Little-known trader made billions from sub-prime bust

THE big losers in the United States sub-prime crisis are well-known – Citigroup, Merrill Lynch and UBS.

But probably the biggest winner is Mr John Paulson, a little-known hedge fund manager who made an estimated US$3 billion to US$4 billion (S$4.3 billion to S$5.7 billion) for himself from the crisis – believed to be the largest one-year payday in Wall Street history.

Ironically, his hedge fund company, Paulson & Co, that has profited most from the bursting of the US housing bubble hired as adviser this week the man widely blamed for inflating it in the first place – former Federal Reserve chairman Alan Greenspan.

Mr Paulson smelled trouble in the market for risky home loans two years ago and devised what proved to be a wildly profitable strategy for betting against the housing market, The Wall Street Journal said on Tuesday in a profile of the man.

Like many legendary market killings, such as Mr Warren Buffett’s takeovers of small companies in the 1970s, Mr Paulson’s sprang from defying conventional wisdom, said the Journal.

In early 2006, the wisdom was that while loose lending standards might be of some concern, deep trouble in the housing and mortgage markets was unlikely.

A lot of big Wall Street players were in this camp, as seen by the giant mortgage-market losses they are now disclosing.

‘Most people told us house prices never go down on a national level, and that there had never been a default of an investment grade-rated mortgage bond,’ Mr Paulson told the Journal.

He also devised a technical way to bet against the housing and mortgage markets.

Also key: Mr Paulson did not turn bearish too early.

Some close students of the housing market did just that: investing for a downturn years ago, only to suffer painful losses waiting for a collapse that they finally unwound their bearish bets, said the Journal.

The low-key Mr Paulson, who grew up in New York, began his career working for another legendary investor, Mr Leon Levy of Odyssey Partners.

Now 51, Mr Paulson has benefited from an earlier housing slump 15 years ago, buying houses in foreclosure sales. In 1994, he started his own hedge fund with US$2 million and built it up to US$500 million by 2002.

In January 2006, he launched a hedge fund solely to bet against risky mortgages. The result: Funds run by him were up US$15 billion last year. His investment gains have boosted the total amount his firm manages to US$28 billion, making it one of the world’s largest.

 

Source: The Straits Times 17 Jan 08

Time to redraw your retirement plan

Longer life expectancy and erosion of traditional pension schemes signal that retirees may outlive their assets, says KURT REIMAN

RETIREMENTS are becoming ever longer and more costly. Pensioners need to save enough to fund a comfortable life and to ensure they can leave assets to the next generation.

Retirement, in its current form, will soon be a thing of the past as demographic, financial and lifestyle factors lay siege to the traditional models. Pension plans, both public and private, face a squeeze from fewer people working and more people retiring. Meanwhile, medical and healthcare spending are rising, putting government finances under additional strain.

Yet most people expect to lead active and healthy lives during retirement, with some hoping to combine relaxation with a job, part-time or otherwise. Together, these trends are reshaping our thinking about careers and how to pay for what comes afterwards. Retirement, in short, is evolving into something completely new.

Traditionally – and particularly in places other than Singapore – retirees have relied primarily on government and corporate pension plans and think of their personal savings as an extra resource for additional or unforeseen expenditure. But the health of state-run pension programmes is under scrutiny, forcing individuals to take more responsibility for their well-being in old age. Against this background, living too long and spending too much have emerged as major risk factors. The latter hazard is accentuated by the ever more active lifestyle of senior citizens.

If enterprising and adventurous pensioners want to enjoy their third age to the full, however, they need to ensure that their assets will stay the course.

Will I outlive my assets?

According to the United Nations, people born today in developed countries can expect to live 75.6 years on average, up from 66.1 years for those born in the 1950s. Moreover, today’s 60-year-olds can expect to live even longer than these statistics suggest, having survived the high risk periods of infancy and early youth. Indeed, they might well live another twenty years on average, and this life expectancy continues to lengthen.

