Real Estate Bubble and Financial Crisis

objective Estate Bubble and Financial CrisisIntroductionThe most significant stinting way out in 1990s was the Financial Crisis in East Asiatic, which also affected the world economy in the next few decades. People probably inquire the specificity of the East Asian Crisis. Radelet and Sachs (1998.p.1) gave a response to this question The East Asian financial crisis is remarkable in several ways. The crisis has hit the most rapidly development economies in the world. It has prompted the largest financial bailouts in history. It is the sharpest financial crisis to hit the developing world since the 1982 debt crisis. It is the least anticipated financial crisis in years.In my view, Asian financial crisis is triggered by rattling estate bubbles. This newsprint is organized around the topic the collapse of authorized estate bubble commences Financial Crisis as below. Section 1 introduces what is existing estate bubble what are the operators inducing the occurrence of a received estate bubble and by what measurings to identify this phenomenon. Then, Section 2 discusses the effects of real number estate bubble in Financial Crisis reflect in different approaches theoretical economic approach statistical data and historical facts. In conclusion, to a fault summarize the main idea of the overall contents, the exposure of the limitation of the theoretical economic approach will be mentioned.Real estate bubbleThe real estate bubble, also known as property or housing bubble is considered as an economic bubble, which is also a cyclical phenomenon occurs in the local or worldwide real estate grocery store. Its prime feature is that the valuation of housing is growing swiftly, however, once the peoples financial situation and economic indicators uneffective to raise such upward trend of expenditure that follows the collapse of housing pricing. That implies a negative equity in investment for the proprietors. (Investor Dictionary. Com)There are several facto rs that earn the burst of the real estate bubble in Asia from 1997 to 1998. The following focuses on several main reasonsAn excessive support of swear lendingThe developers are unable to cope with the investment of the real estate based on their own capital due to the function of this industry-capital-intensive. Thus, cant lending becomes a major first of funds. Before the mid-90s, the Asian real estate is fairly booming. However, because of the lack of a formal system of banking supervision, banks competed for developers by lowering interest browse. (Koh, Mariano, Pavlov, Phang, Tan and Wachter, 2004)Governments improper macro-guidance and overtopGovernment intervention influences the real estate bubble in two perspectives On the one hand, the land market and economic system is not get along with or perfect enough. On the other hand, 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 Comparison of the Real Estate Bubble, 2009)Some other reasonsFor subject, the relaxed financial environment excess international capital flows (An International Comparison of the Real Estate Bubble, 2009) excessive sum up of family line ownership speculate 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 more or less affordable for the typical mansionhold. The HAI incorporated changes in key variables affecting affordability housing prices, interest rates, and income. The formula isHAI= (Median Family Income/Qualifying Income)*100%HAI ratio denotes the direct of affordability. When HAI ratio is high , more people are able to buy a house. (Dr. Econ, 2003) This index facilitates banks to adjust fiscal policy. Assumed that the HAI is high, banks probably adopt liberal policies to gallop loans, such as decrease the lending rates.Price to earnings ratioThe real estate price 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 renting a house and the spending on renting a house. The formula isReal Estate P/E Ratio House price/ (RentExpenses)This ratio provides an intuitive epitome that how purchasing houses restricts other family expenses. (The Real Estate Bubble in the 2000s-Housing Market Indicators, n.d.)Give an example of Washington DC House P/E ratio, which provides an structured thinking about how purchase interacts with rent. The graph below states a rapidly grow in the ratios, which implies that the speed of raising purchasing p rice is extremely swift than that of renting price. It seems that such increasing trend will lead 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 among 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 remarkable economic growth worldwide. According to the Gross Domestic Product, it seems that economies of these states increased by 6% to 9% annually. However, good time do not last long, from June 1997 to January 199 8, the burst of financial crisis this Asian miracle was dashed to the estate. In the end of 1997, collapses of the stock and currency markets in these state occurred frequently, then, at the jump 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 breeding ground of the real estate bubble, but also potential risks for financial crisis. Because of the rapidly decrease of real estate price, on that point was a disastrous loss of bank lending in some Asian countries, which also affects the current monetary assets. (Lanka Rating Agency Limited, n.d.)There is a theoretical economic approach (Koh, Mariano, Pavlov, Phang, Tan, and Wachter, 2006) that analysis the corre lativity between the decrease of real estate and the fluctuation in the giveing of bank loans. If the numerical value of the correlation is below zero, which indicates a phenomenon of downstairs pricing, which prick up the exacerbation of financial crisis. This assumption could be explained though a formula, that calculates the housing price for tradeP=V () M (, s ()) +BHere 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 deposit rate denotes the intending move level of a house s denotes bedcover of the bank loan according to certain deposit rate.Assumed that set an ideal price for mortgage, a houses marketable valuation is equivalent to par valuation, in addition, price for trade is equivalent to the basic valuation of a house. Suppose that is an nonparasitic variable, while s is a depe ndent variable, thus0= 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 u nder 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 thoughtlessness 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 pricing, 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 deficit of 8% in 1997. The valuation of housing increased swiftly and collapsed swiftly. The main component part that generated difficulties for financial institutions was the loans to real estate. (Hunter, Kaufman, and Krueger, 1999)According to the data from the Investment Property Databank , (Koh, Mariano, Pavlov, Phang, Tan, and Wachter, 2006) the figure 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 cause a great amount loss of funds, which will finally deteriorate into a financial crisis. From the above figure, Thailand is the typical example that explains the real estate bubble causes financial crisis.At the set out of the 1990s, a massive amount of fo reign 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 country encouraged people to seek investment channels with higher return. Meanwhile, foreign funds benefited the growing of the real estate industry. Additionally, because bank expand the total 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 $clx 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 industries related to the real estate and manufacturing from 1987 to 1996 in Thailand. It is obviously that the loans to real estate sector rapidly grew between 1989 and 1990, after that the percentage of real estate loan to the total loan maintained at a sexual relation high level, which was between 20% and 30%.(Source 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 much greater than that in Germany (19%), United Kingdom(16%) and United States (21.5%). However, this deepen the formation of the Asian real estate bubble. (Koh, Mariano, Pavlov, Phang, Tan, and Wachter, 2006)It shown in the below figure that Malaysia, Philippine, and Singapore also generated an negative correlation before the occurrence of financial crisis cultureTo summarize this paper, at the beginning a briefly introduction of the real state bubble is given. In this part it includes the definition, the reasons f or 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 real 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 withdraw further improve.