Housing Bubbles: An Ounce of Prevention is Worth a Pound of Cure
IMF Blog, January 7, 2015
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- Authors: Kevin Fletcher, Peter Kunzel
- Published: January 7, 2015
Boom–bust dynamics in housing markets
- During booms, lax lending standards and low interest rates help drive up house prices and mortgage debt.
- When the bust arrives:
- Over-indebted households can become underwater on their mortgages—owing more than their homes are worth.
- Reduced household wealth and access to credit depress consumption.
- Lower house prices cause investment in new houses to tumble.
- Non-performing loans increase and banks tighten credit and lending standards, amplifying the downturn.
- The combined effect significantly depresses output and increases unemployment.
Recent experience: four European countries
- IMF analysis examined Denmark, Ireland, the Netherlands, and Spain, each of which suffered real house price declines of 25 percent or more.
- Current status:
- Prices are now rising in Denmark and Ireland.
- Prices have begun to stabilize in the Netherlands and likely also in Spain.
- Legacy problems still being addressed:
- Significant output gaps—the difference between actual output and potential output.
- Private-sector debt overhangs with household debt-to-income ratios ranging from around 125 percent in Spain to about 300 percent in Denmark.
Policies to support recovery and deleveraging
- Supportive macroeconomic policies:
- Monetary easing (for example, by the European Central Bank during the crisis) helped lower interest rates, boost nominal incomes, and ease debt-servicing costs.
- Faster nominal income growth reduces the real cost of deleveraging by allowing debt-to-income ratios to adjust more through the denominator (nominal income).
- Policies to help households access assets to pay down debt:
- The Netherlands adopted temporary tax exemptions enabling parents to help children pay down mortgage debt.
- Reforms allowing first-time home-buyers to access pension savings without penalty have been used in the United States and Switzerland.
- Effective debt restructuring frameworks:
- Regulatory and supervisory incentives to encourage banks to use existing resolution frameworks (example: Ireland requires banks to meet targets for offering and concluding sustainable solutions to mortgage arrears).
- Establishing effective insolvency frameworks, including promoting less-costly out-of-court workouts.
- Fiscal incentives, such as easing taxation of debt relief granted to highly indebted borrowers.
- Strengthening bank balance sheets:
- Well-capitalized and provisioned banks are needed to overcome debt distress episodes.
- Ireland and Spain benefited from forced recapitalization of banks following asset-quality reviews and stress tests.
- Limits on the percent of profits that banks can pay out in dividends have encouraged banks to boost capital rather than cut back excessively on lending.
Lessons and policy recommendations to reduce future housing crises
- Remove incentives for excessive debt accumulation:
- Gradually reduce the income tax deductibility of mortgage interest.
- Update house valuations so property tax payments reflect current valuations, avoiding implicit subsidies to housing and mortgage debt.
- Trim distortions in the rental market:
- Progressively reduce rent controls and provide more flexibility in lease contracts (Spain did so in 2013).
- Making rental housing more available can reduce the need for households to take on mortgage debt.
- Use prudential tools to lean against the cycle:
- Limits on debt-to-income ratios can make it more difficult for borrowers to take on ever-larger mortgages as house prices rise.
- Balance deleveraging with output stabilization:
- Encourage household debt reduction in ways that minimize drag on growth (for instance, policies that rely on nominal income growth rather than forced debt repayment).
- Continue to evaluate and implement country-specific measures to strengthen resilience and reduce the likelihood and severity of future housing crises.
_ Source: Housing Bubbles: An Ounce of Prevention is Worth a Pound of Cure, Kevin Fletcher and Peter Kunzel, January 7, 2015. https://www.imf.org/en/blogs/articles/2015/01/07/housing-bubbles-an-ounce-of-prevention-is-worth-a-pound-of-cure_
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