1

ERES 2009 Stockholm, Sweden Haven’t Learnt from Past?

A Common Symptom of Asset Bubble Implosions

section 6-B (1) Cycles and Crises, Room Q34

CY YIU, Sherry YS Xu and Coune YJ CaoDepartment of Real Estate and Construction

The University of Hong Kong25 June 2009

2

Research Questions

Can Asset Price Bubble Implosions be predicted?

If yes, can it be prevented?

3

Predatory Lending?

DIRECT

REAL ESTATE

Mortgages / Collaterals

MBS / REITs / ABS

CDO / CDS / Minibonds

Market Plummets

Sub-prime Crisis

Financial Institutions Quake

Global Financial Tsunami

4MBS/REITs/ABS CDO / CDS / Minibonds

AAA

DIRECT

REAL ESTATE MORTGAGE

?

Credit Ratings?

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Other suggested causes

• Irrational Exuberance?! - dot-com bubble• Contagion?! - Asian Financial Crisis• Slow Government Response?! - Japan Lost Decade• Greediness?!• Globlization?! Deregulation?!• Saving too much?! Spending too much?! • Unknown?! No cause?!

• Every bubble implosion has a unique cause?• Is there any common symptoms?• Any tests conducted across bubbles?

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Causes of Asset Price Bubbles

• Irving Fisher (1911), John M. Keynes (1936), Milton Friedman (2003): – Asset Price:

• Interest Rate, Inflation Rate, Risk Premium, Expected Growth

– Money/Credit Supply and Demand,– Information Asymmetry and Availability,– Risk Assessment and Leverage,– Expectations and Regulatory.

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What’s New?

Discount Rate

RiskPremium,

Interest Rate, r

Inflation Rate, i

Expected Growth, g

Money/Credit Supply

RiskAssessment or

Leverage

Money/Credit Demand

Expectations / Experience

Shadow Banking

Fiat Money

Bank Money

Bubble-Credit Spiral

Information Asymmetry and

Availability

Moral Hazard

Pre-emptive Policy

Credit Derivatives

SIVs

Credit Ratings

Scarcity of Resources

Savings

Permanent Income Growth

Global Fund Flows

Exchange Rate

Trade Surplus /

Deficit

Short Term Interest Rate

Long Term Interest Rate

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What is a bubble?

• A bubble is defined as – “an upward price movement over an extended

period of 15 to 40 months that then implodes.” and

– “in the 20th Century most of the manias and bubbles have centered on real estate and stocks.”

(Kindleberger and Aliber, 2005)– magnitude of change of the asset price

exceeds 40%

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A study across 3 bubbles

• Japan (The Lost Decade) in 1989,

• Hong Kong (Asian Financial Crisis) in 1997,

• The US (Subprime Crisis) in 2008.

• Any common symptoms across the 3 bubbles, happened in 3 cities, in 3 decades, and of 3 different causes.

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Japan Land Price BubbleIndex of Urban Land Price (Residential)

Japan (1980 -- 2008)

40.0

50.0

60.0

70.0

80.0

90.0

100.0

110.0

120.0

130.0

140.0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Up from 60 to 126 (110%) in 11-year time, and then dived into 72 (43%) continuously for 17-year

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Housing Price Index Hong Kong (1980 -- 2008)

40

80

120

160

200

1993Q

1

1994Q

1

1995Q

1

1996Q

1

1997Q

1

1998Q

1

1999Q

1

2000Q

1

2001Q

1

2002Q

1

2003Q

1

2004Q

1

2005Q

1

2006Q

1

2007Q

1

2008Q

1

Hong Kong Property Price Bubble

Up from 85 to 170 (100%) from 93 to 97 (5-year), then dropped to 60 (99%) in 2003 (6-year). Up again to 123 (105%) to 2008 (5-year), and is now dropping…

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US Home Price Index 1970 - 2008

0

50

100

150

200

250

300

350

197

0

197

1

197

3

197

4

197

6

197

7

197

9

198

0

198

2

198

3

198

5

198

6

198

8

198

9

199

1

199

2

199

4

199

5

199

7

199

8

200

0

200

1

200

3

200

4

200

6

200

7

The US Property Price Bubble

Up from 32 to 294 (819%) from 1970 to 2007 (37-year), then plummeted in 2007/2008 …

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A unique cause of the Japan Land Price Bubble?

• The Plaza Accord signed in Sep. 1985,

• Yen to US$ exchange rate dropped continuously and substantially,

Exchange Rate of Yen to US dollar Japan (1980 -- 2008)

0

50

100

150

200

250

300

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

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A unique cause of the Hong Kong Property Bubble?

• Asian Financial Crisis (Currency) started in Thailand in July 1997,

• but Hong Kong dollars is pegged to the US$, no currency risk,

• the bubble burst was said to be a contagious effect of the whole region

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A unique cause of the US Property Bubble?

• Subprime mortgages– High risk loans

• Credit derivatives– Alphabet soup (CDO, CDS, MBS, TABX…)– Credit Risk Transfer by Securitization

• Deregulation of banking industry– Shadow Banking

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Any Common Symptom?Real Interest Rate in Japan (1982 -- 1996)

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

5.00%

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

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Real Interest Rate in Hong Kong (1993 -- 2008)

-8

-6

-4

-2

0

2

4

6

8

10

12

14

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Any Common Symptoms?

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Real Interest Ratein U.S. (1991 -- 2008)

-5.00%

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Any Common Symptoms?

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Why Cut Interest Rate?

• Curing bubbles:– the year-2000-bug in 2000 (US), – the dotcom bubble in 2004, etc (US).

• Currency board arrangement (HK):US and HK interest rates (1993 -- 2008)

0.00

2.00

4.00

6.00

8.00

10.00

12.00

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

HK r

US r

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Why Cut Interest Rate?2

• cushion the effect of the strong currency :– 1980 - 1989 (JAP)

Basic Loan Rate in Japan (1980 -- 2005)

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

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Return v Real Interest Rate, Japan

Scatterplot of Housing Return v Real Interest Rate in Japan (1980 - 1992)

y = -1.2102x + 0.0874

R2 = 0.0432

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00%

Real Interest Rate (%)

Ho

us

ing

Re

turn

(%

)

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Return v Real Interest Rate, Hong Kong

Scatterplot of Housing Return v Real Interest Rate in Hong Kong (1993-2008)

y = -0.0056x + 0.0163

R2 = 0.1349

-0.25

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

-10 -5 0 5 10 15

Real Interest Rate (%)

Ho

usin

g R

etu

rn (

%)

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Return v Real Interest Rate, the US

Scatterplot of Housing Return v Real Interest Rate in the US (1991 - 2007)

y = -0.2091x + 0.0156

R2 = 0.1191

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

-3.00% -2.00% -1.00% 0.00% 1.00% 2.00% 3.00% 4.00%

Real Interest Rate (%)

Ho

usin

g R

etu

rn (

%)

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Why haven’t learnt from past?

• A drug addiction model. • A growth of the economy achieved by credit expansion

works like drug addiction, • as it provides a pleasant reinforcer of further growth, and • an unpleasant symptom of recession associated with

withdrawal. • Unfortunately, with repeated drug use results in

addiction, and • which would intensify the magnitude and the duration of

the unpleasant symptom. • In other words, with more successful preventions of

recession by credit expansion, more substantial credit supply is necessary to keep the bubble booming, and the more torturous the results of a bubble implosion would be.

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The End

For enquiries, please send email to

Dr Edward CY YIU

Department of Real Estate and Construction

The University of Hong Kong

ecyyiu@hku.hk