporean residents having more than $1 million USD in liquid assets to invest, it is little surprise that this number is at this level.  Given that small countries will both trade and invest more outside of their own country, the risk here might be considered slightly elevated but not excessive or extreme.
  2. Singapore real estate prices and debt appear to have a somewhat elevated but not excessive risk.  Though there are numerous data and methodological issues associated with obtaining good estimates of the relationship between income and housing prices, Singapore real estate prices and related debt markets do not appear to be excessively stressed.  For instance, the population of Singapore demonstrates relatively high inequality and available wealth.  These two factors generally push real estate prices higher raising the overall home price to income ratio.  Taking a simple, unweighted average of resale prices for apartments in Singapore from official data, the average price is $521,861 (I used this simple calculation as an approximation as better data to make a more precise estimate is not available).  Given an average per capita GDP of $66,521 SGD according to the IMF in 2013, this implies a home price to income ratio of 7.85.  Again, this is elevated and puts stress on families and business but again this is not excessive and seems not to imply an Icelandic style meltdown.  Though the coming surge of home being built by developers may soften prices or push asset prices down, that is very different than causing a precipitous drop that ignites a painful financial crisis.
  3. The uniquely Singaporean characteristics.  Though I am normally reticent to describe a situation as different, I do believe there are some uniquely Singaporean characteristics that are overlooked.  Let me give you a couple of examples.  First, though there is a very large public debt, it is owed to the citizens of Singapore via the Central Provident Fund holdings and controlled primarily by the Singaporean government.  While that does not make the debt and accompanying interest payments any less real, it does eliminate the possibility that investors will dump government bonds.  Second, the Monetary Authority of Singapore has large foreign exchange reserves and could defend all but the largest of financial crises against currency runs or bank recapitalization needs.  Furthermore, give the managed exchange rate, it is not inconceivable that should a significant risk of financial crisis arise, that MAS would simply impose currency controls keeping bank deposits in Singapore.  Third, one of the risk of being a small country is the push to invest and trade abroad.  Countries like the United States and China have very small external economic activity numbers, Singapore especially as a true financial center has to engage with the outside world raising many of these numbers.
  4. A few specific rebuttals.
    1. The chart on the second page of the piece which says that Singapore has high household debt relative to GDP fails to control for wealth and is consequently essentially meaningless when compared to other countries given the level of financial asset wealth in Singapore compared to other countries.
    2. The chart on the second page of the piece which says that Singapore is experiencing an “epic” housing bubble is again blatantly misleading.  While recent increases have been above the long run trend, the long term trend is nothing out of the ordinary and as shown by a simple estimation of the home price to income ratio, is elevated by not remotely close to “epic” or anything triggering a major financial crisis.  The long run price increase, given that 1998 is equal to 100 in the figure, produces a long term price increase of 5% annually.
    3. The numbers cited on page 2 for the home price to income ratio cannot be reconciled with third party data.  For instance, according to the methodology used by the website he cites, the average price in Singapore would need to be approximately $2.25 million SGD!  Now even if you are skeptical of official Singaporean statistics on apartment resale value or my simple calculation above, I doubt anyone would believe that the average home price in Singapore is $2.25 million SGD.  If you take the much more restrictive household median income using official statistics, this would still yield an average housing price of nearly $1.6 million SGD!  Additionally, somehow the city center and the outside the city center home price to income ratio for Singapore are both higher than the ratio for the entire country.  Given that Singapore is a city state, this seems mathematically impossible.
    4. On page 4 of his piece where he complains that assets under management in Singapore surged by 9% annually between 2007 and 2012 and 22% in 2012, he should keep in mind that given returns on capital and any new inflows, that is about right.  Important to put this all in perspective.

I do want say very clearly that I share many of Mr. Colombo’s concerns about the expansion of credit, low interest rates, and rapidly rising real estate prices.  However, and this is very important, he so drastically overstates them to the point that valid concerns about potential financial risks become lost in a haze of hyperbole and hype.

As anyone who has read anything I have written about Singapore knows, I am no defender of the current economic policy in Singapore or the enormous irregularities in public institutions.  There are some distinctly valid and reasonable concerns about economic and financial risks in Singapore.  However, there is no reason to believe that these risks will result in an Icelandic style financial crisis.

Note 1:  Wikipedia has a good summary of the Icelandic financial crisis.

Note 2:  Here is a basic spreadsheet with Icelandic economic data between 2000 and 2014 from the IMF World Economic Outlook database.

Note 3: The external debt statistics were taken from the IMF and World Bank Quarterly External Debt Statistics database.  You can find that database with data for Singapore as well as other economies here.

What Investment Banks are Saying About China

According to JP Morgan report on housing in China from late November, “we think homes are still broadly affordable to the general public and policy risk should be contained in 2014.”  Wonder if they interviewed anyone in China or looked at any measure of home prices for this piece of crack research?

