A leveraged bet on London banking and oligarchs: James Saft

March 11, 2014

March 11 (Reuters) – As a symbol of Britain’s ill-advised
romance with banking and dubious foreign money, a new prime
London property investment fund is hard to beat.

The investment vehicle from asset manager London Central
Portfolio Ltd, which will commit 100 million sterling to prime
residential property, amounts to a bet that London retains
official policies that make it the corrupt rentier’s bolt-hole
of choice.

To be clear, there is nothing illicit about investing in
London property, but London is what it is because of official
policy choices which are good for banking and for wealthy people
from less democratic places.

First, a quick take on the fund, which is interesting mostly
for the assumptions underlying its mode of doing business.

Citing what it says is a 40-year track record of 9 percent
annual price appreciation in central London property, the fund
plans to buy up one- and two-bedroom units, with an eye towards
renting them and then flipping them in five to seven years. If
you consider eternal 9 percent growth in property prices, even
in districts popular with Russian oligarchs, optimistic, wait
until you hear about the annual 14 to 18 percent rate of return
the fund is targeting. That figure is only therefore achievable,
of course, with a liberal dose of borrowed money.

So on the face of it, you have a fund with many of the
features of a speculative bubble; a leveraged investment in an
illiquid asset which is arguably already overvalued. Gross
yields on flats in prime central London only amount to a bit
less than 3 percent of the value of the property, according to
data from real estate firm John D Wood & Co. And as that is a
gross yield, making no allowance for running costs much less
periods of vacancy, these are likely to be investments which you
pay to own, rather than vice versa.

But that’s not what is really remarkable here. What really
sings about this fund is the tacit underlying assumptions: that
Britain will continue on its path of ever-greater
financialization with an ever-growing banking sector centered on
London; and that this will go hand-in-glove with keeping open
house in central London for people who earned, shall we say,
their money elsewhere, often through ‘government service’ or at
least by being useful to governments.

For Britain, these twin strategies are economically unwise
and morally distasteful.

HOW BIG IS BIG ENOUGH?

Those expectations, though, seem pretty reasonable based on
recent developments. A photographed official document revealed
last week showed the British government strategizing about
countering Russian incursions into Crimea in ways that wouldn’t
“close London’s financial centre to Russians.”
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And though visa or travel restrictions are a possibility,
the clear indication is that London’s role as a financial
entrepot is central to British policy, a strategy which has
historically also led to both money and people finding their way
to the city.

From a human standpoint, that’s wrong because it enables
corruption. In an un-democratic and massively corrupt country
like Russia the principal fear of anyone close to power is that
some day power turns on them. Having a vibrant world capital
like London, rather than a dreary island somewhere, as a place
through which one can dry-clean one’s money and as an escape
hatch gives them a special kind of security.

Why work towards security of person and property at home
when the money is so good and can be enjoyed in a place like
London where those rights are respected?

From a purely financial standpoint, welcoming this tide is
also unwise, though exceedingly expedient.

Britain’s financial sector is now about four times as large
as its annual output. That creates a lot of high-paying jobs in
London but also, as we saw during the financial crisis, a lot of
latent risk. The tab for that risk won’t be picked up, if we
suffer another crisis, by the bankers and oligarchs. It instead
becomes, in an extreme, a sovereign liability.

Remarkably, though, Bank of England chief Mark Carney laid
out in October a vision of Britain in which banking becomes even
more important (and presumably central London property even more
valuable).

While stressing that it isn’t his job to dictate how big the
financial sector is, Carney laid out a future in which, if
current trends hold, banking assets grow by 2050 from four times
the size of annual output to nine times. By comparison, U.S.
banking assets are just a bit bigger than annual GDP.

For a man whose successor in 2050 might have quite the
banking mess to clean up, Carney seemed remarkably relaxed about
this.

From fund managers, to investors, to politicians to central
bank chiefs it seems money, regardless of its source, is often
pleasant enough to blind you to risks.

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