The Unassuming Economist

From IMF’s latest report on Czech Republic:

“Amid robust mortgage credit growth, property price-growth significantly accelerated from already elevated levels stretching valuations and worsening affordability. Property prices grew by about 8½ percent in 2020, down from about 9¼ percent in 2019, but accelerated to 14½ percent y-o-y in 2021:Q2. The Czech Republic has experienced one of the highest property price appreciation rates in the EU, reaching a cumulative growth rate of about 54 percent in the five years prior to 2021. The CNB estimates property prices to be overvalued by 25 percent on average (as of mid-2021). The steep property price increase has deteriorated affordability as reflected in price-to-income and price-to-rent ratios.

Macrofinancial vulnerabilities due to increasing risk-taking by lenders amid growing household leverage and high and rapidly rising property valuations warrant close monitoring. Although aggregate household indebtedness is still low compared to other EU countries, it increased robustly by 2½ percentage points to 34 percent of GDP during 2020. Fast increases in property prices, amid loosening credit standards and macroprudential policy during the pandemic, resulted in households/lenders taking larger and riskier mortgages (…). Significant increases in risk taking, in an environment of high and rapidly rising house prices, exposes households to price and interest rate shocks that could harm those who purchased in overvalued areas, who are highly levered, or low-income households—for which debt service is already burdensome. These vulnerabilities might be compounded by the large proportion of mortgages with fixation periods up to five years.

Recent developments warrant tightening prudential tools while deploying coordinated housing supply and tax policies. Properly calibrated income-based measures can improve risk taking incentives and support affordability. Staff welcomes the CNB’s decision in November 2021 (effective from April 2022) to tighten limits on mortgage loan ratios as follows: DTI (8.5), DSTI (45 percent) and LTV (80 percent). Close monitoring of market developments is necessary with a potential for further tightening down the road. Importantly, clear communication of macroprudential policy actions and adequate coordination of the overall policy mix are key to ensure a smooth stabilization. Proper calibration of macroprudential tools for lower risk groups—first-time home buyers and low-levered households—is warranted to safeguard proper access to financing. An improved risk-based prudential framework (Section D) could be combined with the macroprudential setup to facilitate calibration of these measures.

Housing Supply

Pre-existing housing supply shortages persisted throughout the pandemic, partly reinforced by temporary pauses in construction activity. A new construction law, aimed at simplifying the construction code and the reportedly cumbersome permitting process, through creation of a one-stopshop for construction companies, was adopted in July, 2021 but implementation of some of its provisions will take until 2023. The impact on the number of granted residential building permits has been limited so far.

Tax Policy

Revenues from property taxes are low in comparison to other countries and will further fall after the recent cancellation of the property transaction tax. Real estate property taxation should be based on current market valuations and not on floor space. While the recent reduction of the maximum deductible amount of mortgage interest from CZK 300,000 to CZK 150,000 per year starting in 2021 is welcome, this benefit could be eliminated completely as in other countries.

Staff welcomes the recent reform of the macroprudential framework that provides the CNB with the legal powers to implement macroprudential policy. In July 2021, the CNB was given powers to make macroprudential limits legally binding, which is consistent with international best practice.

Authorities’ Views

The authorities acknowledge the risks stemming from the heated property market and stand ready to tighten macroprudential policies as needed. They acknowledged the increasing risk taking by households amid high and rapid house price growth and stand committed to closely monitor market developments to decide on further policy actions. On the basis of new statutory powers, the CNB Bank Board decided on November 25, 2021 to reintroduce limits on DTI and DSTI ratios and to tighten the LTV limit.”

From a VoxEU post by Gonzalo Paz-Pardo:

“Homeownership among younger households has been decreasing in several major advanced economies. This column shows that increases in labour income inequality and uncertainty are key drivers of this trend. Confronted with high house prices and low, risky incomes, many young households cannot or do not want to risk making such a big, illiquid investment. As a result, they accumulate less wealth.

Figure 1 shows that, in the US, younger generations are less likely to be living in their own homes than older generations were at the same age. Among households headed up by someone born in the 1940s, 70% owned their homes by age 35. This figure dropped to 60% for those born in the 1960s and about 50% for the early ‘millennials’ born in the 1980s. In southern Europe, too, homeownership rates at age 35 have dropped – by over 10 percentage points when comparing those born from 1965 to 1979 with those born in the 1980s. At the same time, young people are taking longer to leave the parental home and live independently (Becker et al. 2008).

Homeownership is a frequent subject of political debate. Owning a house is crucial for the wealth accumulation of most households (Paz-Pardo 2021), and housing plays a role in a well-diversified portfolio (Chetty et al. 2017). Shutting young people out of housing markets may distort their marriage and childbearing decisions (Laeven and Popov 2017), and homeownership rates relate directly to the strength of local communities, social capital, and political engagement (Glaeser et al. 2002, Rohe et al. 2002).

