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Housing (worldwide): the biggest bubble ever

by Jerome a Paris Fri Jun 17th, 2005 at 08:23:08 AM EST

Remember 1990? The Japanese economy was invincible. They were invading the markets with their cars, semi-conductors, and buying assets all over the place, what with the land in Tokyo being worth more than the whole of the USA (or something like that). Remember how it ended? Well, now have a look at this:

Not convinced? See below.

:::::::::::::::::::: More below ::::::::::::::::

the graphs above as well as the quotes below are from the Economist (behind subscription wall)

NEVER before have real house prices risen so fast, for so long, in so many countries. Property markets have been frothing from America, Britain and Australia to France, Spain and China. Rising property prices helped to prop up the world economy after the stockmarket bubble burst in 2000. What if the housing boom now turns to bust?

According to estimates by The Economist, the total value of residential property in developed economies rose by more than $30 trillion over the past five years, to over $70 trillion, an increase equivalent to 100% of those countries' combined GDPs. Not only does this dwarf any previous house-price boom, it is larger than the global stockmarket bubble in the late 1990s (an increase over five years of 80% of GDP) or America's stockmarket bubble in the late 1920s (55% of GDP). In other words, it looks like the biggest bubble in history.


Calculations by The Economist show that house prices have hit record levels in relation to rents in America, Britain, Australia, New Zealand, France, Spain, the Netherlands, Ireland and Belgium. This suggests that homes are even more over-valued than at previous peaks, from which prices typically fell in real terms. House prices are also at record levels in relation to incomes in these nine countries.

See this graph:

These are relative numbers - the ratio of house prices to rents, so the absolute level is irrelevant. And the conclusion is unavoidable:

America's ratio of prices to rents is 35% above its average level during 1975-2000. By the same gauge, property is "overvalued" by 50% or more in Britain, Australia and Spain. Rental yields have fallen to well below current mortgage rates, making it impossible for many landlords to make money.

Anf the Economist addresses the issue that low nominal (apparent) interest rates may justify such higher prices:

A common objection to this analysis is that low interest rates make buying a home cheaper and so justify higher prices in relation to rents. But this argument is incorrectly based on nominal, not real, interest rates and so ignores the impact of inflation in eroding the real burden of mortgage debt. If real interest rates are permanently lower, this could indeed justify higher prices in relation to rents or income. For example, real rates in Ireland and Spain were reduced significantly by these countries' membership of Europe's single currency--though not by enough to explain all of the surge in house prices. But in America and Britain, real after-tax interest rates are not especially low by historical standards.

Banks are fuelling the craze by providing ever riskier instruments:

New, riskier forms of mortgage finance also allow buyers to borrow more. According to the NAR, 42% of all first-time buyers and 25% of all buyers made no down-payment on their home purchase last year. Indeed, homebuyers can get 105% loans to cover buying costs. And, increasingly, little or no documentation of a borrower's assets, employment and income is required for a loan.

Interest-only mortgages are all the rage, along with so-called "negative amortisation loans" (the buyer pays less than the interest due and the unpaid principal and interest is added on to the loan). After an initial period, payments surge as principal repayment kicks in. In California, over 60% of all new mortgages this year are interest-only or negative-amortisation, up from 8% in 2002. The national figure is one-third. The new loans are essentially a gamble that prices will continue to rise rapidly, allowing the borrower to sell the home at a profit or refinance before any principal has to be repaid. Such loans are usually adjustable-rate mortgages (ARMs), which leave the borrower additionally exposed to higher interest rates. This year, ARMs have risen to 50% of all mortgages in those states with the biggest price rises.

Banks have loosened their standards to the point it is hard to find charitable ways to describe their behavior. But they are not totally stupid - at least they have emasculated the bankruptcy procedures that allowed people to dump the assets on them and take off, so the hardest pain will not be on them this time, but on the home buyers, who risk paying for today's follies for the rest of their lifes.

So what will happen?

A drop in nominal prices is today more likely than after previous booms for three reasons: homes are more overvalued; inflation is much lower; and many more people have been buying houses as an investment. If house prices stop rising or start to fall, owner-occupiers will largely stay put, but over-exposed investors are more likely to sell, especially if rents do not cover their interest payments. House prices will not collapse overnight like stockmarkets--a slow puncture is more likely.


