Introduction: European housing markets, economics and finance – after the crisis

Introduction: European housing markets, economics and finance – after the crisis

Article Type: Editorial From: Journal of European Real Estate Research, Volume 7, Issue 3

It is now more than seven years since a crisis in the US mortgage market rippled across the world economy, precipitating a Global Financial Crisis (GFC). National European housing systems have been affected by the GFC to different degrees in both the shorter- and longer-term. Where systems of housing finance remained relatively isolated from the broader financial flows and mortgage markets were relatively shallow, the impact has been moderate. In other countries, the effect has been profound: in several liberalized systems disruption and dysfunction have been substantial.

The crisis has presented the academic community with analytical challenges at the micro, meso and macroscales. It has caused us to reflect on how well we can account for household behavior in the housing market and how well we can account for the aggregate behavior of housing markets at different spatial scales. The ongoing dissection of the crisis and its causes invites reappraisal of the robustness of housing market models, and of the way in which we understand the subtle interconnections between housing markets and the broader economic and financial system. Some of our analysis has been found to be robust when stress-tested in the face of the crisis; some of it has fallen short. This special issue continues the analytical task by bringing together six papers analyzing housing and mortgage markets and policy from across Europe.

There remains controversy over the precise relationship between housing markets and national economies in terms of transmission mechanisms and, therefore, the appropriate levers with which they may be influenced by policy-makers (reviewed in O’Sullivan and Gibb, 2012). Nonetheless, what does seem clear is that across a range of institutional and housing system settings, banking exposure to excessive subprime lending and related exotic financial products led to a collapse in lending that precipitated a downturn in national housing markets and property lending more generally. Several economies, including those of the UK, Spain and Ireland, were unbalanced: they were over-reliant on debt-fuelled property price inflation feeding through into consumption-led growth. The spatial heterogeneity of housing markets and patterns of price appreciation meant that the economic damage that followed the market downturn was not simply macroeconomic and international but also had a strong regional and local profile. Job losses, business closure, disinvestment and newly built ghost towns and contagious negative equity characterized cities and suburbs across many parts of Europe.

The initial response to the GFC was for many economies to use public resources to combat recessions and banking frailty, and this, in turn, mutated into austerity responses by governments as they reduce public spending (including capital funding of new housing) and raised taxes to shore up their fiscal position. And, in an era reminiscent of the early 1930s, many European economies further contracted. In some worst case examples, countries like Greece, bound to the Eurozone, faced repeated sovereign debt crises requiring still further (externally imposed) austerity measures. In turn, this has stimulated political crises of democratic legitimacy.

Not only did the GFC bring an end to the benign macroeconomic conditions of the “great moderation”, it exposed the fragility of highly leveraged mortgage markets. The importance of attending to solvency as well as liquidity has been rediscovered (Gjerstad and Smith, 2014). For many nations, the long-term effects of austerity and lost output will be felt for many years to come. Much has been written after the event about the failure to identify and, therefore, prepare for systemic risks to the banking system in such an interdependent global financial system. There is also a debate over how best to manage these risks in future: whether traditional tools of fiscal or monetary policy are sufficient or whether newer micro- and macroprudential tools are likely to be more effective (Crowe et al., 2013).

For this special issue, we invited papers that reflect on this housing market reversal from a national and comparative European perspective. The issue combines a mix of conceptual, empirical and policy papers presenting analyses from individual European countries and comparatively. The papers are less about housing and the origins of the GFC and focus more on consequences for local and national markets. They look at micro-processes but also at more macro- and policy dimensions.

Before discussing those papers in a little more detail, we briefly consider the way in which economists working in housing and real estate research approached the evidence prior to the crash.

