A study conducted by two economists from IPEA (Institute of Applied Economics Research), a Brazilian government agency (believe it or not), suggests that there is “concrete evidence of the existence of a property bubble in Brazil,” which may burst with a potential rise in interest rates.

According to the authors Mario Jorge Mendonca and Adolfo Sachsida, the soaring prices of houses, land and apartments in recent years have resulted in unrealistic and unsustainable values. They estimate that prices between January 2008 and February  2012 rose by 165% in Rio de Janeiro and 132% in Sao Paulo, compared to an inflation rate of 25% in the period.

Here is how they define their study:

“This article verifies the occurrence of a real estate bubble in the Brazilian economy. Overall, our results suggest the existence of a bubble in the real estate sector of the economy. The Austrian School of economics provides a solid explanation to this phenomenon, which are reinforced by statistical techniques, suggesting the Federal government, with equivocate fiscal and monetary policy, as the main responsible for the creation of this problem.”

And here is their final conclusion (full study for download below):

“This study employed various methodologies at both the microeconomic as at the macroeconomic level to verify the possibility of a bubble in the Brazilian real estate market. Overall, the results point to the concrete existence of a bubble in the property market in Brazil. Objectively, our study provides a solid theoretical foundation to explain why the federal government, through its tax policies and credit stimulus, is the primarily responsible for the emergence of this bubble. The government’s insistence on further stimulating an already heated housing market will only make the outcome even worse.

It should also be noted that most mortgage contracts in Brazil are done with floating-rate interest. Furthermore, as results from the econometric study suggest the housing market is sensitive and responds negatively to increases in interest rates. In other words, increases in interest rates may bring significant problems to the housing market. As a matter of fact, this is precisely what caused the implosion of the U.S. housing bubble in 2007-2008.

It is clear that the current fiscal and monetary policies implemented by the Brazilian government are inflationary. Such policies will inevitably lead to inflation and to an increase in the cost of living in Brazil. Global interest rates are at record minimum levels, which means that, sooner or later, rates will rise. When this happens, Brazil will also be required to increase its domestic interest rate. Only then, the true costs associated with current tax and expansionary monetary policies implemented by the Brazilian government will appear.

Naturally, no one believes that a crisis in the Brazilian real estate market will have catastrophic effects, as was the case in the United States and in some European countries, because the supply of credit in Brazil is still quite restricted. However, the effect of the burst of the bubble will not be negligible. When the Brazilian government raise interest rates, there will be a direct effect on the real estate market. Then it will be Brazil’s turn to deal with a crisis created exclusively by the mismanagement of monetary and fiscal policies by the Brazilian government. It would not be the market that created the crisis, but the Brazilian government itself.

Finally, when such a disaster occur, the government will look for the guilty. It will blame everyone except its lack of fiscal and monetary responsibility. Brazil should have seized its good momentum in the global economy to make the necessary adjustments that the country needs. However, the time is passing and the opportunity is being wasted. When the crisis arise, the government will give a wrong response. It will very likely increase spending further, setting an even more expansionary fiscal policy, and facilitate credit further. And these measurements will make the crisis even more enduring and profound.

When several people are wrong for a long time and in significant magnitude, there is a price that needs to be paid. Government interference only prolongs and increases this cost. It does not fix the error, it only transfers the costs of the sector that made the mistake to the rest of the economy. The “bubble” in the Brazilian real estate market is being created and sustained by the government. When it “explodes,” the government will propose a fix, in the wrong way, to a crisis that it itself has created.”

Full study (in Portuguese), below.
ipea td_1762


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