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Housing bubbles worldwide will test a big lesson from the financial crisis

Can you slow housing prices without raising interest rates?


 

(Mike Cassese/Reuters)

Bank of England Governor Mark Carney is concerned about the “prospective evolution of the housing market.” That’s the rhetorical flourish central bankers use to say that they think they’re sitting on something that’s starting to resemble a bubble. You might recall such a figure of speech being deployed by Carney in mid-2012—one of many examples— when the governor announced measures intended to ensure the “sustainable evolution” of the housing market. Only, back then he was the governor of the Bank of Canada, a position he left in June after being poached for the top job at Old Lady of Threadneedle Street.

The new gig must feel a lot like the old one. Property prices in central London are now well over 10 times average earnings, and just around 10 times are great as prices in the suburbs. Prices in the rest of the country haven’t reached their pre-crisis peak, but, as Alen Mattich of the Wall Street Journal notes, the greater London area is home to fully one-fifth of the British population. Across the country, households with debt five times their income make up 20 per cent of the mortgage market. The governor, then, is back to his old task of trying to let the air out of the bubble gradually (he likes to call it a “constructive evolution”), without triggering a pop and without raising interest rates. But this isn’t only Mark Carney’s curse. Central bankers and finance ministers in Norway, Israel, Switzerland and New Zealand, to cite a few, are trying to pull off the same trick. Their efforts are testing one of the big lessons the West thought it had learned from the financial crisis: That you can use regulations alone to tame bubbles.

That lesson came from Asia. Well before the financial crisis, Hong Kong, South Korea and others had started regulating and supervising the financial system as a whole, rather than focusing on single banks and financial institutions. After the collapse of Lehman Brothers, cold-sweating Western eggheads started to pay attention. Low interest rates had helped fuel the disastrous U.S. housing bubble, but the midst of the worst recession in half a century was no time to raise them. How to keep monetary policy loose without fuelling new bubbles and borrowing binges? By using regulations to toughen financial conditions in certain trouble areas even as low interest rates kept propping up the rest of the economy.

Countries that, like Canada, emerged relatively quickly and unscathed from the Great Recession seem set to be the testing ground for this new kind of thinking. We weathered the storm well because of our tightly-regulated banks and soon returned to growth. Our interest rates, though, have been very low for years. A number of foreign investors have lent us their prized savings because we seemed a safe place to put their money. And a number of our local residents have been borrowing merrily, feeding various housing booms. Norway, Israel and other have similar stories. Great Britain had a much rougher ride in the aftermath of the financial crisis, but London is still one of the favourite hangouts for the world’s super-rich, so property prices there have been skyrocketing anyway.

With growth still sluggish, though, no one is eager to hike up interest rates, which would raise borrowing costs for everyone, not just homebuyers, and hurt exporters by tilting up the exchange rate. So we’re all trying the alternate approach. Here in Canada, Jim Flaherty has tightened mortgage rules on government-insured mortgages four times since 2008. The Office of the Superintendent of Financial Institutions, Canada’s financial watchdog, has toughened underwriting standards and is contemplating a few more targeting uninsured mortgages. So far, though, this seems to have simply slowed the pace of housing prices and household debt growth. Both are still rising. Around the world, similar maneuvers have produced similarly iffy results.

Maybe the key is to be a lot bolder. Maybe Canada should do more to limit the use of CMHC insurance, as the IMF suggested this week. CMHC was meant to provide government backing for risky mortgages made to Canadians who wouldn’t have qualified for one otherwise. In recent years, though, banks have been using CMHC insurance to cover portfolios of low-risk mortgages, which are then repackaged as bonds often sold to foreign investors. In general, the IMF said, extensive access to CMHC insurance provides an incentive for banks to pump too much capital into the housing market and lend to little to, say, businesses that want to expand and upgrade.

For now, the jury on whether tighter rules are really a substitute for tighter monetary policy is still out. Managing a prolonged period of low interest rates without creating dangerous asset bubbles would be the equivalent of the proverbial having your cake and eating it too. As we all know, it doesn’t work in the world of physics. Whether it will in the world of finance remains to be seen.


 

Housing bubbles worldwide will test a big lesson from the financial crisis

  1. Stagflation. Like Japan.

    • Actually Japan has suffered from deflation and a growth recession. In order to have stagflation there has to be a long period of high inflation beforehand. According to the Philips curve one doesn’t expect to see a recession when there is high inflation. But it would appear that inflation eats into the returns on investments producing low or negative returns and interest rates, which is the source of the recession: withdrawal of capital.

