The smallest decisions in your life can ricochet through the financial world. Simply by taking a taxi or using an Uber, for example, might mean a loan going bad. It might lead to a downgrade on the share market. Today’s Daily Reckoning will explain why you should care about all of this.
Bloomberg reports that US banks that have lent against taxi medallions are reporting a high percentage of their loans are at risk of default.
In the US, a taxi medallion is a government licence to operate a cab. Seems simple. It was — until Uber and the rest of the ridesharing companies came along.
Americans, like Australians, are increasingly using ridesharing platforms to get around. That undercuts the value of the taxi licences. In 2014, a taxi medallion in the US was worth more than a million US dollars. Today that’s been cut in half. There’s every chance it might end up at zero.
You see, the licences were primarily valuable because they locked out competition. If you limit the number of licences, their value will soar. That’s what happened. The government sponsored the creation of a cartel of taxi licence owners.
The result was predictable. Those who owned the licence got richer than they otherwise would have at the expense of the consumer. Anyone taking a cab trip paid more than the natural market rate.
Service and driver standards became a secondary concern. You had no choice but to take a government-licensed cab.
Meanwhile, licence owners then also do everything they can to limit the number of further licences issued. Whenever a government creates a licence, it creates a vested interest alongside it.
Is a self-managed super fund right for YOU?
In this special Daily Reckoning report, award-winning wealth manager, Vern Gowdie shows you how to set one up…avoid dodgy advice…and choose the right investments.
PLUS you’ll get The Daily Reckoning every weekday…absolutely free.
Enter your email address below and hit the ‘Claim My Free Report’ button now.
The Market is Destroying One Government Privilege
The fact that the value of the licences soared higher created a further problem. To simply own the right to drive a cab often meant owners (or owner drivers) had to go into large amounts of debt. The security for the loan was the taxi licence.
As the value of the licence falls, the collateral for the loan naturally goes down too. That’s a problem for the bank because, at the same time, the income stream to pay it off is falling too. That’s because of the increased competition in the market. The bank can end up with non-performing loan and collateral worth less than the amount outstanding. That can lead to bad debt charges against its capital base. Not fun if you’re a bank.
Falling values in taxi licences is not a major problem in the grand scheme of things. They’re a niche market. Most likely, US banks who have loans against these licences will have to absorb the hit and write them off.
But can you guess what the loss of half a million dollars in value on the US medallion is? It’s the vengeance of the free market at work. The same thing is happening here.
Understanding this might have kept you out of a stock like Cabcharge [ASX: CAB], for example. This week, the company announced to the market an impairment charge on the value of its licence plates. That’s the second time in 18 months. The market has been discounting this. The stock is down around 13% since December.
This whole scenario reveals an important economic and investing insight. You need to be able to see where value is genuinely being created by the market or protected by the government.
You can apply this line of thinking to the Australian real estate market. Governments do everything they can to protect this market. Rising ‘house’ prices are highly correlated to happy voters.
The government doesn’t have a choice, anyway. Australians have over $1 trillion in mortgage debt. These loans are secured by the value of the property they’re held against.
You can see that the banks face a similar risk here as they do in lending against taxi medallions. A freehold property title is a government-granted privilege in a similar way as a taxi plate.
Should land values fall below the debt outstanding, the banks have a serious problem. This is the fatal weakness of the Australian economy. Any breakdown here and the whole thing keels over.
And yet there’s serious money to be made in the rising value of property. Do you play the game or stay out? And, yes, it is a game. It’s called Monopoly.
Over at Cycles, Trends and Forecasts, we see more gains from Australian property. However, we’re under no illusions about how it will end up. The key question is the timing. For our research on that, go here.
Editor, The Daily Reckoning