Saturday, January 29, 2005

Is a new bubble ready to burst?

International Herald Tribune


DAVOS, Switzerland Martin Varsavsky did quite well out of the technology boom, earning €38 million when he sold a Spanish Internet company to Deutsche Telekom in 2001. But then, mindful that the technology business was headed downhill fast, Varsavsky tried to be more conservative with his next big move. "I wanted to go into something with less of a downside, so I went into land," the 44-year-old Argentine entrepreneur said, highlighting his purchases of real estate in Madrid and the Balearic Islands. Then something funny happened. Spanish residential property prices rose - by 17 percent last year alone. And although he saw technology go bust, Varsavsky is serene about real estate, even as the market boils. "The Spanish market may stop rising," Varsavsky said on the sidelines of the annual meeting of the World Economic Forum here, "but I don't think it's a bubble." But there is a danger he may be wrong. As the world economy heals from scars left by the decline of the technology sector, economists are on the lookout for hot spots in the world that would feed the next potentially destabilizing bubble. Out on the horizon, bullish bond markets, juiced by the prospects of low inflation, could be sowing the seeds of trouble. But it was the sharp rise in housing prices from London to Los Angeles to Lisbon that most worried economists, policy makers and industry types gathered in this Alpine town. "If there were a major contraction in prices, then there would be serious consequences," said Richard Syron, the chief executive of Freddie Mac, the big American mortgage financing company. Consumers in America, Europe and parts of Asia have gotten rich as the value of their real estate has surged in recent years. Stung when money vanished after the technology bubble burst, they have opted for seemingly safer investments in bricks and mortar. Rock-bottom interest rates, now hovering around 50-year lows in the United States and Europe, have fueled a buying spree that has pushed prices up sharply in London in the past three years and by 20 percent in New York in a single year. In Shanghai, where job-seeking Chinese are migrating in droves, housing prices have soared 20 percent over the past 18 months. Consumers have used the rising value of their homes as collateral for loans that have allowed them to spend significantly over the past five years, keeping factories humming from Chicago to Shanghai. The worst-case scenario is that if home values suddenly collapse, consumers will sharply rein in purchases, throwing economies into a tailspin. Some countries have already sought to prevent a rapid deterioration in price levels: the Bank of England, for instance, has with some success been notching up interest rates to reverse conditions of super-easy money. Actions like these may help. But as long as consumers and investors ride the euphoria of double-digit returns, it is tricky to know when a bubble may be close to bursting. Robert Shiller, a Yale University economist and author of the book "Irrational Exuberance," published in 2000, has tracked the notion of bubbles in history, but a precise definition has eluded him. Broadly, he says, a bubble economy is a time when expectations of future price increases are used to justify current values. But this conclusion often comes only after the bubble pops. Few economists would doubt that people in the United States, Spain, Britain, Australia and parts of China have rapidly bid up home prices over the past five years on the belief that values will continue to rise. Part of the gold-rush mentality has been fueled by the industry itself and by economists and academics who argue that a given asset is not overvalued. The media, by publishing their views, become unwitting accessories, Shiller says. Shiller says that the public became convinced in the 1990s that even embryonic technology companies could be worth billions before they ever earned a profit because the Internet had upended business models. Likewise, real estate today profits from the belief that a house is a solid asset with impregnable value. Similar beliefs are feeding fears of another potential bubble, in the bond market. With demand rising, companies and countries in emerging markets have been able to reduce the interest they pay, forcing yields down. Though it is historically abnormal, defenders of this trend note that the outlook for inflation is better now than it has been in a generation, making investors willing to put their money into assets that pay a low interest rate. "The most credible counterargument that we're facing a bubble is that economic volatility is much lower," said Andrew Bosomworth, senior vice president with Pacific Investment Management, a major American bond fund. The argument offered by many for why bubbles appear can be summed up in two words: easy money. Excess liquidity is now chasing all sorts of assets, forcing up prices. The U.S. Federal Reserve opened the money spigot as the American economy began to creak in 2000 and kept providing cash after the terrorist attacks of Sept. 11, 2001. Though it began to raise rates last year, U.S. credit is still historically cheap. The European Central Bank has kept its benchmark rate at 2 percent since mid-2003. A jarring rise in interest rates might well punish real estate or bond speculators by depriving them of loose credit, Takatoshi Ito, a professor at the University of Tokyo, said. But it would also hit ordinary homeowners. "Once you have it, deflate slowly," Ito said, recalling his personal losses