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A case study; You are the Chief Financial Officer for a company that manufactures a simple consumer product (let us call it Candy Bar SIWASH) that is taken as a snack by people. This company is multinational and this simple product has been in existence for a long time produced from two factories (one in Turkey and one in the UK) alongside other products. The city of Dubai was always supplied by the Turkish plant.
Well, due to natural growth and the two factory lines achieving full capacity, there will be a third factory next year which can also provide this candy bar. Thus, you will have to take some portion from each of the three factories and the unit cost will differ. How can you ensure that you are fair?
Well, one approach was to price the unit cost at an average price of the three factories thus, allowing your team in Dubai to not care who provides them with the product (assuming the packaging/taste/colors are the same as it is a simple product). Seems simple enough, and has been done before, but it is not the best answer. Why?
Because it does not reward good performers nor does it penalize bad performers. As the average price is taken, then factory managers will not identify ways to cost-cut as the incentive from them is gone. Their survival is not threatened. Meanwhile, if the price per unit is determined according to the lowest price, then the incentive is to receive orders or risk shutting down.
What does this have to do with Dubai and mortgage lenders? Well, yesterday I found out that Amlak has raised the profit rate (Islamic interest rate) on my mortgage to 7.75% which is ridiculously high. The reason behind it is due to the uncertainty in the freehold market and the fear of defaults by a significant number of people. In other words, let us penalize the ones who will be paying to make up for the defaulters. Well then, what is the incentive for a person to pay instead of deciding to default and run away? This definitely does not make sense.
Can the top officials of these organizations please go back to business schools or “common sense” school? These are the hard questions that the superiors of Dubai should be asking them. Just like the example of Simon Ford, Blue Banana owner who decided to flee as it was the better alternative to them, we will see many taking the same choice and the hole that is being dug will only become deeper and deeper. There is no confidence in any person of authority taking up the “common person’s” cause and becoming their advocate.
A simple suggestion: Amlak and Tamweel (alongside the semi-government property companies such as Emaar, Nakheel, and Dubai Holding) should renegotiate the agreed purchase prices of these properties that have a mortgage on them. They should share in the pain of “taghreer” which they have done by launching properties at highly inflated prices from their true value and reduce the prices as the end-user has to pay. So, the prices have declined by 40% (if not more) from their highs in the summer of 2008. How about a reduction in the selling prices by 20% (thus sharing in the burden with the purchasers)? Makes your mortgage payment easier, and encourages you to make it and stay instead of seeing that running away is your only option.
Sadly, I do not see RERA and/or Land Department of Dubai thinking strategically like this. Call me a cynic, but we all await the disaster that is coming. I hope I am proved wrong.
Showing posts with label mortgages. Show all posts
Showing posts with label mortgages. Show all posts
Monday, June 29, 2009
Saturday, October 11, 2008
A Basic Explanation of the Global Credit Crunch
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At the outset, let me point out that I am not a financial expert, but one who has an active hobby in understanding finance and economics. My MBA degree also lends me certain credibility in this sphere. I will attempt to give a basic explanation of what happened during the past week in the financial crises that has wiped out people’s savings and fueled panic selling making markets lose 30% of their capitalization amounting to billions and billions of dollars.
The main reason (and there are many other reasons that have contributed to it) behind was a strategic planning mistake by the US banks. Instead of assessing the credit worthiness of the applicants and their ability to make the monthly payments when applying for loans, especially home purchases, they assessed the amount of credit based upon the current market valuation of the actual homes. Well, once the economy was healthy and booming with the prices of homes increasing on a regular basis, this was fine. However, it transferred the risk to the banks and this was the strategic mistake once the economy slowed down.
When they attempted to get rid of these home assets (once they reposed them), they could not at the price they had valued them in their balance sheets. Thus, a fire-sale ensued which led to huge write-offs.
The other strategic mistake is that they collateralized these mortgages to be able to take out more credit from other banks and become more aggressive. Thus, the domino effect happened and with one bank going down, the rest had to follow. That is why the bank bail-out was so important and the government having to guarantee people’s deposits. Otherwise, the ramifications would have been unthinkable.
However, I do not understand how this got translated towards the Arab world whereas the stock markets have shed about 20-30% of their market value over the past week. After all, accessing credit in the Middle East is a lot harder and restrictive than the Western world. In addition, there is only a small portion of mortgages as a percentage of banks’ portfolios relative to the Western world. Moreover, the high price of oil (which is our main produced component) shows no sign of easing or disappearing. In other words, our fundamentals are still strong. So, who can explain it to me?
One person who is a director for a reputed financial institution told me that if the market prices of real estate go down (and not maintain their prices within Dubai specifically and the Middle East in general), then we will see the effects over here. However, he also assured me that the sovereign wealth funds would be more than able to compensate by shifting their money from the Western world to the local country. With the stock markets collapsing as they are, let us all hope that we do not see this doomday scenario.
At the outset, let me point out that I am not a financial expert, but one who has an active hobby in understanding finance and economics. My MBA degree also lends me certain credibility in this sphere. I will attempt to give a basic explanation of what happened during the past week in the financial crises that has wiped out people’s savings and fueled panic selling making markets lose 30% of their capitalization amounting to billions and billions of dollars.
The main reason (and there are many other reasons that have contributed to it) behind was a strategic planning mistake by the US banks. Instead of assessing the credit worthiness of the applicants and their ability to make the monthly payments when applying for loans, especially home purchases, they assessed the amount of credit based upon the current market valuation of the actual homes. Well, once the economy was healthy and booming with the prices of homes increasing on a regular basis, this was fine. However, it transferred the risk to the banks and this was the strategic mistake once the economy slowed down.
When they attempted to get rid of these home assets (once they reposed them), they could not at the price they had valued them in their balance sheets. Thus, a fire-sale ensued which led to huge write-offs.
The other strategic mistake is that they collateralized these mortgages to be able to take out more credit from other banks and become more aggressive. Thus, the domino effect happened and with one bank going down, the rest had to follow. That is why the bank bail-out was so important and the government having to guarantee people’s deposits. Otherwise, the ramifications would have been unthinkable.
However, I do not understand how this got translated towards the Arab world whereas the stock markets have shed about 20-30% of their market value over the past week. After all, accessing credit in the Middle East is a lot harder and restrictive than the Western world. In addition, there is only a small portion of mortgages as a percentage of banks’ portfolios relative to the Western world. Moreover, the high price of oil (which is our main produced component) shows no sign of easing or disappearing. In other words, our fundamentals are still strong. So, who can explain it to me?
One person who is a director for a reputed financial institution told me that if the market prices of real estate go down (and not maintain their prices within Dubai specifically and the Middle East in general), then we will see the effects over here. However, he also assured me that the sovereign wealth funds would be more than able to compensate by shifting their money from the Western world to the local country. With the stock markets collapsing as they are, let us all hope that we do not see this doomday scenario.
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