1 Graph to Put Europe in Perspective

Come on, Europe! Can't you just fix yourself already? So say the Americans, but while the U.S. is now seeing rising housing prices in some areas (knock on wood), the bottom may have yet to fall out of a few European housing markets. And just like in Japan in 1990 and America in 2008, markets do not perform well when home values collapse. But before all of the specifics, take this chart in:

The above chart plots out home price indices that measure the relative value of houses. Using 2001 as the base year, France and U.S. housing took the same trajectory upward until 2006. Spain soared even higher than both of them! In the U.S., you might recall that this was the period when kids in your neighborhood flipped houses instead of running a lemonade stand. As evidenced in Michael Lewis' The Big Short, a nanny owned six townhouses in Queens, and "a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $724,000." No question these practices were unsustainable, and thus, demand and prices for homes fell in the U.S.

France
However, unlike the U.S., French housing more than doubled in value by the end of 2007 -- a little more than six years. Now, if the population doubled, or France experienced dramatic inflation, or wages doubled, this run-up in prices might make sense. But the population growth in France is about 0.5%. Inflation in France during this period was mostly under 2% per year. Household incomes are up only 35% since 1998. Is France -- the second largest European economy by GDP -- going to have a similar housing crash as the U.S.?

Predictions range for a slide in prices from 12% to 15% by the end of next year, to 40% over five to 10 years. If the French housing index matched U.S. growth since 2001, it would have to fall by more than 70%. Demographics won't save France either -- as reported by The Telegraph, the consultancy PrimeView states: "Those younger than 58 are net buyers of property, those older are net sellers. The buyers stay constant at 33m, while the sellers rise by 1.2m every five years for a quarter century."

Just in case the bubble wouldn't pop itself, politicians also put a new 15% tax on foreign owners of second homes, which will also help cool demand.

And unlike Americans, who hold 27% of household wealth in real estate, the French have a whopping 57% tied up in housing. Remember the big story on how American wealth fell 40% between 2007 and 2010? The French could be looking at a much bigger cliff.

The upside is that the French did not dabble in such subprime loans as the Americans did. French regulators recommend that banks shouldn't issue mortgages if payments will be greater than 33% of a borrower's income, and as The Economist reports, "banks are under a legal obligation not to push borrowers into more debt than they can manage, and cases are regularly brought to court."

This has left French banks like BNP Paribas (OTC: BNPQY.PK) in a better position than American counterparts during tough times. The bank recently announced an almost 9% Tier 1 ratio, a measure of good to risky assets, putting it ahead of its competitors. But even with regulations, bubbles can still fly high and wreak havoc on their way down.

Spain
Housing in Spain has already lost more than 25% of its value from its high in 2007. Amazingly, properties in Spain doubled in value in a little less than five years, from 2001 to the end of 2005. As Fool Sean Williams pointed out in April, home prices would need to fall another 30% just to be in line with Spanish wage growth over the past 15 years. Will housing be Spain's final nail in its already-sealed coffin?

It certainly doesn't help that Spaniards hold 80% of their assets in real estate. And for Spain's housing index to come in line with U.S. growth since 2001, it would have to drop 47% more. With a lack of employment and falling home prices vaporizing citizens' largest asset, it's no wonder that mortgages that back bonds managed by JPMorgan Chase (NYSE: JPM  ) , Barclays (NYSE: BCS  ) , Banco Bilbao Vizcaya Argentaria (NYSE: BBVA  ) , and Banco Santander (NYSE: SAN  ) , among others, have delinquency rates creeping higher every quarter. While the bonds only total 2.6 billion euros, they can give a hint of the underlying weakness of the total mortgage market. The cumulative delinquency rate for all mortgages backing the bonds is now higher than 15%. For a scary comparison, the delinquency rate in the U.S. peaked at 10.1% in 2010.

Take shelter at home
The rise in housing indices of Spain and France could be well-deserved, and there is no guarantee that just because they've outpaced the U.S., they must come back in line with the U.S. After all, these are three very different countries. However, it does seem that, based on the evidence, prices are somewhat inflated. And as these prices fall -- and the largest portion of household wealth in France and Spain deteriorates -- consumers in these countries will find it harder to pay bills and buy cars, iPhones, and leather handbags.

Luckily, the U.S. remains a relatively safe place to invest. And banks in the U.S., while beaten up, could offer some great returns. For one bank that shakes its head at the riskier moves that put its rivals in trouble, take a look at our free report: "The Only Big Bank Built to Last."

Fool contributor Dan Newman holds no position in any of the above companies. Follow him @TMFHelloNewman.