The housing market has played such a big role in propping up America's economy that a sharp slowdown in house prices is likely to have severe consequences. Over the past four years, consumer spending and residential construction have together accounted for 90% of the total growth in GDP. And over two-fifths of all private-sector jobs created since 2001 have been in housing-related sectors, such as construction, real estate and mortgage broking.

Note these numbers again:

90% of GDP growth

40% of all new private sector jobs

The Economist provides the example of the Netherlands, who was hailed as a model economy in the late 90s, with low unemployment, strong growth, and yet a decent welfare system. Well, it was all an illusion. House prices were increasing by 20% per year. Than they stopped growing (and did not evne drop), and the economy has been in a recession ever since. And that's the best case scenario.

The more comparable scenario is the one pointed out in the graph above the fold, i.e. Japan:

Japan provides a nasty warning of what can happen when boom turns to bust. Japanese property prices have dropped for 14 years in a row, by 40% from their peak in 1991. Yet the rise in prices in Japan during the decade before 1991 was less than the increase over the past ten years in most of the countries that have experienced housing booms.

Okay, the Economist has been bearish on housing prices for a number of years now, and they have been very wrong in their predictions a few times in the past (including predicting 5$/bl oil in 1999), and scary headlines on housing prices certainly will sell a few more papers, but are there rational arguments to say that:

  • house prices are not totally out of whack with what people can afford to pay;
  • the majority of financial instruments currently provided in the housing market are incredibly risky;
  • housing price increases have sustained so much of the current economic growth that even a slowdown of that growth (a highly optimistic scenario) will create real economic pain;
  • a drop in housing prices, like has already happened in Australia and the UK is very likely, and will have horrifying economic conseuqences in overextended America?

Can't argue with the bit about the banks. People think we're mad for only borrowing what we did 18 months ago. We borrowed well within our capacity: we could withstand much higher interest rates without hardship. Most people I know have borrowed far less conservatively than that, and when they get a bit of extra money they're buying bigger cars rather than paying extra off the mortgage, investing it, or saving it to hedge against interest rate hikes or property values dropping.

Many people have not only a mortgage against their own home, but a guarantee or mortgage against their parents home and/or they've borrowed large amounts of money from parents. I'm talking about middle and working class people who have just paid off their homes re-mortgaging in order to help their kids buy. A drop in values will hurt two generations in these cases. The banks have been pushing this: a friend of mine was actually told there would be no problem, because they'd looked at her father's account and he could afford to help her out. That discussion didn't end well.

There's certainly  a bubble here, and some of it is speculative, but there are structural reasons for the high prices as well. They can't last: the question is whether they will crash or just settle. I hoping they don't crash too much!

by Colman (colman at eurotrib.com) on Fri Jun 17th, 2005 at 08:44:51 AM EST

Are there any statistics on 'churn' rates and intervals?

What I'm getting at is, how much is the boom fuelled by people buying and re-selling at shorter intervals? I saw a report that this is a problem in NYC.

Eats cheroots and leaves.

by NeutralObserver on Fri Jun 17th, 2005 at 09:06:07 AM EST
Sorry, no idea!

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Jun 17th, 2005 at 09:09:23 AM EST
[ Parent ]
Inchoate evidence is coming from miscellaneous news reports.  The Economist has reported house prices in Australia are being kept up by the purchase of second homes and residential structures for investment.  The LA Times and NY Times have reported the same for their respective metropolitan areas.  

The only potential measure of churn rate is the "Sales of Pre-Existing Homes" metric.  This measure, however, does not breakdown the sales by intent and, thus, just about useless.  One would have to graph Pre-existing Home Sales versus Time of Ownership to get at the trendline.  Those graphs may exist - somewhere - but I haven't been able to find one with a quick Google search.

My guess it is the increase in M3 (total amount of currency available) across the world (US, EU, and etc) that is the underlying factor fueling an real asset price bubble.  Churn, then, is a secondary or microeconomic result of the macroeconomic enviornment.  

