Bubble or no bubble –household debt makes Swedish economy vulnerable

Oct. 10, 2016

Is there a housing bubble – and if so, what should we do about it? Swedish House of Finance and the European Commission gathered policy makers and researchers to discuss diagnosis and solution.

The household indebtedness, if left unaddressed, can have ugly consequences, stated Istvan Szekely of the EU Commission, in a seminar on Swedish housing market arranged by Swedish House of Finance in cooperation with the European Commission. The commission is calling upon Swedish policy makers to reflect and remedy the situation.

Professor Peter Englund from Swedish House of Finance started out exploring the possibility of a bubble in the Swedish market, based on the simple notion that houses are overvalued if the return (expected capital gains plus the value of housing services) exceeds the capital cost of owning a house. His conclusion was that the housing price level is not obviously out of line with fundamentals.

“This is provided that supply adjustment continues to be slow, that major metropolitan areas keep growing and the real interest rate stays low. Price adjustments may be dramatic if these conditions are not met”, Peter Englund said.

 

"A major vulnerability"

Professor Harry Flam from Stockholm University stated that he does not believe there is a bubble in the Swedish Housing market. He argued that the restrictions on subletting puts a hard brake on the possibility of investing in housing as an investment, and not just for living.

“I think that is one reason why we do not have a bubble here in the same sense as in Ireland or Denmark. But we may have a large decrease in housing prices, for instance if the interest rate would climb to the same levels as before the crisis.”

Kent Janér, from the hedge fund Nektar, stated that the question of whether it is a bubble or not is unanswerable.

“We should make a distinction between overvaluation and high valuation. Overvaluation is something that is extremely likely to correct over time, possibly in a turbulent way. High evaluation means that it will not necessarily correct, but it clearly means higher risk which is the same as increased vulnerability. What we have in Sweden today is high valuation, explained by current fundamentals. But these fundamentals could change, not the least through the type of new measures being discussed here today. And today's high valuations are built on high leverage. That combination is problematic and a major vulnerability. When we have the next external shock, I see this as the major weakness in the Swedish economy.”

 

Call for new bancruptcy law

Professor Per Strömberg from Swedish House of Finance argued that we should worry more about financial stability than about over valuation of housing.

“The banks haven’t seen any defaults on their household mortgages. One reason for this is because you can never walk away from your loan in Sweden. Instead of defaults, we are going to see severe repercussion on consumption and GDP will drop, leading to defaults in other places. It will eventually hit the banks in other ways. I do think we need to prepare to clean up a future mess. I would argue that one thing that has been neglected is personal bankruptcy law,” said Per Strömberg.

The second panel focused on how to remedy the situation. Karolina Ekholm from the Ministry of Finance started by stating that the government’s focus is to facilitate an increase in the supply of housing.

“A lot of experts also look for changes in taxation. That is something where there does not seem to be a broad political agreement now”, she said, welcoming suggestions for housing taxation that would meet approval by the general public.

 

No risk of defaults

Erik Thedéen from Finansinspektionen stated that Sweden has one of the highest ratios of mortgage debt in relation to GDP.

“It could be an indication that something could go really bad”, he said.
He also discussed the possibility of introducing regulations concerning LTI, loan to income.
“This has been introduced by some other countries such as Ireland and the UK. It could be a good way to limit the borrowing activity.”

Why then are the banks not reacting to a rising LTI? asked Istvan Szekely from the European Commission.

“They know they do not have any failures on household mortgage”, answered Erik Thedéen.
“It is rational from the banking side not to be as prudent as I want them to be, because I take the systemic risk perspective. It is micro versus macro. They are prudent from their perspective.”

 

Sensitivity, but no bubble

Professor John Hassler, from Stockholm University, concluded that the panelists agree that prices are high andhousehold debt is high, but that there is no bubble in the academic sense of prices having lost touch with fundamentals.

“But this is nevertheless problematic, because it makes households and the economy fragile. Households become sensitive to fundamentals when the interest rates are low, the tax deductions on interest payments are high and the property tax is low”, he said.

Martin Flodén from the Riksbank stated that all fundamentals are extreme in Sweden.
“Extreme fundamentals mean that they probably can change quite a lot. The Riksbank does not really have a view on whether there is a bubble. It is about the vulnerability when things change.”

He continued by discussing the risk allocation in the economy, as well as how the housing market affects the efficiency of the economy as a whole.

“We all know that the housing market does not work very well, and we have problems with mobility. I think it’s crucial for an economy to have a good rental market, because it is not a good idea for all households to own their home. Now we are forcing some groups to take too much risk. This is not only about financial stability risk, but also about the efficiency of the economy.”

 

EU commission urges: Get ahead of the curve

Peter Englund stressed the importance of focusing on the property tax, and cautioned the policy makers to be careful in changing the interest deductions.
“At normal interest rates, the property tax is the thing that stands out.”

Istvan Szekely concluded that the take-away from the discussions was that Swedish policy makers should try to get ahead of the curve – and give the mandate to Finansinspektionen to take necessary measures.
“The earlier we do it, the better it is”, he concluded.