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Opinion

At Yahoo: Innovations and Curses

At Yahoo, I write about Innovations and Curses:

In the last 10 years, India has grown at a rate that defies belief. Yet, the rate of growth and the dramatic increase in technology that accompanies it has come with certain curses — the side-effects of what has been a fantastic decade for India.

Curse #1: Floating Rates, Pre-closure charges, Teaser-rates

Home loans have, in the past, been sold as fixed rate loans where you pay a fixed rate of interest for the tenure of the loan. For about seven years now, banks have been pushing floating rate loans hard — where interest rates change according to the bank’s lending rates. Now floating rate loans aren’t necessarily bad; because banks borrow short-term (1-3 years, through deposits) and lend long term, when short-term interest rates go up, fixed rate loans hurt the bank since they get only that much interest but have to pay out more. Floating rate loans gives them the ability to adjust both lending and borrowing rates.

Unfortunately, the practice is now a curse — to squeeze the maximum out of customers, banks have only raised rates at the drop of a hat. When interest rates fell, banks refused to cut lending rates — which made the concept of “floating” more like a one-way street, in favour of the banks. Another trick was to create different internal “benchmark” lending rates — so new customers were offered loans that floated with a lower benchmark rate to attract new business, but existing customers were linked to a higher different benchmark rate. The RBI has recently tried to curb this practice by making fresh loans linked to only one rate called a “base” rate, but the multiple benchmarks for the old loans will continue.

Even “fixed” rate loans are no longer fixed — most banks will only offer fixed rate loans where they can reset the rate every few years, which is as good as floating rate loans with a staggered reset cycle. Recently banks offered “teaser-rate” loans — a lower rate for a few years before going back to a floating rate system; if the current sequence of interest rate increases continues, the “resets” will be to a point that will increase EMI payments substantially — for instance, a 3% increase in rates when reset (from 8 to 12%) will result in a 23% increase in EMI.

And then there are pre-closure charges, between 2% and 3%, ostensibly to prevent customers from going to another bank — but banks will charge some part of it even if you change from fixed to floating with them. Finally, you need to take on life insurance in case you die before you repay — that adds an extra annual cost.

These “innovations” have just made products more complicated. The banks’ nickel-and-dime customers — a fee here, a charge there, an unmentioned cost somewhere else. In the process of offering something for everyone, they’ve muddied the waters for everyone — and the lack of knowledge is harnessed by bankers and intermediaries to mis-sell. Flexibility is, to the uninformed, a curse.

Curse #2: Super Built-up area

Thanks to the Great Indian Real Estate Story, we can never know what a house costs anymore. If you’re buying a flat from the builder, they’ll give you a rate per square foot of a “super-built-up” area. And add on parking charges, registration and deposits for water and electricity. This much is what it used to be, earlier.

But when you hear of a 1,800 sq. ft. apartment, you aren’t usually told that means only 1,300 of it is “carpet area”. The rest — the “super” part of super-built-up area — is your share of common areas like corridors, lifts, parks, and probably of a nearby minister’s house as well; you will never know. Ask for a detailed calculation and builders look away.

Then you have interest free maintenance that will cover maintenance costs for a while after you occupy the premises. Some part of this will never be returned. They also charge you additionally for a “clubhouse”, sometimes up to a few lakhs —which you might later find that you have already paid as part of “super-built-up” area.

To curb speculative buying of property, some builders decided to add a “transfer” charge for sales before construction was complete — the “buy-to-flip” model. (Between Rs. 50 and Rs. 200 per square foot)

Once you occupy the property, they charge you maintenance fees that range between Rs. 1.5 and Rs. 2.5 per square foot. This can be a hugely profitable business for a builder, and instead of transferring the maintenance to the residents (required by law in some cities), builders have started putting in clauses that ensure they retain management authority even after you take possession of your apartment.

You may not be able to avoid these shenanigans, but they are the curse of a hot market. Property prices have gone up too fast; the charges are an indicator that people don’t care enough to protest. If prices are going even higher, why bicker about a detail that will eventually be the problem of the person I sell to?

Curse #3: Dirty Data Decisions and Markets

Technology has rapidly increased the availability of information. Sitting in the corner of Gurgaon, over an internet connection I can quickly collect data about long term interest rates in India, or inflation statistics, or prices of any stock and many bonds. The information is useful but sometimes outdated, incorrect or useless.

Take, for example, GDP growth. We quote real GDP growth as equivalent to Nominal GDP growth minus impact of inflation. Here, one flaw is that our inflation statistics aren’t very valid — that is, we either have much higher or lower inflation than reported; if we use the WPI, there is no mention of the cost of housing or services, which are a significant part of spending.
If we use the CPI, where these are considered, there are four different indices — and for each of them the data is either too old or not being reported. The CPI (Urban), for instance, might be the index of choice, but data is still being collected and the index doesn’t have a number. We then use the CPI (IW) where the index elements and weightages are fairly outdated.

Even in the US, they talk of “core inflation” which excludes food and energy, but this is the exact group of items that are important for measuring price changes, regardless of the counter argument that they are volatile. (That’s like saying doctors should only treat those patients that aren’t too badly hurt) And after that they make random other adjustments just to make inflation look benign.

And even reported figures go through various restatements — recently, inflation figures of the past have been revised to more than 1% higher than earlier reported. The Index of Industrial Production is a wildly volatile figure that, on looking at the revisions, seems like the initial report involved placing a wet finger in the air. But what people seem to care about is the “headline” number.
Rating agencies have been horribly bad at actually re-rating companies that are in trouble — such as Enron or Bear Stearns or even Lehman Brothers.

The problem is that we seem to rely too much on this data. Markets react, for instance, to a headline IIP number, and people like me write long dissertations on why India is either great or heading for disaster. And when that data is later revised or found inaccurate, none of these statements are retracted. Markets can live and die by the headline sword — as we found out in 2004, when the finance minister announced one figure as the newly instituted securities transaction tax and later changed it to something more acceptable. Or with inflation and IIP announcements, a temporary stir of the markets happens; it wouldn’t surprise me to hear that none of the big players care — or that only act assuming that other people care.

In some cases, policy or financial decisions are made based on this data — like CPI is used to calculate the “dearness allowance” and therefore the index number actually has an impact on government sector salaries. Rating agencies might cause a serious increase in collateral requirements (like in AIG’s case) for a company when they downgrade it. Such decisions that are based on faulty data are a time bomb — and it’s surprising that the age of fast information has transformed into the age of even faster misinformation.

The curses of growth and technology are perhaps evident in other places — traffic, for instance. Financially, though, the curse of growth has been to make us blind, just when we must be seeing better than ever before.

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