What Makes a Bubble Burst?
Sometimes jail is a good place to be.
The best players in Monopoly know, near the end of the game, that jail is actually a safe-spot; it can be costly to move around the board.
Putting yourself in fictional jail is similar to locking away your cash. Let’s see if it’s a good idea:
#1 Case study – Asian Financial Crisis 1997
There were early warning signs. The IMF warned that the real estate sector posed a significant risk to financial stability.
And yet, Asian countries were still caught up in reward. They turned a blind eye to risks.
Borrowers and lenders were incentivized to provide high estimates on the collateral value of assets (that is, on the value of assets used to receive loans).
Borrowers wanted to maximize the amount while lenders wanted a share of the market.
The banks became extremely exposed to the real estate market, as you can see below.
After the crisis unfolded, IMF’s Stanley Fischer blamed “…lax prudential rules and financial oversight which led to a sharp deterioration in the quality of banks’ loan portfolios”.
This was combined with government negligence, technologically deficient credit risk management systems, and weak property and foreclosure rights.
Banks also freely extended credit to real estate, which is typically the destination of between 20 to 50 percent of their credit outflows. The ASEAN region had particularly high exposure rates.
The lower exposure found in the Philippines was due to slow economic growth. And in Korea, capital flowed more to conglomerates.
But overall, during the crisis, non-performing loans reached over 20 percent of bank assets across the region!
#2 How major meltdowns in Asia are driven by booms and busts in real estate
Expectations play a large role in the rise and fall of bubbles.
Expectations lead to a crowd mentality with irrational exuberance even when fundamentals falter. The common theme in most cases is private bank lending that correlates strongly with asset prices.
Banking credit also tends to be asymmetric in determining rising or falling property prices.
Banks are critical to allowing the progression of asset price rises through credit access.
Then after the peak, banks restrict access. They try to reduce their own exposure to the sector.
This all happens in the last chapter of the game.
And trust us, during this late hour, after a period of excessive credit and spending, you want to be protecting your assets and be debt free.
So it’s usually better to find an “Illinois Avenue”. Don’t be the one to buy “Park Place”.