Two things stand out in the pre-crash literature – the lack of clarity over a significant imminent turning point in the housing market (Croce and Haurin, 2009, suggest why this might be the case) and a lively debate about whether there was, in fact, a speculative bubble in the housing market, particular for the USA. This debate about whether bubbles could form and had formed, conducted on the basis of models built around fundamentals, is captured in papers such as Case and Shiller (2003), Himmelberg et al. (2005), Smith and Smith (2006). The dominant role of fundamentals in the UK context was reasserted by Meen (2008). Bubble-type explanations could be constructed with reference to the underlying drivers being psychological factors (Case and Shiller, 2003) or momentum trading (Black et al., 2006; Piazzesi and Schneider, 2009). The challenge in identifying the existence of price bubbles becomes increasingly apparent as the idiosyncratic trajectories of local housing markets and the role of heterogeneous expectations are recognized (Burnside et al., 2011).

As the GFC approached, no one was developing the line of argument that we can rely entirely on bubble-type explanations to account for increases in US house prices. Case and Shiller (2003), whose work first drew attention to the role of psychological factors in explaining house price movements, developed a more nuanced argument. Fundamentals could do a good job of accounting for price movements in many local housing markets: it was only in certain cities that survey evidence suggested that an adequate explanation would also require the incorporation of psychological factors linked to expectations. Similarly, Goodman and Thibodeau (2008) argue that, in general, it is fundamentals that matter: speculation is localized and not a more general feature of the US housing market. They highlight the importance of localized pockets of extreme price inelasticity of supply in fuelling localized speculative activity. While elsewhere it was argued that evidence was emerging that fundamentals could not explain the run up in US metropolitan house prices, it was acknowledged that the challenges of disentangling the existence of a bubble from changes in market structure – such as the arrival of subprime lending – are considerable (Wheaton and Nechayev, 2008).

There is limited evidence in the literature of that the coming general crisis was anticipated, despite a degree of interest in researching the under-served mortgage market, sub-prime loans and securitization, in general. It is perhaps only on the very verge of the GFC, with papers such as Shiller (2007), that more focused attention was given to the possibility that the market more generally had departed a long way from fundamentals.

The GFC has demonstrated graphically that consequences of housing market volatility for the wider economy are profound. There has, therefore, been a considerable increase in interest in housing and its interconnections with the macroeconomy. Adams and Fuss (2010), for example, study the long-term macro determinants relationships of 15 Organisation for Economic Co-operation and Development (OECD) housing markets. Their analysis applies an integrated framework and reinforces earlier national level studies, indicating strong effects with respect to economic activity, construction costs and interest rate changes. Nguyen (2013) looks at housing investment across the OECD and argues that mortgage market liberalization adds to housing market volatility. The role of liberalization in driving the market is similarly highlighted by Duca et al. (2010). Housing collateral that plays a pivotal role, a role that is amplified by more liberalized national mortgage markets. Calomiris et al. (2013) model housing prices and foreclosures alongside key macro variables and illustrate the complexity of the dynamics involved: foreclosures at inter-state level impact negatively on house prices, but the relationship not only also holds in the other direction – i.e. prices to foreclosures – but the effect is much larger. Complex multidirectional causality is equally apparent in relationships at the macroscale (Goodhart and Hofmann, 2008).

The special issue

Turning to the six papers in this issue, Wieser and Mundt’s paper looks at housing subsidies and taxation across six European Union (EU) countries. The authors try to capture the range and scale of housing financial interventions that have operated over the last decade. Analysis is carried out for Britain, Spain, The Netherlands, the Czech Republic and Austria. The analysis spreads over two decades and considers the impact of austerity measures. The authors find that official estimates of state subventions are often too low because of a failure to deal adequately with tax expenditures. However, they also run up against methodological and measurement difficulties that, in part, stem from longstanding difficulties agreeing and operationalizing an acceptable counterfactual (in this case tax neutral benchmarks).

