The Unassuming Economist

In the interview below, Marja C Hoek-Smit—Director of the International Housing Finance Program at the Wharton School and Director of HOFINET—the Housing Finance Information Portal—talks about her work, about housing markets in emerging and developing economies, and about some of the challenges, and success stories. In doing so, she provides a global picture of the housing market in emerging and developing economies—a region where much remains to be known.

Hites Ahir: Please tell us about your work.

Marja C Hoek-Smit: The broad focus of my work is first on improving the efficiency and reach of urban housing markets in developing and emerging market countries, both real-side markets and housing finance markets. Second, an increasingly important part of what I do is to find the best way to subsidize those who cannot afford to pay for available housing or need a subsidy to access housing finance. In many emerging market countries 60 to 75 percent of the urban population cannot access formal housing markets for a variety of reasons.

Housing is important from an economic, social and political perspective, and, in countries with substantial mortgage markets, the housing sector is critical from a financial stability perspective. Yet, housing has for the past decades not received the attention it deserves, and housing conditions in some developing countries have deteriorated despite economic growth. International agencies have mostly focused on upgrading slum areas. Poor housing is too often just seen as a poverty or low-income problem relative to “unavoidable” house-price trends, a perception that leads to very blunt policies for the improvement of housing conditions, in particular in the type of subsidies applied to housing. For example, in many countries subsidizing interest rates on mortgage loans provided through state housing finance institutions, remains the preferred way to address the “affordability” problem, even though such subsidies are known to be unnecessarily costly, limit the expansion of the private housing finance system and are inequitable. Reasons for high and increasing house-prices are often not analyzed in any detail, nor are reasons for housing finance markets to remain small and mortgage interest rates high relative to the risk-free rate. Yet answers to these questions are critical in the design of the right policy instruments aimed at making these systems more efficient.

Housing markets are complex and depend on well-functioning finance- and land-markets, and on facilitative legal and regulatory systems and administrative procedures in these supply markets. The analysis of housing markets therefore requires many different types of skills. In many countries housing policy is still seen as the domain of planners and architects, and it is difficult to incorporate economic and financial sector aspects of housing in policy analysis.

My consulting work is focused on assisting governments in bringing the different strands of housing market analysis together- on the demand and supply side- and in developing comprehensive housing policies for different segments of the housing market. For the broad middle income market that means addressing the constraints facing private developers in supplying housing for this population segment, and working with the financial sector to assist the expansion of mortgage markets. Relatively small demand-side subsidies may be needed to improve access for households at the margin. For the market segment where low-incomes and poverty make it impossible for market actors to deliver housing, support needs to be much more comprehensive and may focus primarily on the supply of rental housing or alternative home-ownership strategies.

The second pillar of my work is education. My academic and executive teaching is similarly focused on the housing sector in this broader context. Jointly with my colleagues from the Wharton School, I established an executive education program with a focus on housing markets, and housing finance sector analysis, and the related public policies, for senior public and private sector professionals from developing and emerging market countries. The International Housing Finance Program (IHFP) of the Wharton Zell/Lurie Real Estate Center has consistently offered courses both at Wharton and in emerging market countries over the past 30 years and has developed a joint housing finance program for Sub-Saharan African countries with Cape Town University.

More recently a third component has been added to this mix, the development of global data systems for the housing finance sector. Because of the dearth of comparable data on housing markets and housing finance systems globally, the IHFP established a standardized and longitudinal data collection effort – the Housing Finance Information Network. We research and work with many countries’ housing finance institutions to collect such data for more than 140 countries and make it available on a public web-portal — HOFINET. http://hofinet.org

Hites Ahir: What are the key problems and challenges that the housing sector faces in emerging market economies?

Marja C Hoek-Smit: On the demand side, low incomes relative to house prices, the informality of incomes (often as high as 60 percent of the labor force), high inequality (increased over the past years particularly in Sub-Saharan Africa and SE Asia), high indebtedness, and related low propensity to save, are major constraints on the demand side, exacerbated by a lack of access to finance.

