11 November, 2009

Asset Bubble

Last couples of week, we noticed that newspaper put up "asset bubble" to be another timeboom. Previously, some statement is posted that the asset bubble risk is growing.

How this asset bubble form?
When government pump in money into the market through stimulus package. The intention is to improve the liquidity of the market which badly hit by the credit crunch.

The interest rate has been gone to the historical low level. It encourages consumer to take loan and indirectly stimulate the economy by consumer spending. Due to the low interest rate, those who disqualified for loan suddenly to become “arithmetically” qualify. The throng rush to bank and apply for loan, during crisis, people always think it is the best time to buy property with low interest rate and cheap property.

Problem begin from here.

In the foreseeable future, government will withdraw their stimulus by adjusting the cost of fund. It is to anticipate and cure the potential inflation risk in country. Increase the interest rate is one of the monetary tools that commonly used by central bank.

Those loan borrower will face the repayment difficulty with the interest rate increase because most of them do not price in the risk of rate increment as the margin of repayment is at the minimal level.

It will cause another property crisis and many fire sales or auction of property by default repayment will happen if the situation is not managed properly.

First, banker shall lower their loan percentage to 75% or 80% of property price instead of 90% or 95%.
Second, banker is to reduce the age limit instead of 70 years old to 60 years old.

The above is to provide a buffer for the bank in the event of default by the borrower in loan repayment. The bank can review and adjust the repayment by prolonging the repayment period.

Ultimately, the heat need to be gradually cool down before it becomes a second wave of crisis to the economy. Do not simply pulling 1 leg out from a swamp by deepening another leg in.