Longer lives and the erosion of traditional pension schemes add to the danger that retirees will simply outlive their assets. So does the fact that life expectancy estimates have often erred on the low side in the past: that is, people have tended to live far longer than the statisticians have predicted.

All this increases the uncertainty surrounding the key question – how long they will live – that individuals need in planning for retirement. Nor do life expectancy forecasts account for the important differences stemming from gender, status, occupation, educational attainment, and country of residence.

If they rely on average life expectancy statistics, five people out of 10 run the risk of living longer than their assets will last. To mitigate that risk while they are still earning and saving money, investors would be best advised to calculate their retirement horizon conservatively (that is, by assuming a rather high life expectancy).

At the same time, they should factor in any relevant variables such as their physical condition and family medical history. A realistic perspective on one’s personal life expectancy can go a long way to mitigating longevity risk.

Once they have accumulated the assets which will pay for their retirement, investors can also reduce that risk by purchasing an annuity, which comprises a series of payments of set size and frequency during the life of the holder.

Although annuities are not risk-free – they are, for example, exposed to the hazards of inflation or the failure of the providing institution – they do ensure a constant nominal income stream regardless of how long the holder lives.

Demand for such instruments is on the increase as pension schemes become less generous. However, the amount of money that should be invested in an annuity remains a highly personal choice and it should always be borne in mind that committing assets to an annuity can reduce the amount of a portfolio that can be passed on to the next generation.

Will I overspend my assets?

The danger that one might live beyond one’s means, also known as liability risk, is another increasingly relevant factor in retirement planning. It is linked to the fact that people are living longer and arises partly from the trend towards increased individual responsibility for healthcare. Additional factors include the growing taste for more ambitious lifestyle goals, such as frequent travel and staying young and fit.

There are numerous ways to reduce liability risk. One can continue to work longer or relocate to a country with a lower cost of living (see Figure 2). This also helps to reduce the chance that you will live longer than your assets last. Each extra year of spending that is funded from employment income represents an additional year that retirement withdrawals can be postponed and investments can continue to grow.

Another option is to limit the uncertainty related to future costs by purchasing elderly and long-term healthcare insurance. Without this insurance, individuals may need to plan for worst-case scenarios for healthcare liabilities, or face the prospect that healthcare costs will erode assets that would otherwise be passed on to the next generation. Individuals can also pay down debt before they retire in order to increase their net worth.

Mandatory v discretionary

needs When it comes to reckoning up the total income a retiree will need, expenses should be classified into mandatory and discretionary. Mandatory expenses are those related to basic daily needs, including housing (mortgages, taxes, and maintenance fees), food, and medical care. Discretionary expenses are everything else, accounting for the remainder of the total income requirement.

To estimate how much income you might need, consider the things that you really cannot do without and the things you might be able to sacrifice or scale down. An apartment, for example, might be more convenient and cheaper than maintaining a house, and holidays at home might be less costly than travelling. Downsizing your lifestyle might be an option if you fear that your assets might melt away too soon. A solid estimate of your mandatory needs also helps you to determine the amount of assets that should be invested in an annuity, if any.

Figure 3 shows a hypothetical income and expense framework during retirement. Mandatory expenses are met with pension and annuity income, while discretionary needs are funded by assets allocated first to an absolute return portfolio. Other discretionary income sources could also include rental income, royalty payments, or  other alternative income streams. Assets above and beyond these mandates are contained in a growth portfolio, which can be allocated in line with investors’ longer-term goals.

When there is a high probability or desire to leave a bequest, assets can be allocated with the beneficiaries’ time horizon in mind. Consider also that bequest motives require prudent estate planning; holding rapidly appreciating assets can significantly increase estate tax liability.

Review regularly

No estimate or forecast can be safely relied upon unless it is regularly reviewed in the light of changing economic, financial, regulatory, demographic, and personal circumstances. Without such a review, even the most finely tuned income scheme may quickly lose its relevance. It is important to keep track of realized investment returns, as well as expenditure, and to adjust spending habits and lifestyle as necessary. Retirees should, therefore, review their retirement plans regularly and discuss their plans with their client advisers.

