Raghuram Rajan, the governor of the Reserve Bank of India (RBI), merely stated the obvious when he

said today (20 August 2015): "It would be a "great help" if realty developers sitting on unsold stock bring
down prices…Once the prices stabilize, more people will be keen to buy houses."

The RBI governor added that property prices need to fall before interest rates on home loans come
down, any further. "I think we need the market to clear. With growing unsold stock, we need to see the
ways to do it. Some of it might be by making loans easier, but we also don't want to create a situation
where prices stay high at the level which means demand can't pick up," he said.

There are multiple points that need to be made here: First is that Rajan was essentially replying to all the
real estate wallahs (real estate companies, lobbies and others associated with the sector) who demand
interest rate cuts at a drop of a hat. The message from the RBI governor is loud and clear. The home
prices are in a bubble zone and he does not want to inflate the bubble further by cutting interest rates.
Home prices need to fall.

Also, it is worth mentioning here that even at high interest rates home loans given by banks continue to
grow at a very brisk pace. The Reserve Bank of India (RBI) puts out the sectoral deployment of credit
data every month. As per these numbers, the total amount of home loans given by banks grew by 15.6
percent to Rs 6,53,400 crore, over the last one year. In comparison, the overall lending by banks grew by
just 7.3 percent. These numbers were as of June 2015.

How was the situation in June 2014? Home loans had grown by 17.1 percent to Rs 5,65,000 crore. In
comparison the overall lending by banks had grown by 12.8%. What this clearly tells us is that even
though the overall lending growth of banks has crashed from 12.8 percent to 7.3 percent, home loans
continue to grow at a fairly brisk pace.

Further, banks have given out Rs 88,400 crore of home loans in the last one year. This formed around 21
percent of all the lending carried out by banks. For a period of one year ending June 2014 and June
2013, home loans formed around 12.7 percent and 12.2 percent of the total loans given by banks.

What this clearly tells us that banks are giving out a greater amount of home loans as a proportion of
their overall loans, than they were in the past. And if this hasn't led to a fall in inventory of unsold
homes, the only reason is that home prices have gone up way beyond what most people afford. Hence,
even though the total amount of home loans has gone up, the total number of home loans being given
out may have even fallen (This data is not available).

The only way this situation can be corrected is if home prices fall, which is precisely what Rajan said.

The other interesting point that needs to be made here is that central bank governors normally stay
away from calling a bubble, a bubble. Alan Greenspan, the chairman of the Federal Reserve, from 1988
to 2006, was a pioneer in this school of thought. He told the US Congress in June 1999: "Bubbles are
generally perceptible only after the fact. To spot a bubble in advance requires a judgment that hundreds
of thousands of informed investors have it all wrong. Betting against markets is usually precarious at
best."

So, the Federal Reserve could not spot the dotcom bubble, explained Greenspan. But once it had burst,
steps could be taken to ease its fallout, Greenspan felt. As he said in a speech titled Economic Volatility
on 30 August 2002: "The notion that a well-timed incremental tightening could have been calibrated to
prevent the late 1990s bubble is almost surely an illusion. Instead, we noted in the previously cited mid-
1999 congressional testimony the need to focus on policies 'to mitigate the fallout when it occurs and,
hopefully, ease the transition to the next expansion.'"

There is a fundamental problem with this argument. Greenspan was basically saying that the Federal
Reserve could not recognize a bubble, but it could figure out when the same bubble had burst.

Rajan exposes the flaw in this argument in his book Fault Lines. As he wrote: "This speech seemed to be
a post facto rationalization of why Greenspan had not acted more forcefully on his prescient 1996
intuition: he was now saying the Fed should not intervene when it thought asset prices were too high
but that it could recognize a bust when it happened and would pick up the pieces." Greenspan had used
the term "irrational exuberance" to describe the dotcom bubble in a speech he had made in December
1996, and then chosen to do nothing about it.

Rajan clearly does not believe in the fact that a central bank cannot identify a bubble. What he said
today regarding property prices being high and that they need to fall, before people can start buying
homes again, clearly proves that.

Further, the real estate wallahs seem to have come up with a new explanation for why real estate prices
cannot fall any further(they have barely fallen to start with). As Shishir Baijal, chairman and managing
director of Knight Frank India, a real estate consultancy, told Mint recently: "Theoretically, if prices come
down, perhaps the demand can increase. But I'm not sure if developers have any leeway left now for
reducing prices. This is because input cost has increased quite a lot over the past few years- be it cost of
labour, construction and material, or even the historical cost of land itself, which is very high. It does not
look like there is any scope left for a serious correction in prices."

This, after he had said: "There is a mismatch [between demand and supply] because people are finding
it unaffordable (to buy)." And this came, after he had said: "If you look at investor demand, property is
not their primary choice anymore. This is due to muted price appreciation, high level of unsold
inventory, and the fact that there are other more lucrative financial instruments to choose from. Earlier,
there weren't any options as the equity market was not performing."

So, investors are not buying because they are not getting high returns from investing in real estate,
anymore. The end users are not buying because prices are high. But prices will still not fall, say the real
estate wallahs. What sort of an argument is that?

If home prices do not fall, the real estate sector will continue to remain in a mess for a much longer
period of time. The market will go through what analysts call a longer time correction (i.e. prices will
stagnate for a long period), if prices don't fall. And this can't possibly be good for anyone-buyers will
continue to stay away, and sellers won't be able to sell.

This will mean that the real estate companies will continue to hold on to unsold homes that they have
accumulated over the years. Given this, Rajan was absolutely right when he said if the market has to
function, and buy and sell transactions have to happen, home prices need to fall. The sooner the real
estate wallahs understand this, the better it will be for all of us.