A property bubble like the one that devastated the United States and Europe in the 2008 financial crash, may now be threatening Colombia, warned the country’s Central Bank Tuesday.
“We find evidence of a bubble (defined as explosive behavior in a sub-sample of the series) during the second semester of 2012,” Jair Ojeda-Joya, co-author of the Central Bank’s research told Colombia Reports.
Colombia Central Bank researchers published a report titled “Testing for Bubbles in Housing Markets: New Results with New Methods” in which they say they have found evidence of a property bubble. They also note that they are unable to relate this bubble to a possible financial crisis the likes of which the U.S. and Europe saw in 2008.
“During the last few years, housing prices as well as stock prices have steadily grown in the country, motivating a heated debate on whether or not Colombia is experiencing a new housing price bubble,” said the researchers. “In contrast to earlier papers …. we find that currently the country could be experiencing a residential property market price bubble.”
If what the Central Bank has found is true, then Colombia could be facing a similar financial crisis to that which hit the U.S. and Europe five years ago.
Economists rarely identify a property bubble until after it has burst, often because of optimistic forecasts, political pressure, and a public aversion to listening to “doom and gloom” type predictions during times of prosperity.
A myriad of factors contribute to the inflation of a property bubble, with banks, credit agencies, national financial regulators, public planning policies, and consumers all shouldering some of the blame.
The bubble in the U.S. began with credit expansion and predatory lending practices, which resulted in the percentage of sub-prime mortgages reaching around 20% from 2004 to 2006.
The readily available credit along with the house price explosion in Europe and the U.S. led to a hunger for property and a building boom, resulting in an eventual surplus of homes.
U.S. house prices fell around 20% in 2008 after the sub-prime mortgage industry collapsed in 2007. Other parts of the world saw even greater depreciation. For example, home prices in Ireland plummeted, in some cases, over 60%.
This suspected Colombian bubble “could be associated with the period of extensive expansion of credit recently experienced by Colombia,” according to the authors of the report, drawing formidable lines between the beginning of the financial collapse which the U.S. is now slowly crawling out of.
As events in the U.S. and Europe have shown, property bubbles are strongly connected to financial crises. The authors of the report however, are reticent about forecasting the same disaster for Colombia as yet. “This piece of research is about performing statistical, bubble-detection methods on Colombian housing-price data. However, we are unable to relate this result with a possible financial crisis,” said Ojeda-Joya.
Increased foreign investment in coal, oil and technology, and an expanding economy could make the conditions in Colombia just right for a property bubble. The country is already showing increased spending power in the middle classes which is demonstrated in increased sales of automobiles and technology.
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If what happened in the U.S. is any indicator, as buyers grow more confident and take out bigger loans, the lending institutions grow more predatory with their lending practices. For example between 2001 and 2007 U.S. mortgage debt almost doubled while wages stayed essentially the same.
“Many financial crises have followed episodes of exuberant price increases,” admit the Central Bank researchers. However Ojeda-Joya said they will remain “silent about the relation between our result and the behavior of the housing construction sector, the mortgage market and financial regulation.”
“We are working on related research and hope to report new results during the next few months,” said the author.
Sources:
- Email from Jair Ojeda-Joya
- Testing for Bubbles in Housing Markets: New Results using New Methods (Central Bank)
- Subprime mortgage crisis (University of North Carolina)
