How To Create a Housing Market Bubble

You allow the banks to lend out as much as they want. Graphically, that would be something like this:

New loans to households in millions of krona (we use . instead of , to represent ,000s). In August 2004 the banks entered the mortgage market with at-that-time revolutionary type of mortgages: 25 or 40 years and 4.2% real interest rates (the principal was indexed to the CPI) which later were lowered to 4.15% due to fierce competition in getting people to borrow money. The result was a housing boom of extraordinary heights (see next graph) which is being corrected through inflation, although the recent spur of mortgage growth is halting that much needed correction. Many thanks to Thorvardur Olafsson and Karen Vignisdottir at the Central Bank of Iceland for the data.

What do the colours mean? Blue: mortgages in ISK, red: mortgages indexed to the value of foreign currencies (loans in ISK where the principal fluctuates with the value of ISK in foreign currencies), green: car loans in ISK, yellow: car loans in ISK but indexed to the value of foreign currencies. The indexation to foreign currencies was later (2011) ruled out to be illegal according to law from 2001 (a long story but rather representative of the scandalous workings of the Icelandic financial system).

Here is the house prices saga in Iceland:

House prices in Iceland according to Thjodskra

And people seriously say that we had a financial crisis because of the collapse of Lehman and other problems in international markets?! Please, this was a home-made problem, and we still haven't solved it!