June 10, 2001

Why inflated golf club fees point way to economic bust

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There is something extraordinarily morbid about golf club politics and the rather unsavoury process of becoming a member. We all know people who spend their waking moments busily networking in the hope of being elevated to the inner sanctum of an old, established club.

Given that this ritual usually involves waiting for a member to croak, it seems a bit distasteful. However, social etiquette aside, doing the chicken dinner circuit and waiting in line is probably more palatable than coughing up for membership of one of the new clubs that have sprung up around the country.

In the mid-1990s, membership of one of the swankier clubs on Dublin’s outskirts cost around �2,500; this year it will set you back �25,000. Indeed, banks are financing loans for memberships and at least one enterprising individual has made a healthy crust trading golf club memberships, buying them cheap and flogging them on later.

In the 1980s, a similar craze gripped Japan. As the economy boomed, so too did golf. The game was a central feature of Japanese corporate life and a permanent fixture in the shain ryoko or company outing. Membership and position in the club denoted a certain privilege and bestowed a clear hierarchical structure on what is a very position-conscious society. As property prices boomed, banks fell over themselves to lend to golf course developers, seeing golf clubs as a property play.

In 1982, one of Japan’s leading newspapers, the Nihon Keizai Shimbun, launched the infamous Nikkei Golf Membership Index which calculated the average price of membership in 500 clubs. From its base of 100, the index rose steadily to 160 in 1985 and then took off in the “bubble” years of the late 1980s to peak at 1,000 in June 1990. The market in club membership was sustained by salesmen who earned commissions flogging membership certificates with banks financing up to 90 per cent of the so-called “collateral”.

The golf club index became one of the most accurate indicators of the Japanese property market’s boom/bust cycle. By 1992, the index had halved as the collapsing property market caused trade in memberships to dry up.

The golf club saga and the massively inflated property market were the result of what was termed tochi-hon’i sei or the “land standard”. This monetary standard — not dissimilar to the gold standard before it — is a financial system where land is used as collateral to generate credit.

Since the end of the war, land prices had fallen only once, in 1974. So, Japanese banks believed that prices would continue to rise forever. In the early 1980s, banks began to lend against land price rather than cashflow — even if the borrower was a small company or individual.

Obviously, this process moves in self-reinforcing stages. In stage one, initial credit drives up land prices. In stage two, the higher land prices make the initial loan look very prudent and the loan to asset ratio falls. By stage three, the perceived robustness of the original loan increases incentives to borrow more and lend more. In stage four, the new credit pushes the price of land up further and the whole process repeats itself.

Thus, the “land standard” rapidly leads to a credit explosion where it becomes hard to distinguish whether it is the land price driving the credit or the credit driving the land price.

Either way, it is a recipe for disaster with the banks playing the key role in the upswing and the downturn.

Ireland today is operating a very similar “land standard” and it is interesting to see that as the property market slows significantly (caused by ludicrous values and a modest tightening of bank’s internal procedures last year), the banks are becoming markedly less flaithiuil with credit.

The problem is: the tighter the credit, the more the property prices will fall. However, the more the property market falls, the worse the loans to asset ratios. As the financial ratios deteriorate, less credit will be extended and the downturn will be exacerbated.

Typically, before this process becomes embedded, a central bank cuts interest rates aggressively, injecting credit into the economy. The Irish central bank cannot do that. This makes the Irish “land standard” extremely unstable because, without a central bank, no commercial banks will be willing to risk bucking the market by lending excessively on land which is deemed to have peaked in value. It is not difficult to see how the herd could turn from bulls to bears in this environment.

Where would such a bearish downturn leave us? Property booms, like any booms, are nothing more than a transfer of wealth from one section of society to another. A property boom transfers huge wealth from wage earners to landowners with the banks sitting in the middle facilitating the trade. Wage earners become relatively poor and, not surprisingly, will ultimately strike for more income. We are seeing this process at the moment as partnership, or at least the wage component of the deal, unravels.

Unfortunately, the pendulum will not swing back in the event of a downturn because of the huge amounts of debt which young wage earners have incurred to get onto the property ladder. This is the other lasting legacy of a property boom — a second massive transfer of wealth from the young to the middle-aged. The young are in debt mortgaged up to the hilt, the middle-aged are in clover, sitting on a semi-detached gold mine. This demographic feature is not a recipe for economic dynamism. All financial models of spending patterns over our lifetimes point to serious spending from the ages of 18 to 50. If this cohort of the population is in serious debt, they will not spend enough and less spending means very little growth.

Periods of speculative excess also lead, in every country, to extraordinary disparities of wealth. The “new rich” typically have their counterpart in a “new poor”. In Ireland, the property bubble has created an entire demographic section of highly indebted commuter/workers in tandem with a booming private client business for the banks and brokers.

With the banks sitting in the middle providing liquidity to the entire structure, they are now the most powerful players in the economy, much more potent than the government. Unfortunately, given the dynamics of our “land standard” and the absence of a functioning central bank, it is not in the interest of any individual bank to be left overly exposed to the property market. So when one tightens, they all tighten and this increases exponentially a self-reinforcing fall in property prices.

Next time you’re out on the golf course and your partner tells you about a great membership deal on a new course, listen intently because it might be the sign that you’ll have more time to work on your handicap in the future than you ever dreamed of — or wanted.


  1. Brendan Doyle

    It seems to be conventional wisdom that the price at which
    land (and property in general) trades exceeds its economic
    value. How does one ascertain the long term economic value
    of an asset? Conventional financial theory holds that asset
    prices should be driven by a combination of expected cash
    returns to be generated by the asset and the level of
    interest rates used to convert future returns into present
    value terms. Is property overvalued taking a long term
    view? The answer given in the article would appear to be
    yes. If this is so, could the author outline which of the
    assumptions underlying the current price of property is
    false? Are future income streams to be below expectations?
    Interest rates to rise faster than expected? Are there
    other factors at play?

    There is no doubt but that the rapid growth in property
    prices has proved a boon to mainly the older generation.
    The article however fails to demonstrate that it is a
    wealth transfer from young to old. It is certainly a cash
    transfer, but until values fall it can hardly be considered
    a wealth transfer. People who purchase property are making
    a lifestyle choice as well as an investment decision. They
    choose to live in a certain location in a property of a
    certain size. Cheaper choices are available to them.

    If there is a bubble in property prices, and if it bursts,
    the wealth transfer will become horrifically apparent. This
    article stops short of advising the investor/house buyer
    how to counteract the wealth transfer effect described.
    Should a family rent accommodation for a period of time
    until the bubble bursts? How long will this take? How much
    of a drop can be expected to occur when it does occur? Alan
    Greenspan warned of irrational exuberance in the US stock
    market in 1996. The correction didn’t come until 2000. Even
    by 2003, at the bottom of the market, the Dow Jones Index
    hadn’t fallen to the 1996 level. Does this prove Alan was
    wrong? Or is the market fundamentally irrational? Property
    is inherently less volatile than stocks. To a potential
    house buyer, four year’s rent would knock a significant
    amount off the purchase price of the house, also
    eliminating a significant part of the interest rate risk.

    Congratulations on a thought provoking column. These are
    the thoughts provoked in me. I would welcome feedback on
    these points.

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