Thursday, June 4, 2009
Friday, June 5, 2009

In cooperation with

Report by, By Esa Jokivuolle, Research Supervisor, Research Unit, Bank of Finland and SUERF Council Member

Almost eighty participants from Europe, the United States and Asia participated in this conference which was jointly organized by SUERF and the Bank of Finland. This was the fourth such joint event between SUERF and the hosts.In their welcoming words and opening address, respectively, Catherine Lubochinsky, President of SUERF, and Sinikka Salo, Member of the Board of the Bank of Finland, both noted that asset prices are back on the agenda of central banks’ policy discussions. Ms Salo also reminded of the important role of well functioning structures and institutions of housing markets in providing cost-effective and quality housing to the society. She took a closer look at Finland and pointed out that notwithstanding plentiful supply of land, the market for land development is not functioning well. This has implications both for the supply of housing and house prices in Finland.

In her keynote speech Loretta Mester, Director of Research at the Federal Reserve Bank of Philadelphia, further examined arguments for and against the view that asset Prices should be given a more central role in monetary policy. She concluded that differences between the two views are mainly at the level of nuances. It is important to monitor developments in fi nancial imbalances and acknowledge more explicitly that these have an impact on the outlook of economic output and infl ation in the longer term. When taking questions from the audience she also added that much more research is needed to develop current macro models in order to better understand crisis episodes and the developments leading to them.In Session 1, two presentations, one empirical and the other theoretical, dealt with credit constraints in modeling and understanding house prices. Anthony Murphy of Oxford University, in a joint work with John Duca and
John Muellbauer, used data on fi rst-time home buyers from the American Housing Survey to demonstrate the effect of credit constraints on house prices. He argued that the rise in loan-to-value ratios which indicates easing of credit constraints likely refl ects two fi nancial innovations: the adoption of credit scoring technologies to sort and price nonprime mortgages and securitizations to fund them. With a theoretical model, Essi Eerola of University of Helsinki, jointly with Niku Määttänen, showed that the effect of credit constraints on house prices depends on whether house price changes are driven by income or interest rate shocks. Moreover, because of credit constraints house prices may react asymmetrically to large positive and large negative income shocks.

In Session 2, two papers presented client-level evidence on mortgage decisions in the US housing market. In the first paper, aptly titled Where’s the smoking gun?, Rajdeep Sengupta of the Federal Research Bank of St. Louis (jointly with Geeteesh Bhardwaj) argued that, contrary to popular belief, underwriting standards of the subprime mortgages did not weaken post-2004 so that such Deterioration could not explain the collapse of the subprime market. The weapon that brought down the financial system may thus be still missing, but the authors point to the “bridge-fi nance” nature of subprime mortgages, which they have studied in more detail in their subsequent research. On the other hand, the second paper by a group of US based authors, which was presented by Souphala Chomsisengphet, analyzed the consequences of mandatory third-party review of high-risk mortgage applications, applied in the State of Illinois. They found that such increased oversight led to improved Screening by lender institutions which further showed up in lower default and foreclosure rates. In the panel on political economy of housing markets, ending the fi rst day of the conference and chaired by Heikki Loikkanen of the University of Helsinki, Yannis Ioannides (Tufts University) recapped the recent housing price development in the US market. He pointed out big regional differences within the US, and emphasized that there had been clear political encouragement of homeownership in the US. He also noted the deeply rooted belief in the United States in houses as a safe store of value. His remarks were followed by Peter Englund from Stockholm School of Economics who gave a historical perspective on the Nordic housing booms and busts in connection with the Nordic banking crises of the early 1990s. Referring to the full-recourse nature of the Nordic mortgages he noted that mortgage losses to banks were ultimately not very big in comparison with losses from corporate credit. Raymond Duch from Oxford University had explored the connection between political Sentiment and expectations concerning housing markets but
concluded that the link is not as strong as with other key macroeconomic variables; such as the link between political sentiment and infl ation expectations. Risto Murto from Varma Mutual Pension Insurance Fund represented views of the asset management industry. He described the challenging investment environment of the past year and reminded of the break in diversifi cation benefi ts during extreme market events. He concluded that although cyclical factors seem to be currently easing, structural factors related e.g. to high government debt levels remain demanding. In the ensuring questions session, the issue was raised of what triggered house price decline in the US. The panel’s view was that we may not know yet. A comment from the fl oor referred to evidence from the implications of a change in the US bankruptcy law which may have had a bearing on the reversal of house prices.

The second day opened with an invited speech delivered by Antonio Cortina, Deputy Head of Research, at Banco Santander. Both he and the chairman of this session, Juan Ayuso,Banco de España and SUERF, emphasized the specific structural factors that contributed to the Spanish housing market boom together with cyclical factors. These structural factors included immigration as well as increasing demand by retired Northern Europeans for second homes in Spain. Mr Cortina also alluded to shortcomings in the rental market.

In Session 3 Carmen Martinez-Carrascal of Banco de España demonstrated empirically the strong long-run interaction between house prices and housing loans. Studying the Spanish housing market, she provided insights into how overvalued house prices may lead to a false sense of there being no over-indebtedness among individuals who have taken housing loans. In the discussion it was brought up that also the distribution of indebtedness among individuals
may matter for fi nancial stability.

In Session 4 the general topic was monetary policy and house prices. Using a two-country macro model of the US and the euro area, Alessandro Notarpietro of Bocconi University and Banca d’Italia (jointly with Matthieu Darracq) argued that monetary policy has reacted to housing-related shocks and that, according to additional normative analysis, monetary policy that takes house price movements into account is indeed optimal. Finally, Jean-Stéphane Mésonnier (and Sébastian Frappa) from Banque de France provided evidence that infl ation targeting has contributed to higher levels and volatilities of house prices in a group of 17 industrial countries, 9 of which have been involved with inflation targeting over the period 1980-2006. These results support the often-heard criticism that infl ation targeting may contribute to build-up of fi nancial imbalances. A comment from the audience pointed out the importance of checking for whether single country observations may affect the results. Also, other evidence was referred to, which suggests that a low-infl ation environment goes together with a lower probability of banking crises. Guido Wolswijk from the ECB presented the ECB Structural Issues Report 2009: Housing finance in the euro area in his invited speech. The main fi ndings of the report suggest that although there has been a decrease in mortgage spreads within the euro area, perhaps as a result of increased competition, considerable differences in levels remain. These fi ndings point to institutional differences between countries. The originate-and-distribute model, one of the central background factors of the current global crisis, has been less developed in the euro area compared to the US and the UK. This may be one reason why euro area housing finance markets have appeared more resilient to shocks.

The second keynote speech, Housing markets and the financial crisis of 2007– 2008: lessons for the future, was delivered by John Duca, Vice President at the Federal Reserve Bank of Dallas. He said that the current US fi nancial crisis shared most of the standard features of earlier fi nancial crises but that it also points to two key fl aws in standard economic frameworks. These are 1) the omission of credit standards and financial innovations from macroeconomic
models, and 2) the oversimplifi cation of treating housing as liquid as standard fi nancial assets. Among lessons for the future, he noted that perhaps the policy approach of promoting homeownership by easing credit supply should
not be the only approach, and that measures to improve housing supply should be considered as well.

In his concluding remarks, Jouko Vilmunen, Head of Research at the Bank of Finland, noted that beside the demand factors that the conference presentations had mainly dealt with, future challenges also concern supply side factors, as emphasized by Sinikka Salo in her Opening address and echoed in the second Keynote.