Lessons from Japan's Housing Bubble - III

Bubble Indicator: Mad Rush for Home Loans and Huge Debt

The rush to use housing loans to fund home purchases and retail borrowers becoming very comfortable with taking on huge debt is an indicator that a bubble may be in place.

During Japan’s housing bubble, banks came out with exotic loans that required very little money upfront and promised extremely low EMIs for the first few years.

Surprisingly, despite having seen this taking a toll on the Japanese, US financial corporations did not hesitate to devise similar debt options, to fuel the housing boom in the US, and consequently these loans were responsible for what is now famous as the Subprime crisis.

Japan’s exotic loans included the so-called three-generation loan, a 90- or even 100-year mortgage that permitted buyers to spread payments out over their lifetimes and those of their children and grandchildren.

Perhaps the one redeeming factor in India is that home loans are conservative products of 15- and 20-year tenures, given only after a 5-10% down payment is made. Loans in India conform to stringent qualifying mechanisms, which may be one reason why many believe that there may not be a bubble in place.

It can be argued that a lack of exotic loans has in fact prevented a blow-up, but this does not mean it will be enough to prevent it. To take things in perspective, salaried individuals in India have been a conservative lot, who until 1991 were expected to buy a house with their savings.

This continues to be the general line of thinking, but people have become more aggressive and speculative. It is not unknown to find 25-year-old ITES employees to splurge of large homes using home loans. This has also caused the average age for home purchase to fall to 32, while in 1991, when the Indian economy opened, the average age of a home purchaser was around 38.

Nonetheless, the prime driver for real estate in India continues to remain the stock markets. One must not forget that in 1995 the per-sq-ft rates for homes were the same as in 2006. New highs were made only in 2007, driven by the large sums of monies made available to real estate companies, either through listing, or through private equity funding.

The boom of 1995 was without cheap credit and private equity, which counters the argument that the lack of exotic loans in India has prevented a housing. It is worthwhile to note that floating-rate interest loans in India are a form of exotic loans, where the EMI could increase if the RBI increases the repo rates – the rate at which the RBI lends to banks.

But when property prices dropped in Japan, homeowners found themselves saddled with loans far larger than the value of their real estate. Many fell into bankruptcy, especially those who lost their jobs or took pay cuts as declining property prices helped to incite a broader recession.

Read next story in this series: Marooned in Distant Suburbs

This article has been developed from the October 2005 issues of the New York Times. You can read it here