There is no disputing that there are such things as asset price bubbles. There have been plenty of examples of bubbles bursting in history, and they were all marked by price increases that were clearly unsustainable. Unsustainable price increases do not mean that they have to reverse into big price collapses. Alan Greenspan, the previous Federal Reserve chairman, had been credited with both announcing the presence of irrational exuberance and of declaring that there is no telling about a bubble until after it had burst. Still, the quick expansion and then collapse of an asset price bubble is among the worst fears for policy makers. They all declare that they want to guard against this type of development. Yet the fact remains that what they do to "guard against housing price bubbles" often turns out to aggravate the negative impact of an asset price collapse, or even make a bubble formation more pronounced and then the eventual collapse more painful.

The 1994 effort to combat property speculation is a case in point. In that year, aggregate demand was temporarily suppressed by government efforts that made speculation more costly. Supply was reduced in response to a short term price decline. But exactly because of the reduction in supply that followed, when the suppressed demand eventually resurfaced the bubble that followed in 1996 and 1997 was worse. The eventual collapse was also more serious and more painful.

The 1997 effort to beat property speculation by drastically increasing supply to 85,000 units per year was yet another example of policy makers worsening a crisis. As a matter of fact, prices tend to correct themselves after running ahead of themselves. But an effort to increase supply drastically would turn that collapse into a long drawn-out catastrophe. So increasing supply to suppress price expectations, as recommended by some people including developer Mr Ronnie Chan, is really not an appropriate policy response to a run-up in housing prices.

This is not to say that the excessive restraint on the housing supply as witnessed over the past few years is the right policy. I agree that we need to increase supply. But that is only because the annual housing supply had been too small relative to the demand. I have always argued that housing supply should be held at a level in line with long term demand. This means that we should ignore temporary price fluctuations that occur from year to year. I would further underscore the importance of announcing a housing supply target to the public - at a level that are more or less consistent with the average market absorption over the past 10 years. This will help stabilize market expectations. Making reference to past absorption provides, of course, only a rough guide. But the advantage is that this will not be too far off from what is right. Making projections based on various assumptions or wild guesses is an extremely hazardous enterprise, and should provide information only to "fine-tune" the moving average target incrementally.

I would in particular warn against adjusting supply to manage prices. While supply increases will certainly dampen demand, an oversupply will almost certainly generate a catastrophe. In principle, what we should do is to ensure a stable supply that is based on meeting the needs of society, considering all the competing wants: the need for environmental protection, the need to preserve heritage, the need for more open space, the need for dwelling space, the need for roads and mass transit, etc.

From the point of view of the monetary authorities, what is needed is to contain systematic risks. That is why the Hong Kong Monetary Authority (HKMA) has all my support to adjust the mortgage loan ratio. I have always had high praise for the HKMA for containing leverage, so that notwithstanding the huge housing price collapse in the aftermath of the Asian financial crisis, not a single licensed bank in Hong Kong ever failed. That is quite an impressive achievement.

Many people now worry that the low interest rate environment is creating a property price bubble. There is no doubt that low interest rates will boost asset prices, but increasing mortgage lending rates is really not the answer. The fact is that given the magnitude of the global financial crisis that occurred and the need for the global economy to mend, interest rates are going to stay low for a while. Borrowers should be warned against possible price increases, and lenders should be careful to ensure that the borrower has the ability to repay should interest rates head north. Boosting lending rates will not help buyers who are complaining about the high prices.

Of course the government should also consider the proposition that it relaunch the highly successful Home Ownership Scheme housing program, as I have argued in this column before. But over-reacting by excessively boosting supply should be avoided.

The author is director of the Centre for Public Policy Studies, Lingnan University.

(HK Edition 08/03/2010 page2)