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 Cao Department of Real Estate and Construction The University of Hong Kong 25 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

4 MBS/REITs/ABSCDO / CDS / Minibonds AAA DIRECT REAL ESTATE MORTGAGE ? Credit Ratings?

5 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?

6 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.

7 What’s New? Discount Rate Risk Premium,  Interest Rate, r Inflation Rate, i Expected Growth, g Money/Credit Supply Risk Assessment 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

8 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%

9 A study across 3 bubbles Japan (The Lost Decade) in 1989, Hong Kong (Asian Financial Crisis) in 1997, The US (Subprime Crisis) in Any common symptoms across the 3 bubbles, happened in 3 cities, in 3 decades, and of 3 different causes.

10 Japan Land Price Bubble Up from 60 to 126 (  110%) in 11-year time, and then dived into 72 (  43%) continuously for 17-year

11 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…

12 The US Property Price Bubble Up from 32 to 294 (  819%) from 1970 to 2007 (37-year), then plummeted in 2007/2008 …

13 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,

14 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

15 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

16 Any Common Symptom?

17 Any Common Symptoms?

18 Any Common Symptoms?

19 Why Cut Interest Rate? Curing bubbles: –the year-2000-bug in 2000 (US), –the dotcom bubble in 2004, etc (US). Currency board arrangement (HK):

20 Why Cut Interest Rate?2 cushion the effect of the strong currency : – (JAP)

21 Return v Real Interest Rate, Japan

22 Return v Real Interest Rate, Hong Kong

23 Return v Real Interest Rate, the US

24 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.

25 The End For enquiries, please send to Dr Edward CY YIU Department of Real Estate and Construction The University of Hong Kong