The Unassuming Economist

The IMF notes: “Real estate boomed during 2006-09, but the market started to correct in mid-2010. The correction is adversely affecting the economy, but could bring prices more in line with the region.”

IMF staff report says:

• Over the last two years Norway has seen one of the most rapid paces of real house price appreciation in the OECD. 

• Housing valuations continue to appear on the high side. Standard metrics, such as price-to-rent and price-to-income ratios, indicate a risk of overvaluation. 

• The ratio of house prices to rents has risen sharply during the boom and is now nearly 70 percent above its historical average—the highest such deviation in any OECD country.

• The house price-to-income ratio has also been rising. This ratio is now 28 percent above its historical average—higher than the peak reached before the last major house price bust in Norway two decades ago. 

• While fundamentals explain part of the boom, signs also point to risks of overvaluation. On balance, model based estimates from the IMF’s Early Warning Exercise (EWE), which take into account the key determinants of house prices, suggest that Norwegian residential property prices may be misaligned by 15-20 percent. However, there is admittedly a high amount of uncertainty around this estimate in both directions.

• Expectations of increasing prices may lead agents to buy for speculative motives. An increasing number of households believe that property prices will continue to appreciate. (…) Today, 70 percent of the survey respondents expect price to increase over the next 12 months. 

• Another candidate for explaining the boom is loose credit conditions. (…) the share of mortgages with loan-to-value (LTV) ratios over 90 percent has been high since data were first collected in the late 1990s, after the boom was already underway. However, it is somewhat worrisome that the share of mortgages with LTVs over 90 percent has increased since 2010, despite the issuance of FSA guidelines recommending against allowing LTVs to exceed this level, other than in exceptional circumstances. 

• About 95 percent of mortgages loans are adjustable-rate and interest payments are front-loaded, low interest rates have made mortgages cheaper and homes significantly more affordable. 

• Total household mortgage debt as a fraction of disposable income has increased to 195 percent by end-2010.

• The volume of secured loans issued by mortgage companies has picked up considerably since 2008. In 2011, loans from mortgage companies represented nearly 50 percent of new mortgages. 

• Owner-occupied housing receives quite generous tax treatment in Norway. 

• A house price bust would likely be associated with depressed economic activity and increased financial sector stress, especially given high levels of mortgage debt. 

• The estimates suggest that a 10 per cent drop in real house prices in Norway is associated with roughly 1 percentage point lower GDP growth than otherwise. (…) A correction of 30 percent in house prices—as occurred during the crisis in the 90s—would exert a non-negligible effect to the real economy. 

As the United States continues to grapple with the fallout of its housing bubble and blow-up, recent research from the International Monetary Fund uncovers some startling statistics about other countries that could be headed toward their own U.S.-style housing crises.

While home prices have fallen in about half of the countries the IMF tracks, they’ve risen in the other half. Those trends coupled with data used to gauge the affordability of housing and whether homes are valued correctly seems to indicate prices have significant room to fall.

In other words, home values in many countries are inflating much like the run-up the U.S. saw in the early 2000s and could be headed for a correction.

Continue reading here.

What’s likely to happen to house prices in Canada? Are house prices more out of whack with fundamentals in British Columbia than in Ontario or Alberta? And what would the consequences be for the economy if house prices fell?

The IMF’s economic outlook for Canada has an extensive discussion of prospects for the Canadian housing market. IMF staff noted that “the [house] price-to-rent and [house] price-to-income ratios are 29 percent and 20 percent above their averages for the last decade, respectively”. My earlier post compares Canadian ratios to those in the U.S. and Europe.

IMF staff said that “while there are structural factors that can explain increases in such ratios, their elevated level and other empirical evidence suggest that house prices may be higher than justified by underlying fundamentals, at least in some provinces—staff estimates indicate an average price overvaluation of around 10 percent, with significant regional differences.”

A companion paper estimates “house prices in 2011 to be above the levels consistent with the current levels of fundamentals in British Columbia, with some signs of overvaluation also in Ontario, and to a lesser degree, in Quebec. By contrast, the estimated models suggest house prices to be mildly undervalued in Alberta.” Averaging these estimates (with weights based on provincial GDP levels), the paper suggests “that house prices in Canada are on average ten percent above the level consistent with current fundamentals.”

The companion paper also studied “the impact of a potential correction in house prices on consumption through household wealth effects.” The paper’s authors concluded that the “empirical estimates suggest that a ten percent decline in house prices would lead to a 1¼ percent decline in private consumption.”

The full report can be found here. In it, IMF staff noted that “to ensure the long-term stability of housing markets” the Canadian government has “increased public awareness of the risks and … tightened mortgage insurance standards several times since 2008.”

An interesting paper by my IMF colleagues Deniz Igan and Heedon Kang looks at how limits on loan-to-value ratios and debt-to-income ratios affect the housing market in Korea.

“Prior to the crisis, when it came to dealing with asset price booms, the widely-accepted tenet was one of ‘benign neglect’, namely, to wait for the bust and pick up the pieces (Bernanke and Gertler, 2001). Yet, the crisis and its formidable costs shifted the balance to the opposite camp favoring pre-emptive policy actions that could stop bubbles or, at least, could contain the damage to the financial sector and the broader economy when the bust comes. In other words, many policymakers now think that it is better to act than wait on the sidelines because the cost of inaction may greatly exceed the potential negative side effects of policy intervention. (…) In the quest to better design the policy toolkit to deal with real estate booms and busts, macroprudential tools such as maximum limits on loan-to-value ratios (LTV) and debt-to-income ratios (DTI) are heavily advocated. This has led several countries to recently adopt such limits or measures that would discourage high-LTV/DTI loans.”

 Korea is one of a dozen countries that have adopted such limits.

“we know little about the impact of these measures that have become popular with many regulators after the crisis. Theoretically, limits on LTV and DTI can kill two birds with one stone: they can curb the feedback loop between mortgage credit availability and house price appreciation, and, by restraining household leverage, they can help reduce the incidence and loss given default of residential mortgage loan delinquencies.”

The paper asks two questions

“First, what happens when LTV/DTI limits are adjusted in response to developments perceived to be risky? Second, can we quantify the impact of LTV and DTI limits on housing and mortgage activity?”

What are their conclusions? Igan and Kang find that

“transaction activity drops significantly in the three-month period following the tightening of LTV/DTI regulations. Price appreciation slows down a bit later, in a six-month window rather than the three-month window. Moreover, price dynamics appear to be reined in more after LTV tightening rather than DTI tightening. [The authors provide evidence for what the] channel for the impact of the policy actions may be: expected house price increases in the future become lower after policy intervention and this is more prevalent among older households while plans to purchase of a home are more likely to be postponed by those who already own a property, i.e., potential speculators, but not by those who do not own a property, i.e., potential first-time home buyers. These findings suggest that tighter limits on loan eligibility criteria, especially on LTV, curb expectations and speculative incentives. Policy implications of our analysis are encouraging. In housing markets, expectations are key as they often facilitate the settling in of bubble dynamics. If, as suggested by the evidence presented here, limits on LTV curb expectations and discourage potential speculators, they can be effective tools to tame real estate booms and contain the associated risks.”