The Motley Fool owns shares of JPMorgan Chase. Motley Fool newsletter services formerly recommended JPMorgan Chase. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (23) | Recommend This Article (99)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 16, 2012, at 8:56 PM, whachagonnabet wrote:

    The taxes are also decidedly different in France and Spain than in the US. The single largest tax subsidy in the US is the deduction for Mortgage interest and real estate taxes. Do Europeans enjoy the same subsidy?

    The US thrives under a system that is charging higher taxes than it currently does...what's to happen when the taxes here go up again as they surely will?

  • Report this Comment On August 16, 2012, at 10:27 PM, rmondave2 wrote:

    America is rigged. Save your money, it is stolen through slick monetary policy; invest your money it is manipulated into a bubble and then popped. Pay your taxes and see them given in "entitlements" to your entitled neighbors. Your MF organization has a vested interest in the crap game that is America.

  • Report this Comment On August 16, 2012, at 10:38 PM, irvingfisher wrote:

    Basel III will cut bank ROEs by 20-50%. Keep that in mind when looking at banks.

  • Report this Comment On August 17, 2012, at 2:00 AM, HerrGlock wrote:

    You only have to watch an episode or two of House Hunters International of people looking for places ANYWHERE in Europe. You would think those teenie tiny cramped little podunk residences and apartments were made of gold. This mess is gonna squash them like bugs, you watch. Will make our housing problems look like child's play!

  • Report this Comment On August 17, 2012, at 9:46 AM, FelixHoenikker wrote:

    Per the demographic predicitons of H S Dent, Euorpe is in for a whole lot of real estate deflation. The US also has another 20-30% of air left in its real estate bubble which has to be let out before a true recovery can start.

  • Report this Comment On August 17, 2012, at 12:01 PM, Brent2223 wrote:

    Wonder if rent/own %'s play into this (more owners, more wealth in real estate).

    I believe Spain has high own ratio, so understandable more wealth is tied up there. But France has lower ownership rates than the US, so they look to be in some real trouble...

  • Report this Comment On August 17, 2012, at 1:36 PM, Darwood11 wrote:

    @Brent2223. The percentage of ownership is an excellent point.

  • Report this Comment On August 17, 2012, at 1:48 PM, TMFHelloNewman wrote:

    @Brent2223

    Correct - in 2001, Spain had 85% homeownership, France had 63%.

    http://www.nahb.org/generic.aspx?genericContentID=57411

  • Report this Comment On August 17, 2012, at 3:10 PM, PositiveMojo wrote:

    You have an interesting analysis but it lacks one thing, the number of payment defaults.

    I acted as CTO for a nationwide lender during the housing bubble, with billions of loans closing each month. We saw the number of payment defaults rising in the first quarter of 2008, and we knew that a huge number of loans were schedule for an ARM reset in August of 2008, which is exactly what triggered the panic.

    So my question is: Are France and Spain seeing a problem with payment defaults, since that is the early warning signal?

  • Report this Comment On August 17, 2012, at 3:15 PM, PositiveMojo wrote:

    Regarding my question about payment defaults, here is an interesting article that indicates defaults in France are not a problem and states why.

    http://www.connexionfrance.com/french-foreclosures-rarer-tha...

  • Report this Comment On August 17, 2012, at 3:20 PM, PositiveMojo wrote:

    Here is an article on payment defaults in Spain. While the article is ominous for those who have defaulted, it states that 98% of Spaniards are meeting their mortgage obligations, which is really quite amazing considering their unemployment rates. So, can we conclude that payment defaults are not a problem in Spain either?

    http://www.huffingtonpost.com/2011/07/10/spain-mortgage-defa...

  • Report this Comment On August 17, 2012, at 3:35 PM, dag154 wrote:

    Huuu, prices are set by offer and demand. Do you have any idea on the balance in each individual country? That might be helpful ...

  • Report this Comment On August 18, 2012, at 10:40 PM, Beanfarmer wrote:

    Check you facts, that is not what a Tier 1 9% means.

  • Report this Comment On August 19, 2012, at 12:52 PM, TMFHelloNewman wrote:

    @PositiveMojo

    Thanks for those links. As I said for that one specific set of Spanish bonds based on mortgages, delinquency rates are higher than 15%. And of course, France's tighter regulations on risky mortgages will help keep defaults down. Even so, I think a precipitous fall in home values - especially since so much of the countries' assets are tied up in real estate - will have a huge negative impact on Europe's turnaround.