after the Japanese property bubble was pricked in the late 1980s. DAVOS, Switzerland Martin Varsavsky did quite well out of the technology boom, earning €38 million when he sold a Spanish Internet company to Deutsche Telekom in 2001. But then, mindful that the technology business was headed downhill fast, Varsavsky tried to be more conservative with his next big move. "I wanted to go into something with less of a downside, so I went into land," the 44-year-old Argentine entrepreneur said, highlighting his purchases of real estate in Madrid and the Balearic Islands. Then something funny happened. Spanish residential property prices rose - by 17 percent last year alone. And although he saw technology go bust, Varsavsky is serene about real estate, even as the market boils. "The Spanish market may stop rising," Varsavsky said on the sidelines of the annual meeting of the World Economic Forum here, "but I don't think it's a bubble." But there is a danger he may be wrong. As the world economy heals from scars left by the decline of the technology sector, economists are on the lookout for hot spots in the world that would feed the next potentially destabilizing bubble. Out on the horizon, bullish bond markets, juiced by the prospects of low inflation, could be sowing the seeds of trouble. But it was the sharp rise in housing prices from London to Los Angeles to Lisbon that most worried economists, policy makers and industry types gathered in this Alpine town. "If there were a major contraction in prices, then there would be serious consequences," said Richard Syron, the chief executive of Freddie Mac, the big American mortgage financing company. Consumers in America, Europe and parts of Asia have gotten rich as the value of their real estate has surged in recent years. Stung when money vanished after the technology bubble burst, they have opted for seemingly safer investments in bricks and mortar. Rock-bottom interest rates, now hovering around 50-year lows in the United States and Europe, have fueled a buying spree that has pushed prices up sharply in London in the past three years and by 20 percent in New York in a single year. In Shanghai, where job-seeking Chinese are migrating in droves, housing prices have soared 20 percent over the past 18 months. Consumers have used the rising value of their homes as collateral for loans that have allowed them to spend significantly over the past five years, keeping factories humming from Chicago to Shanghai. The worst-case scenario is that if home values suddenly collapse, consumers will sharply rein in purchases, throwing economies into a tailspin. Some countries have already sought to prevent a rapid deterioration in price levels: the Bank of England, for instance, has with some success been notching up interest rates to reverse conditions of super-easy money. Actions like these may help. But as long as consumers and investors ride the euphoria of double-digit returns, it is tricky to know when a bubble may be close to bursting. Robert Shiller, a Yale University economist and author of the book "Irrational Exuberance," published in 2000, has tracked the notion of bubbles in history, but a precise definition has eluded him. Broadly, he says, a bubble economy is a time when expectations of future price increases are used to justify current values. But this conclusion often comes only after the bubble pops. Few economists would doubt that people in the United States, Spain, Britain, Australia and parts of China have rapidly bid up home prices over the past five years on the belief that values will continue to rise. Part of the gold-rush mentality has been fueled by the industry itself and by economists and academics who argue that a given asset is not overvalued. The media, by publishing their views, become unwitting accessories, Shiller says. Shiller says that the public became convinced in the 1990s that even embryonic technology companies could be worth billions before they ever earned a profit because the Internet had upended business models. Likewise, real estate today profits from the belief that a house is a solid asset with impregnable value. Similar beliefs are feeding fears of another potential bubble, in the bond market. With demand rising, companies and countries in emerging markets have been able to reduce the interest they pay, forcing yields down. Though it is historically abnormal, defenders of this trend note that the outlook for inflation is better now than it has been in a generation, making investors willing to put their money into assets that pay a low interest rate. "The most credible counterargument that we're facing a bubble is that economic volatility is much lower," said Andrew Bosomworth, senior vice president with Pacific Investment Management, a major American bond fund. The argument offered by many for why bubbles appear can be summed up in two words: easy money. Excess liquidity is now chasing all sorts of assets, forcing up prices. The U.S. Federal Reserve opened the money spigot as the American economy began to creak in 2000 and kept providing cash after the terrorist attacks of Sept. 11, 2001. Though it began to raise rates last year, U.S. credit is still historically cheap. The European Central Bank has kept its benchmark rate at 2 percent since mid-2003. A jarring rise in interest rates might well punish real estate or bond speculators by depriving them of loose credit, Takatoshi Ito, a professor at the University of Tokyo, said. But it would also hit ordinary homeowners. "Once you have it, deflate slowly," Ito said, recalling his personal losses after the Japanese