Kurt Reiman is head of thematic research at UBS Wealth Management Research. He can be contacted at kurt.reiman@ubs.com

Source: Business Times 14 Nov 07

MONEY MATTERS – Never react to market chatter

Investors tempted to flee the US stock market, given the bad news coming out of America, might do well to reconsider

THERE has been no dearth of sensational headlines relating to the financial world in the media over the past few weeks. Oil prices are fast approaching US$100 per barrel. Financial institutions are taking accounting charges for sub-prime write-downs. CEOs have stepped down. The US Federal Reserve has lowered interest rates to ease credit in a slowing economy. Unemployment rates are down and inflation is an on-going worry. Minerals and metals, especially gold, are trading at new highs. The US dollar is sliding fast. Global stock markets have been very volatile.

How should a Singapore investor respond to all of these issues? Let’s examine the fundamentals of the US economy, and the US stock market and assess how macro economics affect the value of the US dollar and investor behaviour.

The US economy

Our prime minister was recently asked about the possibility of a recession in the US. He said ‘perhaps’. But will a recession in the US affect Singapore? He replied ‘most definitely’.

The total decoupling of the US economy from the rest of the world has not materialised and global economies are intertwined in terms of economic cycles.

The arguments for the outlook of the US economy go something like this. The probability of a full-blown recession is less than 50 per cent, based on broad consensus. US home prices will probably decline further and we have not seen the end of the sub-prime mortgage mess.

Containing inflationary pressures in the US will be a continuing challenge for the Fed as it lowers interest rates to avoid a hard landing. Lower interest rates translate into lower exchange rates for the US dollar. This anticipated decline in the US dollar will make American exports more competitive and improve the earnings of some US companies.

The US trade deficit will improve in the near term and may check the fall of the dollar.

If the US real economy maintains such a course, the Asian story will go on. This means that Singapore investors should strike a balance by staying invested in global securities for diversification and risk management of their investment portfolios.

There is no reason to dump US securities within a diversified portfolio based on concerns about the possible slow growth of the US economy in the near term.

The US stock market

The valuation of US shares will be of interest to investors. The forward price earnings (PE) ratio of the S&P 500 is now at 15.7 times compared to the pre-bubble 60 times in 2000. In fact, we should turn our attention to exposure in emerging market equities.

Equities in China, India and other emerging markets have appreciated at a much faster clip than those of the developed markets in the last two years due to strong GDP growth. The sensible course of action for an investor is to rebalance a portfolio that has a heavy allocation in emerging markets to a more broadly diversified one because the likelihood of repeat performances in the near term is hard to predict.

Human behaviour is such that not only is the exposure to emerging markets, including Asian stocks, preserved but there may be a tendency to chase performance with fresh capital infusion into Singapore and Asian shares just because there is negative news from some American companies.

Going back to US shares, on average, 25-50 per cent of sales and earnings of US-listed companies come from abroad. This is good news for the global investor.

One can argue that the weak US dollar will contribute to higher earnings for American companies with positive impact from foreign currency translation in the financials. So whether the US economy goes into a recession or not in the near term, some large-cap US equities will continue to deliver growth from sales to the rest of the world in the long term.

Nestle is an example of a global player whose country of listing is not relevant when compared to the company’s sources of revenues.

Even if the US stock market experiences volatility in the near term, there is no case to avoid quality shares listed in the American stock exchanges for a long-term investor.

The US dollar

The Monetary Authority of Singapore has decided to accelerate the appreciation of the Sing dollar versus a managed basket of currencies. This policy is aimed at tackling inflation in our domestic economy. The outcome is a manifestation of the weakening US dollar.

The point is, the Sing dollar is not the only currency that is strengthening. Our currency is moving in tandem with the euro, yen and other regional currencies (see Chart C). But there is no escaping the US dollar for a global investor. How else can you buy into Berkshire Hathaway and Microsoft or Coke and Pepsi?

