South Africa should look to the lessons of the United States housing correction to avoid poor lending practices locally from knocking economic growth and stability, according to market analysts.
“While South Africa has been applauded for having one of the most sound and transparent banking systems around the world, it can be criticised for the less prudent lending practices banks have adopted lately,” analysts at Econometrix Treasury Management (ETM) said.
“South Africa will not want to introduce a potential source of macroeconomic volatility after it has made so much progress in enhancing the general stability of the domestic economy,” they pointed out.
“Although the correction in the US property sector is a lot more severe than the muted slowdown in growth experienced locally, the US still provides a great example of how reckless lending practices and a substantial subprime mortgage market could impact on growth and economic stability,” they said.
Subprime mortgages are usually granted to those with bad credit history, thus demanding a higher interest rate to compensate for the added risk premium.
According to Absa, the country’s biggest mortgage lender, house-price growth is expected to level off later this year to 10% year-on-year — which is still down significantly from 30% year-on-year experienced in 2004.
“Clearly the banks are feeling a little uncomfortable with the amount of credit that they have extended, as we see increasing amounts of debt being securitised and sold off,” ETM pointed out.
ETM further warned that slower house growth could have a “considerable implication” on the growth of the South African economy, as it would mean a reduction in fixed investment and employment in the construction sector.
Drawing on the property correction in the US, ETM said: “In the same way the property boom in the US boosted the wealth effect and overall consumption demand, South Africa’s growth was equally well supported. A slump or even reduced growth in the housing market will have considerable implication on the outlook for future growth in both economies.”
The ETM analysts added that the slump in the US housing market will “inevitably” affect the broader US economy as the effects of a slowdown in consumer spending take hold.
In 2003, facing the concerns of a deflation trap, the Fed’s fund rate in the US was reduced to a historical low of 1% and kept below 2% until 2004.
ETM said the result of such low interest rates was an excess supply of liquidity, which helped steer the US economy out of a deflationary environment.
The “cheap money” available during that period created a housing bubble, where the total value of real estate jumped from an estimated $11-trillion to $21-trillion by 2006.
“The attractively low interest rates also led to the biggest expansion of debt in history, where mortgage debt between 2000 and 2006 soared from $4,8-trillion to $9,5-trillion. While data regarding the size of subprime mortgage market is unclear, it is estimated at around $400-billion to $500-billion, and subprime mortgages represents 20% of new mortgages,” ETM said.
As $1-trillion-worth of adjustable rate mortgages in the US reset later this year, it would not only affect subprime mortgages, but also borrowers with prime mortgages.
“Many of these buyers will be trapped with higher monthly repayments, while their homes have already depreciated 10% to 20% in value,” ETM explained.
This is known as “negative equity” mortgages where house owners find that their property value is insufficient to repay their mortgages should they wish to sell their houses to remove the burden of high interest rates.
Upcoming South African credit legislation — to be implemented in June this year — is expected to go a long way in introducing some checks and balances, which is encouraging given that prudent lending practices will add to the macroeconomic stability of the South African economy, ETM concluded. — I-Net Bridge