Property news - SA housing price bubble bursts

Recent newspaper headlines said that South African house prices are set to drop by 40 percent. The bubble has burst. I have argued that South Africa had a house price bubble. Alan Greenspan, former US Fed chief, famously commented that one can only tell if there is bubble after it bursts.

I do not agree with Greenspan's view. It allowed him to let the dotcom bubble grow and to ignore the US subprime bubble. However, even Greenspan would now agree that there was a bubble in the South African housing market. I should add that the bubble was mainly in the affluent house market. A large proportion of South Africans does not own homes and do not have access to credit markets. Therefore, the bubble was confined to certain sections of the South African housing market.

I warned that South African growth was looking too much like US economic growth. Much of US growth was built on the booming real estate market and related financial services. The growth was debt-driven, consumption-led growth. In South Africa, affluent home owners were using their homes as ATM machines, similar to their counterparts in the US. In other words, as house prices grew more people were able to increase their debt because they had an increase in net wealth. However, the increase in net wealth in a bubble market is short lived but the increase in debt remains with them for a long time.

The banks have to accept a lot of the blame for current problems in debt markets. South African financiers were loosening criteria for credit provision. Except, the US bankers were a bit less racist and a much larger percentage of Americans - of all colours - had access to credit. Many South African financiers, like the US banks, changed their financial function from risk assessment and holding loans on their books to originators of loans.

They gave loans but did not bear the risk. The growth of securitized debt markets allowed the banks to sell their loans and to pass on the risk to other investors. Therefore, banks started reducing their risk assessment functions and gave loans more easily. The National Credit Act (NCA) was introduced to limit poor risk assessment practices in the financial sector. The NCA also recognized that borrowers would be the ultimate victims of the short-term pursuit of high returns by financial institutions.

The South African Reserve Bank has to accept some blame for the bubble. They dropped interest rates at a time when house prices were increasing. This decrease in interest rates to home buyers allowed house prices to increase even faster. I am not arguing that South Africa should have had higher interest rates. My argument is that policy choices that address problems in one sector can negatively affect other sectors. Higher interest rates today have curbed growth of house prices but they harm productive investment.

There is a need for much smarter economic policies. The NCA has gone some way towards addressing the problem. It has reduced loans for housing purchases and consumption. However, more is needed. If the problem is too much finance for affluent houses and financial speculation but not enough for productive investment then government and the SARB have to figure out smart ways to turn off the private sector credit tap for affluent home loans and financial speculation and opening it for productive investment. The way in which they offset the negative impact of the house bubble crash on the economy and the sustainability of economic growth depends on the willingness of government and SARB to develop these types of smart solutions.

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