How do you know if you actually own something? With personal property carrying it around in your pocket might be sufficient. Keeping your car locked and in a locked garage also might protect it. Real estate and intangible personal property, things like stocks and bonds, are different. The thing that tells you that you own a piece of land or a stock is simply a piece of paper. The only thing that gives that paper value is the legal system that backs it up. Without a legal system, clear rules regarding land ownership, a open and transparent land registry, the piece of paper could be just that, a piece of worthless paper.
The problems of land registry are endemic throughout emerging markets. For example, in Indonesia according to a World Bank report only 17 million of the 80 million land parcels in Indonesia are registered. Such problems can lead to evictions of the residents on a particular property. These evictions often result in mass demonstrations and violence. This has happened not only in Indonesia, but also in Russia and especially in China where small scale wars have erupted.
The problem of title is not only for the poor. At least the poor in these countries can throw bottles, attack construction sites and start riots. Foreign investors do not even have that option. In relationship based systems, there is no recourse to courts. If your development needs to be moved, because someone wants it moved. You will lose.
I wrote about these problems in my book concerning an incident in Beijing about a McDonald’s franchise. Certainly large scale high profile evictions are less likely, but if local power brokers can throw anyone out of their house, they can throw out foreign investors.
This is why the concept of mortgage backed securities in China and many other emerging markets are foolish. It is a piece of paper using another piece of paper as collateral. Nevertheless, Australia’s Macquarie Bank and Dalian Wanda Group, a Chinese real estate developer, are on a road show to sponsoring the sale of $145m of dollar-denominated mortgage-backed securities.
These mortgage backed securities are apparently not for residential properties. They are for domestic shopping mall complexes where the retail space is rented to foreign firms such as Wal-Mart, KFC and Pizza Hut, and Parkson, the Malaysia-based department. This is an excellent example of the illusion of safety in emerging markets.
The investment in mortgage backed securities is supposed to give the holder the right to foreclose on property that pay interest based on rent to foreign firms. For the transaction to work the mortgage, the land title and the lease all have give real legal rights enforced by courts. Any failure of any of these legal rights endangers the entire transaction. In China you cannot own land anyway. It is subject to long leases. Titles are obscured because the records at land registries are often incorrect or unavailable. Regular leases can be invalidated by local courts as can mortgages.
The end result for investors in these things is the enormous illusion of low risk. If the truth could be know, these securities might be correctly price, but as it is, they are nothing more than pieces of paper.
William Gamble
EMERGING MARKET STRATEGIES
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