Thursday 31 May 2012

Bloomberg bested: Update on the "Housing Bubble"

Bloomberg had an article recently where the currency controls were blamed for a formation of another possible housing bubble in Iceland. The take was that since the capital/currency controls locked funds inside the economy and investors were finally realising that they were going to be around for a long time, they best get their money into cement rather than let them rot in low-interest deposit accounts or bonds. The influx of money into the housing market then creates and supports unsustainable house prices - and inflation since housing is about 20% of the Consumer Price Index base in Iceland.

House prices went through the roof in mid 2000s only to come down crashing again. Now nominal prices are rising again, pulling inflation up with them.

I am not going to disagree on the possible formation of an unsustainable rise in the housing prices in Iceland supported with funds of high net-wealth investors, I already warned of that in February (Daily Mail and House Prices in Iceland). I am, however, going to emphasise the point that the influx of money into the housing market due to the capital controls is massively supported by creation of new mortgages (Bloomberg mentions this). Taking the expansion of new mortgages into account I'm not so sure the (acclaimed) flow of capital-controls-locked money into the housing market matters that much on its own, it is the leverage in the form of mortgages that brings the fuel.

First, what seems to support the view that capital-controls-locked money is mainly causing the rise in housing prices is the apparent divergence between new mortgages and prices, starting in mid year 2011 or so. Until then, house prices had always run parallel to the issuance of new mortgages. 

New mortgages and change in house prices. Notice the apparent divergence around mid year 2011 supporting the view that the recent rise is only caused by new funds locked in by the capital controls.

But cracking the data shows that the connection between new mortgages and the change in house prices is still around - correlation of 0.83. Both the change in the flow of new mortgages and the acceleration of the flow of new mortgages are still strongly connected to the change and acceleration of house prices. And notice that the mortgages lead the change in house prices, not the other way around!

Although the flow of new mortgages into the market has dislocated itself with the change in house prices (see previous graph) the change in the flow has certainly not!

Relative acceleration of house prices and relative acceleration of new mortgages (if new mortgages accelerate, the change in house prices should as well). Mortgages have been rather constantly accelerating since May 2010 and guess what, so have housing prices. Mortgages are still driving the housing market, with help from new funds or not.

In conclusion, the locked-in money is not suddenly infusing the rise in housing prices on its own. The connection between house prices and mortgages is still around and still going strong and I do not see any reason for changing my opinion since February: high net-wealth investors use mortgages to leverage up their position in the housing market. 

Good thing Bloomberg finally picked that up.

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