What has driven these changes? To identify the key factors, I build a model of homeownership and portfolio choice over the life cycle with a rich structure of risks (Paz-Pardo 2021). According to the model, it’s not about younger generations not wanting to buy their homes anymore: changes in the economic environment fully explain the magnitude of the drop in homeownership rates.”

From the IMF’s latest report on France:

“Risks from real estate markets require continued vigilance. Over the last decade, household debt grew steadily from just below 60 percent to over 100 percent of disposable income and debt service to disposable income (DSTI) has increased. The deterioration reflects in part the need for higher debt to cover increasing housing prices, resulting in higher LTVs. Consequently, in 2019, the ESRB issued a warning related to medium-term vulnerabilities in the real estate sector, citing higher prices, weaker lending standards, elevated household debt, and rapid mortgage lending growth in France. While supervisory action by the High Council for Financial Stability (HCSF) has capped the deterioration in lending standards, low interest rates, a relatively inelastic housing supply and increased demand for home renovations continued to fuel real estate price growth in 2020 and 2021.

Several features in France can attenuate risks from market corrections to mortgage defaults, but banks’ profits could be at risk. Household repayment risks are contained because, among other factors, mortgage interest rates are fixed, and employment losses are protected by unemployment insurance. Banks are partially protected from potential losses predominantly through mortgage insurance, and borrowers’ legal obligations. However, profit margins on housing loans are estimated to be nil or even negative since 2017. Thus, the large volume of mortgages with long residual maturity and low fixed interest rate creates a persistent risk to bank profitability, which would intensify with selected defaults or increased funding costs of banks.

(…)

To limit excessive risk-taking by banks, borrower-based measures should be maintained and expanded. To shield banks from loan losses, the HCSF issued recommendations (declared legally binding as of January 1, 2022) that banks must limit mortgage length to 25 years and DSTI to 35 percent (up from 33 percent in the guidance)—with up to 20 percent of new mortgage loans excluded primarily for owner-occupied housing. As a result, banks have actively adjusted their lending practices, with falling DSTI. As of August 2021, the banking sector was within the flexibility margin. However, fueled by low interest rates and a relatively inelastic housing supply, house prices continued to increase and mortgage debt-to income remains elevated, reflecting the need to cover increasing housing prices. In addition, downside risks from structural factors remain, such as weak banking sector profitability due to persistently low rates and high cost-to-income ratios, banks’ high market risk exposure, wholesale funding risk, cyber security, and climate change risks. If these trends continue, fine tuning existing borrower-based measures or deploying complementary measures, such as the now available (sectoral) systemic risk buffer, may become appropriate to more broadly limit excessive risk-taking.”

From Econlib:

“Back in 2009-10, I did a number of posts criticizing the theory that rising house prices in the early 2000s represented a “bubble”.  In one post, I pointed to an article in The Economist that criticized Eugene Fama, and bragged that they had presciently foreseen the housing bubble.  In fact, the specific predictions they cited (from an 2003 advertisement for The Economist, since deleted) turned out to be almost entirely wrong, indeed wildly off base.

The Economist did not take kindly to my post:

Mr Sumner disagrees. He seems to think it’s funny that The Economists pent much of the last decade warning that, globally, home prices were rising in a troubling manner. Contrarianism is fun and all, but this strikes me as an odd way to process the experiences that led us to this point.

I responded:

I would note that Free Exchange seemed to enjoy making fun of Fama’s views.

Now The Economist has seen the light:

Perhaps it is just a matter of time before the house of cards collapses. But as a recent paper by Gabriel Chodorow-Reich of Harvard University and colleagues explains, what might appear to be a housing bubble may in fact be the product of fundamental economic shifts. The paper shows that the monumental house-price increases in America in the early to mid-2000s were largely a consequence of factors such as urban revitalisation, growing preferences for city living and rising wage premia for educated workers in cities. By 2019 American real house prices had pretty much regained their pre-financial-crisis peak, further evidence that the mania of the mid-2000s was perhaps not quite so mad after all.

Fundamental forces may once again explain why house prices today are so high—and why they may endure. Three of them stand out: robust household balance-sheets; people’s greater willingness to spend more on their living arrangements; and the severity of supply constraints.”

From Marginal Revolution:

“Paul Krugman is coming very close to admitting a) “real estate bubble” was not the best formulation, and b) Kevin Erdmann was right.”

Tweets from Paul Krugman:

“Aha. An economic mystery solved, I think (with a suggestion from Charlie Steindel). I’ve been noting that we’re currently seeing a surge in real house prices up to 2000s-bubble levels 1/

But the 2000s bubble was geographically very uneven: prices surged in cities with strict zoning, but not in places where developers were free to sprawl => elastic housing supply. This time the price rise is across the board, in fact in some cases higher in sprawl areas 2/

Eg Atlanta v Boston, on a log scale so you can see proportional differences: Boston >> Atlanta last time, if anything Atlanta > Boston now 3/

What’s going on? The answer surely involves weak supply response 4/

And that in turn points to our old friend disrupted supply chains, which have made construction very expensive 5/

Suggests that prices may eventually fall in smaller/less zoned cities, once houses can be built in large numbers 6/”