Latin America's Resilient Housing Market

New York – As the consequences of the sub-prime mortgage meltdown in the United States spread through global markets, will one of the most positive trends in Latin America – the expansion of local credit markets, which has dramatically expanded access to homeownership throughout the region –be jeopardized?

Big multinational banks and mortgage lenders have moved into markets across Latin America, providing financial services that allow lenders to better manage risk. Banks are creatively tapping into migrant worker remittances, multiple-family households, and other previously overlooked sources of potential income and creditworthiness. Similarly, the spread of microfinance lending has made capital available to borrowers who until recently were not seen as creditworthy.

So far, the sub-prime crisis has had a limited direct impact on Latin America’s mortgage markets. In Mexico, the market for new low-and middle-income housing has grown rapidly, thanks to the creation of a market for residential mortgage securities in 2003. In the last quarter of 2007 alone, Mexican issuers sold $1.5 billion in new mortgage-backed securities – a significant portion of $4.4 billion outstanding – with only a slight drop in prices to reflect globally induced risk, according to the publication Asset Securitization Report . Chilean markets also have stayed relatively calm.

These markets have been insulated in part because most investment in real estate-backed securities has come from local investors who often need to invest in local-currency markets. Most important, Latin America’s mortgage markets and homeowners are very different from those in the US.

“It’s natural that the state of global markets will have some kind of ripple effect,” says Greg Kabance, managing director for Latin American structured finance at Fitch Ratings, the international credit ratings agency. “But Latin American countries, from a credit standpoint, are a lot better off than they have ever been to withstand turbulence and weather global market problems.”

To their benefit, Latin American governments have applied the lessons of the past. Mexico’s “tequila crisis” of 1994-1995 forced many homeowners into default when the peso fell by 70% and interest rates soared. In Mexico, all mortgages carry fixed interest rates, unlike the infamous “exploding ARMs” that left US homeowners ruing their choice of adjustable-rate mortgages when interest rates rose. Mexican mortgages are indexed to inflation, but the state mortgage agency links that index to the minimum wage and makes up the difference if mortgage interest adjustments for inflation outpace wage growth. This protects both borrowers and lenders.

Thus, although delinquency rates have risen slightly in Mexico since the mortgage market was created in 2003, only about 5% of mortgages are between 31 and 60 days late. Only 2% are between 61 and 90 days late. In the US, by contrast, 21% of adjustable-rate sub-prime mortgages are 90 days late or in foreclosure.

Standard & Poor’s analyst Juan Pablo de Mollein points out that Mexico does not have a liquid secondary market where mortgage securities can be traded to buyers who are far removed from the original issuer. That tends to make buyers more cautious.

The silver lining of past financial crises in Latin America is that most individuals carry far less debt than do Americans. In Mexico, for example, mortgage debt represents less than 10% of GDP, compared to about 50% of GDP in Europe and 82% of GDP in the US – a ratio that has increased more than fourfold in the last two decades.

Latin America’s low personal debt levels have created an opportunity to build a constructive culture of borrowing while expanding economic opportunity. There is no doubt that the expansion of access to financial services has enormous positive potential, when handled responsibly.

In his 2000 book The Mystery of Capital, Peruvian economist Hernando de Soto argued that access to credit is a powerful under-used force for development. He emphasized the crucial role of housing in allowing low-income individuals to raise capital that can be used for investment in small businesses, in education, or in other projects that can significantly improve standards of living over the medium to long term.

But as the array of financial services available in Latin America expands, the danger of misuse rises. There is a clear lesson to be learned from the US, where easy credit created complacency on the part of authorities, opportunity for charlatans, and tragedy for those who lost or will lose their homes. Americans homeowners came to treat their houses as cash machines from which they withdrew equity lines of credit for consumption instead of investment. The dramatic run-up of home prices made it too easy to count on real estate values to continue to rise.

Latin Americans have long regarded real estate as a long-term asset and as protection against inflation. With much lower inflation over the past two decades, other investment opportunities were better options, which helped to keep real estate values in check. At the same time, expanded access to credit has supported a building boom to meet vast untapped demand. Mexico alone is estimated to have a housing deficit of six million units.

As the US and Europe lower interest rates to try to revive their economies and calm financial markets, the most significant impact of the sub-prime mortgage crisis for Latin America may turn out to be inflation. Ironically, then, the expanded access to mortgage lending that creates new homeowners in Latin America may end up protecting the region from the disaster that too-loose credit created in the US.