the Carry Trade and the Real Estate Bubble

The carry trade has entered into the real estate bubble. Individuals are getting loans in other currencies than their home country, and hoping that their own currency does not collapse in value.

Reports are that:

Millions of people throughout the world, especially in Eastern Europe, are using the carry-trade, usually the preserve of big-time gamblers, to take out home mortgages. In the carry-trade, an investor borrows money from one country, where the borrowing cost is low, and invests it in another country, where investments yield a high rate of return (see yen carry trade). Now, households are insanely engaging in this risky practice, taking out a home mortgage in a foreign currency at low interest rates, sometimes half the rate of interest charged in their home country.

The May 29 Wall Street Journal reported the case of Tamas Bencze, of Budapest, Hungary, who took out a foreign-currency mortgage loan at 5.75%, whereas if he took out that same mortgage loan in Hungary, the interest rate on the loan would be 14%. However, if the Hungarian currency, the florint, were to sharply depreciate, then Bencze's mortgage would become suddenly unpayable.

The mortgage carry-trade is the latest craze. In Poland, one-third of all mortgages are contracted in foreign currencies. In Hungary, half of all the mortgage loans are foreign currency-denominated, according to the country's central bank. The Swedish bank SEB reports that 70% of its lending in Latvia, is in foreign currency, rather than the local currency, the lats.

The mortgage and regular carry-trade have created an immense danger. In countries throughout Eastern Europe-- Poland, Hungary, Latvia-- the foreign currency debt coming due now exceeds the reserves of those countries' central banks. Were foreign investors to pull out funds from those countries-- which prop those currencies up-- the currencies would crash. This would intensify ungovernability in Europe.

The U.S. has also jumped aboard the mortgage carry-trade bandwagon. According to the Journal, an individual bought a 7-bedroom house in Kissimmee, Florida, by borrowing the equivalent of $240,000 in yen from Britain's Lloyds Bank. Some giant banks are making such loans with the same fervor that they had made with subprime mortgages. This added element of insanity will make the housing market explosion a once-in-a millennium event.