Thursday, 29 November 2012

Housing Bubbles

The data below are from a Eurostat estimate of the Housing Price Index in all EU nations. 4 out the 6 EU countries in trouble (Spain, Ireland, Greece and Cyprus) can attribute all or part of their troubles to a housing bubble and the graph is indicative of this fact. Specifically, in the case of Ireland the rise and fall of housing prices is astonishing. The index which reached as high as 150 in 2007 is now looking to stabilize at about 75.

When beginning this article, I had in mind foreign purchases of housing units in each of the above nations. Foreign purchases, especially in relatively small countries like Greece, Ireland and Cyprus can significantly increase the level of prices, especially in a short period of time. I was only able to find some data for Spain which state that "Property sales made by foreign residents in Spain experienced an increase of 24.7% in the third quarter of 2011". In another article, 8.9% of purchases in Spain was attributed to foreigners. If in a country as large as Spain (with a 46 million population) foreign purchases of real estate can amount to that much you may imagine how much they could amount for in the aforementioned 3, which have a combined population of 16 million.

Compare this to Denmark, where the state law indicates that "Unless foreigners are permanent residents in Denmark and have lived in the country for a period of at least five consecutive years, Danish law states that they must obtain permission from the Danish Ministry of Justice (Justitsministeriet) to buy property. (unless they will use it as a permanent residence)" Even though the law is harsher on foreigners in Denmark than the rest of the Southern nations, we can easily question what it has done to prevent a housing boom in 2007 and 2008. Although the subsequent fall was not as sharp as the one experienced in Ireland, it was approximately like the one in Cyprus, and much worse than the one in Greece and Spain.

Then what is the solution for not experiencing housing bubbles you may ask? The answer is relatively simple: increased taxes in real estate combined with stricter mortgage regulations. Although Denmark's law did not stop the country from experiencing a rapid fall in housing prices, we cannot know what would have happened without it. However, when real estate taxation is high (and I do mean tax paid on the unit's value not transfer costs, lawyer fees and other costs relating to the purchase) less people would be willing to buy a house if they do not intend to live in it. Nevertheless, taxation should be lower for those who are buying their first house, with the purpose of living in it. As young couples are what is driving demand in most nations, with the application of such laws the governments would have taken specific measures to safeguard this demand. 

Also, when mortgage demands are stricter (forcing you to have at least 20-25% of the value of the unit you intend to purchase) demand will be more stable and the banks will face less problematic loans. With demand not rising and falling to extremes, it would be much easier for developers and real estate agents to predict the market's future needs and thus they themselves would be less inclined to fund projects which would take many years to yield profits, straining the banks and the economy. 

Nobody in their right mind could ever propose that bubbles can be left out of the system. Demand will always fluctuate and we can do our best to estimate it. Most likely our estimation will be wrong; and we can surely not expect strange phenomena like hurricane Sandy which caused some USD 71 billion of damages in the states which it hit. Nevertheless, it would also be a shame not to do what is expected of us to make this world less crisis-prone.

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