For years, I have taken great pains to avoid taking a stand on whether the Norwegian housing market is in a bubble or not. My comment has constantly been that there is no shortage of fundamental explanations; but that this has been the case also for all the housing booms that in hindsight have proved to be bubbly. Now, however, I increasingly feel that the housing market in and around Oslo show clear signs of bubbliness. The clearest one is the widening contrast between the rental market and the asset market. True, the Norwegian rental market is small and the price statistics sketchy; but the tendency seems clear enough. People who want to rent our apartments have a hard time finding takers, whereas houses and apartments for sale are picked up at ever rising prices at the blink of an eye.
This doesn't mean that the purchase market is dominated by speculative investors. By speculators I mean people who buy apartments mainly for the profit of reselling them at higher prices. Although I do believe their numbers are rising, I also believe that the large majority of buyers intend to live in the house or apartment that they buy. It's just that they are not desperate to find a roof over their heads, only eager to buy before prices rise further. Young people, especially, seem anxious to "get into the housing market" before it's too late. In other words, they want to buy rather than rent because they fear that the price of buying will have risen too much before they actually get around to buying. To me, that is dangerously close to speculative behavior.
If this is a bubble, it is likely to burst some time. I plan to get back to that issue in a later blog. For now, I want to focus on the measures that the FSA (Finanstilsynet) has proposed to cool the frenzy. In short, they want to tighten the already fairly tight restrictions on banks' mortgage lending, in terms of loan to value, loan to income, and amortization. I share their concern. And I agree that macroprudential instruments are much better suited than monetary tightening (higher interest rates) at protecting financial stability.
However, I doubt that the proposed measured will work. They remind me of a catchy line that Ronald Reagan once used against the Democrats, "It didn't work, so let's do more of the same." Although I didn't agree with him on the issues he discussed at the time, but I do feel his phrase fits now. Essentially, the FSA proposes to curtail further bank's opportunity to do the things that they find profitable. The proposed measures will not make mortgage lending less profitable for the banks, only make it harder for them to do it within the rules. Experience from at home as well as abroad tells us that banks and other financial institutions then invariable find ways to circumvent such rules.
Why not raise bank's cost of mortgage lending instead? A simle way to do that would be to raise the risk weight of mortgage lending for banks' capital requirements. That way, banks will need to use a larger share of equity in their funding for each mortgage loan. And equity funding is significantly more expensive, at least at current prices. Such a requirement would be much more difficult to circumvent. I know, of course, that many banks base their risk weights on internal models; but the government could still raise the floor for how low the model-based risk weights can be.
Another advantage to such a regulation is that it does not interfere with the banks' own risk evaluations. Banks should be better at micro managing their own decisions than government agencies. And relieving them of this responsibility could spell the loss of important banking expertise.
To some extent, the FSA can be excused for not having mentioned risk weights. Their letter to the ministry was in response to a request to evaluate the current set of regulations that does not include this instrument. Furthermore, the Norwegian government cannot regulate the risk weights of Norwegian branches of foreign banks. A further risk would be that prospective buyers would seek alternative funding sources, such as credit cards and short-term consumer loans. I still think it would be worth trying.