Procter & Gamble (P&G) owns Pringles, Braun, Gillette, Tampax, Max Factor and Duracell. The only way you can be a shareholder of the company that owns these global brands is to buy P&G shares denominated in US dollars. A global equity portfolio will include companies like P&G.

Whether the direct shares, private equity or unit trusts are denominated in the US dollar, Sing dollar or Australian dollar, it makes little difference in the long term as long as the underlying securities represent profitable companies around the world. It does not make sense to own only shares in companies with strong currencies compared to the US dollar.

Conclusion

Timing the market is next to impossible. Adopting the correct time horizon for specific investment objectives is, however, essential.

Staying invested in the market for the long term is the only way to achieve long-term goals such as retirement funding. The more frequently investors evaluate their returns, the more likely they are to make inappropriate shortterm decisions because myopic loss-aversion causes such investors to treat the long-term as a series of short-terms.

Leading behavioural finance researcher Hersch Shefrin explains this framing concept in his book Beyond Greed and Fear.

So should we be concerned about the US dollar or something far more important?

Going back to basics: review your goals, decide how much is enough in S$ medium- to long-term returns, get the asset allocation right, insist on quality underlying securities without undue concern about the currency of denomination and assess if overall risks for total investment assets are appropriate to your investment time horizon.

Old-fashioned dollar cost averaging will cover market and currency fluctuations in the medium and long term.

Never react to market chatter. Stay invested. Once the framework is in place, allow the strategy a chance to work.

Roy A Varghese is Director, Financial Planning Practice, at ipac Singapore. The views expressed are his own. He can be reached at roy.varghese@ipac.com.sg

 

Source: Business Times 14 Nov 07

Time to raise the $8,000 income ceiling for HDB flat buyers?

THE economy is booming and property prices are heading north. Although the housing market moves at a frenetic pace these days, one thing has stayed the same for more than 12 years now – the $8,000 ceiling on monthly household income for those buying new Housing Board flats.

Of late, some people have wondered if home prices are getting out of reach. The Government appeared to try to tackle those concerns last month by expanding the pool of low-income households which qualify for extra housing aid.

Households earning up to $4,000 a month, instead of up to $3,000 previously, are now eligible for grants of as much as $30,000 to buy their first home. With this change, more people now qualify for the aid, and households already qualifying will now get an even bigger grant.

But what about the $8,000 income ceiling? Will it be raised too? The current cap has not changed since it was last raised from $7,000 in December 1994. For most of 1992, it stood at $6,000.

Yet many things have changed since 1994.

Data from the General Household Survey, which is conducted once every 10 years, shows that the proportion of resident households earning $8,000 and above every month has nearly doubled from 10.85 per cent in 1995 to 19.9 per cent in 2005.

This means that the proportion of households qualifying to buy new flats shrank by roughly 9 percentage points.

More recent data from the Department of Statistics shows that the proportion of employed households earning $8,000 or more stood at 23.4 per cent last year.

This means that the proportion of households not qualifying for new public housing is even bigger when we factor out the number of households made up of unemployed people, who probably would not be in a position to buy homes.

And in real terms, taking into account inflation, $8,000 in 1994 had the same spending power as $9,110 in July.

Meanwhile, the price index of HDB resale flats grew 36 per cent from 1995 to June this year.

New HDB flats are the cheapest homes in Singapore, a refuge for home seekers feeling the heat from the buoyant private and HDB resale market.

So the real question for policymakers is this: Have market conditions changed sufficiently since 1994 that households earning somewhat more than $8,000 now need the option of buying new HDB flats?

One can tell what a difference that option makes by comparing the prices of flats within one area. A batch of new four-room flats in Sengkang were offered at $145,000 to $200,000 in May. Resale four-room flats in the same area, for the period from April to June, changed hands at a median price of $245,000, notably higher.

In the more volatile private market, prices of 99-year leasehold condominiums – a typical choice for many home buyers who could otherwise have picked HDB flats – grew 11 per cent between the third quarter of 1999 and the second quarter of this year. Given the massive slump that followed the 1997 Asian financial crisis, there’s a chance they could be cheaper now than they were in 1994.

