Churchouse Letter
November 2013         by Peter Churchouse

Asia on the Brink Again?

Should I stay or should I go? That’s the question facing not only fans of The Clash but also investors with a portfolio in Asia.

After the U.S. Fed’s announcement that it would “taper” its massive money-printing exercise, cash fled Asia, doubts are rising and the skeptics say it’s time to leave.

There are plenty of similarities with 1997, when a meltdown in the Thai economy spread throughout the region. This time, India and Indonesia are under heavy pressure, their currencies down heavily, and government liabilities and current account deficits rising by the day.

Are we witnessing another Asian financial crisis?

The November edition of AHA answers that question with a look at the current economic climate in Asia and a frank assessment of the risks we now face.

This edition explains how every crisis has its roots in overborrowing, whether it’s 1997 or now. It’s always high levels of debt that make up the kindling of a crisis and it only needs a spark, a catalyst, to set it on fire.

I’ve been around long enough to see several cycles, and the first crisis that I sat through is burned in my memory. It was back in 1980, and I was new in Asia, a fresh-faced analyst.

My clients were putting me through the wringer as we planned an entire new town in Hong Kong. I was regularly working 16-hour days, serving a consortium led by Li Ka-shing, now Asia’s richest man – and he got there not only by being a great dealmaker but also by being a hard task master.

So late one night you would have found me pouring over a stack of charts showing the movement of the stock market and property prices. On this particular evening I uncovered something that made the hair on the back of my neck stand up.

It was easy to make money in property, and prices had doubled – for three years in a row! But as I looked over the spreadsheets, I knew something was wrong. The levels of debt that Hong Kongers were taking on to pay for skyrocketing property meant that only five percent could properly pay their mortgage. This was going to be a crash. The only question was when.

My bosses laughed at me, telling me I didn’t understand life in Asia. But three factors bothered me – telling signs of crisis that I outline in this report.

I thought prices would fall 10 to 20 percent. I was wrong. They fell by almost 70 percent. This crisis made the Asian financial crisis and the global financial crisis look like a kiddies’ picnic.

Today, property prices have once again shot up around Asia. Global Central banks keep minting new money, flooding the market with capital, and encouraging you, me, everyone to borrow.

So are we sitting on the bonfire, waiting for that spark to ignite all that debt?

Enjoy the issue,


Another Asian Financial Crisis?

It was late 1980, and I was reaching the end of yet another 16-hour day, pouring over a bunch of charts showing recent moves in stocks and real estate prices in Hong Kong and Singapore. The eagle’s nest of an office that my team called home seemed perfectly designed to give us perspective – we were half-way up Hong Kong’s tallest building at the time, the 66-storey Hopewell Centre.

I had been called in to advise a group of corporate investors, led by Li Ka-shing’s Cheung Kong (Holdings), to develop a 1,200 acre site in northern Hong Kong. That might not seem like a lot of land to people sitting in the United States or Australia – after all, CNN founder Ted Turner holds almost 500 times that amount on his own, with a 590,823 acre ranch in Montana.

But 1,200 acres is a lot of space in Hong Kong, one of the most crowded and vertical cities in the world. My job was to help them build a new town of 535,000 people.

When I say help, I should say “Help make money.” My main job wasn’t to plan the city but to figure out how much would be in the bags that the consortium was going to haul down to the bank.

Making money in real estate wasn’t hard. Regional property prices were on steroids. I’d never seen anything like this before. Hong Kong had witnessed increases of between 100 percent and 125 percent.... for three years in a row!

I was a younger and less experienced analyst back then. I had been in Asia for six months. “You don’t understand Chinese culture,” my superiors would say when I raised doubts.

But as I looked over the spreadsheets late that night, I knew something was wrong. This was unsustainable. Prices had to come down, and I knew it wouldn’t be by two or three percent. This was going to be a crash. The only question was when, and what would trigger off the bomb that blew up, financially, all these buildings.