On the supply-side, constraints in real-supply-systems are frequently a more difficult problem to solve and lead to high prices relative to construction costs. Rapid urbanization at increasingly lower levels of per capita income strain governments’ capacity to provide services and infrastructure, including transportation systems, for formal housing expansion, increasing land scarcity. Unrealistically high standards and zoning/planning restrictions, as well as inefficiencies of the permitting process drive up housing costs and make it impossible for developers to cater to lower middle, and middle income groups.

Difficulties in safely expanding housing finance systems, are often a more binding constraint on the supply-side and include: i) poor systems to understand and deal with credit risk, ii) high transaction costs associated with lower-income and non-salaried customers, iii) stress on funding sources, iv) lack of mechanisms to deal with asset-liability mismatches when capital market funding is limited, and, iv) in some emerging market economies, the dominance of government housing finance systems benefitting from implicit subsidies and the related reluctance of private lenders to enter the market, ultimately limiting the overall scale of mortgage availability. In addition, Basel III regulations and solvency and liquidity requirements make it more difficult for the banking sector to expand longer term mortgage lending and the banking sector is the core provider of mortgage loans in most emerging market countries.

Hites Ahir: Which regions face the biggest challenges and why?

Marja C Hoek-Smit: Low-income countries that are urbanizing rapidly, starting from a low urban base, face the most complex urban housing problems, i.e., countries in Sub-Sahara Africa, and South and SE Asia. On the other end of the spectrum are the highly urbanized middle income countries of Latin America with dominant state supported and subsidized housing finance systems, such as Mexico and Brazil, which have created policy-induced volatility in the housing- and construction markets and stress in the housing finance systems. While these policies were successful in addressing high income inequality, they created locational inequalities and housing risks for households and government. Mexico has started a process of comprehensive policy reform both on the real-supply side and in the housing finance system.

Hites Ahir: What are some of the successful approaches to expand affordable housing?

Marja C Hoek-Smit: From the above discussion it follows that there is not one right approach or set of policies that address the housing affordability problems across emerging market countries and that policies must differ according to the specific demand and supply constraints in each market. In general, countries that have invested in a comprehensive housing market analysis, differentiated by type of urban area, and have put in place a medium/long-term agenda for reforms of land-policies, and land registration systems, planning regulations, housing finance sector and subsidy policies, have done better compared to countries with similar demographics and income levels that have not addressed these issues. Several countries are in the process of implementing such comprehensive approach to housing reforms, e.g., Mexico, South Africa, Egypt, India, and, although in an early phase, Indonesia. I focus here on two countries that have gone through such reforms in the past.

Thailand is a country that reformed its housing finance system and its urban development policies in the 1980s and 1990s, and was able to gradually expand the formal supply of middle and lower-middle income housing with minimum subsides. Community-based upgrading and resettlement policies were effective in further decreasing its sizable urban slum population by the early 2000s. Political instability and budget cuts for housing during the recent decade, however, are serving to jeopardize these achievements.

Chile is a country that has implemented a successful housing sector reform program that has been fine-tuned over many years. Like Thailand, it reformed its government housing finance system in the 1980s. It introduced demand-side subsidies linked to market-rate loans for the middle income segment. Its private housing finance system expanded and so did the private housing market. Gradually, Chile was able to decrease the proportion of the population that cannot access market provided housing, but with increasing subsidy levels. It adjusted its approach to support housing for the lowest-income group many times, and, currently, supports the supply of housing for the poor with very high supply-side subsidies channeled through NGOs. The recent economic down-turn has put pressure on the subsidy budget, however. This cloud may have a silver lining. It may entice Chile’s housing ministry to analyze whether its liberal housing subsidy system may in fact have price effects that it should address.

Outstanding issues in both countries are the lack of development of a private rental sector.