Credit Suisse has even better crack research, which albeit defies the laws of mathematics, but offers hope for those who failed statistics.  According to CS, “all of them (Chinese real estate developers) expect their own company’s growth to be higher than the market’s – even though some of them have been underperforming the overall market in terms of contracted sales growth over the past few years.”  Let’s break this down real slow.  First, it is mathematically impossible for everyone to “be higher than the market”.  If you believe this is possible, no wonder you are optimistic on Chinese developers.  Second, if you ignore the fact that sales growth is contracting then yes, you can continue to remain upbeat on Chinese developers.  Amazing that you need an MBA to come up with research like that.

Credit Suisse which appears to be able to state the obvious writes of the recently finished government audit PR campaign of public debt that “Local government debt (LGD) almost quadrupled from Rmb4.5 tn in 2007 to Rmb17.9 tn by 1H13 (or +67% since 2010)…we view fast LGD growth in the past few years as not sustainable.”.  That bit of profound financial insight just might be the understatement of the year by the same people that believe all companies will outperform the market.

According to another JP Morgan report from earlier this month on Chinese financials, “we believe that 2014 is going to be a tougher year for banks, compared to 2013, as the liquidity situation is going to be tight and asset quality deterioration will continue.” Just to be clear, the year when at least one Chinese bank has acknowledged being in technical default is going to be the easy year?



My Favorite Things in Chinese Finance

Best thing I have read on the explosion of Chinese credit and wealth management products:  “Looking purely at the decline in the year-on-year rate of credit expansion is kind of like arguing that if I chase my shot of vodka with a pint of beer, I’m actually exercising moderation because the alcohol proof level of my drinks is falling.”

How much risk to Chinese corporates and specifically developers actually face?  One Chinese developer doing a USD bond offering is paying 3.6% more than Zambia, 1.4% more than Ghana, and 2.6% more than Nigeria.  To put this in perspective, USD bond investors would rather send their money to Nigeria the 144th most corrupt country in the world than a Chinese developer.

As every monthly spike in Chinese interest rates is supposedly due to to “seasonal” fluctuations you become a bit cynical, but now it might actually be true.  Happy Spring Festival everyone.

Is Singapore Headed to an Iceland Style Meltdown: Part I

The piece by Jesse Colombo asking whether Singapore is headed to an Icelandic style meltdown received a lot of attention but not a lot of analysis.  I think it is important to examine not only the factual basis for the arguments put forth but also the bigger picture philosophical framework for predicting financial crises.  Today in the first part, I will place the arguments in a type of philosophical framework and the biases we have with regards to economic and financial analysis.

Event convergence.  Plane crashes are fascinating events.  They are rare and unpredictable events that are normally a confluence of divergent factors that uniquely converge at one point.  Many of the factors that are present in plane crash are common in many flights that never crash.  An accumulation of risk factors does not guarantee a catastrophic event but only increases the probability necessitating a catalyst event to cause a crisis.

Many of the financial and economic risks that Mr. Colombo cites are valid concerns, though I do not share his belief about the severity of those imbalances and their probability in causing a financial crises.  Real estate prices, excessive debt levels, and monetary stimulus are all elevating risk factors many of which have been acknowledged by the Singaporean government.  However, I do not currently believe that these factors are so unbalanced as to cause a financial crisis.

All the world is a nail if you only have a hammer.  There is a joke about the stock market that says it has successfully predicted 10 of the last 3 recessions.  Since the 2008 global financial crisis, many people carrying forward those lessons have dedicated themselves to forecasting bubbles   Unfortunately, irrational exuberance has given way to irrational bubble obsession.  A range of analysts, not just Mr. Colombo, have taken to calling just about everything the next bubble.  Given the number of bubbles that Mr. Colombo is predicting it is not unreasonable to think that one of them may come to pass though given the number of bubble forecast, that does not validate his wisdom but prove only that he makes lot of predictions.

Mr. Colombo is predicting bubbles across a wide range of economies and individual markets.  From Canada to Asia and higher education, social media, health care and housing, the prediction of bubbles everywhere we look is swamping reality.  I believe the reality is much more complex and driven by different factors.  To give one simple example, most commodity prices have grown relatively slowly post 2008 and enjoy significant new demand from emerging markets like China and rapid supply growth due increased oil and gas output in the United States.  If everything you see is a bubble, you miss much of the complexity of the global economic system and the underlying dynamics.

When is a bubble a bubble? Prior to the 2008 financial crisis, there was a debate in central banking circles about whether or not monetary policy should be concerned with asset values like home prices.  Alan Greenspan made a cogent argument that bubbles could not be identified before they “popped”.  He was not saying the bubble did not exist but only that predicting bubbles was akin to astrology.  In fact in his career, Alan Greenspan correctly understood the rapid increase productivity in the late 90’s due to improved information technology but failed to understand the importance of low interest rates in fueling the disastrous housing bubble in the United States.

The Icelandic meltdown was a catastrophic event that was accompanied by large defaults, collapses in real economic GDP, and a fall in the exchange rate.  In fact, may countries have had similar economic and financial imbalances without suffering a catastrophic financial bubble crisis.  However, Mr. Colombo has predicted a catastrophic event like the Icelandic meltdown and not a slowdown in asset price increases, recession, or other such mitigating process.  History tells us instead that financial crises are relatively rare events while it is much more common to have a “balance sheet” recession or reduction in credit due to higher default levels.  In other instances, asset prices may fall or slow for extended periods of time without having a full crisis.

