Real Estate Bubble and Financial Crisis

existent E submit Bubble and Financial CrisisIntroductionThe around significant s comparabilitying event in 1990s was the Financial Crisis in East Asiatic, which overly affected the world sparing in the following(a) few decades. People probably question the specificity of the East Asiatic Crisis. Radelet and Sachs (1998.p.1) gave a response to this question The East Asian fiscal crisis is remarkable in several(prenominal) ways. The crisis has hit the some speedily induceing economies in the world. It has prompted the largest fiscal bailouts in history. It is the sharpest fiscal crisis to hit the developing world since the 1982 debt crisis. It is the least anticipate fiscal crisis in years.In my view, Asian financial crisis is triggered by sure body politic pass offs. This paper is organized around the topic the collapse of certain landed country spill the beans reasons Financial Crisis as downstairs. Section 1 introduces what is true(a) state spew what are t he factors inducing the occurrence of a genuinely estate bubble and by what measurements to identify this phenomenon. Then, Section 2 discusses the personal effects of solid estate bubble in Financial Crisis reflect in different approaches theoretic economical approach statistical data and historic facts. In conclusion, besides add together the main(prenominal) idea of the overall contents, the picture show of the limitation of the theoretical economic approach will be mentioned.Real estate bubbleThe literal estate bubble, withal kn protest as property or living accommodations bubble is considered as an economic bubble, which is alike a cyclical phenomenon occurs in the local or worldwide palpable estate grocery. Its prime feature is that the valuation of housing is maturation swiftly, however, erst the peoples financial situation and economic indicators uneffective to sustain such up tr overthrow of worth that follows the collapse of housing set. That implies a n egative rectitude in investment for the proprietors. (Investor Dictionary. Com)There are several factors that induce the demote of the in truth estate bubble in Asia from 1997 to 1998. The following focuses on several main reasonsAn high-spirited support of margin bringThe developers are unable to cope with the investment of the certain estate based on their own capital due to the function of this industry-capital-intensive. Thus, avow contribute becomes a study source of bills. Before the mid-90s, the Asian real estate is fairly booming. However, be stir of the overlook of a formal system of deposeing supervision, banks competed for developers by lowering interest rate. (Koh, Mariano, Pavlov, Phang, tangent and Wachter, 2004)Governments improper macro-guidance and controlGovernment intervention influences the real estate bubble in two perspectives On the one hand, the land market and economic system is non mature or perfect enough. On the anformer(a)(prenominal) han d, it is the limitation of the land resources and the market mechanism. Therefore, inappropriate regulation contributes to the growing of the real estate bubble. (An International similitude of the Real Estate Bubble, 2009)Some earlier(a) reasonsFor casing, the relaxed financial environment excess international capital flows (An International Comparison of the Real Estate Bubble, 2009) excessive step of dwelling ownership presuppose in purchasing and bad lending practice ( Merriam, 2009)When economists acknowledge the reasons of bubble burst, they strive to distinguish the breading real estate bubble by the measurements of financial dimensions and economic indicators. That aims to prevent the bubble burst.Housing affordability indexMonthly housing affordability index (HAI) is a method to identify whether housing is becoming to a greater extent or less affordable for the typical kinfolkhold. The HAI incorporated changes in detect variables affecting affordability housing l egal injurys, interest rates, and income. The formula isHAI= (Median Family Income/Qualifying Income)*100%HAI balance denotes the direct of affordability. When HAI dimension is high, more people are able to deprave a house. (Dr. Econ, 2003) This index facilitates banks to adjust fiscal policy. Assumed that the HAI is high, banks probably dupe liberal policies to extend lends, such as decrease the lending rates. footing to lolly ratioThe real estate hurt to earnings ratio (P/E ratio) is the basic measurement to evaluate the comparatively assessment of the equities. This ratio is determined by three factors The price of purchasing a house the price of letting a house and the spending on renting a house. The formula isReal Estate P/E symmetry House price/ (RentExpenses)This ratio provides an intuitive analysis that how purchasing houses restricts other family expenses. (The Real Estate Bubble in the 2000s-Housing Market Indicators, n.d.)Give