Cross-Country Analysis of Housing Finance and Real Estate Booms

By Eugenio Cerutti, Jihad Dagher, and Giovanni Dell’Ariccia

Housing finance—considered one of the villains of the recent global financial crisis—was seen, at least until recently, as a vehicle for economic growth and social stability.  Broader access to housing finance promotes home ownership, especially for younger and poorer households; which in turn is often linked to social stability, and ultimately economic growth.

But real-estate boom episodes have often ended in busts with dire economic consequences, especially when the boom was financed through fast credit growth.  Several countries have seen these boom-bust patterns over the last decade, particularly in some of the hardest hit countries during the global financial crises, such as Ireland, Spain, and the United States. Despite having different mortgage market structures, these three countries saw an astonishing increase in house prices and construction on the back of risky lending which was followed by a painful adjustment period—a mortgage credit boom gone bad.

Where are we now in this debate between broadening access to housing finance and containing the dangers associated with fast growing mortgage credit?

Here, we think policy needs to be informed by a better understanding of the role housing finance plays both in funding households (and ultimately economic growth) and in generating financial vulnerability. For example, how and why does housing finance differ across countries? What are the effects of these differences for economic growth? How does housing finance affect housing booms and their association with the probability and severity of financial crises?

In a recent staff discussion note we examine some of these issues. This is made possible by a new dataset on housing finance characteristics, house prices, and household credit for a sample of more than 50 countries. This new detailed cross-country analysis confirms some of the findings of previous work, but also offers new insights. We draw the following broad conclusions.

First, the size of the mortgage market relative to GDP varies significantly across countries (Chart 1). Deeper mortgage markets are associated with better institutional quality and low inflation environments. They are also accompanied by higher home ownership rates, which, in turn, are linked to higher school attainment, higher social capital, and lower crime.

SDN on Housing 1

Second, some of the housing finance characteristics associated with deeper mortgage markets are also linked with increased risks of crisis. The characteristics of the mortgage market vary across countries (Chart 2). These characteristics are worth examining since they affect the buildup of risks during a boom.  For example, higher loan-to-value ratios (LTVs), allow less wealthy individual to enter the housing market, but are also associated with excessively rapid house-price and credit growth during booms.  Banking systems that rely more heavily on wholesale funding (rather than customer deposits) tend to provide a greater supply of mortgages, but they also perform worse in the aftermath of housing booms.

SDN on Housing 2

Third, to achieve deeper mortgage markets as a way to increase access to home ownership, countries should focus first on improving institutions (e.g., legal rights) and the economic environment (e.g. stabilize inflation). This is perhaps a safer way to promote mortgage markets compared to measures that may unintentionally lead to looser credit standards and  incentives for excessive leverage.

Fourth, in the event of a housing boom, macroprudential tools (in particular ceilings on loan-to-value-ratios) should be the first line of defense against the build-up of excessive vulnerabilities. These instruments have an advantage over monetary policy due to their narrow focus. They are able to address potential excesses in one sector of the economy without having a large impact on others. 

Don’t downplay the role of monetary policy

That said, the role of monetary policy in addressing house-related credit booms should not always be downplayed. Despite the absence of important inflation pressures, about 60 percent of the identified past real-estate booms occurred as a result of, or at the same time as, rapid economic growth and broad high credit growth in the economy. Monetary policy would be a necessary complement of macroprudential measures in those cases. Further, should macroprudential tools prove ineffective, monetary authorities should weigh the benefits and costs of “leaning against the wind” (a tighter stance than what is needed to maintain price stability) to contain imbalances that could lead to worse outcomes over the medium run.

Finally, dealing effectively with real-estate booms requires a broad mix of policies. Macroprudential and monetary policies are key ingredients, but fiscal incentives and house supply considerations are structural country-specific elements that may bear heavily on the probability of booms occurring and the potential costs of a bust.

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