Economic Crisis

Unreal estate bubbles

For some reason people love real estate (property) bubbles. As prices rise everyone deludes themselves into thinking that they are getting richer (even though the number of bricks in their house stays the same). Therefore vote-seeking politicians love real estate bubbles as well. Anything to keep the punters happy.

The trouble is all bubbles go pop. Bursting real estate bubbles are especially damaging, since they affect rich and poor alike and hit large parts of the economy. Most families own a property, usually their home, and a lot of businesses make their profits in the sector.

As prices fall, hard earned buyers’ cash deposits are wiped out. People start to default on mortgage loans. Lending banks write-down assets and sometimes go bust. The wider economy takes a hit as people feel poorer and spend less. Construction companies lay off workers. Furniture stores go bankrupt. Estate agents close offices. Governments often get kicked out of office at the first opportunity.

…global banking system was exposed as a house of cards (which, by the way, it still is), and many huge banks had to be bailed out by their governments.

You’d have thought that with all that went on in the US and Europe in recent years that we’d have learnt our lesson by now. The entire global banking system was exposed as a house of cards (which, by the way, it still is), and many huge banks had to be bailed out by their governments. All of this was triggered, initially, by falling real estate prices in the US after the bubble there peaked in first quarter 2006.

But no, we don’t seem to have learnt anything. Many bubbles continue to be inflated by cheap money and government policy. Take a look at this chart from the Economist of selected countries’ house prices, adjusted for inflation and going back to the third quarter of 1984 (which happened to be a low point for many markets).

House-price index

The Economist house-price index
The Economist house-price index: Price in real terms.

It’s as plain as the nose on your face that Hong Kong, shown in dark green, is experiencing a property bubble (I recently wrote about it here, here and here). Adjusted for inflation, prices are now well above the last bubble top in the middle of 1997. Although to be fair the government has been trying to calm things down.

It’s also pretty clear that the US bubble was a small one, in percentage terms, when compared with other countries. Spain and Ireland both had massively larger bubbles, and are still going through massive busts. Each of these countries is a member of the eurozone, and had excessively low interest rates and easy credit to fuel the booms, once they’d given up their own currencies.

Then there’s Canada. This has been ticking steadily higher since 1999. But now it has definite signs of bubbliness. The ratio of median prices to median incomes in Vancouver is second only to Hong Kong. The governor of the Bank of Canada, Mark Carney, appears to have seen the writing on the wall, and is skipping town. He’s transferring his bubble blowing skills to the Bank of England, where he’ll take over as governor in July. He should fit right in with the Brits…

There’s an exception on this chart. Look at the orange line at the bottom. That’s Japan. Prices peaked there in early 1990 – along with a stock market bubble – and are still falling, 23 years later. In fact they are down about 50% in inflation adjusted terms. So much for real estate prices always going up…

Unreal estate bubbles

Just as in Spain and Ireland, the bubble in Britain has been massive as well. Prices have come down a little since the mid 2007 peak, when adjusted for inflation, but it looks like there is still a long way to fall to get back to historical norms. Yet the government in Britain has introduced policies to pump the bubble back up again. In this sense prices aren’t real, and set by supply and demand in free markets, they are “unreal”. Will these meddlers never learn…

…the government lends cheap money to banks provided they lend it on to companies and private individuals.

It’s worth taking a quick look at the British policies, to get an idea of the kind of idiotic things that politicians do from time to time (or maybe all the time). The first policy is the “funding for lending” scheme, where the government lends cheap money to banks provided they lend it on to companies and private individuals. One result has been to reduce interest rates on mortgages, which supports prices.

Next they have the “help to buy” scheme, where the government will lend up to 20% of the price of a newly built property, interest free for five years. Alternatively they will guarantee certain mortgages, effectively taking the risk away from lending banks.

This kind of thing is nuts. It’s just yet more government intervention and manipulation of markets, such as the “quantitative easing” (money printing) used to prop up government bond markets. It’s central planning, Soviet Union style, and just about as likely to be successful in the long run.

It doesn’t seem to have occurred to these fools that low prices would be the best outcome, not higher ones. The lower the price the more that people get for their money. This is especially important for first time buyers and those with low incomes. Plus if people spend less to buy their homes, and have smaller mortgages, they’ll have more to spend in other parts of the economy (and less lining the pockets of the banks).

These control freaks will re-learn that markets work, eventually, and if you interfere with markets they’ll turn around and slap you in the face. You may be able to delay and defer that face slapping for a while. But a face slapping is surely on the way, one day.

There are real estate bubbles in many parts of the world, including other countries so far not mentioned (such as Australia, France and Belgium). Some bubbles are still inflating (Hong Kong, Canada), others are still deflating (Ireland, Spain), some are being prevented from deflating (Britain), and others have convincingly popped (USA – although prices may still fall a little further there).

These bubble prices for property are not real. They are propped up by cheap money and government policy meddling. That’s why I call them “unreal estate”.

If you’re unfortunate enough to live in a country with a property bubble, at OfWealth we recommend that you are careful. All bubbles burst, eventually.

Until next time OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.