But families with only a little more than $8,000 in monthly income may not be in a strong position to buy a home for $600,000.

New HDB flats, by comparison, are a ’safer’ choice. Although their prices generally follow market trends, it is understood that the changes are moderated by the Government in order to keep public housing affordable.

The Singaporeans caught between public and private housing are the proverbial ’sandwich class’ – not well off enough to cruise into private housing but not poor enough to be entitled to much government aid.

Is housing becoming less affordable for them? Are they left with the option of spending an increasing – or perhaps disproportionate – part of their income on housing?

If so, is it time to adjust the $8,000 income limit to put them back under the HDB umbrella?

After all, a household earning above $8,000 a month is not just barred from new HDB flats, but also disqualified from subsidised housing loans and housing grants of up to $40,000 to buy resale flats. (Those earning not more than $4,000 a month are entitled to additional grants, as explained above.)

The HDB does ‘exercise flexibility on a case-by-case basis’ for home buyers whose household incomes marginally breach the limit.

But rather than bending the rules occasionally, perhaps it should be reviewing the limit instead.

For if encouraging home ownership is a key strategy to root Singaporeans to Singapore, then shouldn’t the Government be concerned about the increasing proportion of Singaporeans possibly finding homes less affordable?

Public housing here plays a different role from that in other countries, where it is often merely a roof for the poor. In Singapore, more than 80 per cent of the population live in HDB flats. These properties are seen not just as a store of value but also a source of retirement income.

To be fair, the HDB has to perform a delicate balancing act. It cannot lift the income ceiling by too much lest demand for resale flats collapse. This would depress the value of what, for many people, is their single biggest asset.

But perhaps the balance has now swung too far against the middle-income group.

It could have been something on the minds of policymakers when they recently decided to raise the income limit of families receiving aid for their children attending independent schools. From next year, the ceiling will be set at $7,200 monthly, almost double the current cap.

The HDB income ceiling question rings even louder these days as the Government looks at ways of getting its rapidly ageing population to save enough for retirement.

An obvious way of doing so is simply by not overspending on housing in the first place. And that can best be done when someone actually has the choice of buying the cheapest home available.

 

Source: The Sunday Times 9 Sept 07

A Wall Street trader draws some sub-prime lessons

SO right after the Bear Stearns funds blew up, I had a thought: This is what happens when you lend money to poor people.

Don’t get me wrong: I have nothing personally against the poor. To my knowledge, I have nothing personally to do with the poor at all. It’s not personal when a guy cuts your grass: that’s business. He does what you say, you pay him. But you don’t pay him in advance: That would be finance. And finance is one thing you should never engage in with the poor. (By poor, I mean anyone who the SEC wouldn’t allow to invest in my hedge fund.) That’s the biggest lesson I’ve learned from the sub-prime crisis.

Along the way, as these people have torpedoed my portfolio, I had some other thoughts about the poor. I’ll share them with you.

1) They’re masters of public relations.

I had no idea how my open-handedness could be made to look, after the fact. At the time I bought the subprime portfolio I thought: This is sort of like my way of giving something back. I didn’t expect a profile in Philanthropy Today or anything like that. I mean, I bought at a discount.

But I thought people would admire the Wall Street big shot who found a way to help the little guy. Sort of like a money doctor helping a sick person. Then the little guy wheels around and gives me this financial enema. And I’m the one who gets crap in the papers!

Everyone feels sorry for the poor, and no one feels sorry for me. Even though it’s my money! No good deed goes unpunished.

2) Poor people don’t respect other people’s money in the way money deserves to be respected.

Call me a romantic: I want everyone to have a shot at the American dream. Even people who haven’t earned it. I did everything I could so that these schlubs could at least own their own place. The media is now making my generosity out to be some kind of scandal.