an manakin of Washington DC House P/E ratio, which provides an integrated sentiment about how purchase interacts with rent. The graph below states a rapidly grow in the ratios, which implies that the speed of raising purchasing price is extremely straightaway than that of renting price. It seems that such increasing mode will soften to real estate bubble, if none approaches is using to control it. (Eric, 2006)Some other financial ratios or economic indicatorsSuch as real estate price to rent ratio gross rental yield ownership ratio housing debt to income ratio housing debt to equity ratio or accommodate to income ratio. (The Real Estate Bubble in the 2000s-Housing Market Indicators, n.d.)Real estate bubble cause Asian Financial CrisisThe growing booming economy of Southeast Asia is known as the the tiger economies in the midst of the late 90s and early 20s. Counties in Southeast Asia such as Thailand, Malaysia, Singapore, Indonesia, South Korea and Hong Kong (China) were regarded as the states with the most re markable economic growth worldwide. According to the Gross Domestic Product, it seems that economies of these states increase by 6% to 9% annually. However, good times do not last long, from June 1997 to January 1998, the burst of financial crisis this Asian miracle was dashed to the ground. In the end of 1997, collapses of the have a bun in the oven and currency markets in these state occurred frequently, because, at the beginning of 1998, the stock market lost more than 70% of their profits. (Hill, n.d.)In the economy system, real estate, compare with other sectors, it is the most highly leverage sector that cause a financial crisis of the utmost probability. The increasingly compound of issues or difficulties lead to the real estate deviates from the normal development. That not only generates a fosterage ground of the real estate bubble, but also potential risks for financial crisis. Because of the rapidly decrease of real estate price, there was a foreboding(a) loss of bank lending in some Asian countries, which also affects the current monetary as garbs. (Lanka Rating Agency Limited, n.d.)There is a theoretical economic approach (Koh, Mariano, Pavlov, Phang, Tan, and Wachter, 2006) that analysis the correlation surrounded by the return of real estate and the fluctuation in the airing of bank loans. If the numerical apprise of the correlation is below zero, which indicates a phenomenon of at a lower place pricing, which prick up the provocation of financial crisis. This assumption could be explained though a formula, that calculates the housing price for tradeP=V () M (, s ()) +B here are the meanings that each symbol denotes V denotes the basic valuation of a house M denotes the valuation of bank lending for having a mortgage on a house and the par valuation of bank lending for having a mortgage on a house with certain doctor rate denotes the intending fluctuating level of a house s denotes spread of the bank loan harmonize to certain deposit rate.Assumed that set an accurate price for mortgage, a houses marketable valuation is similar to par valuation, in addition, price for trade is equivalent to the basic valuation of a house. Suppose that is an independent variable, while s is a dependent variable, indeed0= 0is equivalent to zero, as the spreading of the bank loan modulates according to recoup the bank for the transformations in the value as a result of the put option is included in the mortgage lending.When is equivalent to zero, it means the transformations in the growing fluctuating level of a house ( is completely spread round. However, when is below zero, it means the intending fluctuating level of a house ( has an impact on the covariance of the house return with the market. When the house price changes in response to the spreading= 0 = 0 0Thus, if the growing fluctuating level of a house ( is completely spread round, then the correlation between the house price for trade and the spreading of bank loan is equivalent to zero. Furthermore, if this correlation influences the covariance between the house and the whole market is influences, it on the verge of zero.From another point of view, assumed that the spreading of the bank loan transforms according to chthonian price rather than the intending fluctuating level of a house (, the house price changes in response to the spreading is completely distinctive= 0 = 0 and 0Therefore, correlation between the house price for trade and the spreading of bank loan is below zero, as following equations= )) 0These two distinctive house prices which are influenced by remissness spreading generate an appropriate effect of under price Under pricing of the default risk in non-recourse lending produces a negative correlation between asset returns and changes in the default spread. Correctly pricing the default risk in non-recourse lending produces no correlation between