Owner-Occupied Property in Regulators Sights
The overheating of some housing markets and the attendant risks are a hotly debated issue. Various case studies show what measures governments have taken, and what their experience has been.
In general terms, worldwide housing markets cannot be regarded as overvalued at present. The global house price index of the International Monetary Fund (IMF), which shows the development of house prices in more than 50 industrialized and emerging-market countries, has been rising since mid-2009; measured against economic growth, however, it has risen by a comparatively modest 3.2 percent in overall terms. Some countries have recorded very strong real growth rates, on the other hand. Recovery movements can be seen in the likes of Ireland (+23.1 percent since the start of 2013) and the US (+22 percent since the start of 2012). Since 2000, real house prices have also risen strongly in Switzerland (+55 percent), the UK (+68 percent) and most of all Sweden (+123 percent).
Price Increases Problematic When Combined with Rising Debt
Price increases are not yet necessarily a problem in themselves; the risk of overvaluation often arises only in combination with sharply rising debt. The growth in credit volumes is trending higher in many countries, as are price levels in relation to incomes and rent levels. In terms of affordability, Sweden, the UK and Australia stand out in particular. There, house prices are already well above their long-term average compared with incomes and rents.
More Restrictive Monetary Policy Frequently Not an Option
The most obvious tool for keeping lending and consequently real estate prices in check is a restrictive monetary policy. As this has a braking effect not only on the real estate market but also on the economy as a whole, it is not an appropriate instrument amid the current environment of tentative growth because it is disproportionate. Examples like Sweden have also shown that monetary policy alone is often not enough to curb an overheating real estate market. To exert a dampening effect on the housing market, the required hike in interest rates would in many cases be too large from the perspective of the economy as a whole and would consequently involve too much collateral damage.
Action Can Be Taken in Relation to Banks As Well As Households
Targeted regulatory intervention can be taken in relation to households as well as the banks. Intervention falls into the category of fiscal policy measures and primarily affects the tax treatment of real estate purchase, ownership and method of financing. Whereas transaction taxes increase the cost of purchasing owner-occupied housing, wealth taxes are aimed at reducing the attractiveness of home ownership in itself. Macroprudential regulatory measures, on the other hand, are aimed at the level of indebtedness of banks and households. More stringent capital requirements for banks and greater risk provisioning in the good times (countercyclical capital buffer) subdue credit growth and encourage the build-up of reserves. On the borrower side, upper limits for loan-to-value ratios and the level of indebtedness, i.e. the ratio of debt to income, reduce the vulnerability of household balance sheets to fluctuations in real estate prices and interest rates.
Fiscal Policy and Macroprudential Measures Implemented in Singapore
Singapore is an interesting case in that a whole series of measures have already been implemented there. Sellers' stamp duty (SSD) was introduced following real growth in prices of 34 percent between mid-2009 and mid-2010. This stamp duty originally had to be paid if a buyer of owner-occupied housing sold it again within a year of acquisition. Holding periods and the level of duty were successively increased from 2010 onwards. In addition, various loan-to-value ratios have been tightened on a constant basis. Protectionist measures were also introduced to make the purchase of owner-occupied housing more expensive, particularly for persons without Singapore citizenship. Sales figures in this customer segment consequently fell by 23.5 percent within a year. An actual fall in prices was not observed until the end of 2013, however, following the introduction of the total debt service ratio (TDSR). This stipulates that banks can only grant a mortgage if no more than 60 percent of income is used for debt servicing on all loans. A minimum imputed interest rate of 3.5 percent is used for the computation of all mortgages on owner-occupied property.
Banks and Lending in Sweden and Australia Increasingly in Spotlight
In Sweden it is not only house prices that have risen sharply in the last 10 years (+65 percent in real terms) but also the level of debt among private households. Although an 85 percent ceiling on loan-to-value ratios was introduced in October 2010, it was not until fall 2014 that far-reaching macroprudential measures were taken in relation to the banking sector. The Swedish central bank's current expansionary policy is nevertheless likely to tend to exacerbate problems on the real estate market. Moves toward stricter lending criteria have recently been made in Australia too. The Australian Prudential Regulation Authority (APRA) announced that bank mortgage lending would be more closely scrutinized and appropriate measures taken if necessary. They include the likes of even higher capital requirements. Special attention is being paid to high-risk loans in the banks' mortgage portfolios as well as to lending to professional real estate investors.
Transfer of Country-Specific Measures Should Be Treated with Caution
Other countries' experience of specific measures can be thoroughly instructive, although the direct transfer of instruments to another country is a thorny subject in view of the very different overall conditions in each country. In our view, two conditions need to be met before new measures are introduced. First, politically induced distortions and disincentives that contribute to the growth in real estate prices must be eliminated or at any rate tempered. These include structurally driven shortages on housing markets, government-guaranteed mortgages as well as tax breaks for owner-occupied housing. Second, maximum use needs to be made of existing regulations. For example, this means more systematic enforcement of microprudential regulations within the credit business – supervision at individual institution level – and insisting on compliance with standards relating to the granting of loans.
Delegation of Regulation Is One Option, But Uncertainties Remain
Mandatory self-regulation is a promising way forward. Instead of determining the details of regulation itself, the regulator specifies the effect to be achieved but leaves the specific design of the measures to the market players. The latter generally have a better understanding of the most efficient way of achieving the intended effect and at the same time have an interest in avoiding undesirable side-effects. The fact remains, however, that every real estate market is different and it is very difficult to gauge in advance whether and to what extent a measure will actually be effective. Furthermore, a price correction observed on the real estate market cannot always be clearly attributed, with hindsight, to a specific measure. Very rarely is it possible to establish unequivocal evidence of the interaction between individual regulatory measures.
Switzerland in Pioneering Role
The debate about a possible overheating of the real estate market has continued to hit the headlines in Switzerland too. Measures implemented to date include a higher capital buffer for banks, minimum equity requirement for mortgage financing, shorter repayment periods and systematic application of the lower-of-cost or market principle. An international comparison of the number and depth of regulatory interventions taken thus shows that Switzerland is in a leading position behind Hong Kong and Singapore. However, this needs to be seen in light of the fact that the overheating of real estate markets in these two city-states has assumed far more dramatic proportions than is the case in Switzerland. Switzerland can also be considered a pioneer in a European context too, though it remains to be seen whether this is in a positive or a negative sense. Although prices of owner-occupied housing have risen much faster in Norway and Sweden than in Switzerland, regulators there have so far dragged their feet in terms of far-reaching measures.