The looming global property crisis

As collateral securing credit, tangible property values are the underpinning of credit upon which a modern economy depends. If there are serious credit problems in the private sector, they usually radiate from property. Property secures credit for not just property itself, but directly or indirectly influencing almost all other finance. As we saw in 2008 when excessive lending through securitisation backed by liar loans were unwound in the US, the potential for a great financial crisis emanating from a sectorial property crash in just one jurisdiction, let alone a global one, should not be underestimated.

We face such a crisis today. Here is a brief summary of the elements:

• Commercial real estate (CRE) is in crisis, not just in America but also in all other advanced economies where oversupply has been compounded by higher interest rates.
• When there is a high element of fixed rate term mortgages involved, residential property is on a longer fuse. But this market is already stagnating and can be reasonably expected to decline further, if only because affordable mortgage credit is becoming unavailable to prospective buyers.
• Property is the basis of collateral for Main Street activities, with consequences for bank credit generally. Savills estimated global real estate was worth $326.5 trillion in 2020, more than twice current assessments of global financial asset values.
• If a crisis is to be avoided, interest rates must decline. Unfortunately, they are set to rise instead as I explain later in this post. When markets awaken to it, the anticipation of rising interest rates and bond yields will undermine all asset values.
• US inflation is on the rise, with the monthly rate having increased five months in a row, which is why interest rates cannot decline.
• Credit defaults across all economic activities will increase this year due to bank credit being withdrawn as lending risks increase.
• Led by the US, G7 economies face not just a recession, but a deepening slump from a debt crisis. This will add to government funding requirements, driving bond yields higher still.

In the face of these verifiable facts and the reasonable projections based upon them, it seems extraordinary that otherwise rational investors turn a blind eye. Here they are, happily creating wealth, oblivious to the mounting dangers to debt, and therefore the existence of all forms of credit:

It really is a case of see no evil, hear no evil, and say no evil. It has, perhaps, all the ingredients of a case study in wishful thinking ex post facto.

The purpose of this article is to warn those prepared to listen to reason about the enormous dangers the world of fiat currency and bank credit faces. And this understanding must come from a full appreciation of the role of collateral, how its values are tied to interest rates, and how and why those values will almost certainly decline.

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