Thursday, August 16, 2007

A housing bubble burst?

I wrote in an earlier post that the central banks would manage to contain the crisis in the international financial markets and that it was unlikely the world economy would tip into a recession.

In the TOI last Sunday, Swaminathan Aiyar agreed with my contention that the health of the underlying economy was not necessarily determined by the health of the stock market. Nevertheless, he argued, the subprime mortgage problem in the US had the potential to create a worldwide economic crisis because it signalled a housing bubble burst in the US. This would drag down the US economy and housing bubbles elsewhere, including India, too would burst.

I am not convinced. A sharp deceleration in housing had already been factored into the IMF's forecast of a slowdown in the US economy, the subprime crisis does not change that. I don't see the US or global economic outlook changing because of the subprime crisis.

As for the prospect of a housing bubble burst in India, we have to remember that housing prices have been driven by very basic supply-demand imbalances. There is a supply shortage for various reasons and demand comes, not from speculators, but to a large extent from buyers of homes.

In the US, housing purchases are driven by borrowing against assets, including an existing house. So a decline in asset prices has a huge adverse impact on the housing market. In India, people are buying against future income - and rising incomes at that. Movements in asset prices such as those of stocks have little impact on this demand. If housing prices fall, that will translate into greater demand.

Again, since people are not consuming by borrowing against housing or other assets, the wealth effect on consumption will be very small. Yes, we could see a correction in housing prices but its economic impact will be negligible.

1 comment:

Anonymous said...

"If housing prices fall, that will translate into greater demand."

How would prices fall to begin with, if price is determined by demand and supply?! Since you say, price fall will lead to higher demand, so demand fall can't be responsible for price fall. Then is it supply rise? But there is no reason to believe that US subprime problems will lead to higher supply of houses in India! Then why should house prices fall in India at all?