The ECB must confront the housing bubble by having their hands tied

The ECB must confront the housing bubble by having their hands tied ...

  • Euro zone house prices, mortgages boom
  • ECB can't afford to raise rates too fast or far
  • Must rely on reluctant governments to set curbs

FRANKFURT, February 23 - Global house prices have risen as pandemic stimulus and a shift to work from home have added fuel to a multi-year boom driven by historically low interest rates.

Despite the fact that authorities from Auckland to Stockholm have demonstrated that they can remove monetary and regulatory pressures to reduce property prices, the euro zone's dividing into 19 national markets means the European Central Bank's hands are tied.

According to International Monetary Fund reports, the world's biggest increase in house prices in 2020 was in the euro zone.

As memories of the 2008 tragedy fade, this is raising concerns at the ECB about a new housing bubble that might wreak havoc.

The ECB isn't able to reduce interest rates too rapidly or far to help some euro zone members, as it would shammer the most endebted euro zone nations, such as Italy and Greece, and the central bank is keen to avoid another debt crisis.

Instead, it must rely on often dissatisfied governments to lower property markets with so-called macro-prudential measures, which also have the benefit of focusing on real estate rather than the economy at large.

They range from obtaining additional capital when they make home loans to imposing mandatory limits on the size of mortgages depending on the purchase price or the income of the purchaser.

"Not in the euro zone, macro-prudential tools are suited to reducing housing bubbles," says a senior Bruegel think tank.

The problem is that the ECB cannot apply these brakes directly and can only issue warnings and recommendations through the European Systemic Risk Board (ESRB), the European Union's financial stability watchdog.

In the most recent type of move, the ERSB, which is established inside the European Central Bank and headed by Christine Lagarde, urged Germany and Austria to impose restrictions on mortgages and raise capital demands for banks.

However, its regulations are not binding. According to Germany's finance minister, it pushed back on the recommendation to establish a loan-to-value ratio for home buyers.


This type of regulation, according to history, might be effective.

In the early 2000s, authorities were able to slow down house prices by imposing a debt-to-income ratio.

And the proprietor successfully reduced the cost of a house in 2018, requiring homeowners to repay at least 1% of their loan balance every year if they received mortgages greater than 4.5 times their household income.

"That would have a very strong impact and very quickly," says Matthias Holzhey, who is co-author of UBS' annual Global Real Estate Bubble Index.

Despite its advantages, it might include making mortgages all but unaffordable to younger households.

These are the reasons why national regulators in the euro zone, which include often government officials who would pay the electoral cost of public outcry, have been laying their feet.

Germany for example has just announced intentions to implement some braking a decade after the start of its housing boom, with house prices already around 20%-35% over-valued according to the Bundesbank.

"You disrupt the party when you implement tough macroprudential procedures," said Commerzbank's chief economist. "It requires a very independent position."

Despite its recommendations, the ESRB said this month that Finland and the Netherlands were not doing enough to reduce mortgage lending.

"There's no cost for a politician failing to act," said Bruegel's Claeys. "We need a financial stability council that can bite."


Yet research monetary policy remains important and may, if it supports it, be true, or it may trump if it works in the opposite direction.

According to some economists, regulation may make significant difference as long as mortgage rates remain below inflation, making property investments attractive for families and professional investors.

According to the most recent ECB data, investors were locking in an annual mortgage interest rate of just 1.3 percent for ten years in December, comparable to an expected inflation rate of just under 2%.

Kraemer of Commerzbank is one of the many economists who anticipate that these negative real yields would persist, reducing the effects of regulatory restrictions.

"When rates are too low, it's an easy task," said the author.

Ireland is a case in point.

Despite tough restrictions introduced in 2015, home prices at the helm of the country increased by 14.4%, caping mortgages at 3.5 times the average annual income of a borrower.

In keeping with that, some ECB policymakers suggest that the central bank prioritize house prices when it comes to inflation and setting interest rates.

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