Though Sensex is on a strong up trend but global economy is weak and risk of a global recession is rising. We have been focusing on the US economy as it is world’s largest economy and its currency is the world’s reserve currency. The last recession had originated in US and the next global recession will also come from here.
2008’s recession was created by sub-prime housing loans, and this time also the housing sector seems to be the trigger.
The reason housing is always so critical is because of the size of this sector – it is a huge sector in almost all the countries. In US it contributes about 9% of the GDP, in India this figure is 13%.
House price valuations in US have reached ALL TIME HIGH, much higher than they were before the 2008 housing bubble! This article analyzes why there is a bubble in US housing, and why it may be worse than that of the 2008 crisis.
How to do valuation of houses
The price-to-rent ratio is the ratio of home prices to annualized rent in a given location. The price-to-rent ratio is used as an indicator for whether housing markets are fairly valued, or in a bubble. This ratio is also used as a benchmark for estimating whether it’s cheaper to rent or own property. It compares the economics of buying versus renting. A price-to-rent ratio of 21 or more means it’s better to rent.
Global Price-to-Rent Ratios of Major Countries
Source: https://tradingeconomics.com/country-list/price-to-rent-ratio
Russia 174
Portugal 163
New Zealand 158
Canada 156
Germany 153
United States 143
United Kingdom 132
Japan 115
INDIA 26
So, why is it so low in India?
Housing Bubble in US
The chart here shows house price-to-rent ratio for US –
US Price-to-rent Ratio
The dramatic increase in the ratio leading up to the 2008-2009 housing market crash was a red flag for the housing bubble.
And the current levels show a clear housing bubble, bigger than that of 2008!!
Stock markets in India had crashed by over 58% in 2008 US housing crisis.
Let us look at current US housing bubble –
- Both bubbles are result of fed’s near zero interest rate policy.
- The 2008 bubble was caused by fed chairman Alan Greenspan’s low interest rate regime where he reduced rates to near 1% after the Nasdaq bubble burst.
- The 2022 bubble was caused by nearly 15 years of near ZIRP and QE by fed.
US fed interest rate vs house price index
Neither 2008 crisis was blamed on fed, nor will be the present one. One must understand that doing so puts the blame on government which in turn can affect political power. In current scenario, the most popular scapegoats are pandemic and Russia war, often highlighted as supply-chain issues. It is like “if investors were drunk, the only bar in the town was fed”. The height of US government’s cunningness is that they even awarded Nobel price to Ben Bernanke, the then fed chairman, responsible for the current inflation bubble.
The Lehman moment 2
It is almost guaranteed that when this housing bubble bursts, there will be a massive default on home loans, and the 2008 Lehman moment will be replicated – but it will be much worse.
We have a very toxic combination today; it will be the history’s worst economic crisis. It is a bubble in making since last 25 years created by US fed’s easy monetary policy started by Alan Greenspan. (see interest rate chart above)
Why is it much worse than 2008?
- The mortgage market size is now 20% bigger, a bigger bubble
- The personal debts are at all time high
- US government debt/GDP is also at all time high
- Inflation in US is already very high, ZIRP or QE will not work like it did in 2008, rather they will make the bubble even bigger
US mortgage debt
US personal credit card debt
US government debt/GDP
Home loan defaults cannot be more certain than this. It will be extremely difficult situation for home loan takers, banks, and ultimately for the stock market!
Can it be prevented?
The best course of action for US fed is to allow the US economy to sink today by continuing the monetary tightening policy to save the dollar. This is what Paul Volcker did successfully with his 20% rate during 1979-1981.
Will the US fed do it?
The problem with the right approach is always political and the lack of common man’s understanding of economics. Common man does not like high interest rates and the tough times that come with it, they will vote against the government.
Lehman 2 impact will be global, like what happened in 2008, even in India, much bigger, much worse.