property bubble was pricked in the late 1980s. Martin Varsavsky did quite well out of the technology boom, earning €38 million when he sold a Spanish Internet company to Deutsche Telekom in 2001. But then, mindful that the technology business was headed downhill fast, Varsavsky tried to be more conservative with his next big move. "I wanted to go into something with less of a downside, so I went into land," the 44-year-old Argentine entrepreneur said, highlighting his purchases of real estate in Madrid and the Balearic Islands. Then something funny happened. Spanish residential property prices rose - by 17 percent last year alone. And although he saw technology go bust, Varsavsky is serene about real estate, even as the market boils. "The Spanish market may stop rising," Varsavsky said on the sidelines of the annual meeting of the World Economic Forum here, "but I don't think it's a bubble." But there is a danger he may be wrong. As the world economy heals from scars left by the decline of the technology sector, economists are on the lookout for hot spots in the world that would feed the next potentially destabilizing bubble. Out on the horizon, bullish bond markets, juiced by the prospects of low inflation, could be sowing the seeds of trouble. But it was the sharp rise in housing prices from London to Los Angeles to Lisbon that most worried economists, policy makers and industry types gathered in this Alpine town. "If there were a major contraction in prices, then there would be serious consequences," said Richard Syron, the chief executive of Freddie Mac, the big American mortgage financing company. Consumers in America, Europe and parts of Asia have gotten rich as the value of their real estate has surged in recent years. Stung when money vanished after the technology bubble burst, they have opted for seemingly safer investments in bricks and mortar. Rock-bottom interest rates, now hovering around 50-year lows in the United States and Europe, have fueled a buying spree that has pushed prices up sharply in London in the past three years and by 20 percent in New York in a single year. In Shanghai, where job-seeking Chinese are migrating in droves, housing prices have soared 20 percent over the past 18 months. Consumers have used the rising value of their homes as collateral for loans that have allowed them to spend significantly over the past five years, keeping factories humming from Chicago to Shanghai. The worst-case scenario is that if home values suddenly collapse, consumers will sharply rein in purchases, throwing economies into a tailspin. Some countries have already sought to prevent a rapid deterioration in price levels: the Bank of England, for instance, has with some success been notching up interest rates to reverse conditions of super-easy money. Actions like these may help. But as long as consumers and investors ride the euphoria of double-digit returns, it is tricky to know when a bubble may be close to bursting. Robert Shiller, a Yale University economist and author of the book "Irrational Exuberance," published in 2000, has tracked the notion of bubbles in history, but a precise definition has eluded him. Broadly, he says, a bubble economy is a time when expectations of future price increases are used to justify current values. But this conclusion often comes only after the bubble pops. Few economists would doubt that people in the United States, Spain, Britain, Australia and parts of China have rapidly bid up home prices over the past five years on the belief that values will continue to rise. Part of the gold-rush mentality has been fueled by the industry itself and by economists and academics who argue that a given asset is not overvalued. The media, by publishing their views, become unwitting accessories, Shiller says. Shiller says that the public became convinced in the 1990s that even embryonic technology companies could be worth billions before they ever earned a profit because the Internet had upended business models. Likewise, real estate today profits from the belief that a house is a solid asset with impregnable value. Similar beliefs are feeding fears of another potential bubble, in the bond market. With demand rising, companies and countries in emerging markets have been able to reduce the interest they pay, forcing yields down. Though it is historically abnormal, defenders of this trend note that the outlook for inflation is better now than it has been in a generation, making investors willing to put their money into assets that pay a low interest rate. "The most credible counterargument that we're facing a bubble is that economic volatility is much lower," said Andrew Bosomworth, senior vice president with Pacific Investment Management, a major American bond fund. The argument offered by many for why bubbles appear can be summed up in two words: easy money. Excess liquidity is now chasing all sorts of assets, forcing up prices. The U.S. Federal Reserve opened the money spigot as the American economy began to creak in 2000 and kept providing cash after the terrorist attacks of Sept. 11, 2001. Though it began to raise rates last year, U.S. credit is still historically cheap. The European Central Bank has kept its benchmark rate at 2 percent since mid-2003.A jarring rise in interest rates might well punish real estate or bond speculators by depriving them of loose credit, Takatoshi Ito, a professor at the University of Tokyo, said. But it would also hit ordinary homeowners."Once you have it, deflate slowly," Ito said, recalling his personal losses after the Japanese property bubble was pricked in the late 1980s.