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sat Jun 18th, 2005 at 09:48:19 AM EST
[ Parent ]
250 percent average?  hah.  in my town (Coastal California USA) the factor is more like 500 percent -- in some cases more, depending on neighbourhood (location, location, location).

many people -- myself included -- are thinking hard about whether this is the time to cash out, to sell our primary residence for its enormously inflated value and become renters.

of course, if the US economy tanks as hard as it might given a housing bubble collapse, then the US dollars we might realise by selling the house would also lose their value pretty fast.  it may be a no-win situation for property owners in the bubble economies.  any ideas on this from those who understand financial risk?

The difference between theory and practise in practise ...

by DeAnander (de_at_daclarke_dot_org) on Fri Jun 17th, 2005 at 10:09:12 AM EST
LOCATION Prices are ridiculous in my backwater California area. We're near the bottom in income, yet here's this on the market right now:

3 Bed, 2 Bath
2,289 Sq. Ft.

Single Family Property
Year Built: 1966
3 total bedroom(s)
2 total bath(s)
2 total full bath(s)
Approximately 2289 sq. ft.
And the photo.

Then we have Syracuse, New York. A forgotten industrial City on the Erie Canal. Forgotten, but 5.2% unemployment, it is better than my area. Here's a house selling for $320,000:

8 Bed, 4.5 Bath
4,686 Sq. Ft.

SYRACUSE W; STRATHMORE AREA ONONDAGA COUNTY Historically significant home, victorian interior with all natural Quarter sawn oak in most rooms; mahoghany in the dining room, birdseye maple in music room. Leaded and stained glass windows, hardwood floors, true judges paneling-plus 3rd floor nanny suite, with kitchenette. Additionally the 2nd floor of carriage house has a one bedroom state of the art suite with Jacuzzi style tub with marble surround; beamed ceiling. parking for 2 cars in carriage house. Neighborhood of stately homes.
Photo, photo, photo, and photo.

by capslock on Fri Jun 17th, 2005 at 10:32:48 AM EST
[ Parent ]
Gotta get the carriage house photo to work!!
by capslock on Fri Jun 17th, 2005 at 10:35:00 AM EST
[ Parent ]
One way we might consider this is how ridiculous housing prices are also concomitant with ridiculous executive bonuses and stock options in the US. Greenspan spoke today about the ever increasing gulf between the top 20% and the average American worker. It's getting worse, and it's not healthy for an economy. While it apears that the average worker's pay is rising in the US, in real terms, this average is skewed by the immense increase for the richest in the form of options and bonuses, versus the stagnant salaries of your average worker.

This translates into the housing market in certain financial hotspots in the US. San Francisco, LA, New York and Boston especially.

Up here where I live, in Buffalo, housing is still quite reasonable, as it is in many American cities.

by Upstate NY on Fri Jun 17th, 2005 at 11:21:07 AM EST
[ Parent ]
The only way to answer this question is to actually run the financial calculations.  This would involve comparing the rental and purchase prices of comparable residences in your location, adjusted by your specific financial situation, and then perform Present/Future Values computations to see what you get.  

For a lark I ran the numbers for Albuquerque New Mexico several months ago.  The result was ~$40,000 net gain by renting - and investing the monthly Purchase - Rent money - over Purchasing. My feeling is that this will hold true for most of the world tho' I don't have any numbers to substantiate this claim.

One thing to note: a lot of "profit" people see in homes, when inflation is subtracted, comes from the enforced discipline of making the monthly house payments and the consequential flow-through to equity.  This makes the "profit" more like "savings" (if you will). Greater discipline is required to sock the purchase/rent difference into an investment vehicle than merely chucking a check at a mortgage lender.

Lastly, both mortgage and rent payments must be met out of income not net assets.  Lenders have a nasty habit of wanting the money they lend back with a profit.  Your house may be worth $100,000,000 more than when you bought it but, if you can't meet the monthly payment, it will be repossessed turning it into a net worth of $0.  Don't forget to figure your debt/income ratios when casting your balance sheet.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sat Jun 18th, 2005 at 11:02:22 AM EST
[ Parent ]
just out of curiosity, what's the deal with coastal and beach property?  i would imagine that people snapping up all those beach houses and such might not be in such bad shape when the ol' bubble burts.  i definitely could be wrong though, it's not like i know much about economics or real estate :)

I guess that coastal area prices could have gone up even more ridiculously?  Help lessen my ignorance, please.

