The Next Housing Bubble

As we continue to sift through the wreckage of the housing crisis, fingers are pointing left and right in an attempt to assign blame. No small number of academics and economists are now blaming the Fed as one of the primary enablers of the housing bubble. After all, they charge, the Fed lowered interest rates and kept them low early in the decade, thus fueling a massive spurt of lending to qualified and unqualified buyers alike.

While the ultimate blame likely lies on many fronts -- the Fed, banks' lax lending standards, overreaching homebuyers -- the bursting of the housing bubble has caused tremendous damage. Large financial institutions like Citigroup (NYSE: C  ) and AIG, as well as government-sponsored entities Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) , were brought to their knees, and foreclosures are still rising. But even as we begin to heal from the housing mess, similar bubbles may be inflating in other parts of the world.

Foreign markets heat up
Don't look now, emerging-markets fans, but China may be next in line. Real estate prices in Shanghai and Beijing have quadrupled in recent years, and they're fast rising out of reach for many Chinese families. Perhaps even more importantly, potential homebuyers expect prices to continue rising at their current rate. As a result, many are stretching themselves thin to purchase a home at today's lofty prices, for fear that prices may spiral even farther out of reach in the near future.

With a forecasted 2010 growth rate of 8.3%, the Chinese economy certainly has a lot of underlying support for its expanding housing supply. However, the astonishingly rapid rise in prices and increasing speculation are classic signs of an overheating market. According to Pimco, bank lending in China rose by 30% last year, thanks in part to lax lending standards. Signs of investment overcapacity are also beginning to show in China's industrial sectors. According to one estimate, on an average day in 2009, more than 1,000 new industrial projects were initiated. This is one dragon whose roar is definitely being heard.

Taking a breather
If nothing else, the Chinese government is aware of the potential problem, and it's making some initial moves to cool down the housing market. Earlier this week, Beijing increased required bank reserves by half a percentage point in an effort to slow lending. Officials have also imposed other measures, including imposing taxes on certain property transactions and ordering more scrutiny of loans. Any Chinese family buying a second home must now make a down payment of at least 40%.

Nervous global investors are no doubt drawing parallels to the situation in Japan in the late 1980s. After a massive real estate run-up there, the bubble popped, hammering the economy, the stock market, and the balance sheets of large banks. Economic growth in Japan slowed to a crawl for more than a decade. If the same thing happened in China, it could have vast implications for the rest of the world, which is still struggling to get its own economies back on track.

Reasoned investing
Given the length and breadth of China's growth streak, it's not unreasonable to assume that a pullback is in order. Foreign markets, especially emerging economies, can be a risky place to invest, which investors tend to forget when they are earning hefty double-digit returns. But even if China's housing market is overheating a bit now, there's no denying the long-term potential there. China is a hands-on favorite to post some of the greatest global growth in the next decade -- and some of the highest investment returns.

In my opinion, investors should avoid making bets on individual countries via mutual funds. There's just too much risk involved, especially given the current potential for a deflating housing bubble in China. Instead, opt for a low-cost, well-diversified exchange-traded fund that focuses on , like Vanguard Emerging Market Stock ETF (NYSE: VWO  ) . This fund invests in larger emerging stocks like Mexican wireless operator America Movil (NYSE: AMX  ) and Taiwan Semiconductor (NYSE: TSM  ) , and it clocks in with a low 0.27% annual expense ratio.

If you want the power of active stock-picking on your side, consider Matthews Pacific Tiger (MAPTX). This fund invests in Asian countries other than Japan, and it has racked up an impressive track record over its more than 15 years in operation. Chinese names make up roughly 18% of assets here, including stocks like Ctrip.com (Nasdaq: CTRP  ) , a China-based travel service provider.

Investors should definitely watch the situation in China carefully. If the housing markets continue to heat up, we could be in for a wild ride on the downside. But over the long run, investors shouldn't miss out on the incredible power this emerging nation has to offer.