Bubble Trouble In Finland?
by Edward Hugh
According to an intriguing article I read in Bloomberg recently an alert signal has been sounded due to the fact that house prices in the Scandinavian countries have been rising very rapidly of late. Judging by what they explain what is now going on in the housing markets of Norway, Sweden and Finland would seem to have all the hallmarks of a "mini-bubble", one which is all the more perplexing given the lowish level of economic activity which characterises the current environment. But then I asked myself, and those whopping German export numbers we saw in the second quarter, weren’t they also some kind of "mini bubble" which was quite out of keeping with what we should expect to be seeing.
Worse, if this seeming Scandinavian bubble were to pop, it could well send what has up to now been among the strongest regional rebounds on the whole European continent straight into a nosedive. In particular the Finnish problem interests me, house prices are rising steadily, and with them construction activity, even as the economy in general remains severely depressed following one of the sharpest output falls to be found in the Eurozone.
The central cause of the problem is not hard to pin down, it is to be found the widespread recourse to variable rate mortgages, which make activity in the housing sector (and through it the economy as a whole) highly sensitive to short term movements in interest rates . About 95 percent of mortgages in Finland and Norway follow money-market levels, while about 60 percent of Swedish loans are based on adjustable rates. This exposure to variable rates mirrors closely the situation in Spain and compares with that in Germany where some 90 percent of homeowners make fixed interest payments, or in France where the percentage of fixed rate mortgages is slightly less than in Germany but substantial nonetheless. Really I’m rather surprised that more of the experts on our financial systems haven’t made this variable rate boom/bust behaviour connection during the recent debate.
Anyway what this flexible rate exposure means is that last the record low borrowing costs which are available in European money markets have simply fed straight into the Nordic region housing markets – where householders were not so deeply leveraged going into the crisis as they were in Spain or Ireland – and it has done so much faster than in it has in other parts of Europe. France would be the other country to watch (or Poland) but at least in France the central bank has a better hold on the situation via the insistence on a fixed rate mortgages policy.
And the situation is not to be laughed at: Bloomberg quote Finnish Finance Minister Jyrki Katainen as saying he is "very worried" since in his opinion “There could be a housing bubble in the making in Finland. There is a risk that mortgage borrowing costs are too low.” My feeling is that by the time Finance Ministers start talking about the problem it is already too late.
So, with my curiosity piqued, I duly went over to the Finnish central bank website where I found the following:
"Households’ new drawdowns of housing loans amounted to EUR 1.5 billion in August, up by 1% on July 2010 and 20% on August 2009. The average interest rate on new housing-loan drawdowns rose to 2.08% in August, from 2.03% in July. A typical housing loan drawn down in August was tied to a 12-month EURIBOR and had a maturity of 20 years. The stock of MFI housing loans to households grew by EUR 0.4 billion on July, to EUR 75.0 billion at end-August. The annual growth rate of the housing loan stock slowed to 6.7%, from 6.8% in July. The average interest rate on the stock of housing loans rose by 0.02 percentage point from July, to 1.96%".
So it is true, interest rates in Finland are ultra cheap (around 2%) and the stock of mortgages is rising by nearly 7% annually: not ultra high by historic standards, but we are in the midst of, well you know. Which takes me back to my last post on imbalances in the Eurozone, and what the ECB can do to prevent a situation like the one in Finland becoming a repeat performance of what happened in Spain or Ireland.
In Finland, existing flat prices rose by an annual 10 percent in the second quarter, after surging a record 11.4 percent in the first three months of the year. In Greater Helsinki the growth rate was 13.6 percent and in the rest of the country 7.0 percent.
The situation with house prices is similar, since after a 1.5% fall in 2009 (with the price in large urban areas falling by as much as 8.7 percent they are now back back on their way up again.
And the pressure is mounting, since household debt in Finland rose to 107 percent of disposable income at the end of last year – up from 65 percent in 2000. Which means that any significant rise in interest rates at the ECB could see many of those with mortgages having difficulties maintaining their monthly payments.
What is even more curious is that all of this is taking place even while the Finish economy is a long way from emerging from the deep hole into which it fell. Finland’s GDP is expected to grow by 1.5 this year, following last years 8 percent contraction, according to a government forecast which does not seem totally unrealistic. But if we look at the chart below, which shows the GDP indicator produced by the Finnish statistics office, there is still a very, very long way to go to get back to where we were.
Yet despite this, consumer confidence is at what are effectively record levels.
So with all this money going into construction and consumption the Finnish economy is starting to suffer from structural distortions (heard about that before somewhere, have we?).
Retail sales have more or less recovered, and are now steadily moving above their pre crisis level.