by Meandering Fox on Fri Jun 17th, 2005 at 10:48:15 AM EST
We live in the Californian littoral.  17 years ago, we purchased a home inland of here--up over the first major range of hills (an old map of the area labels them the "Rocky Mountains"--and they are, indeed, the rockiest damned mountains I've ever seen.  But I've lived in and around mountains and I still say they're hills).  The market was hot then, and we got gouged because of an unscrupulous real estate agent who had close ties to the seller that weren't revealed.  Price for that 1600 sq ft, 3 bdrm home, in 1988: $134,500

Ok, we made improvements.  It's now just under 2000 sq ft.  Nicer.  But the real estate agent tells us -- she'll be putting a figure on it for us in the next day or so (should have been done yesterday, but the tenant had a problem...) -- it's worth around $550,000.

That's close to an hour's drive from the coast in a town that isn't even suburbia.

Now we live just barely in sight of the coast (hilly area allows that), and the beach is ~20 minutes away.  Less if traffic's not jammed up.  The house was $215,000 in 1998.  My guess is that it'd go for about $700,000 now.  Maybe more; I consistently find I'm lowballing prices when I try to guess these days.  Nothing's changed about it other than my habitual home renovations, and the addition of a photovoltaic array.  It was just a hair over the median home price when we bought it.  Railroad tracks just down the hill; a train squeals through onece or twice a day on those barely usable tracks.  They're upgrading them for a commuter rail line.  No sidewalks, in a small suburban city; the neighborhood on the other side of the track (oh, yes, I'm aware of the irony...) is all apartments, "low" rent; there's a drug rehab complex and the local main post office, and strip malls.

Nice view, and we can't hear the freeway from here.  We CAN hear the artillery practice at Camp Pendleton.

That's $700,000 (or so) in not really coastal California.

Shoot over to the real coastal cities, and even in Oceanside, which is that last city that caught the wave (being as how its neighbor is Camp Pendleton, and its long history of catering to their needs, desires and entertainment made it a less desireable area... but that's passing; coastal property's too dear, and the citizenry now insists that they don't have to put up with it all...) property has skyrocketed.  Start looking for your million dollars and up for anything that's even battered but vaguely akin to a median home....

How oft the sight of means to do ill deeds Makes ill deeds done. Shakespeare; King John

by ogre (p-mclaughlin@REMOVETHIScox.net) on Fri Jun 17th, 2005 at 12:07:24 PM EST
[ Parent ]
When the bubble pops... those owning coastal homes that require incomes of more than $200,000 to support... well...

tea leaves?

How oft the sight of means to do ill deeds Makes ill deeds done. Shakespeare; King John

by ogre (p-mclaughlin@REMOVETHIScox.net) on Fri Jun 17th, 2005 at 12:08:29 PM EST
[ Parent ]
A factor that needs to be included is the baby boomer effect. The boomers are right now at their peak buying power. They're in their fifties, kids out of college, good jobs, and lots of disposable income. It's not that hard to buy an expensive house if you're in that situation.

That's a different group from the ones taking out interest-only loans.

by asdf on Fri Jun 17th, 2005 at 10:53:29 AM EST
Are there any statistics that show if the percentage of people owning their own homes has gone up in North America (where is Canada in all this, do they have a housing bubble?) and Europe.  One talking point I can imagine Republicans coming up with in the US is that more and more people are realizing the American dream of owning their own home.  But how that would relate to the rise in house prices I don't know.

And there is no "European dream" of owning your own home, is there?  Haven't fewer Europeans owned their own homes historically than Americans?  Or have I been too influenced by all those "lord in the manor house" historical epics that are shown on PBS.

La vie n'est de soi ni bien ni mal, elle est la place du bien et du mal selon que vous faites.

by Time Waits for no Woman (time.waits_at_gmail.com) on Fri Jun 17th, 2005 at 01:11:16 PM EST
Without spending too much time trying to drum up an analysis from some of the underlying data, here goes:

In the U.S., ownership rates began a steady, relentless increase around the beginning of the Clinton Administration and haven't let up since.  In 1994, it was 63.8%, and in the first quarter of 2005, it stands at 69.1%.  (Source: Homeownership Rates for the United States:  1965 to 2005)  Regional variation in the rates has also been a constant, with the Northeast and West lagging well behind the Midwest and South.  (See this Census survey.)

