7/31/2012 8:03 PM ET|
US housing mess: It's not the worst
You've heard that all real estate is local, but the bubble has been global -- though certainly not uniform. Take a look at how other countries have fared.
Every month, it seems, you hear about a real-estate bubble bursting somewhere in the world. Americans are in year six of the U.S. meltdown, long enough to make us curious: Are these others like ours? Or different? Is it all one big epidemic?
It's not particularly comforting to know that economists are asking the same questions. "People already are doing research on it. We'll be arguing about it for the next 10 years," says Stephen Malpezzi, a professor of real estate and urban land economics at the University of Wisconsin-Madison.
To learn more, we asked experts to compare the U.S. housing fiasco with those in Ireland, Spain, China, Australia and Brazil.
What makes a bubble?
The more-or-less simultaneous rise of bubbles in many countries is unprecedented. Previous bubbles tended to be local and isolated. Oil wealth in Texas, for example, or a shortage of buildable land in San Francisco might drive prices ridiculously high, particularly if the local economy was booming. But other cities stayed untouched.
Now, instantaneous communication, easy travel and interconnected global financial systems can make national or even global property markets feel local to investors looking to make a buck, says Robert Shiller, a professor of economics at Yale University. He warned early of a possible U.S. real-estate bust in his 2000 best-seller, "Irrational Exuberance."
As property markets from Phoenix to Majorca, Spain, heated up, not only resident homeowners but investors everywhere jumped in. "I think of a bubble as a social epidemic of sorts," Shiller said in a recent phone interview. "It spreads like a disease. Enthusiasm goes from one person to another."
In reality, though, real-estate assets aren't mobile. They're fixed in one location.
For a healthy economy, you can't have more houses than people to live in them. There's no hard-and-fast definition of a bubble, but telltale signs include:
- Home prices that grow out of proportion to incomes. (Sustainable home prices are three to four and a half times buyers' incomes. Bubbles prices run seven or eight times greater than incomes, or more.)
- Rents that skyrocket compared with incomes.
- Home prices that soar while costs for land and materials remain flat.
Buyers also hold nonsensical expectations that prices will keep rising more or less forever. A hot market becomes a bubble when people buy even if they can't afford it, and their purchases have no financial justification. Bubble buyers panic that they might lose out, Shiller says.
Similar but different
Access to cheap credit by developers and consumers is a common theme among contemporary bubbles. From rents, sales, mortgages and construction to furnishings, home improvements and consumer spending of equity, housing adds up to about 20% of the gross domestic product in developed countries.
Experts point to governments' cracklike addiction to pumping up economic growth by stimulating housing markets. Largely that's done by keeping interest rates low.
In most recent bubbles, banks lent cheaply and often irresponsibly. "Credit was not priced according to the risk at all," says Marja Hoek-Smit, the director of the International Housing Finance Program of the University of Pennsylvania's Wharton School.
Yet despite the similarities, the causes of bubbles vary. Here's a look at the timing, gains and losses for five nations' housing bubbles:
|Bubble began||Prices peaked||Total gain*||Loss from peak**|
|Australia||Q4 1990||Q4 2010||153%||7%|
|China||February 2006||May 2012||42%||9%|
|Ireland||Q3 1994||Q2 2007||213%||30%|
|Spain||Q4 1994||Q1 2007||125%||27%|
|United States||Q1 1993||Q4 2006||52%||28%|
|Source: Global Property Guide |
*Prices adjusted for inflation / **As of June 2012
Looking at Australia
Home prices rose quickly in Australia during the 1990s. By the early 2000s, bubbles in Ireland, Spain, China and the United States had been launched, according to Global Property Guide, an international real-estate research site.
About 65% of Australians own homes, as in the U.S. But where cheap credit, speculation and easy construction loans inflated the U.S. bubble, Australia's housing market was fueled by too many buyers competing for too few homes, says Michael Lea, the director of the Corky McMillin Center for Real Estate at San Diego State University.
Aussies are mostly bunched up in six coastal cities with limited room for building, so the growing population creates a great demand for homes. Not everyone agrees that Australia's boom was a bubble. Home prices, as in the U.S., grew out of proportion to incomes but not as much as in, say, China or Spain.
Australian home prices hit a peak in late 2010. They've been falling gently, by 1% or 2% a quarter, like the current rates of decline in the U.S. but unlike the sickening quarterly plunges of 2% to 3% we endured in 2008.
The Australian government should get credit, Lea says. "The one country that acted proactively and pierced the bubble was Australia. In 2003 or 2004, they saw prices were too high, and they raised interest rates and headed it off."
China's bubble also was fueled largely by cheap credit. Unlike the U.S., though, China has dodged a crash in home prices -- so far.
Three years ago, the central government began raising interest rates to calm home sales. It tightened requirements for down payments and mortgages, and it limited how many homes a family could buy. The result: Home prices nationally have dropped slowly. It's too soon to know if the retreat will continue to be manageable. Recently, the People's Bank of China retreated from its tough stance in order to tickle the weakening economy.
