Dealing with Housing Booms and Busts

Deniz Igan, IMF-ResearchLIME Workshop

Brussels - December 8, 2012Disclaimer: 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…

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

Booms in housing markets are particularly dangerous

Boom, Leverage, and DefaultsBoom, Leverage, and Defaults

AUS

AUT

BGR

CAN

CHN

HRV

CYP

CZEDNK

EST

FIN

FRA

GRC

HUN

ISL

IND

IRL

ITA

KOR

LVALTU

NLD

NZL

NOR

POL

PRT

SVN

ZAFESP

SWE

CHE

UKR

GBR

USA

y = -0.0416x - 4.1152R² = 0.1496

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Change in house prices f rom 2000 to 2006

Figure 2. House Price Run-Up and Severity of Crisis

Source: Claessens et al (2010).

Bubble size shows the change in bankcredit f rom 2000 to 2006.

Real Effects of House BustsReal Effects of House Busts

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 policyFiscal toolsMacro-prudential measures

General Points

When to take actionDeviation from yardsticks (price-income, price-rent,

leverage, credit growth)Bubbles difficult to spot but many policy decisions are

taken under such uncertainty

ObjectivesPrevent unsustainable booms and leverage buildupIncrease resilience to busts

No silver bulletBroader measures: hard to circumvent but more costlyTargeted tools: limited costs but challenged by loopholes

Monetary Policy

Fiscal Tools

Macro-Prudential Tools

Most ‘experiments’ in emerging markets, particularly Asia

Common tools: Maximum LTV/DTI limitsDifferentiated risk weights on high-LTV loansDynamic 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 deficitsRelatively low growth (and very low productivity growth)Large current account deficits

But Spain, Ireland, Latvia differentPrudent fiscal (at time of crisis, plenty of fiscal room)But buoyant private sectorAsset price bubbles and credit boomsLarge 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 boomLack of monetary/ER instruments

Bubble burst in 2007: Dynamic provisions accounting on average for 10% of net

operating income of banksTotal 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 defenseTarget leverageStrengthen balance sheets

Monetary policy definitely to be involved when there are other signs of overheating

Fiscal tools hard to use cyclicallyBut removing distortions may help at the structural level

Important Open Questions

Who does what?Where should macro-prudential authority reside?

Relationship among policiesTo what extent are these independent tools?

Rules versus discretionFar away from IT standardsRisks associated with excessively interventionist policyChallenges from political economy perspectivePreventing circumvention and risk shifting

Hong Kong: Limited effectiveness of LTV limits

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2009 - Mar 2009 - May 2009 - Jul 2009 - Sep 2009 - Nov 2010 - Jan 2010 - Mar 2010 - May 2010 - Jul

New loans approved Prices

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.

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%.

Korea: Effective LTV limits, but difficult calibration?

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-1%

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2000 - Jan 2001 - Apr 2002 - Jul 2003 - Oct 2005 - Jan 2006 - Apr 2007 - Jul 2008 - Oct 2010 - Jan

September 2002:Introduced LTV limits

June 2003:Lowered LTV in speculative areas

October 2003:Lowered LTV in speculative areas

July 2009:Lowered LTV in non-speculative areas

February 2007:Tightened DTI

August 2005:Introduced DTI limits

September 2009:Tightened DTI

Month-on-month house price changes in 'speculation zones' (LHS)

Policy rate (RHS)