Methodological issues are also prominent in our second paper. Grover and Grover revisit the topic of house price indices but consider a novel question: the scope for a pan-European index to aid macroeconomic management and the challenges to be faced in its construction. This is very much a live policy issue. Monitoring trends in house price data is a prerequisite for avoiding future bubbles and instability, though it is not sufficient in itself. While financial integration has occurred across Europe and the case can be made for a European house price index, the diversity of national housing systems raises major problems for an index premised on the aggregation of national data. The danger is that current proposals will leave too much discretion in index development in the hands of national governments and, hence, that there will not be a meaningful or coherent pan-European approach. Moreover, the paper implies that there is a need for a more systematic and consistent approach across Europe to the wider analysis and monitoring of European housing markets and their links to economy and society.

In complete contrast to the pan-European scope of the first two papers, Anundsen and Røed Larsen present a conceptual paper that focuses on strategic sequencing by sellers in the housing market who are also buyers. This links to the literature on search, matching and time on the market. The paper reflects on the policy implications of two key types of movers: those who buy before selling and those who sell before buying. Anundsen and Røed Larsen consider Norwegian movers in both of these strategic sequence channels before, during and after the financial crisis. They hypothesize that strategic sequencing and house price movement change together and that stability may be assisted by policies such as bridging loans for those who must hold two mortgages and also two mortgage insurance for those who cannot sell. The authors argue that their analysis can help governments better understand the transmission mechanism between micro-level housing behavior and monetary policy, and so provide tools to help mitigate future similar crises.

Francke and Schilder’s paper uses a discussion of mortgage losses in The Netherlands as a way to better understand and respond to high levels of mortgage defaults witnessed internationally following the GFC. The authors’ model losses on mortgages from the National Guarantee Fund in The Netherlands over the period 1976-2012, capturing an earlier crisis in the 1980s and the more recent episode. House price falls and unemployment are key drivers in turning defaults into insurance losses. Losses are also more likely in younger mortgages; in contrast, affordability measures such as price-to-income ratios are not good predictors of loss.

Duffy and O’Hanlon present an exploratory analysis of detailed micro (time series individual loan) data which describes and assesses the type of households who experienced negative equity in Ireland after 2007. The sharp downturn in the Irish housing market meant that deterioration in household balance sheets was widespread. The paper imputes considerable (tens of billions of Euros) wealth losses to Irish households, which compounded the austerity and Troika-led post-crash adjustments to the Irish economy. Nearly two-thirds of those borrowing between 2005 and 2012 experienced negative equity and this was particularly pronounced for those aged under 40 years. This is a particularly rich data set with obvious potential for further analysis and modeling.

Finally, Chowdhury and Maclennan examine the duration and magnitude of regional house price cycles in the UK. Drawing on NUTS1 regional data covering 1978-2012, and a modeling strategy employing Markov Switching Vector Auto Regression, they argue that their results have implications for housing and macroeconomic policy. Specifically, the UK can be characterized as having two super regions (one of which is centred around London), which are characterized by structurally different cycles. Nationally uniform policies reinforce the underlying differences in housing and labor markets at regional level. Moreover, credit loosening policies targeted at housing borrowing, in an attempt to hasten economic recovery, may well be concentrated in the London/South East super region and further destabilize the regional and, hence, longer-term national recovery.

These papers provide a variety of insights from across Europe concerning housing markets, mortgage finance and connections to broader economic and public policy questions. Their diversity both in terms of what are the important issues locally and also in terms of the impact of the crisis locally suggests that the comparative picture is indeed one where significant national (and smaller scale) variations apply. The importance of thinking through spatial heterogeneity (the focus of the paper by Chowdhury and Maclennan) also applies across Europe. Institutional and housing system variation, political norms and important path dependencies all suggest real and enduring national differences in terms of responses to common shocks. However, as the contributions by Weiser and Mundt and by Grover and Grover indicate – access to genuinely comparable data is a major constraint on understanding consistently what is occurring in post-crisis European housing markets. We must travel carefully when seeking to identify common, distinct or unique lessons from comparative housing and social policy responses to the economic and financial crisis.

