Bubble? Depends on where and how you look

A BUBBLE can provoke fear or outrage.

Fear, because if a speculative bubble rising on nothing but hot air bursts, the resulting sudden plunge in asset values can bode ill for the economy and cause unemployment and personal hardship. Outrage, because the continued existence of such a bubble implies the failure of regulators to protect the man on the street from rushing headlong towards disaster.

To say a bubble exists in Singapore means that there is a lack of control by the powers that be, which is anathema to the government's perception of itself as a forward-looking architect of a well-planned and orderly economy.

So one can very well imagine the reaction of Singapore's central bank when Jesse Colombo, a French-born, American independent economic analyst who just turned 28, wrote a widely circulated column last Monday warning that there is not just a low interest rate-fuelled credit bubble here, but also a residential property bubble, construction bubble, financial-sector bubble, wealth bubble and population bubble.

Mr Colombo did not only see bubbles all around Singapore and surrounding emerging markets, he went on to argue that the foundations of the Republic's wealth - sovereign wealth funds Temasek Holdings and GIC - were at stake, and that Singapore's current prosperity was illusory.

The Monetary Authority of Singapore's (MAS) response was swift.

"Singapore is not facing a credit bubble that puts the country or its banking system at any risk of crisis," the central bank said last Tuesday evening.

While MAS said that unusually low interest rates have caused credit growth and a rise in property prices in Singapore and other countries, the government has "taken decisive steps to cool property demand and prevent excessive leverage".

MAS added that the property market is stabilising, new housing loans have been declining, household balance sheets are strong, and the financial system here is strong, as reflected by Singapore's AAA rating from major credit rating agencies.

Mr Colombo replied that the MAS was in denial, just like other governments in the region. Household balance sheets might be strong now when interest rates are low, but not so when they rise, he said.

Low interest rates might stay for a few more years and delay the burst of Singapore and the region's wealth bubble, he said. But "it also means that the city-state's asset and credit bubbles are likely to grow even larger and more threatening than they currently are".

What is a bubble?

Bubbles are a nebulous concept. There is a difference between the temporary insanity of a bubble and the normal ups and downs of a market, when assets are just overpriced. Hence, to decide whether Singapore is indeed caught up in a bubble, it is important first of all to define what a bubble is.

Bubbles have a psychological element that make them dangerous. The building of a bubble requires a kind of spontaneous optimism characterised by British economist John Maynard Keynes as "animal spirits", and later by former Fed chairman Alan Greenspan as "irrational exuberance". While property showrooms may still be packed here, an element of caution has crept in, with the property market by all accounts slowing down. The animal spirits are subsiding, in no small part due to a debt servicing framework introduced in mid-2013.

In a bubble situation, prices of assets deviate significantly from their fundamental values. What constitutes "significant" is arguable. Given sufficient historical data, a possible starting point for a bubble call is when financial ratios deviate from their long-term averages by, say, more than two standard deviations.

A recent instance of a bubble was the dot-com boom of the late 1990s. Then, the long-term cyclically adjusted price to earnings (PE) ratios of America's S&P 500 index went up to more than 40 times, more than three standard deviations from the 130-year average of 16.5 times and even the post-war average of 18.4 times. In Singapore, the Straits Times Index (STI) is trading at roughly or just under its long-term average of about 15 times earnings. Using our definition, we can safely say there is no bubble in our equity markets.

Moving on to property, a common indicator of value is the ratio of median house prices to median household yearly incomes. By various accounts, this ratio peaked in America in 2006, almost hitting five times and deviating more than two standard deviations from its long-term average of about 3.5 times. Median household incomes were around US$50,000 then, so median house prices were about US$250,000.

In Singapore, one might very well ask if there is a residential property market bubble. In the HDB resale market and the private property market, average prices have doubled from a decade ago. Incomes have increased by only about 60 to 70 per cent.

Mr Colombo cited a statistic from cost-of-living comparison website Numbeo that showed Singapore's price-to-income ratio at 25 times, which is the third-highest in the world. On the surface, the number makes sense: The typical price of a suburban condominium is $1.2 million, with the implied median household income at $48,000.

These statistics are flawed, however. The latest household income data show that households earning $48,000 a year belong to the bottom third of income earners, who live in much cheaper, subsidised HDB flats anyway.

More than 80 per cent of Singaporeans live in HDB flats. This puts those who live in condos in the top fifth of wage earners. One cannot benchmark a typical Singaporean to a condo unit.

There should thus be at least two separate price-to-income ratios for Singapore when measuring whether the market is in a bubble: one for the private property market, and others for various segments of the HDB market.

Assuming the top fifth of households buy condos, the next fifth buy five-room HDB flats, and so on, back of the envelope calculations using latest data show the price-to-income ratio for HDB five-room flats at about 4.2 times, and 4.3 times for condos - both very far from the statistic of 25 times used in Mr Colombo's piece.

By comparison, at the property market trough 10 years ago, the equivalent ratios would be about 3.3 times for five-room flats and 3.6 times for condos.

More data could be crunched to find out whether Singapore's price-to-income ratio differs significantly, or outrageously, from historical averages. But that does not seem to be the case from an initial reading of the data - with a caveat that people must buy within their means.

Basically, between 2003 and now, homes cost about 0.6 to one year's worth of household income more at the most, from trough to peak. This means people have to take two to three more years to repay their loans, assuming they use a third of their incomes every year to do so. If they only use a fifth of their incomes, then they will take three to five years more.

If Singaporeans buy property within their means, three or four extra years of paying the mortgage, given later retirement ages and longer lives, seem to be reasonable.

Interesting tidbits can be gleaned from the analysis. If people aim beyond their wage bracket, house prices become pricey. A typical median-income household buying a five-room resale flat, or even an 81st to 90th percentile household buying a suburban condo, will see their price-to-income ratio shoot up from three-plus to six times - which is arguably unsustainable. If a family can only use 20 to 30 per cent of its income to pay the mortgage, this easily means an extra 10 years of work.

It is therefore not surprising that with increased expectations, even the middle and upper middle-income groups would complain that houses have become unaffordable. Going by the data, the average Singaporean household can aim for a $500,000, four-room resale flat to keep the affordability ratio within four times annual income.

Mr Colombo is not wrong in warning Singapore of the dangers of rising asset prices, if they are not backed by productivity gains or economic growth.

However, the situation confronting Singapore's residential property market now is more inflated expectations and less runaway prices.

Commentators pointing out numerical increases in any statistic should define what makes something a bubble and what does not. Overusing the word can obfuscate rather than illuminate.

haoxiang@sph.com.sg