asset returns and changes in the default spread. Countries that experience under p ricing, experience larger market crashes following negative demand shocks.On the base of this theoretical economic approach, we could analyze the practical cases, in 1997 Asian Financial crisis, to support the idea that the collapse of real estate bubble causes Financial CrisisThe financial crisis was began from Thailand and then extended over the whole Asian even the whole world. During that period, the characteristic of its economy is overheating with a shortage of 8% in 1997. The valuation of housing change magnitude swiftly and collapsed swiftly. The main element that generated difficulties for financial institutions was the loans to real estate. (Hunter, Kaufman, and Krueger, 1999)According to the data from the Investment office Databank , (Koh, Mariano, Pavlov, Phang, Tan, and Wachter, 2006) the realise below is obtained.Based on the theoretical economic approach, the numerical value of correlation below zero will lead to a result of under pricing. Such under price may cau se a great amount loss of funds, which will finally put down into a financial crisis. From the above figure, Thailand is the typical example that explains the real estate bubble causes financial crisis.At the beginning of the 1990s, a large amount of alien funds continued to flow in the Asia market until the 1997 Asian Financial Crisis started. During that period, the lower deposit interest rate in the hoidenish encouraged people to seek investment channels with higher return. Meanwhile, foreign funds benefited the growing of the real estate industry. Additionally, because bank expanded the bring amount of lending though decreasing the lending rate, under pricing became uncontrollable. (Koh, Mariano, Pavlov, Phang, Tan, and Wachter, 2006)In the In 1996, Thailand loaned to the real estate sector US $ one hundred sixty billion, which accounted for 30% to 40% of the total lending. (Mera and Renaud, 2000) The figure below illustrates the amount of funds finance companies lend to in dustries related to the real estate and manufacturing from 1987 to 1996 in Thailand. It is patently that the loans to real estate sector rapidly grew between 1989 and 1990, after that the per centum of real estate loan to the total loan maintained at a relative high level, which was between 20% and 30%.(Source coin bank of Thailand)Another support case is Malaysia. Between 1992 and 1996, over 70% of the bank lending was invested in real estate sector and stock market. (Mera and Renaud, 2000) The massive amount of funds injected into the real estate industries lead to a rapidly increase in GDP in that period. It is the fact that GDP increased by 40%, 62% 115% and 70% in Malaysia, Indonesia, Philippines and Thailand respectively, that was frequently greater than that in Germany (19%), United Kingdom(16%) and United States (21.5%). However, this accelerated the formation of the Asian real estate bubble. (Koh, Mariano, Pavlov, Phang, Tan, and Wachter, 2006)It shown in the below figur e that Malaysia, Philippine, and Singapore also generated an negative correlation before the occurrence of financial crisisConclusionTo summarize this paper, at the beginning a briefly introduction of the real state bubble is given. In this furcate it includes the definition, the reasons for breeding real state bubble, for example banks compete by lower lending interest rates to excessive support the real estate industry, and governments improper macro-guidance and control. Follow that are the measurements of financial ratios and economic indicators, such as housing affordability index and price to earnings ratio, which benefit to identify the signal of bubble burst.The most important part in the paper is to analyze the relationship between the real estate bubble and the financial crisis to produce a result that the real estate bubble is a factor that triggers the start of the Asian financial crisis. A theoretical economic approach is given with some statistical data, figure and re al facts of Asian financial crisis.However, there some limitations in this theoretical economic approach, that do not agree with the reality. In the above figure, Hongkong and japan generate positive correlation, according to theory this do not according with under pricing lead to financial crisis.The fact is that Japan is a typical example to illustrate that governmental action has negative impacts on the real estate industries. The Nikkei 225 index increased rapidly from 10000 to 38916 (peak value) between 1985 and 1989. Facing this, the manager of the Bank of Japan focused on relations with the inflation rather than shrinking monetary policy, which reflected a decrease trend in housing price. The real estate bubble burst. (Frankel and Tschoegl, 1993) This is one of the limitations of the economic approach, which need further improve.