The law of unintended consequences is often associated with American sociologist Robert Merton, though its general spirit appears in many forms. Not least in Adam Smith’s notion of the “Invisible Hand”.
The idea is that when people intervene in systems with a lot of moving parts, especially ecologies and economies, the intervention, because of the complex interrelationships among the system’s parts, will have effects beyond those intended. Including many that were unforeseen or unforeseeable.
Examples abound. Prohibition led to the rise of organized crime in the US. A ban on the hunting of mountain lions in Australia had the unintended consequence of endangering local joggers.
Because governments typically ban only things for which people have a taste, when bans do arise, people find a way to satisfy those tastes either through substitutes or black markets. The consequence is typically a rise in prices as consumers flock to satiate their appetite.
Ban the offplan
It is in this context that many have suggested for a temporary ban in real estate residential construction. Not only to arrest the decline in asset prices (despite mounting evidence that these may have already bottomed out), but also to balance demand and supply dynamics and reduce the burden of depleting cashflows for existing developers. (Which itself is an unintended consequence of payment plans, and led to a rise in demand for such assets in the primary market at the expense of secondary market sales).
Secndary market stumbles
Furthermore, as secondary market sales traded at a higher discount to primary market transactions, and because valuations could not account for the discrepancy between these two variables, there was a stronger disincentive to purchase from the secondary market. Thus creating a vicious cycle as valuations could not account for the healthy demand that was inherent in the system for “new builds”.
Consequently, as the system caught up, primary launches receded, as developers catered to the completion of existing projects. It led to a dominance in market share for one developer, as others struggled to complete their projects on time.
Complex forces
There is something oddly beautiful about the tendrils of causality in complex systems. And none of this is to say that the inevitable chances of being surprised by our interventions means that we give into pessimism. Rather it is an invitation to understand the complex forces at work in an advanced economy.
Simone Weil stated that “a modern economy consists in certain methods of production, consumption, and exchange, which are continually varying (and need to be constantly measured), however which depend on certain fundamental relationships: between the production and circulation of goods, between the circulation of goods and money, between money and production and between money and consumption”.
The key variable here is the measurement problem; how we perceive and measure these constantly changing relationships, rather than convert them into an abstraction that defies all definition. And then made responsible for every hardship that is endured by oneself or others.
Even though the introduction of payment plans (itself encouraged by IFRS 15) led to a flurry of new projects that have suppressed asset prices, it has been the measurement problem that has compounded the decline and confusion, despite an ever increasing numbers of transactions.
A further unintended consequence of payment plans was that, at the margin, it converted certain tenants, thereby reducing rents as developers started to “mimic” rental payments as a method to lure buyers. Despite the yawning gap between the primary and secondary market prices, there has been no comprehensive measurement tool in place that accurately gauges the appetite for demand.
Instead, standard valuation techniques have exacerbated the disincentive for snapping up secondary market values, thereby creating an intended consequence of exaggerating market declines, when in fact it has been the valuation techniques that have been at fault.
An easy fix to the above is not a blanket ban on construction, but rather a more nuanced set of mechanisms that acknowledge these differing valuation techniques and putting in place a mechanism that allows for developers to not stall their projects, through a combination of liquidity spigots, financial prerequisites (such as financial close) and lending caps (which have already been raised). And allows for an orderly clearance of such inventory.
Again, at the margin, a relaxation on the collateral minimums banks require would also allow for an increase in mortgage demand appetite, thereby increasing liquidity into the marketplace.
As we gradually increase our understanding of large complicated systems, we will develop new ways to glimpse the unintended consequences of our actions. And while there will always be unintended consequences, they needn’t be completely unanticipated.
