As real estate markets worldwide move in tandem by showing clear signs of a downturn, two major international financial bodies this week have reiterated their concerns over the housing market’s potential impact on financial stability. Both the European Central Bank and the International Monetary Fund have raised a red flag. Investment Officer looks for answers to some key questions at a moment when mortgage rates are at their highest in 15 years.
The ECB’s latest Macroprudential Bulletin released on Tuesday is completely focused on real estate and financial stability. It noted that high leverage is a well-known component of boom-bust scenarios. “Credit-fuelled real estate booms can pose financial stability risks due to the important direct and indirect links between real estate markets, the economy and the financial system,” said the ECB.
Presenting is World Economic Outlook, the IMF addressed what it calls the global cost-of-living crisis. “This year’s shocks will re-open economic wounds that were only partially healed post-pandemic,” said Pierre-Olivier Gourinchas, the IMF’s research director. “In short, the worst is yet to come and, for many people, 2023 will feel like a recession.”
“The housing market remains a potential source of macro-financial risk,” the IMF report said.
‘Buoyant’ growth
The ECB’s concerns follow an end-September warning by the European Systemic Risk Board, the ESRB, whose remit is macroprudential oversight of the EU financial system and the prevention of systemic risk. The ESRB warned of a build up of cyclical risks backed by “buoyant house price and mortgage lending growth.”
“Rising mortgage rates and the worsening in debt-servicing capacity due to a decline in real household income can be expected to exert downward pressure on house prices and lead to a materialisation of cyclical risks,” the ESRB said.
Mortgage lending at a record
Europe, at the end of the first quarter, was home to a record of more than 8.100 billion euros worth of residential mortgages outstanding, the largest volume ever recorded, and continuing a long trend of growth that first started in early 2017, according to the European Mortgage Federation, EMF, which monitors 19 EU countries and the UK that account for about 95 percent of the European mortgage market.
This growth is particularly fuelled by low interest rates. However, since inflation emerged, central banks had to raise policy rates, which then resulted in higher mortgage rates. In Luxembourg, for example, the going rate for a fixed-rate 3-5 year mortgage has risen nearly by one third in a month and now nears 4 percent. This picture is not much different elsewhere in Europe. US mortgage rates on Thursday reached their highest level since 2006, with the benchmark 30-year rate hitting 6.75 percent.
At Aegon Asset Management, Frank Meijer, global head of fixed income & structured finance, said that at present there are few signs though of forced sellers in the market, given persistent strength in the labour market, although this could change if a major recession were to emerge. And that then could lead to lower rates again, supporting home prices.
‘Range bound’ decline in home prices
“Note that in a recessionary environment, interest rates and hence mortgage rates will likely drop – supporting the housing market again,” he said. “So most likely the house price decline will be “range bound”. And least impact in the large cities, as there is a structural shortage of housing supply. There will likely also be a difference between countries – in the Netherlands, for example, the population growth is structurally higher than the housing stock growth. This will likely dampen house price declines in some countries.”
Recent inflation data shows that prices continue to rise, leaving central banks with no other option than to continue raising interest rates. The author of a major 2013 IMF report on global house prices has warned that the aggressive increases in rates we have seen so far will take time to play out for households.
‘Synchronised housing market downturn’
“We will observe a globally synchronised housing market downturn in 2023 and 2024,” Hideaki Hirata of Hosei University, a former Bank of Japan economist who co-authored an International Monetary Fund paper on global house prices, told Bloomberg last week. “Sellers often overlook signs of shrinking demand,” he said.
A copycat repeat of the 2008 financial crisis, which started in the US sub-prime mortgage market, looks unlikely in Europe. Nowadays a mere 700 billion euro of the European mortgages are held in securitised, pooled products - known as Residential Mortgage Backed Securities, or RMBSs - that banks have created to better handle mortgage risks.
The bulk of the RMBSs are now on the balance sheet of the ECB after commercial banks gave to Frankfurt as collateral for the money they borrow there. A decade ago, Europe still had some 1.200 billion euro in RMBSs.
Mortgage lending regulated differently
“Securitisation used for funding through residential mortgage backed securities by large universal banks has diminished significantly in Europe, primarily due to the relative cost of issuance vs. other products such as covered bonds,” said Shaun Baddeley, managing director for securitisation at AFME.
“Generally speaking, bank utilisation of RMBS as a tool is lower now than it was in the run up to and in the immediate aftermath of the Global Financial Crisis,” said Alastair Bigley, who tracks EMEA RMBS at S&P Global. “What has changed from a risk perspective is that mortgage lending is regulated differently now than it was in the run up to the Global Financial Crisis.”