Cities are different.  There is not a clear answer but major cities, and especially financial centers such as Singapore, operate under slightly different rules than most places.  Cities like New York City, London, Abu Dhabi, and Hong Kong suffer from many of the risk factors such as high real estate prices and rapid expansion of credit and yet they continue to flourish and expand.  During the financial crises and even in other periods of economic stress, these cities have suffered less even though real estate and other financial factors indicated stress.

Iceland however, never had a financial center but only borrowed in other currencies to reinvest else where for its firms global investment.  That makes it significantly more risky than a financial hub like Singapore.

Many cite the old adage that if we do not learn from history we are doomed to repeat it.  I prefer a variant of this saying which says, history repeats itself but just differently enough to fool us into thinking we know what we are doing.  While I agree with many of the general risks cited with regards to the Singaporean economy, I think it suffers from a variety of defects not least of which are some philosophical or theoretical short comings.  Though I am no defender of the economic and financial policies of the current Singaporean government, as anyone knows, I think the risks of a catastrophic financial crisis are extremely over stated.

Note: The second part of this series will deal with the analysis of risks cited and what the risk for a catastrophic financial and economic crisis in Singapore is.

Returning to Chinese Debt Concerns Part I

A New Year and another round of end of month Chinese liquidity concerns.  Probably the most concerning aspect of the near monthly or at least quarterly money market and bond rate spikes is the regularity with which they are occurring.  These are not one off events but indicators of enormous underlying problems in the Chinese financial markets.

While much of the concern over Chinese debt has focused on either over leveraged consumers buying inflated apartments or public debt, both of these focuses which flow from the 2008 financial crisis and the European experiment rather than considering the big picture of China.  The Chinese National Audit Office released its anticipated report finding that public debt at all level was reasonable and not excessive.  The headline number reported of $3 trillion USD is large and has grown rapidly but still not excessive.  (Though any public economic or financial number from the Chinese government should be deemed more public relations than fact for our purposes, let’s assume the number is real.)

Focusing solely on the headline debt level number overlooks the real importance of the report and the accompanying big picture.  First, while bank lending has remained quite constrained shadow financing channels and related liabilities have exploded.  The Wall Street Journal sums up the problem noting that a “…major increase in funding came from arrangements by local governments to pay later for goods and services, effectively pushing the cost of financing projects onto developers and contractors.”  The net result is not a decrease in the total debt level but rather where the debt is counted, in this case private rather than public debt.

In another example of reshuffling the deck chairs the WSJ notes that the biggest increase  “…was (from) state owned enterprises, or ‘wholly state-owned firms and state controlled firms ….accounting for 43.7% of new funds raised….SOE’s didn’t even make an appearance in the 2010 audit.”  In other words, debt and guarantees, implicit or explicit, by governments to cover corporate debt is exploding.  This matters because the governments have an enormous incentive to move liabilities just far enough off the balance sheet to avoid detection or provide guarantees.  Furthermore, the line between public and private is so blurred in China that studying simply the strictest definition of public debt fails to capture the true picture of the debt problem.

Second, though most of the focus has been on the public debt level, the number that should concern investors is the aggregate corporate debt level.  China’s second largest brokerage noted its concern over the rapidly rising corporate debt level saying it could trigger a financial crisis.  Liabilities at non-financial corporations may exceed 150% of GDP in 2014 and already passed 139% of GDP at the end of 2012 the highest level of major economies.  To put this level in perspective, France is at 108%, Japan at 103%, and the profligate US a relatively small 78% of GDP.  Given the blurred line between public and private interest in China, even if the official public Chinese debt number is true, until a true division of public and private financial interest exists, the corporate debt level should concern any China watcher.

Third, overlapping interests between public and private are not the only cross guarantee concerns.  In China it is very common for companies, governments, or individuals to guarantee the debts of others.  This creates a domino effect where one bad debt can create a cascade if the guarantors cannot cover the debt they co-signed. Given the explosion of trust company and shadow financing in the past few years, this is not an unrealistic concern.  According to one report, “98% of companies” in the prosperous area of Wenzhou have cross guarantee loans.  Though data on these types of guarantees does not exist nationwide, it is believed that this is a very common practice between a web of actors throughout the Chinese economy simply raising the risks in the case of default.  According to one report, even public entities pay in excess of 10% to borrow from trust companies which accompany additional guarantors.  Even in 2010 50% of local government financing vehicles were receiving payments from guarantors and outside parties to service the debt as revenue from project or public sources was unable to cover repayment.  Domestic Chinese financing institutions are giving as clear a picture as possible about their perception of risk to the corporate and public sector.

While the headline number of public debt, if it is real which is a dubious proposition on so many levels, this should not bring relief.  Public liabilities have exploded in the past few years, more expensive non-bank financing is the driver, and corporate debt levels which may or may not be a quasi-public debt are among the highest in the world create a worrying picture.  Focus on the headline number of the Chinese economic public relations machine at your own peril.