Teaser rates weren’t a scandal. Teaser rates were a sign of misplaced trust: I trusted these people to get their teams of lawyers to vet anything before they signed it. Turns out, if you’re poor, you don’t need to pay lawyers. You don’t like the deal you just wave your hands in the air and moan about how poor you are. Then you default.

3) I’ve grown out of touch with ‘poor culture’. Hard to say when this happened; it might have been when I stopped flying commercial. Or maybe it was when I gave up the bleacher seats and got the suite. But the first rule in this business is to know the people you’re in business with, and I broke it.

People complain about the rich getting richer and the poor being left behind. Is it any wonder? Look at them! Did it ever occur to even one of them that they might pay me back by WORKING HARDER? I don’t think so.

But as I say, it was my fault, for not studying the poor more closely before I lent them the money. When the only time you’ve ever seen a lion is in his cage in the zoo, you start thinking of him as a pet cat. You forget that he wants to eat you.

4) Our society is really, really hostile to success. At the same time it’s shockingly indulgent of poor people. A Republican president now wants to bail them out! I have a different solution. Debtors’ prison is obviously a little too retro, and besides that it would just use more taxpayers’ money. But the poor could work off their debts. All over Greenwich I see lawns to be mowed, houses to be painted, sports cars to be tuned up.

Some of these poor people must have skills. The ones that don’t could be trained to do some of the less skilled labour – say, working as clowns at rich kids’ birthday parties. They could even have an act: put them in clown suits and see how many can be stuffed into a Maybach.

It’d be like the circus, only better. Transporting entire neighbourhoods of poor people to upper Manhattan and lower Connecticut might seem impractical.

It’s not: Mexico does this sort of thing routinely. And in the long run it might be for the good of poor people. If the consequences were more serious, maybe they wouldn’t stay poor.

5) I think it’s time we all become more realistic about letting the poor anywhere near Wall Street.

Lending money to poor countries was a bad idea: Does it make any more sense to lend money to poor people? They don’t even have mineral rights! There’s a reason the rich aren’t getting richer as fast as they should: they keep getting tangled up with the poor. It’s unrealistic to say that Wall Street should cut itself off entirely from poor – or, if you will, ‘mainstream’ – culture.

As I say, I’ll still do business with the masses. But I’ll only engage in their finances if they can clump themselves together into a semblance of a rich person. I’ll still accept pension fund money, for example. (Nothing under US$50 million, please.)

And I’m willing to finance the purchase of entire companies staffed basically with poor people. I did deals with Milken, before they broke him. I own some Blackstone. (Hang tough, Steve!) But never again will I go one-on-one with poor people.

They’re sharks.

Michael Lewis is the author, most recently of ‘The Blind Side’, and is a columnist for Bloomberg News.

The views he expresses are his own.

 

Source: Business Times 7 Sept 07

The rich get more, so the poor want more

INCOME INEQUALITY IN THE U.S.

BETWEEN 1949 and 1979, incomes across all classes in the United States grew at about the same rate of 3 per cent a year. The before-tax income of the bottom 20 per cent of households increased by 116 per cent over those three decades, that of the median households by 111 per cent, and that of the top 5 per cent by 86 per cent.

Spending also increased at a fairly uniform rate across the board during this period. The houses of the rich grew larger, but so did the houses of the poor as well as those of the median households – and by roughly the same proportion. A rising tide lifted all homes, as it were, equally.

Between 1979 and 2003, the before-tax income of the bottom 20 per cent of households rose by just 3.5 per cent, that of the median households by just 12.6 per cent, and that of the top 5 per cent by a staggering 68 per cent. The average net worth of the bottom 40 per cent of households actually shrank by 76.3 per cent in that 24-year period, while that of the top 1 per cent of households grew by 42.2 per cent.

In 1982, there were only 13 billionaires on Forbes’ list of the 400 richest Americans – five of them the children of Texas oil tycoon H.L. Hunt. In 2005, there were 374 billionaires. Forbes’ 400 richest Americans are now collectively worth US$1 trillion (S$1.5 trillion) – about 25 per cent of the GDP (in purchasing power parity terms) of India, a nation of 1.1 billion people.

