THE strong buyer demand this month for Sky Habitat, Singapore's most expensive suburban condominium, has created a flutter in the blogosphere. A three-bedroom, 99-year leasehold condo in Bishan for $2 million? Isn't that over the top, even if it claims an 'iconic' design?
But then, how does one know what the fair value is? Some bloggers have supplied buyers with useful rules of thumb. Former NTUC Income chief Tan Kin Lian, who contested last year's presidential elections, has advised readers to buy properties that cost 60 months of their salaries or less. So to afford a three-bedroom unit in Sky Habitat, either the husband or the wife has to earn $33,000 a month, he noted on his website.
Rules of thumb help people decide, but they are not scientific gauges of value. Why 60 months of salary? Why not 55, or 65? What will be a better way to value an apartment? I wish somebody could tell us. The trouble is there is no good way to put a 'fundamental value' on an asset.
The valuation experts who put price tags on capital assets that can be held for a long time, producing an income stream (if rented out), or consumption utility (if self-used), usually do so by discounting risky future cash flows or utility to arrive at an estimate of value today and by comparing it with the price of a risk-free asset like a government bond.
You can throw in 'technical analysis' into the mix and look at past transacted prices. All home buyers do it, including economics professors who scoff at the notion that there is any useful information to be gleaned about future prices by observing the past.
The economics profession can fill a small-sized library with books and journal articles about its pet theory of pricing capital assets. One of the pioneers of this theory - Professor William Sharpe of Stanford University - even got the Nobel Prize in 1990. But we saw once again in the United States housing bust of 2007 and 2008 just how little we know about valuing these mystical objects called assets.
Standard economics has no good explanation for manias, panics and depressions - which occur routinely in most assets - because it assumes that the market consists of one representative investor, a Homo Economicus, who knows all future risks, correctly anticipates their likelihood, and can, therefore, assign an accurate value to every investment today.
What we call market prices are but the beliefs of this person. By definition, they are always right. But what if there is no such representative investor? What if prices are determined by interactions of individuals with different beliefs about an 'unknowable' future?
Think of a market for assets in which investors are like ants that stop by to swop notes and, in the process, shape one another's beliefs. It is as though one ant is 'recruiting' another to its point of view, just as what your colleague told you yesterday about properties in Bishan may have recruited you to her point of view, though neither she, nor you may know it.
Economist Alan Kirman described the phenomenon in a 1993 paper. Leave two identical food sources near a colony of ants. You will, after a while, find them herding at one of them, feverishly exploiting it; the other food source will only have attracted a few desultory ants. A little later, you will find ants' preferences have switched: Now most are devouring the second food source, and few ants are paying any attention to the first. Keeping the two sources constantly replenished does not alter the ants' behaviour.
There may be no difference between ants' approach to food and investors' attitude to risk. Herding is common in markets, and seasoned investors know it.
Another challenge to the conventional theory of pricing assets has come from Yale economist John Geanakoplos. For 15 years now, he has been saying that it matters a great deal to the price of an asset whether its next buyer is an optimist or a pessimist. An optimist will buy it with borrowed money; a pessimist will not. If there are two identical assets, and one can be leveraged but the other one cannot, then the first one will be pricier.
This is why the Monetary Authority of Singapore (MAS) takes loan-to-value seriously. The central bank cannot dictate to people how they should think about Sky Habitat. It can only warn them about the perils of overstretching their finances, warnings that go unheeded in an environment like today's in which rising incomes, small apartment size and low interest rates have combined to increase the potential pool of buyers for suburban property by 70 per cent since the third quarter of 2009 even though prices have increased 30 per cent, according to Citigroup property analyst Wendy Koh. Ms Koh does not rule out another round of property cooling measures, and if those include yet more stringent norms on use of leverage, I will not be surprised.
By controlling leverage, the MAS can try to prevent the most optimistic investors from being at the front of a long line of ants marching toward food. Whether they will find a feast awaiting them, or have to satisfy themselves with crumbs, will be decided by US Federal Reserve Chairman Ben Bernanke. A feast if he prints more money, crumbs otherwise.