    @Beanfarmer

    From my understanding of Tier 1, it is the "the ratio of a bank's core equity capital to its total risk-weighted assets". Would a better quick explanation be a measure composed of equity versus risky assets?

  • Report this Comment On August 19, 2012, at 7:58 PM, Sunny7039 wrote:

    From the article:

    "The upside is that the French did not dabble in such subprime loans as the Americans did. French regulators recommend that banks shouldn't issue mortgages if payments will be greater than 33% of a borrower's income, and as The Economist reports, 'banks are under a legal obligation not to push borrowers into more debt than they can manage, and cases are regularly brought to court.'

    This has left French banks like BNP Paribas (OTC: BNPQY.PK) in a better position than American counterparts during tough times."

    No kidding!

    This article forgets two other trends: New money from all over Europe, and especially Russia, is flowing into French real estate. France is a remarkably beautiful country, with a very high quality of life relative to its standard of living (that is, relative to its per capita income). So people buy real estate there to use it, not to flip it. Even if they buy it as an investment, they know they will have tenants. The quality and style of life there is attractive to many people outside of France.

    Second, the French are savers. In many surveys of developed economies, they come up as the world's biggest savers -- yes, bigger than Germany or Japan.

    These things make France different from other places.

    This does not make me happy, as I am part French and would like to retire there. I always assumed that my savings (in US dollars) would be enough. Oh well, so much for that plan.

  • Report this Comment On August 24, 2012, at 11:48 AM, Lippoldtskivich wrote:

    In addition to domestic demand, French real estate is supported by foreign buyers. Indeed, a big component of Foreign Direct Investment in France is acquisition by foreign firms of French commercial and residential real estate. This strong foreign demand helps to sustain prices in the sector at levels higher than they would be otherwise.

    Doug

  • Report this Comment On August 24, 2012, at 1:49 PM, Johny205 wrote:

    Countries like Spain and Greece and other parts of Europe take month long holidays, retire at about 50 years old, the government pays for college and medical bills. It seems to me like no body wants to work very hard or long but they want everything in return. It almost reminds of how America is becoming. I think this is a piss poor attitude, nothing is for free!

  • Report this Comment On August 24, 2012, at 2:49 PM, jastadler wrote:

    While this analysis is mostly on target, it misses the disparity in pricing levels in 2001. I happened to be looking at jobs in 2002 in Paris, Beijing, and Boston; hence, I had an opportunity to compare real estate prices at that time. Paris seemed remarkably cheap at that time, relative to the US. (Beijing, where I ended up, was even cheaper. . . but that is another story. . .). A good deal of the increase from 2001 to 2007 simply brought France into parity with the US, not into excessive asset/rent ratios. For a real bubble to occur, you should see asset/rent ratios much different from the US, which I don't think you will find.

  • Report this Comment On August 24, 2012, at 3:00 PM, TMFHelloNewman wrote:

    @jastadler

    That's interesting. Check out this graph comparing prices/income starting in 1990 - there doesn't seem to be much of a disparity:

    http://imgur.com/xZ7w8

    You can play with the chart yourself at The Economist website here:

    http://www.economist.com/blogs/dailychart/2011/11/global-hou...

  • Report this Comment On August 25, 2012, at 3:42 AM, seymourfroggs wrote:

    @HelloNewman

    Sadly, the Economist chart wouldn't open for me.

    But Mr Newman's data is 2011 at latest. A friend in France says prices are falling (but not clear how much). So he's right.

    As I recall, the Economist does show rent/assets

    rather similar in US and France.

    The very worst place is Australia. If average rent/assets is set at 100%, Australia is about 140%. This raises questions about these comparisons from country to country.

    The very simple (dig iron ore etc out of the ground) Australian economy permits this. (Eventually it will presumably face a nasty correction). But for many years, the housing bubbles will be stable or unstable depending on the background economy.

  • Report this Comment On August 25, 2012, at 10:24 AM, Intaglio7 wrote:

    In your first graph you state, "you might recall that this was the period when kids in your neighborhood flipped houses instead of running a lemonade stand." I didn't know any of those kids–what are they doing now?

  • Report this Comment On August 27, 2012, at 11:27 AM, Tobyonekenobie wrote:

    I lived in Spain from Nov 04 to Sep 07. The price increase was dramatic but it wasn't because the Spanish were buying...retiring Brits and Germans were everywhere.

  • Report this Comment On August 27, 2012, at 12:05 PM, tcnh6633 wrote:

    I'm not so sure US banks are good investments in the medium to long term. The 3% mortgage interest rate will be a huge negative on the balance sheets when inflation kicks in.

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