Dealing with Housing Booms and Busts
Deniz Igan, IMF-Research
LIME Workshop
Brussels - December 8, 2012
Disclaimer: Views expressed in the presentation and during the talk are those of the presenter and
should not be ascribed to the IMF.
Before the crisis…
 Monetary policy to focus on inflation and output gap (exclusively in
AE, more flexible in EMs)
 Asset prices a concern only through their impact on GDP and inflation
 Benign neglect approach to boom/busts:
 Bubbles difficult to identify
 Costs of clean up limited and policy effective
 Better clean up than prevent
Then came the crisis…
 Bust had enormous consequences
 Standard policies rapidly hit their
limits
 Limited effectiveness of less
traditional policies
 Large fiscal and output costs
Need to Reconsider Consensus
 Benign neglect approach may be dead
 But, problems and trade offs with more interventionist strategy remain:
 Bubbles difficult to detect in real time
 Risks associated with pricking bubbles
 Traditional policies may be ineffective
 And have large costs
Booms in housing markets are
particularly dangerous
 Not all asset-price booms should be target of policy
 But how to choose?
 Some consensus emerging that culprit is leverage (Nasdaq crash was
fine)
 Housing markets are special:
 Leverage (link to crises)
 Large storage of wealth
 Major supply-side effects
 Network externalities
Boom, Leverage, and Defaults
Real Effects of House Busts
Figure 2. House Price Run -Up and Severity of Crisis
Cumulative decline in GDP f rom start to end of recession
10
IND
0
AUS
CHN
NZL
CAN
FRA
GRC
CHE CYP
PRT
AUT
USA
KOR
NLD
CZE HRV
HUN
DNK SWE
BGR
FIN
SVN
-10
ZAF
ESP
GBR
NOR
ITA
POL
y = -0.0416x - 4.1152
R² = 0.1496
IRL
ISL
UKR
EST
-20
Bubble size shows the change in bank
credit f rom 2000 to 2006.
LTU
LVA
-30
-20
0
20
40
Source: Claessens et al (2010).
60
80
100
120
140
160
Change in house prices f rom 2000 to 2006
180
200
220
240
Leverage and Link to Crises:
Current Episode
Booms, Financial Instability, Macroeconomic Performance
Followed by …
Boom
systemic
banking crisis
significant drop in
real GDP growth
either
both
Real estate
53%
77%
87%
43%
Credit
67%
78%
93%
52%
Real estate but not
credit
29%
71%
71%
29%
Credit but
not real estate
100%
75%
100%
75%
Both
61%
78%
91%
48%
Neither
27%
18%
45%
0%
Bottom line
 Strong association between real estate boom-busts and financial
crises/recessions
 Leverage is key
 What to do?
 Monetary policy
 Fiscal tools
 Macro-prudential measures
General Points
 When to take action
 Deviation from yardsticks (price-income, price-rent, leverage, credit growth)
 Bubbles difficult to spot but many policy decisions are taken under such
uncertainty
 Objectives
 Prevent unsustainable booms and leverage buildup
 Increase resilience to busts
 No silver bullet
 Broader measures: hard to circumvent but more costly
 Targeted tools: limited costs but challenged by loopholes
Monetary Policy
 Make borrowing more expensive and may limit leverage and risk
taking
 But:
 Too blunt: costly for the entire economy (unless in context of general overheating)
 Issues for small open economies
 Effect on speculative component may be limited
 Panel VAR suggests impact on house prices at considerable cost to
GDP growth
 100 basis points reduce house price appreciation by 1 but also lead to a decline of
0.3 in GDP growth
Fiscal Tools
 Debt-financed ownership favored:
 allow deductibility of mortgage interest (DMI)
 do not tax imputed rents and capital gains fully
 But:
 No link between favorable treatment and the crisis
 Cyclical use is difficult and violates tax smoothing
 Evidence:
 Structurally, removal of DMI may help reduce leverage
 Cyclically, transaction taxes may help
 during busts
 less so during booms with impact falling on transaction volumes rather than prices
Macro-Prudential Tools
 Most ‘experiments’ in emerging markets, particularly Asia
 Common tools:
 Maximum LTV/DTI limits
 Differentiated risk weights on high-LTV loans
 Dynamic provisioning
 Discretion rather than rule-based
 Mixed evidence on effectiveness
Could macro-prudential tools have
prevented crisis in EuroZone?
 Greece and (to lesser extent) Portugal classic fiscally driven crises:
 Large fiscal deficits
 Relatively low growth (and very low productivity growth)
 Large current account deficits
 But Spain, Ireland, Latvia different
 Prudent fiscal (at time of crisis, plenty of fiscal room)
 But buoyant private sector
 Asset price bubbles and credit booms
 Large current account deficits (especially Spain/Latvia)
 Common currency a constraint for all
Spain: Cannot stop a herd, but…
 Dynamic provisioning in place since July 2000
 Housing demand shock (immigration and foreign investors):
 Rapid growth in prices and credit
 Construction boom
 Lack of monetary/ER instruments
 Bubble burst in 2007:
 Dynamic provisions accounting on average for 10% of net operating income of
banks
 Total accumulated provisions cover 1.3% of consolidated assets while capital and
reserves stand at 5.8%, providing some buffer
Tentative Lessons
 Ensuring financial resilience and avoiding boom-bust cycles are not
mutually exclusive
 Macro-prudential policy still in its infancy
 Pragmatic and discretionary, mobilized within existing institutional frameworks,
targeted at specific markets
 Some evidence of temporary cooling effect on markets and building enough
buffers for bad times
 Too early to judge impact on aggregate cycles and interaction with other
policies
Tentative Policy Taxonomy
 Macro-prudential tools first line of defense
 Target leverage
 Strengthen balance sheets
 Monetary policy definitely to be involved when there are other signs
of overheating
 Fiscal tools hard to use cyclically
 But removing distortions may help at the structural level
Important Open Questions
 Who does what?
 Where should macro-prudential authority reside?
 Relationship among policies
 To what extent are these independent tools?
 Rules versus discretion
 Far away from IT standards
 Risks associated with excessively interventionist policy
 Challenges from political economy perspective
 Preventing circumvention and risk shifting
Hong Kong: Limited effectiveness of
LTV limits
160
New loans approved
Prices
170
150
150
140
130
110
90
70
2009 - Mar 2009 - May
August 2010:
LTV for properties over HK$12 million
lowered to 60 percent, applications for
mortgage insurance exceeding 90% LTV and
50% DTI suspended, maximum loan size for
mortgage insurance eligibility if LTV>90%.
October 2009:
Maximum LTV for properties over
HK$20 million lowered to 60
percent, maximum loan size for
mortgage insurance eligibility
reduced and non-owner-occupied
properties disqualified.
130
120
110
2009 - Jul
2009 - Sep 2009 - Nov 2010 - Jan
2010 - Mar 2010 - May
2010 - Jul
Korea: Effective LTV limits,
but difficult calibration?
6%
6
Month-on-month house price changes in 'speculation zones' (LHS)
5%
Policy rate (RHS)
5
September 2002:
Introduced LTV limits
4%
4
3%
2%
September 2009:
Tightened DTI
October 2003:
Lowered LTV in
speculative areas
1%
3
February 2007:
Tightened DTI
2
0%
June 2003:
Lowered LTV in
speculative areas
-1%
-2%
2000 - Jan
July 2009:
Lowered LTV in
non-speculative
areas
August 2005:
Introduced DTI limits
1
0
2001 - Apr
2002 - Jul
2003 - Oct
2005 - Jan
2006 - Apr
2007 - Jul
2008 - Oct
2010 - Jan