Their houses, of course, have expanded by leaps and bounds as their net worths have grown. Even Mr Bill Gates’ 4,600-sq-m mansion overlooking Lake Washington has become something of a pondok.

There are houses in the same area even larger than his – quite a few over 5,600 sq m, and at least one over 6,500 sq m. And not only their houses, their yachts and jets as well, their ski chalets and beach homes, their cars and toys, their pools and Jacuzzis, their barbecue pits, their carbon prints, have all grown bigger and more extravagant. None of this should be surprising, for that US$1 trillion has to be spent somehow.

What is astonishing is that median household spending has also grown in the same period. Average median household income and net worth have remained virtually stagnant since 1979, but the median size of a newly constructed house has increased by more than 25 per cent in that period – from 147 sq m in 1980 to 186 sq m in 2001.

The average household spends far more on housing now than it used to just 30 years ago, although its income has not grown. And it is not only houses, but also cars and clothes, entertainment and food, haircuts and what not.

Why should this be so?

According to Cornell University economics professor Robert Frank, it is because concentrations of wealth at the very top have set off ‘expenditure cascades’ among the middle class. In a brilliant recent book entitled Falling Behind: How Rising Inequality Harms The Middle Class, Prof Frank argues: ‘As incomes continue to grow at the top and stagnate elsewhere, we will see even more of our national income devoted to luxury goods, the main effect of which will be to raise the bar that defines what counts as luxury.’

The average American will work harder, spend and borrow more and save less, just so as to keep up with the few Joneses who keep getting richer. He will be doubly impoverished – by income inequality in the first instance, and by the ‘expenditure cascade’ that inequality instigates in the second.

He will shed new economic light on the Biblical insight: ‘For he that hath, to him shall be given: and he that hath not, from him shall be taken even that which he hath.’

Prof Frank’s argument is simple. Income inequality has led to a concentration of wealth at the top. The consumption patterns of the wealthy have set an expensive template for the rest of society and shifted the ‘frames of references’ of everyone.

The mere presence of a mansion in an otherwise ordinary neighbourhood shifts perceptions in that neighbourhood as to how large a house should be. ‘Relative deprivation’ – I don’t have what you have – leads to an ‘expenditure arms race focused on positional goods’ – I want what you have.

Mr Gates has a 4,600-sq-m house. In response, his Microsoft co-founder Paul Allen builds a 6,500-sq-m house and, down the line, Mr and Mrs Average scrimp and save to upgrade from a McHouse to a McMansion. Mr Allen can afford to keep up with Mr Gates; Mr and Mrs Average cannot keep up with Mr and Mrs Above-Average, let alone Mr and Mrs Gates. They assume large mortgages, they work harder and longer hours to afford their ‘positional goods’, they do not spend enough on their children’s education, they do not save enough for their retirement. The end result is relative welfare loss all round.

Income inequality has ‘imposed not only important psychological costs on middle-income families but also a variety of more tangible economic costs’, writes Prof Frank.

His solution to this problem is unlikely to be adopted in the US, given the political gridlock in Washington, but it is worth considering – a ‘progressive consumption tax’. Not a steeply progressive income tax, not a soak-the-rich

hiking of the top marginal income tax rate to 99 per cent, not middle-class welfare – but a progressive consumption tax to render expenditure on certain forms of positional goods ‘less attractive by taxing them’.

How many people in Singapore would object if the GST on S$50 electronic watches was 5 per cent, and the GST on S$50,000 Patek Philippe watches was 50 per cent?

It is not clear if income inequality in Singapore has harmed the middle class to the same extent that it has in the US, but it is likely that some degree of ‘expenditure cascade’ does exist here. Median real wages in Singapore have risen only marginally since 1998. And yet the median household does not seem to be spending less on housing or clothes or entertainment.

Are we sure keeping up with the Joneses has not worsened the effects of income inequality in Singapore?

 

Source: The Straits Times 31 Aug 07