Sunday 21 October 2018

Tight credit rules are secret to curbing house price rises

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Brendan Keenan

Brendan Keenan

We do like to think of ourselves as something special: even if we are not always as special as we think we are. But there is no doubt that Ireland does tend to find itself in special positions in those trend charts that economists love to use.

They're the ones that find places or things clustered along a sloping line; suggesting that there is a connection between whatever two parameters are being studied. A little too often perhaps, Ireland is in one corner of the chart, like some isolated star in the night sky.

There was a particularly striking example in a recent working paper from the Geary Institute at University College Dublin. There can be little surprise that Ireland stood out from the crowd, however, since the subject was house price inflation from 1995-2007.

Nor is there much surprise that the nearest object in our bit of the chart was the UK. The two systems have many similarities; including a strong desire to become a home owner early in adult life.

Given its recent experience, it is no surprise that Spain is lurking nearby, but the Spanish economy is very different from ours or Britain's.

Very different as well - but in other ways - are Denmark and Sweden, but they too saw house prices rise significantly faster than the average.

Sweden had the highest inflation of a credit-restricted country, but it was about half the Irish rate.

Prices rose least in Germany and Austria, but inflation was also modest in Italy - a country otherwise noted for inflationary tendencies.

The clue is in what the line connects - gross incomes against the availability of mortgages. The surprise is these connections have received relatively little attention in the past. There has been plenty of work, in what is called comparative political economy, on how labour market institutions shape incomes, but little enough on access to credit.

It is surprising because households account for an increasing share of borrowing in rich countries. Most of that debt is mortgages for home purchase. One has only to think of the shock engendered by the fact that the Central Bank now restricts mortgage availability to see how important such lending is, in this country anyway.

Which makes this paper more than timely. Incomes are once again on the rise but there has been only modest relaxation in the lending rules. In the case of first-time buyers, there was actually a modest tightening in the most recent adjustment, with the numbers being allowed some exemption on the 3.5 times income limit reduced from 25pc to 20pc.

The Central Bank's new Financial Stability Note, published the other week, gave details on the state of the mortgage market. The rules are being applied, with the average loan for first-time-buyers last year just under 80pc of the property's value and three times the buyers' gross income.

This was a small increase on the figures for 2016. In absolute terms, first-time buyers also paid more on average and took out bigger mortgages, based on higher incomes than in 2016.

Average loan size and property value also increased for other buyers but, as might be expected, they are not as exposed as the first-timers, with loans averaging 68pc of value and 2.6 times gross income.

This is a revolutionary change from before the crash, when loans worth more than the property were regularly on offer and could be as much as five times gross income. Applying the new rules would send Ireland scudding across the chart into the tight credit sector. According to the research, it should also cut house price inflation. The core finding is that availability of credit is what matters when it comes to property prices. Incomes play a minor role, which is not quite what previous theory would have said.

The evidence that it might be wrong comes from the proximity of Britain, Denmark and the Netherlands in the inflation chart. The two Nordic countries have centralised bargaining systems which tend to reduce income inflation, whereas the UK does not. The thing all three had in common during the period was easy access to mortgages.

Irish gross incomes are just about the highest in Europe, so the research, if correct, makes the central bank rules even more important than might have been assumed.

On the face of it, though, they do not seem to be working. Both prices and rents - which are a proxy for prices - are rocketing. Or are they?

It is a complicated story. If one takes 1995-2018, price rose by an average 5.5pc: pretty much in line with the economy, as economic history would suggest.

Such a pity that the average wasn't, well, more average.

The 2010-18 period is even less of a guide because of the huge disparity which has opened up between regions. The average house price in Dublin is approaching €340,000 but even popular Galway, which rivalled Dublin in the 2000s, is €100,000 behind that, while the Limerick figure is €180,000.

Nothing like this has happened before. The theory does not incorporate shortages of the kind being seen in Dublin but the statistics do. The latest, from the grandly-named Banking & Payments Federation Ireland (BPFI), which collects data from lenders, showed a 14pc increase in the volume of mortgages, and an 8pc rise in value, compared with the first three months of last year.

Remortgaging existing loans was even more buoyant - a 60pc increase on 2017, but the market is much less active than it should be. Goodbody Stockbrokers point out that there were 40,000 mortgages approved - a modest number by past standards - but only 30,000 were taken up in the first quarter. This compared with just 28,000 approvals in 2016, but 25,000 became active. The assumption is that the difference reflects prospective buyers' inability to find a property.

That is more intense in Dublin than anywhere else. The prices in other urban centres do suggest that inflation is subdued, despite the apparently rapid rise. Taking the last 20 years, it does not look rapid at all. There may have been no real gains at all in rural areas, but again supply and demand distort the picture.

The inability of supply to meet demand where it exists shows massive market failure. Irish governments have too often intervened in markets which needed no such interference but, as now, were unwilling or unable to act when assistance was needed. The inflation analysis suggest one possible worrying reason why fixing this failure it is proving so difficult.

House-price inflation of the kind seen from 1998 could be expected to wash through into cost inflation in the building industry.

Property prices can be cut with the stroke of a pen, but reducing construction costs is a different matter entirely.

We seem to be in a situation where the cost of building, in Dublin at least, is more than the prices which can be paid under present credit restrictions.

The research supports the idea that easing those restrictions would drive up prices - perhaps to a level which would stimulate faster building.

Even if permitted by the ECB, it would be a far from desirable solution - but maybe not so undesirable as having no solution at all.

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