There were three main things that bothered me.

  1. Companies were taking on huge amounts of debt to churn out real estate for buyers and speculators. Property developers had debt-to-equity ratios of 150 percent or more. And they weren’t alone in the corporate world.

    A “healthy” ratio for developers is less than half that, at 40 to 70 percent.

    (The debt-to-equity ratio is a measure of the level of borrowing. It shows whether a company is using more debt or more equity to finance its assets.)

  2. Interest rates were high, and rising fast, at 12 percent and on their way to 18 percent. Forget about paying down the debt. Borrowers were starting to struggle to make their interest payments.
  3. My housing affordability index (which I still use today) showed that in Hong Kong only five percent of households could afford the mortgage on a modest lower-end apartment. The percentage was a little higher in Singapore, where more than 80 percent of housing is provided by the government anyway.

But this couldn’t go on. Something had to give.

I had been hired as a consultant to run the design, planning, economics and engineering of the largest-ever private sector new town in Hong Kong. My client scoffed at my warnings. I remember it vividly! The executives laughed at my predictions of a 10 percent to 20 percent tumble in property prices. And I was wrong. Prices collapsed by an average of 70 percent over the next three years in Hong Kong, a little less in Singapore.

It Was All About the Debt

I had a front row seat and watched the regional debt-induced mayhem unfold over the next couple of years. It was an eye-opener. The debt beasts that had fuelled the boom turned vicious – and devoured companies that had loaded up on bank debt. There was one saving grace: consumer debt in the region was modest, since banks didn’t lend to consumers back then. Credit cards were in their infancy.

The debt lay on the balance sheet of companies, especially property companies, infrastructure companies, and construction companies. Debt-to-equity ratios of 100 to 150 percent were common going into that crisis. Asset markets disintegrated. Property sales collapsed. Interest burdens skyrocketed. A full-scale banking crisis loomed.

Companies and individuals who teetered on the brink of financial disaster (or fell over the cliff) learned their lessons. Once bitten and twice debt shy.

Debt is at the Centre of All Financial Crisis

Nearly all recessions and financial crises start with overborrowing. The extreme debt appears either in key parts of the economy or the economy as a whole. Then there’s a catalyst that pops the bubble. The inevitable fallout follows. We see it time and time again. The global financial crisis we are struggling to exit had its roots in excess lending for real estate in the early part of the last decade. The binge started in the United States, Britain, Ireland and Spain, which got drunk on debt. But the hangover was felt far and wide because so much of this debt ended up in the hands of foreign institutions.

It was over borrowing and unwise levels of debt that caused the 1990-91 recession in the United States and United Kingdom, again largely in the real estate sector. You may remember the Savings & Loan crisis at that time.

Right now, the money printing presses in the West and Japan are spinning. This is all aimed at encouraging you and me to go out, borrow and spend to boost growth. I get a serious sense of déjà vu.

Are we setting ourselves up for a rerun of this bad movie? So far most of the "new" money in the United States remains in the banks. Companies and individuals in the West are not ramping up their debt levels. Consumers and companies are still trying to cut down their debt.

It's a Different Story in Asia and Emerging Markets

Debt can be good. Debt can be bad. The trick is to know when you cross the threshold. It’s simplistic, I know, but it’s true.

There’s an old adage "Neither a borrower nor a lender be,” which is actually a line from Hamlet. I disagree. There have been few, if any, successful businesses in modern history that have not borrowed money. Debt lets you grow a business and your assets using someone else's money. Debt is simply another case of supply and demand. A lender has cash, and would like to make a return on it. A borrower needs cash, and will pay the lender for the use of that cash.

Much of the money printed in the West has found its way into Asia and other emerging markets in the form of debt or equity. With new locally minted money, I have witnessed a new round of Asian borrowing. China in particular pushed 100 percent more bank lending onto its people in 2009, and has kept similar levels of bank lending ever since…

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