I was able to find this summary of ownership rates from Canada:

The proportion of households in Canada living in owned rather than rented accommodation increased considerably between 1991 and 2001. . . .  In 1991, 62.6% of households owned their own home. By 1996, this proportion had risen to 63.6%, and by 2001, it was up to 65.8%. The gain between 1996 and 2001 was the largest for any five-year period since 1971.
(Source:  Statistics Canada; see also Canadian Housing Observer)

As for the UK, The Economist noted a month ago: "Since 1997, when Labour won power, the home-ownership rate has risen rather sluggishly, from 68% to 71%."

Home ownership rates for much of the rest of Europe vary widely, with those in Italy, Spain, Ireland, Portugal, Austria and Greece all exceeding that of the UK (and thus the US as well).  Finland, France, The Netherlands, Belgium and Denmark are some 10-15% below the UK rate.  Germany and Switzerland bring up the rear, with rates of about 43% and 35%, respectively.

Click here for the full-sized original.

A comprehensive survey, the Royal Institute of Chartered Surveyors' European Housing Review 2005 (warning: 155-page PDF file) has a wealth of data available.

And without vouching at all for the legitimacy of his data or analysis, Andrew Oswald of the University of Warwick published a paper in 1999 that posits a relationship between high rates of home ownership and high rates of unemployment: "The Housing Market and Europe's Unemployment".  It's an interesting thesis, though I don't know how well it would hold up today.

Hope this helps.

by The Maven on Fri Jun 17th, 2005 at 04:10:11 PM EST
[ Parent ]
Ask and you shall receive.  This is VERY interesting data.  First I am amazed that rates of home ownership exceed that of the US in the UK and many other countries.  That's one stereotype down the tubes.  I have travelled and lived the most in France and Germany, which have lower rates of home ownership than the US--Germany quite a bit less--so maybe that explains my misconception.

But, in any case, what is called the American dream (or at least one part of it) seems to be realized by quite a few countries in Europe, more than it is in the US.

La vie n'est de soi ni bien ni mal, elle est la place du bien et du mal selon que vous faites.

by Time Waits for no Woman (time.waits_at_gmail.com) on Fri Jun 17th, 2005 at 05:51:52 PM EST
[ Parent ]
Absolutely convinced here.

That bubble has been known for some time.. among respectable economists. It's a shame those guys aren't the ones that generally get press!

When the housing bubble collapses it will be horrifying world wide imho. An economy this large cannot fold that badly without it's effect being felt everywhere.

Plus.. our economy is overemphasizing finance.. stocks.. etc. Similiar to the situation right about 1929, in fact... Mind you, there are more safegaurds in place now than there were then and I'm no economist..but from my layperson's eyes the picture is not rosey

Hermaphrodite with attitude!

by Syniel (syniel :at: gmail :dot: com) on Fri Jun 17th, 2005 at 01:11:48 PM EST
A very useful, informative post and thread!

Jérôme, I note (and how!) the figures you underline for the US : 90% of GDP growth and 40% of job creation over the past four years (!!!)

Do you or does anyone have comparable figures for Europe? I'd be interested in seeing the numbers for the UK in particular.

by afew (afew(a in a circle)eurotrib_dot_com) on Sat Jun 18th, 2005 at 05:53:04 AM EST
I note with interest that my country, Austria, has apparently a high rate of home ownership and virtually no recent price increases. This bears out what I can observe in my own environment, and may have demographic reasons, at least in part. The high rates of home ownership in Italy and Spain may also correlate with their low fertility rates, I surmise. A single child will probably inherit an apartment or house from someone sooner or later, or if not, their spouse will. Unfortunately the location may not be convenient, and selling is expensive and often sentimentally repugnant.  

For instance, a relative of mine inherited several apartments and her father's large house in a provincial city, and found it quite difficult to sell the latter at an accepable price. My three aunts, between 70 and 82 of age, each inhabit a large house all by themselves, while their 7 children - boomers and late boomers - live in apartments or houses they own, mostly mortgage-free. That is pretty normal for the middle class.

Given this scenario, it would seem to make sense for my age cohort to save for the time when the prices come down some more, and then buy some nice apartments or houses in a good, quiet city location as needed for the next generation.

by Danubian on Sat Jun 18th, 2005 at 08:52:08 AM EST

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