Securitization, a danger for Asia by Natacha AVELINE, Senior Research Fellow at CNRS

 

 

It is obvious, the crisis has taken root in the American real estate markets before contaminating the global financial system. By the game of securitization (breaking-up of outstandings), the gigantic real estate debt of the American households was fueled by funds coming from the world over. The American banks were in this way able to cheaply underplay the chances of the borrowers’ failings, by transferring it to the investors. To be always able to lend more, the real estate credit had been extended to households with low creditworthiness, these outstandings were restructured according to risk categories, then securities of securities were issued in order to offer investors a large range of products, giving them the illusion that the risks had disappeared. Therefore it is quite naturally the shortcomings of these riskiest loans –and also the most lucrative, the famous subprimes- which have weakened the structure and induced financial collapse. 

 

Though the subprime crisis brought out the existence of securitization into the open only recently, this technique was not however born just yesterday. Created in Wall Street in the 1970s, it quickly spread to North America, then to Europe in the 1980s, before conquering Asia. During the Asian crisis,  in 1997, the IMF brought out the merits of securitization to recycle the mammoth low grade credit amount that had suddenly got accumulated in the region. Then in the eye of the cyclone, Korea had experienced it, coming after Japan and Hong Kong. Securitization then developed in major ASEAN countries, Malaysia even indicated issue of securities by Islamic establisments. However, in spite of these efforts, the volume involved by these products remained far below the great investment potential in the zone :  banks mainly had the upper hand over the « classical » real estate; as for the other types of securitizable credits (consumption loans, high-risk real estate loans, etc…), the corresponding issue of securities, the ABS, only totalled 100 billion USD in 2005 (two thirds of which were issued by Japan, Australia and Korea), that is three times less than in Europe and eight times less than in United States. These products moreover ran a lower risk than their American counterparts and, with the exception of the Australian case, were traded mainly in the domestic market.

 

The reasons for this lack of zest vary from one country to another, but in any case one can only rejoice the weak development of securitized credit in Asia. In fact there would be everything to fear about the real estate bubble bursting in this region, that would be fueled by securities spread in the whole planet. For, in the light of real estate values in the big Asian metropoles, the American markets pales into insignificance: with a loan limit of 417 000 USD by Freddie Mac and Fannie Mae, we find there is hardly enough to buy a small appartment in a big Asian metropolis. Besides, the unequal risk culture and the strong opaqueness that qualify some Asian financial markets would definately encourage the creation of speculative mecanisms and hinder its curbing.

 

For all that, Asia was not spared by the subprime crisis. The Chinese and Japanese investors were even the main buyers of securitized debt in the United States. They cleverly moved away from the risky subprime  segment: with 379 billion USD of loss registered in May 2008 by big global banks, the share of the Asian banks did not reach 5%. The major part of the Asian capital was invested in Fannie Mae and Freddie Mac’s securities, reputed to be very safe before the crisis. In June 2007, China and Japan held respectively 376 and 229 billion USD with these two establishments. Since then,  the value of these securities melted down like snow under the sun. More generally, the effects of the crisis had already compromised the Japanese revival and threatened to severly affect the Chinese growth.

 

There is another type of securitizationof which we spoke very littleduring this crisis and which has nevertheless made significant progress in Asia recently. It is real estate securitization. Its principle, identical to that of securitization, consists in splitting the real estate portfolios into small parts (securities), to make investment accessible to any type of operator and make transactions easy. The most successful formula is the Real Estate Investment Trusts (REIT), which buys and manages buildings by raising capital at the Stock Exchange. The REITS securities issued by these companies are affordable by any individual, the share amount being 150-200 Euros. This category of securitizationis howeverfar from reaching the size of the previous one: its outstanding is to the tune of 600 billion USD, against 8 700 billion USD for the securitized debt.

 

Not surprisingly the initial REIT funds were raised in the United States, before pursuing their progression in Europe in the 1980s. They penetrated Asia under cover of the 1997 crisis, with the launch of the REIT funds in Thailand to end the deadlock in the disaster real estate market. However, it is in Japan that they met with notable success, about to reach the fourth share of the REIT market globally, in five years only (2001-2006). Launched at the same time as in Japan, the Singaporian REITs occupy the second position in Asia, with 13 companies capitalizing 13 billion USD (against 40 companies and 40 billion in Japan) in 2006. Hong Kong and Korea follow far behind.

 

At Singapore and Hong Kong, the property developers quickly understood all they could get out of the REITs, in order to invest outside their territory. Singapore has become the main hub of REIT funds towards South-East Asia (Indonesia, Malaysia and Thailand especially, more recently in India), while Hong Kong has offered small investors access to the real estate of the Chinese continent, with high rate of returns but with risks in the offing. The first REIT funds invested in China, « GZI REIT », was raised by a Hong Kong investment company in end 2005 and invested in shopping centers at Canton.

 

In Japan, until now the securitized real estate investment has remained turned towards the domestic market for a large part. At the head of the REIT funds are the real estate subsidiaries of the Japanese industrial conglomerates, Mitsui, Mitsubishi and Sumitomo, they alone converging 40% of the national capitalization of the REITs. This capital being invested in office buildings in the most prominent business areas of the country, the corresponding REIT securities were safe values until the subprime crisis came to ram into this market segment.

 

The spectacular progress of the REITs in Asia until 2007 are attributable, like elsewhere, to the low levels of interest rates that have doped the real estate. To this are added the great growth possibilities that a current emerging market offered in the beginning of the 1990s, when the REITs had already reached a high level of development in North America and Europe. Besides the performances of the Asian markets reached their expectations, since the REIT securities offered returns more than 2 points on an average against Treasury bonds.

 

Apart from their advantage as alternative investment product, the REITs accounted for a new financial source for property developers, which can henceforth finance a major part of their real estate projects by raising funds at the Stock Exchange. These new practices have literally revolutionalized the real estate profession. The standards edited by the national regulations to protect the small REIT security holders have forced the investment companies to show proof of transparency in their management and to standardize their evaluation methods. Within a very short time, the certified experts had to swap their old pifometric estimation methods of the estate values against sophisticated techniques based on anglo-saxon models. A same vacuum cleaning served to sweep the archaisms blocking lease contracts, like the chonsei in Korea, an up-front deposit paid by the tenant at the time of signing the lease, which equals half of the market value of the property, and which the tenant recovers when he leaves the premises.

 

The securitized real estate is however far from having only virtues. It deeply affects the dynamics of the real estate markets, by making them more unstable and volatile, for in these markets that have become highly liquid, the slightest movement gets propagated from one compartment to another, very quickly affecting the most healthiest segments. Likewise, the panic and euphoria episodes that recurrently affect the real estate find themselves strengthened by the increased reactivity of investors subjected to sheeplike behaviour. The mimicry does not stop there: the REIT funds follow similar investment strategies, converging on the same narrow niches (shopping centers, offices or prestigious housing), resulting in an artificial rise in land values for some sites while the rest of the territory registers a decline. Such a phenomenon of urban split is observed recently in Japan, where the « satellite - centres» of Tokyo’s suburb and the small provincial cities suffer as a result of an under-investment in real estate renovation, while major projects get accumulated in the centres of big metropoles at the risk of generating a real estate boom.

 

Will the subprime crisis result in at least an iota of realization on the dangers of securitization in Asia ? It is not sure that all the lessons will be taken from the American debacle. History shows that financial markets have a short memory and that good resolutions taken at the time of crisis are soon swept away when a new speculative euphoria episode takes place.