Opinion & Strategies

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Inflation and resilience. Lessons from the 2007 Housing bubble

Housing bubbles form when there is high demand and low supply coupled with inflated prices above fundamentals. Supported by economic growth, low interest rates, easy access to credit and wider mortgage product offerings, these bubbles grow. Hence, a downturn in the economy, with a rise in interest rates and a drop in demand would make a housing bubble pop.

The 2007-08 U.S. Housing market crash allows us to investigate some important factors that led to a crash and how we can avoid repeating this mistake. Do not that there were parallel bubble burst outside the residential housing markets like commercial real estate and consumer credit, and financial crisis in other countries. Many argue that it was the bad state of the economy that caused the crash and not the borrowers. Hence, a wider macro view should be considered during our planning.

2007-08 U.S. housing crash factors:

Tax policy. Taxpayer Relief Act of 1997 made housing the only investment that escaped capital gain tax. Tax Reform Act of 1986 allowed deductible for mortgage interest which encouraged the use of home equity through refinancing, second mortgages, and home equity lines by consumers.
Regulation of the real estate sector. Deregulation of the financial sector which separated commercial and investment banks, through the Depository Institutions Deregulation and Monetary Control Act of 1980, Garn-St. Germain Depository Institutions Act of 1982, Gramm-Leach-Bliley Act of 1999, which removed limits on Banks' interest rates and loans, fueling innovations in adjustable-rate financing that contributed to easy credit.
Housing policies. Federal mandates promoting affordable housing through Fannie Mae and Freddie Mac under the Housing and Urban Redevelopment Act of 1992, pressuring Fannie and Freddie to increase affordable housing purchase to as high as 56% to borrowers with income below the median in their area. This led to an industry-wide loosening of lending standards. Fannie Mae and Freddie Mac share of the subprime loans decreased as the bubble got bigger, from a high of 48% to 24% of all subprime loans in 2006, with much of the nongovernment competitors in the private market coming in to compete.
Historically low interest rates after the dot-com crash made credit easy from just 1% and a return to a high of 5.25% by 2006, resulting in foreclosures, as demand decreased and monthly payments increased.
Enthusiasm for home ownership, and belief as a good investment. Home Ownership Rate in the United States averaged 65.25 percent from 1965 until 2022, reaching an all time high of 69.20 percent in the second quarter of 2004. It was also widely accepted as preferable to renting as mortgage used to pay down the principal builds equity for owners over time, while interest qualifies for a tax break, as compared to renting a place. The popular notion that property prices has been rising on the whole since the Great Depression also supported the belief. As such home prices increased so much to a point that its P/E ratio exceeds the stock market, of about 30-40 compared to the S&P 500 which was around 17 (S&P had a high of 45 during the dot-com crash). Rising prices also encouraged speculative behavior and home prices as a multiple of annual rent also reached above normal multiples.
The expansion of subprime lending fueled by low interest rates, high home prices created an almost risk-free environment for lenders as they could flip homes if borrowers default.
Risky products and low entry for borrowers. Subprime mortgages to borrowers with low credit ratings, adjustable rate mortgages (increasing rate environment), interest-only mortgage, credit default swaps, collagenized debt obligations, stated income loans, non-recourse loans further exacerbated the crash.

Fast forward to 2022. Housing prices have hit record high caused by a housing shortage and low interest rates in 2021. Mortgage rates have continued to increase since, reaching decade highs, raising concerns on another housing bubble. We are also starting to see that there are behaviors similar to the early 2000s, however experts opined that this could be a correction in the housing market and not a crash. While low interest rates are a factor, COVID related supply chain disruptions and policies together with the huge fiscal stimulus impact the housing market. There are many more buyers than homes for sale. In addition, lending practices have improved, investor speculation have ebbed, household balance sheets are still strong and excessive leveraging is not present at this stage.

Singapore

Singapore property prices, inflation and interest rates have also been climbing. Will there be a drop in property prices soon? First, let's have a look at Singapore's real estate market with the factors above.

Tax policy. Stamp duty: Buyers stamp duty, Additional Buyers Stamp Duty (ABSD) for the purchase of additional properties, Seller Stamp Duty, Property Tax with a progressive rates for owner-occupied and non-owner occupied. ABSD rates were increased in December 2021 as part of the property cooling measures.
Regulation of the real estate sector and credit - Monetary Authority of Singapore (MAS) has restrictions on bank loans which cover the maximum tenure of the loan, loan-to-value limits, mortgage servicing ratio, and total debt servicing ratio for individuals to non-individual borrowers. Loan-to-value ratios were also revised for Housing Development Board (HDB) granted loans in December as part of the cooling measures. Refinancing rules for housing loans also apply to cap the loan tenure.
Housing policies in Singapore well structured. Public housing are kept affordable through grants that correspond to household income levels and schemes. The Central Provident Fund was also established to help workers save for housing and retirement, with rules and limits to its utilisation. The Housing Development Board (HDB) also provides loans to eligible residents to encourage home ownership yet limits the loan-to-value amount and mortgage servicing ratio, promoting social equity.
While interest rates has been relatively low. A stress-test interest rate using a medium-term of 3.5% for residential property and 4.5% for non-residential property to exercise financial prudence. The median Total Debt Servicing Ratio (TDSR) in Singapore is 43% as of April 2022. And as part of the property cooling measures, the TDSR was revised from 60% to 55% in December 2021 as well. Mortgage servicing ratio of 30% applies to public housing or executive condominiums with applicable minimum occupation period.
Enthusiasm for home ownership, and belief as a good investment is also prevalent. Home ownership is high with almost 90% of owner-occupied resident households in Singapore. Prices have been on the increase on the long run as well. However, speculative behavior has been curbed by the introduction of a Seller Stamp Duty, ABSD, stamp duties and financing.
Financial Institutions providing housing loans are regulated by the MAS from credit checks to type of credit facilities.
Mortgage equity withdrawal loan rules are also regulated by the MAS.
Risky products and low entry for borrowers. Subprime mortgages to borrowers with low credit ratings, adjustable rate mortgages (increasing rate environment), interest-only mortgage, credit default swaps, collagenized debt obligations, stated income loans, non-recourse loans further exacerbated the crash.

Singapore households have a strong balance sheet (financial and residential property assets increasing more than mortgage and personal loans), healthy debt levels and also rising household income levels (4.9% nominal, 2.8% real) from 2020 to 2021. Moreover, supply of housing stock is still low and developers interest remain strong with a record bid for an EC site (Bukit Batok West Avenue 8), the iEdge SG Real Estate Index which includes real estate developers, real estate operators and real estate investment trusts, is also about 23% below its 2018 peak. Given the above factors, the real estate market will continue to be resilient, property prices may cool but unlikely to drop much. Further, GDP growth continues to be positive across major economies and real interest rates continue to remain low.