The Sky Isn’t Falling – But Your House Might


The Asian stock panic is beginning to look a little overdone. But that is not to say there is not a lot more fallout to come from the bursting of the US real estate bubble. But most of Asia needs to keep its nerve as others crumble. (Only India and China stocks are at risk of a major crash)

We are led to believe by the likes of Goldman Sachs, an interested party if ever there was one, that the US mortgage problem will be confined to the sub-prime sector. Oh yes, and all the others who have borrowed at floating rates to buy a bigger house or borrow on the hope of an assumed value increase to buy a bigger car will be able to pay higher interest rates on assets which start to depreciate.

The sub-prime is simply the tip of an iceberg. It is the most visible part of a massive problem, visible because the sub-prime borrowers, enticed into buying houses at inflated prices on the basis of “no money down” are simply the most immediately exposed. They have the highest mortgage payment to income ratios, with no other asset to cushion them from higher interest rates and prices just beginning a long drop. But it is only a matter of time before the infection spreads and a combination of foreclosures and a rising backlog of unsold new homes forces (or entices) supposedly prime borrowers to walk away from their 100 percent mortgages, many of which have rate increases built into them regardless of what the Federal Reserve does to interest rates.

But do not imagine that the real estate problem will be confined to the US. The UK looks almost as ripe for a painful reversal. It has not had the same level of abusive mortgage selling as the US, but house prices have risen even faster, driven more by the bandwagon effect than anything else. Just as Asia experienced in the 1990s, prices can keep rising for quite a while in the face of higher interest rates and slowing income growth. But a tipping point is eventually reached and not even the most ingenious of central banks or derivative wizards can stop it.

Some markets in Europe such as Spain have also seen bubbles caused by low interest rates and bandwagon buying.

Australia too looks vulnerable now. Prices there have managed so far to plateau rather than fall in the face of rising interest rates. But for how much longer given the number of buy-to-rent investors who must now be underwater despite the generous tax benefits on offer?

Indeed the excesses in much of the western developed world are actually more worrying than anything in Asia – including China, which at least has the advantage of real demand from rapidly rising urban populations and incomes. Demand in mature economies has been more driven by a touching belief that property is always a good investment rather than actual pressure for more or bigger housing.

Of course, the destruction of value in the US and elsewhere in the west will have a serious impact on Asian economies as manufactured export demand slows and commodity prices continue to retreat from recent highs. But don’t be fooled by western fund managers and bankers claiming there will be a flight from “risky” emerging Asia to western safe havens. Yes, India, the Philippines and Indonesia may see an exodus of capital but most Asian countries have an excess of capital and very liquid banks.

What these self-serving firms fail to point out is that in a situation of falling asset prices and (probably) rising real interest rates the lenders will do relatively well compared with the borrowers. And who are the borrowers? The US, Australia, UK etc intermediated by the same bulge-bracket outfits that helped finance the mortgage booms and subsequent and related excesses in private equity, collateralized debt obligations (CDOs) etc.

Asia’s response to a western crisis should be to keep more money in the region, not send more westward to bail out dodgy lenders and their officially backed handmaidens, the likes of Fannie Mae.

The main thing most of Asia should fear is fear itself. Even the once-worrying Korean real estate market has come off the boil and elsewhere in the region apart from some areas of China there is scant sign of euphoria. Yes, in the likes of Hong Kong and Thailand there has been recovery from the crisis but it is hard to argue that levels – apart perhaps from Grade A office space whose rentals have been bid up by investment bankers -- are now excessive given the interest rate outlook. Much the same applies in Malaysia and Singapore, and Taiwan could even be on the verge of a new boom. There is likely to be downward pressure on interest rates as inflation is easing as central banks seek to slow currency appreciation.

Export dependence is not as high as it sometimes seems in Southeast Asia, if only because value added in most industrial exports is low. Stock markets in this region anyway are heavily weighted to consumer, finance and property rather than exporting companies, and northeast Asia is both less export dependent and more likely to gain market share at the expense of Europe as US demand cools.

Helping Asian asset values too will be the desire of China, and now others, to invest less of their surplus in low-yielding western treasury and other bond and more in real and corporate assets. Meanwhile Asian markets have been largely free of the leveraged private equity buyouts in North America and Europe which have helped boost overall asset prices and stock market expectations.

So hold on tight. Expect markets to fall further but don’t panic, and don’t believe that the worst in the west is over till London prime property prices have fallen 35%, US ones by 20% and sterling, the US and Aussie dollars are down 20% against the yen and the yuan.