How the Fed saved Singapore

By J.J. Zhang

Reuters

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A worker assembles a God of Fortune statue Sunday as part of Chinese New Year decorations along the skyline of Singapore.

SINGAPORE (MarketWatch) — The Fed may have saved Singapore. Or at least postponed the apocalypse.

It’s been no secret Singapore property prices have climbed dramatically recently, jumping almost 100% in the last four years. The median private condominium now sells for well over 1 million Singapore dollars, approximately $800,000 for a 1,000 square-foot property.

There are a number of reasons for the rapidly appreciating market including a high influx of foreigners — especially the rich from mainland China — lack of available land, relatively high incomes and a cultural preference for owning land.

However, rising prices has the Singapore government worried. While Singapore has the largest percentage of millionaires in the world — almost one in every six households as measured by disposable private wealth — many are not well off enough to afford the new normal in housing.

About 80% or more of Singaporeans live in government-developed housing lovingly called HDBs after the Housing Development Board, which oversees it, and the median gross monthly income as of 2012 was only $2,400, comparable to the U.S. individual median monthly income of approximately $2,350.

The rapid rise in property prices had several effects, one of which predictably was a rise in property as an investment or as a speculative tool. But with such high prices, many buyers borrowed unprecedented amounts of money to finance these purchases. In a rising property market, these bets paid off handsomely, similar to what happened in the U.S. during the heady days of the now burst property bubble.

To cool off the market frothiness, the Singapore government instituted rule after rule after rule to stop the price appreciation. These measures included stamp duties — essentially a house-buying tax — of 18% for foreigners, monthly mortgage payments that can’t exceed 30% of monthly incomes, and minimum 20% down payments for buyers or 40% if the mortgage will be held past 65 years retirement age. Those down payments are not inconsequential considering that translates to 400,000 Singapore dollars on hand for a million-dollar home.

These measures have finally succeeded in cooling off the market as private property prices have leveled and started to drop, over 2% in the last few months. However as many people in the U.S. experienced, drops in prices create their own set of problems — underwater mortgages and suffocating levels of debt. This is an issue for many Singaporean’s retirement planning as a common practice is to cash out their government-sponsored retirement plan to buy a home.

Not surprising, extraordinarily low interest rates played a large role in the leveraging choices people made. While recent mortgage interest rates in the U.S. hit record lows of 3%, Singapore is beyond comparison. The average Singaporean mortgage is based on Sibor, the Singapore Interbank Offered Rate, plus a flat percentage of around 1%.

Due to a number of reasons, such as Singapore’s focus on managing exchange rates to control its economy instead of other more common policies, foreign interest rates have an unusually high influence. In particular the U.S. fed funds rate, currently 0% to 0.25%, has a strong influence on Sibor, with the two tracking extremely closely.

This resulted in mortgage rates in Singapore of approximately 1%, significantly masking the effects of the housing leverage. To put it in perspective, a 1% interest on a million dollar home loan is comparable to a more reasonable $250,000 mortgage at 4%, even though the principal is much higher. If only rates will stay there…

As expected, miserly rates of 1% are not conducive to banking profits, and one practice lenders have implemented is the virtual elimination of fixed-rate mortgages. Almost all Singapore mortgages are now variable rates.

Underwater mortgages and unaffordable payments

Looking at the history of the fed funds rate, which was at 5% as recently as 2007, it has trended between 3% and 6% for the last several decades. When fed rates return to their historical averages after this exceptionally long period of low rates, Singapore’s housing market will discover a double whammy of underwater homes and unaffordable interest payments.

At 6%, interest payments in Singapore will more than overwhelm the principal and double monthly payments. With retirements basically cashed out to buy homes and all available disposable income being spent on interest, consumer spending will drop along with the overall economy.

But with last month’s Fed announcement: on rate policy Singapore can breathe a little easier, at least for now. With the potential promise of low rates well after original targets and Janet Yellen at the helm, not only will rates stay low in Singapore for some time but also you can expect them to climb slowly when they do.

Historically, the fed funds rate has increased by 1.5 points a year. With expectations of the unemployment goal being reached within the next couple of years, it pushes out the day of reckoning for Singapore mortgage holders to three to five years or longer, giving time for deleveraging and any government interventions.

The winners when rates inevitably rise? Banks such as DBS (up 13% in 2013), HSBC (up 2%), and UOB (up 6%) which have strong presences in Singapore. The losers? Homeowners, property developers such as CapitaLand (down 20% in 2013) and Singapore itself, which has a country ETF that trades in the U.S.

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