As the economic downturn moves into its second year, investors and businesses in The Bahamas are curtailing their spending activities and critically reviewing their cost structure.
This, coupled with central bank policy, which effectively puts a restriction on bank lending except for rolloffs, has had the short-term effect of delaying much-needed investment in this soft economy.
A potential unintended consequence of this restriction on lending is that interest rates can actually rise, thus causing less economic activity as consumers compete for credit or central government borrowing “crowds out” private demand for credit. However, our view is that banking and other financial institutions should first be given the benefit of the doubt, that they would continue good lending practices even in challenging economic times. Therefore, to unilaterally restrict lending by all institutions, irrespective of their actual credit behavior, leads one to question whether there is a presumption that bankers are reckless in their business practices.
While there seems to be no shortage of advice from all quarters on how to stop this downturn, the answer lies in the following question: should we let the liquidation continue until it reflects the proper patterns of consumer spending and preferences? In other words, unless we permit the economy to engage in a very necessary adjustment process, the economy will continue to slide further and further into ruin brought on by institutionalized inefficiency, such as, unsustainable cost structures, outrageous communication and electricity costs, and generally a lack of true value for most goods and services that we sell. Contrary to the beliefs of many, the Bahamian economy is not depression-proof.
Financial professionals seemingly have no shortage of opinions as to what consumers must do in these trying times. Unfortunately, no one is making any recommendations or very few recommendations as to what the Government should do to get the economy rolling. As we have already stated, the global economic slump is going on two years, thus to blame it entirely on the war with Iraq is inconsistent with the facts. However, we readily concede that Operation Iraqi Freedom will further aggravate the situation.
Inaction is an action, albeit an unintended action. Since we are supposedly in the thralls of an economic slowdown, we desperately need to stimulate the economy so as to affect its recovery.
Today, we offer one tangible proposal that could help to stimulate our economy. We propose that Government immediately remove the stamp-tax levy for the refinancing of mortgages. The removal of stamp-tax on the refinancing of real estate would increase competition among lending institutions, which would immediately result in lower mortgage rates.
This would give consumers who own a home additional income if they are able to negotiate lower mortgage rates, which in turn, can be used for savings or further investments. Potential mortgage borrowers can expect to pay less interest, thus increasing the number of people who qualify for mortgages, which in turn, will stimulate construction.
Think about it. There is absolutely no justifiable reason why John Doe who, having got a mortgage from institution A, should have to pay stamp tax again when he wishes to simply refinance that same mortgage with institution B.
Let’s assume that John’s outstanding mortgage balance is $150,000. To move his mortgage could cost $3,000 in legal fees (up to two per cent), plus stamp tax $10,500 (seven per cent) plus a typical lender’s commitment fee of $1,500 (one per cent). Before you are done, this simple attempt to be more efficient could end costing $15,000 or 10 per cent of the mortgage value. If this is not a blaring example of institutionalized inefficiency, then tell us what is!
There is no real basis for believing that markets tend toward under-consumption. Human wants drives an economy and there is never an end to that. As Ludwig von Mises (an Austrian classical economist) argued: “Man acts to deliver himself from present states of uneasiness to more desirable states of satisfaction.” Stated another way, consumer demand stimulates economic activity.
Of course, savings is merely deferred consumption, based on time preference, and investment hinges upon expected returns. Interest rates are the price that regulates credit markets and capital formation. So, interest rates do play a coordinating role in the economy: they coordinate savings and investment, so that savings equal investment.
A persistent potential economic risk that The Bahamas must monitor is its trade cycle and not just recurring economic slumps due to insufficient or low levels of spending. We are continuously being challenged by the task of coordinating the supply of goods with the demand for them through time.
Interest rates can be identified as being central to this problem. Empirical evidence is abundant that proves that heavy taxation can slow economic development. So, there are real and compelling reasons to link taxes to economic performance, but there is also a more important point that is being left out of this debate.
Taxes are supposed to fund necessary functions of the Government. By arguing over how to stimulate the economy, many overlook the fact that government spending consists largely of overt transfers that, very often, only benefit narrow interests. Interest rate relief on mortgages would touch many Bahamians. Coercive transfers (such as stamp tax on mortgage refinancing) are wasteful, inefficient, and inequitable.
The views expressed in this article are those of the authors and does not necessarily reflect those of Colina Financial Advisors Ltd. Please direct your comments or questions to info@colinafinancial.com