Kenneth Gibb, School of Social & Political Sciences, University of Glasgow, Glasgow, UK

Alex Marsh, School for Policy Studies, University of Bristol, Bristol, UK

References

Adams, Z. and Fuss, R. (2010), “Macroeconomic determinants of international housing markets”, Journal of Housing Economics, Vol. 19 No. 1, pp. 38-50.

Black, A., Fraser, P. and Hoesli, M. (2006), “House prices, fundamentals and bubbles”, Journal of Business Finance and Accounting, Vol. 33 Nos 9/10, pp. 1535-1555.

Burnside, C., Eichenbaum, M. and Rebelo, S. (2011), “Understanding booms and busts in housing markets”, NBER Working Paper 16734.

Calomiris, C., Longhofer, S. and Miles, W. (2013), “The foreclosure-house price Nexus: a panel VAR model for US States, 1981-2009”, Real Estate Economics, Vol. 41 No. 4, pp. 709-746.

Case, K.E. and Shiller, R.J. (2003), “Is there a bubble in the housing market?”, Brookings Papers on Economic Activity, Vol. 34 No. 2, pp. 299-362.

Croce, R. and Haurin, D. (2009), “Predicting turning points in the housing market”, Journal of Housing Economics, Vol. 18 No. 4, pp. 281-293.

Crowe, C., Dell’Ariccia, G. and Rabanal, P. (2013), “How to deal with real estate booms: lessons from country experience”, Journal of Financial Stability, Vol. 9 No. 3, pp. 300-319.

Duca, J.V., Muellbauer, J. and Murphy, A. (2010), “Housing markets and the financial crisis of 2007-2009: lessons for the future”, Journal of Financial Stability, Vol. 6 No. 4, pp. 203-217.

Gjerstad, S.D. and Smith, V.L. (2014), Rethinking Housing Bubbles: The Role of Household and Bank Balance Sheets in Modeling Economic Cycles, Cambridge University Press, Cambridge.

Goodhart, C. and Hofmann, B. (2008), “House prices, money, credit and the macroeconomy”, Oxford Review of Economic Policy, Vol. 24 No. 1, pp. 180-205.

Goodman, A.C. and Thibodeau, T.G. (2008), “Where are the speculative bubbles in US housing markets?”, Journal of Housing Economics, Vol. 17 No. 2, pp. 117-137.

Himmelberg, C., Mayer, C. and Sinai, T. (2005), “Assessing high house prices: bubbles, fundamentals and misperceptions”, Journal of Economic Perspectives, Vol. 19 No. 4, pp. 67-92.

Meen, G. (2008), “Ten new propositions in UK housing macroeconomics: an overview of the first years of the century”, Urban Studies, Vol. 45 No. 13, pp. 2759-2781.

Nguyen, Q. (2013), “Housing investment: what makes it so volatile? Theory and evidence from OECD countries”, Journal of Housing Economics, Vol. 22 No. 3, pp. 163-178.

O’Sullivan, A. and Gibb, K. (2012), “Housing taxation and the economic benefits of home ownership”, Housing Studies, Vol. 27 No. 2, pp. 267-279.

Piazzesi, M. and Schneider, M. (2009), “Momentum traders in the housing market: survey evidence and a search model”, American Economic Review: Papers and Proceedings, Vol. 9 No. 2, pp. 406-411.

Shiller, R. (2007), “Understanding recent trends in house prices and home ownership”, NBER Working Paper 13553, Cambridge, MA.

Smith, M.H. and Smith, G. (2006), “Bubble, bubble, where’s the housing bubble?”, Brookings Papers on Economic Activity, Vol. 37 No. 1, pp. 1-67.

Wheaton, W.C. and Nechayev, G. (2008), “The 1998-2005 housing ‘bubble’ and the current ‘correction’: what’s different this time?”, Journal of Real Estate Research, Vol. 30 No. 1, pp. 1-26.

Corresponding author

Kenneth Gibb can be contacted at: mailto:ken.gibb@glasgow.ac.uk