      The reason we have low or negative real interest rates now is because of low inflation and low GDP growth teetering on recession. There is also the low interest rates set by central banks who have reached the zero-bound limit: they can’t set interest rates any lower to stimulate the economy (which is why other options like QE are used.)

      So we are now experience a growth recession like Japan. Considering they’ve had interest rates stuck near-zero for 17 years, it just goes to show how long we can be stuck in this economic quagmire.

      Conditions are similar to the 1930s. Then as now the solution is big government spending to boost demand and economic activity. But we are doing the opposite: cutting spending which is depressing demand and GDP growth. If we don’t change our approach, we’ll still have near-zero interest rates 20 years from now and the same miserable economic growth.

      • Japan had a very long era of inflation….perhaps you’re too young to remember it. LOL

        Their housing bubble involved century-long mortgages.

        A ‘growth recession’? LOL You mean a ‘jobless recovery’

        Japan has also tried big govt spending….to no avail

        They are now trying Abenomics…which is the same as everyone else….and going nowhere fast. Everyone has done near zero interest rates.

        Japan has some fantastic tech….so they’re well able to take the next step forward…..but they won’t because the problem is social and Japan is caught in a time-warp.

        They aren’t getting married, they aren’t even having relationships and sex….so no babies. 25% of the population are elderly.

        The country is vanishing.

        • Yes, Japan got into a 20 year economic quagmire when a housing bubble burst. Same thing is happening now in America and other countries that suffered financial market meltdowns in 2008.

          The problem is Japan had too tight a policy on inflation, which killed off the effects of spending. Abenomics is founded on raising the inflation target to get the economy rolling.

          The same will have to happen in Western countries. Our present 2% inflation target is entirely arbitrary. Back in the 1980s we averaged 4% inflation and had much stronger growth. The “opportunistic disinflation” over the past 20 years has played a major roll in busting wages and killing GDP growth.

          When inflation is low people tend to hoard money rather than invest it. This causes economic growth and job creation to slow. With higher inflation hoarders are punished; increased investment creates economic activity. (Of course, 4% inflation in the medium term is no where near high inflation.)

          • Well you know what Einstein said about doing the same thing over and over again and expecting different results…

            Textbook economics don’t work anymore. So turning a dial here, and flipping a switch there….isn’t going to fix anything.

            Formulaic economics is what has to change.

          • Actually right now we are repeating the same mistakes made during the 1930s.

            In 1929, free-market ideology imploded in a global economic meltdown which produced a never-ending depression. We abandoned that system for centrist Keynesian mixed-market economics in the post-war era which produced phenomenal results. The high inflation of the 1970s was actually caused by living standards being too high.

            Over the past 30 years, we returned to free-market ideology: tax cuts, spending cuts, busting wages, deregulation and trade liberalization (of course, the Keynesian period was far from protectionist…) The end result? A global economic meltdown in 2008 and never ending economic quagmire.

            So yes, repeating the same mistakes made in history is certainly a form of insanity. There is no basis, however, to suggest solutions from the past will not work in the present. Fact is according to Keynes we should have a 14 hour work week by now. What happened? Free-market reforms happened. Instead of all levels of society benefiting from GDP and productivity growth the rich hogged up all the gains: now people are working more for less pay and benefits.

            Free-market economic formulas are entirely self-serving to businessmen. They don’t have to change. They have to be abandoned.

          • Capitalism is an economic system from 1776….of course it won’t work today.

          • Your view are the most nauseating I have seen for a while. You might just be as bad as Paul Krugman. I’m sure he is an idol for you.

      • You are totally nuts and absolutely brainwashed. And gimme a break with your 99% avatar your solution would absolutely crush said 99%.

  2. Tougher rules are not a substitute for tougher monetary policy. Tougher monetary policy is needed to improve the economy, so that investment is not misdirected and squandered on things like million dollar homes the size of a closet.
    The definition of a bubble is misdirected investment caused by low interest rates. If you tighten regulations in one place, the bubble will explode somewhere else.

  3. When the money supply is tinkered with, whether by mortgages given to those who don’t deserve them (with the effect being phantom money driving up prices), or why countries have to offer higher rates of interest to attract buyers of their debt – we honestly cannot say that this hasn’t taken place before 2008.

    Why not look to see how money supplies remained stable, and discern what was the effect of that stability.

    Yes, there will be people with their noses out of joint when those questions are raised, but I firmly believe a situation with too much politics in it is a situation that is less than optimal.

  4. Ron you’re an idiot and you will get burned in the coming crash.

    The great Keynesian experiment WILL come to an end.

    Growth recession what kind BS is that? Japan tight on inflation? Abenomics being a model? Jesus the opium you smoke is goood!

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