There's also a wild card: local bubbles in cities such as Beijing, Shenzhen and Guangzhou. There, prices are rising, and competing buyers line up outside sales offices. Chinese have few legal options besides real estate for investing their money, which fuels a buying frenzy.
The centrally run economy allows China to directly exert control. "When the Chinese government feels the sector is overheating, it can take mitigating action more easily than most other countries," says the Wharton School's Hoek-Smit.
But the central government does not have complete control. Local governments get a lot of revenue from owning and selling land to developers. Many cities are still raising land prices and selling to developers.
"They may be able to not have a major crash," Hoek-Smit says. But with home construction so important, as in the U.S., a housing slowdown will affect the national economy. Already, developer bankruptcies are hurting banks. "It's an enormous country," Hoek-Smit adds. "Different areas will be impacted differently."
What happened in Brazil
While cheap credit was inflating the U.S. bubble by 2003 or 2004, Brazil's housing market stayed normal until 2009, says Hoek-Smit. But then, Brazil, worried by the U.S. financial panic of 2008-09, created programs to stimulate its economy by subsidizing the building of 3 million low- and lower-middle-income homes. When the economy overheated, Brazil, like the U.S., failed to act quickly to slow the growth.
Brazil's expansion, like China's, helped raise a developing nation's living standard and put many poor families in decent homes. But the price of overdevelopment is now clear. A spring report by Capital Economics, an economic research company, estimates Brazilian real estate to be overvalued by as much as 50%. Prices have tripled in Rio de Janeiro and doubled in São Paolo since 2008.
House prices are "out of all proportion" to incomes and rents -- classic tip-offs to a bubble. Brazil's boom appears to have peaked in July 2011, says Global Property Guide publisher Matthew Montagu-Pollock.
Last year, 9 million Brazilians took out loans for the first time, Ricardo Loureiro, the president of credit company Experian's Latin American arm, Experian Serasa, told a Brazilian business magazine.
Vacancies are appearing even in Brazil's subsidized lower-income housing sector, a sign of subsiding demand. Rather than discourage lending, the government made credit easier, allowing 35-year mortgage terms to let even more lower-income people afford payments.
Spain has had one of the highest rates of homeownership in the world. By 2002, 84% of Spaniards owned homes, assisted by steady employment, improved wages and government efforts including a mortgage-interest tax deduction and elimination of rent controls.
Spain and Ireland joined the European Community, the forerunner of the European Union, in 1986, leading to the removal of regulatory and trade barriers and, later, the adoption of a common currency. "Because of the integration, credit was available at a much lower rate," Hoek-Smit says. "Everyone had the same currency, there were no more boundaries financially, no more foreign-currency risk."
But there was a penalty: After Spain and Ireland relinquished control of their monetary policies, they lost the ability to control growth by raising interest rates.
In Spain, legions of sun-seeking Northern Europeans scooped up second homes and retirement retreats. Home prices shot up by 10% to 15% each year for seven or eight years.
Between 2000 and 2006, the average home price grew to 13 times the average worker's salary, according to Spanish real-estate writer Borja Mateo. Imagine a worker earning $60,000 buying a $780,000 home.
Most Spanish mortgages are cheap, adjustable-rate products, says Lea, of San Diego State University. Banks refrained from peddling the risky subprime loans that many American lenders sold. But when Spain's bubble burst, that didn't matter: Nearly a quarter of Spaniards -- and about half of young people -- are jobless now, sending formerly solid borrowers into default.
Spanish real estate, hugely overbuilt, has lost 27% of its value, similar to the average drop in the U.S. nationwide. Experts predict that, unlike U.S. prices, prices in Spain have much further to fall. Spanish banks are getting a 100 billion euro ($121.6 billion) bailout from the European Union. Lea predicts the tumble in Spanish real-estate prices eventually will resemble the some of the biggest plunges in parts of the U.S. -- in Florida (43%), California (44%), Arizona (46%) and Nevada (58%).
Trouble in Ireland
Ireland's bubble, too, was fed by cheap credit, easy lending and overbuilding.
A key difference was scale. The country is small, with just 4.7 million people, yet its banks took on more debt, proportionately, than anywhere else, except maybe Spain. "It was mostly on the construction side . . . enormously irresponsible loans to developers who got stuck with developments they could not sell," says Hoek-Smit.
Home prices grew unaffordable, even with low interest rates and wages rising so high that Irish industry became uncompetitive. "That bubble had to burst, and when it did, it took down the banking system," Lea says.
The government's bank rescue added greatly to the problem, he adds. Ireland guaranteed all bank liabilities, nationalizing two of its three largest banks. Ireland's 64 billion euro ($77.8 billion) bailout was "perhaps a number they could not afford in any stretch of the imagination," says Lea. "Because Ireland was so overbuilt, it'll be many years before you see the property sector contributing to the economy again."
The U.S. bailed out its banks, too, but unlike in Ireland, the American bailout had limits. And U.S. megabanks, at least, have repaid most of the $245 billion they got from the federal government.
The global situation
The fragility created by these bubbles continues to haunt economies around the world. Each country is trying, at its own pace, to contain and absorb losses. But "we are still in the middle of it," Hoek-Smit says. "There are incremental improvements, but it is still dangerous."
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