Housing Bubble Back With a Bang

Market and macroeconomic policy realities show that a housing bubble, which could potentially lead to further global economic stagnation, is looming in many countries around the world, reflects Nouriel Roubini, professor of economics at the New York University, United States. The bigger the bubble becomes, the nastier the collision with reality will be, he argues, in this commentary exclusively submitted to Fortune by Project Syndicate.

It is widely agreed that a series of collapsing housing-market bubbles triggered the global financial crisis of 2008/09, along with the severe recession that followed. While the US is the best-known case, a combination of lax regulation and supervision of banks and low policy interest rates fuelled similar bubbles in the UK, Spain, Ireland, Iceland and Dubai.

Now, five years later, signs of frothiness, if not outright bubbles, are reappearing in housing markets in Switzerland, Sweden, Norway, Finland, France, Germany, Canada, Australia, New Zealand and, back for an encore, the UK (well, London). In emerging markets, bubbles are appearing in Hong Kong, Singapore, China and Israel, and in major urban centres of Turkey, India, Indonesia and Brazil.

Signs that home prices are entering bubble territory in these economies include fast-rising home prices, high and rising price-to-income ratios and high levels of mortgage debt as a share of household debt. In most advanced economies, bubbles are being inflated by very low short- and long-term interest rates. Given the anaemic gross domestic product (GDP) growth, high unemployment and low inflation, the wall of liquidity generated by conventional and unconventional monetary easing is driving up asset prices, starting with homes.

The situation is more varied in emerging-market economies. Some that have high per capita income – for example, Israel, Hong Kong and Singapore – have low inflation and want to maintain low policy interest rates to prevent exchange-rate appreciation against major currencies.

Others are characterised by high inflation – even above the Central Bank target – as is the case in Turkey, India, Indonesia and Brazil. In China and India, savings are going into home purchases, because financial repression leaves households with few other assets to provide a good hedge against inflation. Rapid urbanisation in many emerging markets has also driven up home prices, as demand outstrips supply.

With central banks – especially in advanced economies and the high-income emerging economies – wary of using policy rates to fight bubbles, most countries are relying on macro-prudential regulation and firm supervision of the financial system to address frothy housing markets. This results in lower loan-to-value ratios, stricter mortgage-underwriting standards, limits on second-home financing, higher counter-cyclical capital buffers for mortgage lending, higher permanent capital charges for mortgages and restrictions on the use of pension funds for down payments on home purchases.

In most economies, these macro-prudential policies are modest, owing to policymakers’ political constraints: households, real-estate developers and elected officials protest loudly when the Central Bank or regulatory authority in charge of financial stability tries to take away the punch bowl of liquidity.

They complain bitterly about regulator “interference” with the free market, property rights and the sacrosanct ideal of home ownership. Thus, the political economy of housing finance limits the regulators’ ability to do the right thing.

To be clear, macro-prudential restrictions are certainly called for, but they have been inadequate in controlling housing bubbles. With short- and long-term interest rates so low, mortgage-credit restrictions seem to have a limited effect on the incentives to borrow in order to purchase a home. Moreover, the higher the gap between official interest rates and the higher rates on mortgage lending as a result of macro-prudential restrictions, the more room there is for regulatory arbitrage.

For example, if loan-to-value ratios are reduced and down payments on home purchases are higher, households may have an incentive to borrow from friends and family – or from banks in the form of personal unsecured loans – to finance a down payment. After all, though home-price inflation has slowed modestly in some countries, home prices in general are still rising in economies where macro-prudential restrictions on mortgage lending are being used. So long as official policy rates, and thus long-term mortgage rates, remain low, such restrictions are not as binding as they otherwise would be.

But the global economy’s new housing bubbles may not be about to burst just yet, because the forces feeding them – especially easy money and the need to hedge against inflation – are still fully operative. Moreover, many banking systems have bigger capital buffers than in the past, enabling them to absorb losses from a correction in home prices; and, in most countries, households’ equity in their homes is greater than it was in the US subprime mortgage bubble. But the higher home prices climb, the further they will fall – and the greater the collateral economic and financial damage will be – when the bubble deflates.

In countries where non-recourse loans allow borrowers to walk away from a mortgage when its value exceeds that of their home, the housing bust may lead to massive defaults and banking crises. In countries (for example, Sweden) where recourse loans allow the seizure of household income to enforce payment of mortgage obligations, private consumption may plummet as debt payments (and eventually rising interest rates) crowd out discretionary spending. Either way, the result would be the same: recession and stagnation.

What we are witnessing in many countries looks like a slow-motion replay of the last housing-market train wreck. And, like last time, the bigger the bubbles become, the nastier the collision with reality will be.

By Nouriel Roubini
He is professor of economics at the New York University, United States.

Published on December 8, 2013 [ Vol 14 ,No 710]



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