For a while, I have been wondering about good investment opportunities. A few things have come up in my mind e.g. land, real estate property, stocks, treasury bonds. Like most, I prefer investments that will earn me a lot of returns in a short time, but with my inactive participation. In my wondering, the word price bubble kept popping up in my mind and made me wonder some more, if some of these investment opportunities in Rwanda are in price bubbles that can easily burst.
Price bubbles are sustained rises of the cost of an asset which does not really reflect their true values. They are mostly driven by speculation that their costs will continue rising, so there is a hogging of these assets with the intention of selling at a higher price in future. There is a lot of irrationality and overconfidence in making such decisions. Many times, the demand exceeds the supply of these assets which also contributes to the price rise. Most often, these bubbles burst, meaning the prices get to a level where no investor wants to buy at the exaggerated price for different reasons and then the prices begin to fall. There is also increased supply compared to demand when prices start falling. However, the burst of the bubbles are hard to predict.
Because I had heard this word before in relation to threatening an economy’s financial stability, the economist in me read some more about it and the following are some historic price bubbles I learned about;
1.The Housing Bubble that contributed to the 2008 Financial Crisis
The housing market in the U.S. was doing well with stable gains which attracted investors who started buying collateral debt obligations (CDOs), which include mortgage-backed securities, from banks (the housing prices nearly doubled between 1996-2006—though most of this increase was concentrated in the 2000s). The federal reserve reduced interest rate to 1% in 2003 from previously 6.5%. This increased the demand for housing loans and then prices increased faster than before. Since housing seemed to be in a bubble, investors wanted more CDOs, while the banks became greedy and exercised moral hazard in their lending practices since the risk of the mortgages lied on investors. Banks would just buy the mortgages and sell them to investors almost immediately. The banks then started offering subprime loans-loans to non-credit worthy people i.e. with non-stable income and poor credit histories, with some predatory institutions not even verifying income information. Some analysts joke that they gave loans to anyone with a heartbeat. Ironically, these loans would be given high credit ratings to still attract the investors. These laxed rules to getting mortgages increased demand further hence higher prices. Houses were appreciating at 15 percent in 2005. Adjustable-rate mortgages (ARMs) were also introduced and made it much easier for anyone to get a loan, hence increased demand, since the down payment and interest was very low compared to the fixed-rate mortgages, albeit at first. Later, the Federal reserve tightened monetary policy and those whose had ARMs had ballooning mortgages payments that they could not afford. Borrowers started defaulting, their houses were returned to the market for sale, investors stopped buying the CDO’s, banks were stuck with bad loans, the supply of houses became higher than the demand and the prices plummeted. This had a cascading effect to the financial system, the US economy and other economies. This actually led to the Basel III reforms to increase financial system stabilities. ‘The big short’, is a film of some real characters in America’s financial world, who were able to predict and leverage on the 2008 housing crisis, another name they call the 2008 financial crisis. Now you have a good excuse to watch a film, it’s educational. You better have an economic dictionary next to you though.
2.The tulip price bubble of the Netherlands
In the 17th Century, the Netherlands’s economy was doing pretty well for itself with Amsterdam as a port to Europe and commercial center. The tulip flower was highly demanded as an exotic flower as it took years to grow and was imported. It displayed prosperity in wealthy individuals’ homes in Amsterdam. Due to a virus, some tulips were made even more beautiful with beautiful multi-colored streaks. These even became scarcer. A price bubble then began for these new tulips along with the normal tulips. Everyone wanted some. There was a price increase of up to 5900%. This bubble apparently popped when someone refused to pay for tulips he had bought at an auction.
3.The Bre-X mining stock bubble in Canada
This bubble happened to a group of mining companies in Canada called "Bre-X Minerals Ltd”. Bre-X had purchased a mining site in Indonesia in 1993 where their hired Filipino project manager Guzman, who was a geologist, made continuous claims of presence of gold mines worth 30million gold ounces at first, 60 million and then finally 70 million ounces in 1997. All this while, upon these news, hype around the Bre-X stocks increased back in Canada that made its share prices shoot from previously 1 cent/share in 1993 to $286/share in 1997, about a 13,305% increase. The bubble burst when Guzman jumped off the helicopter in the jungle near the site (or fell off: there’s a lot of speculation of what happened). The shares then became worthless almost overnight when it was realized the claimed gold was inexistent. This fraud had been sustained by salting samples from the mining site with actual gold.
4.Nigerian Banking Crisis
Nigeria, despite its low financial depth, also experienced asset bubble burst that caused a systemic banking crisis which was worsened by the 2008 North Atlantic crisis (above). In the spirit of increasing financial depth and international competitiveness, Nigeria’s Central bank steeply increased minimum level of capitalization for banks, which prompted mergers and acquisitions that led to a decline of number of banks from 89 to 25. This, along with increasing oil prices, made capital abundant, and credit tripled between 2006 and 2009. However, part of this credit financed share purchases, particularly in bank stocks, of which a bubble was created that finally burst, due to the excessive credit rise not being accompanied with better regulatory supervision.
5.The South African Housing Bubble
South Africa also had a boom in housing prices between 2004-2007, which even exceeded the prices in the US and UK markets which were also having similar booms concurrently. Housing loans had increased by over 150 percent between 2000 and 2010. The South African Reserve Bank then tightened monetary policy to reduce these asset spikes and reduce inflation. Luckily for them, it did not lead to a financial crisis.
Some other bubbles include the Japan land bubble, the UK railway bubble, the Dot.com bubble, the list is endless. A couple of analysts also contend that cryptocurrencies are in a bubble, which is about to burst. Even though this has been the warning for a few years now, where there is smoke...
Less occurrence of bubbles and bursts in Africa affecting the entire economies might be a factor of low financial development e.g. the turnover rates of stocks and credit depth is still very low for most of our countries, low formal financial inclusion, low interest rate pass through, higher mandatory capital buffers for banks than international requirements(Griffith-Jones et al, 2016), poverty, among others.
No one foresees the exact moment of the burst of a bubble. Anything can prompt it as we have seen from the examples above. Even a pandemic such as that of Covid-19, which refuses to go away, led to deep plunges of different assets globally due to fears of companies not doing well because of unstable economic activities and restrictions. Some investors hold on to their assets hoping or assessing that the bursts are just temporary, others are not so lucky with assets that take many years to recover their peak prices or assets that lose value permanently. This does not mean we do not invest. It just means you will be unlucky if a bubble happens to burst when the asset is in your hands. With good research and consultation, you MIGHT be able to spot signs of a bubble that is about to burst. So, please enlighten me on legit and well thought-of bubbling investment opportunities so that I can stop wondering. Who knows, I might be one of the lucky ones.
The writer works at The National Bank of Rwanda
The writer is a co-founding partner of Seed, a research-driven advisory firm with offices in Europe and Dubai.
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jp@seedconsultancy.com