But industrial output is remains way down (in July it was still 23 percent from peak, and even showing signs of falling back).
And Finnish exports have completely failed to recover.
A feature which is very clearly reflected in the trade balance, which is now very near to turning negative. Competitiveness problem anyone?
What is quite surprising is that while Finnish industry did pretty well at maintaining its price competitiveness up to 2007 (if we look at the REER chart below), it seems to have lost considerable ground in 2008 and 2009 (ie during the crisis, which seems to suggest "rigidity" rather than "flexibility"), and, of course, (to repeat the old mantra) it can no longer devalue to make an "easy" correction. So it looks like it is going to have to follow its Baltic neighbours down the hard road of a long slow internal devaluation, and especially after the bubble bursts.
Of course, as others have already pointed out, this isn’t simply a Euro problem, since neither Sweden or Norway are in the Euro, and they are also struggling to contain their housing markets. They are typical problems faced by a small open economy in an environment of massive external liquidity. Evidently, as Roubini Global’s Mikko Forss says, tighter regulation from the Bank of Finland would have helped (I fear it is now really too late for this to be effective in the timeframe available) – controlling loan to value ratios, limiting variable rate mortgages, raising income-to-loan parameters, etc. As things stand, the main short-term threat to Finland would seem to come more from a premature raising of rates – which would surely burst the thing – rather than from keeping interest rates lower longer, and trying to implement some emergency measures.
Obviously it is hard to convince a country which has just had such a sharp drop in output that even a 3.8% fiscal deficit is too high in a situation where consumer credit demand is leading the economy to become increasingly distorted, but if its pain you are worried about, then maybe a short term dose is a lot better than ending up where Spain and Ireland are. Without monetary policy tools available all the authorities can do is impose regulations and use their own fiscal spending to regulate demand. And inflation expectations and credit demand are both on their way up. According to the September consumer confidence survey, Finns expect consumer prices to increase by 2.6 per cent over the next 12 months. One year ago the predicted inflation rate was 1.6 per cent, and its long-term average is 2.1 per cent. And when asked about their borrowing intentions, 71 per cent of those questioned stated they thought this was a good time to raise a loan, while in August the proportion was 64 per cent. Hardly a surprising result, with interest rates pinned to the floor, and inflation expectations rising.
So the Finnish economy does seem to be poised on the edge of some sort of cliff, and one day or another it is likely to fall. And it is precisely the existence of problems like these in a country like Finland (far from the Mediterranean beaches and sun) which leads me when thinking about the problems we have on our hands to prefer the expression Europe’s periphery (from Ireland to Finland to Latvia to Hungary to Bulgaria to Slovenia to Greece and Spain and Portugal) rather than the over narrowly-focused (and somewhat abusive) term PIGS. But whichever way you look at it, and whatever you want to call them, there are a growing number of countries inside the EU who face mounting rather than subsiding problems at this point.
Many thanks for that, very instructive. If you have time and interest a deep dive on Sweden would be appreciated.
Denmark is of course also part of Scandinavia and the housing bubble (which many people denied existed) there is bursting as we speak. Not sure what sets Denmark apart from fx Sweden. Maybe that the Danish households are even more indebteded than the rest of Scandi.
Part of the problem here in Sweden, it seems, is that the combination of the high and increasing household debt levels and varible rate financing has pushed the Riksbank in to a corner. Or rather, the Riksbank has let itself be cornered by home buyers who have maxed borrowing because of low interest rates and lax lending conditions (ie no amortization requirements, LTV up to 90-95% being pushed by the state-owned mortgage provider). So I can’t see how Riksbanken can make any meaningful rate hikes without killing a big part of the economy. ZIRP forever then?
vulnerable to rate hikes.
seems is the growing The problem here seems to Seems like the market here has all the ingredients for bubble blowing. I think the biggest problem with all the variable rate mortages is that so many
real nice with the random scribblings not deleted at end…pardon the diletantism
Hi Chris,
Am an expat as well, and have long had musings regarding the scandi housing markets. Particularly Sweden’s. I agree with you that the riksbank has allowed itself to be painted in a corner, and beyond that seems completely oblivious to the risks inherent in excessive household borrowing. It issued a report a year and bit ago dismissing any housing bubble or borrowing fears. Ofcourse it is crazy to finance a long term asset with short term rates – but historically it has been cheaper, and banks seem happy enough to lend in this way and neither the riksbank nor the financial regulator have cared. Nor the government ofcourse. You get the feeling that a lot of these decision makers are far from neutral, no doubt most of them are owner-occupiers themselves and so have a huge self-interest in addition to fears of being blamed for any housing market correction.
