The recent stock market gyrations and the all-too-abrupt decline illustrate the hazards to the broader economy and to investors when valuations get ahead of themselves. The ability to make money and capital on the “wealth effect” quickly turns on its head and tends to terrorise when the markets turn sharply down.
Plans paved years into the future can be destroyed overnight, and in their extreme, leave behind a legacy of unemployment, as was witnessed most recently in the 2008 market bubble. Walter Bagehot in 1856 blamed market crashes on what he called “blind capital”; the times when investors gave up on rationality and flooded into investments at valuations that were unwise.
His recommendation was a regulatory framework that was ready to flood liquidity into the system, but his preference was for these same regulators to be more transparent in issuing warnings and tweak regulations that prevented or mitigated the rise of irrational exuberance in the first place. Dubai has followed his prescriptions down to the tee, with the Central Bank airing concerns of potential overheating in the real estate market.
Earlier, there were the restrictions implemented by the Dubai Land Department to curb speculation both in the ready and off-plan categories.
It is clear that there will be some impact on the real estate market in the near term; a correction was already underway at the higher end of the market prior to the recent downturn in the equity markets. From a valuation perspective, there was some frothiness at the higher end.
A correction is healthy as the price mean reverts to more sustainable levels (from their peaks, prices have corrected by 10-15 per cent). Combined with the current loss of confidence in response to the equity market correction, it is likely that investors will give pause to further real estate purchases.
However, what is equally clear this time around is that this is not a repeat of the 2008 meltdown. The current pace of economic activity is quickening and the employment engine continues to gather steam as the economy diversifies and grows at a sustainable pace.
It is at this critical juncture that regulators need to continue to keep the “animal spirits” — which Keynes repeatedly referred to — alive and simmering to assure investors of continued sustainability in the regulatory regime. The protection of the small and medium investor must be paramount, and nurturing mid-income developments (either by government-sponsored developers or providing incentives to private sector developers) will ensure that rental rates are stable. (Rentals are the biggest concern for this income segment and a huge challenge for sustainable growth in the economy.) These steps will ensure that whatever confidence erosion has taken place is transient.
What history teaches us is that asset valuations have progressively had a bigger impact on the economy. The impact of each retracement of asset values has been greater and greater, as asset ownership spreads over a wider population base.
The role of regulators globally has been to dampen downside volatility without succumbing to moral hazards. The current equity and real estate downturn is nothing but a healthy correction, and regulators have been prudent in navigating a difficult terrain of “guiding” asset values.
However, confidence needs to be nurtured, and for the middle-class to plant their roots in the economy through asset acquisitions, greater choice alongside the requisite protection is the need of the hour. It’s vital for Dubai to continue its trajectory of sustainable growth.
— The writer is the managing director of Global Capital Partners.