What exacerbates the borrowing though is two things in my opinion. The first that interest payments are tax deductable. So borrow more and you pay less tax. Yipeeee! The second is that not only are rates floating, but almost no one is amortizing their debts!
I do think there is something that can be done though. The government can, over a period of 3 to 4 years say, phase out the tax deductability of interest payments for private individuals, the effect would be to gradually increase the real cost of borrowing for mortgages. As this will have a similar effect as rate hikes (the Riksbank is currently slowly hiking rates), the monetary squeeze can be eased by the Riksbank hiking slower than it would otherwise, supporting the corporate and small business sector. This should slow house price inflation by raising the real cost of borrowing, while at the same time promoting amortisation of loans as a form of saving. Since borrowing rates tend to be higher than deposit rates, and saving in the form of amortisation is not taxed. Ie the real return on savings via amortisation is increased.
I’d be inclined to keep the mortgage interest deductability specifically for new builds, but then have it last for only the first 10 years say. This would encourage new housing construction and thereby hit the supply as well as the demand side of the housing bubble.
To be fair to renters and those without loans I’d also propose that tax-free savings accounts are introduced for individual savers, with a yearly maximum deposit, similar to the ISA scheme in the UK. In any event, phase out the tax-deductability of interest rates!
The second measure the government, or the Finansinspection could take, would be to oblige housing loans to be amortised. Say a minimum of 1.5% to 2% of the original outstanding per year. Again this extra cash outflow should stop ridiculously low interest rates from inflating the bubble, while at the same time making sure that home owners gradually deleverage.
Ofcourse, don’t expect anyone in the government, riksbank, finance regulator or the banks to have the necessary “sjukdomsinsikt” (“illnessawareness”) to take these measures. But they are measures which would effectively deal with this issue.
n.b. in 2006 prior to the elections I believe that the leader of the Moderate Party, Fredrik Reinfeld, proposed a scrapping of the tax deductability of mortgage interest as a way of financing the scrapping of property tax. But didn’t get his way as the christian democrats were very much against it.
There are also many people who feel that the deduction makes housing “more affordable” for the young and first time buyers, since it makes their real interest costs lower. Ignoring ofcourse that the deduction also effectively pushes up the purchase price of housing to begin with. It is too subtle an argument to reach most people, believe me, I’ve tried.
same story … cheap money –> bubble (somewhere).
But isn’t Finland one of the few countries, that is rated AAA by all of the three big rating firms plus Dadong?
I’ve been aware of such problems since the turmoil began on 2008. What we can see about the consumer confidence level is really alarming. There are few factors to be added: first of all the euro exchange rates that dramatically dropped during May 2010. We Finns were told how marvellous this is due to Finland can export itself out of recession. Second, the construction companies are more likely co-operating with secret pacts with government. There is (although not verified by authors) planned scarcity on apartments which tend to skyrocket prices. Third, the mentality of a typical Finn: he sees that home is such an investment, paving the way to the wealth. As I’m one of non-typical Finn I see it the more Finn needs to pay for his housing the more satisfied he is.
Intresting. I’m no expert in these things and just read it through out of curiosity, being finnish myself. Although we do have flexible rate exposure like mentioned, i thought it would be good to point out that very big majority of finnish loans are also flexible with time, so what happens when the rates do go up is that your 15 year loan will become 20 year loan or something more, but your monthly payments stay the same. I think that’s a major factor when talking about possible consequences of rates going up. Only small minority have loans where intrest rate growth has direct effect on monthly payments, and even they can easily change the payment plan to something else if needed.
Well, the problem here is that if payback time enlenghtens (or monthly payment grows) it will only mean two things: people’s liquidity shrinks and it is away from somewhere else. I once wrote as if the monthly payment rises e.g. by €50 then it is needed to have 30 €-cent net salary rise per hour to cover same purchasing power. If one does not receive that overall demand for goods halts. If demand halts Finnish people is being sacked. It’s not much better if payback time evades into far future.
Of course, there are individuals sailing past the reefs but alarming problem are the masses. During “cheap interest rate period” for about 20 months there have been vast rush for getting endebted, Cheap rates have also encouraged to apply for bigger loans – which “extra money” transferring more or less directly to the prices of apartments. One more devastating thing is that nearly all the loans are based on very short Euribor rates, which will mean the rates can climb up quite aggressively. I cannot see situation they will fall down anymore.
As once the interest rates go negative and magnitude overtakes the inflation rate I am thinking first time in my life to get indebted. That won’t happen. Interest rates are climbing or are in locked down due to economy starts cool down once again. So it’s bad thing for Finns nevertheless: if global economy cools down Finland’s export will stall and thus GDP gets severely whipped. if economy starts to grow – despite all the omens – indebtors are causing the domestic economy’s cooldown.