HHOUSES RATES in the rich world are growing at their fastest pace in 30 years. Those in America rose a record 19.7% in July, according to figures released on September 28. House prices measured relative to incomes are above their long-term averages in three quarters of OECD countries. Almost everywhere, policymakers are under increasing pressure to make housing more affordable.
Higher interest rates would lower house prices relative to income, making mortgages more expensive to manage and reducing demand for housing. But raising interest rates to cool the housing market now risks jeopardizing the economic recovery after the lockdowns. More promising, in the eyes of some, could be to tighten the “macroprudential” tools available to central banks and financial regulators, who seek to limit subprime mortgages.
On September 23, the Reserve Bank of New Zealand tightened its macro-prudential housing policy for the third time this year, saying past tightening had not done enough to tackle unsustainable house prices. Regulators in several other countries, including France, have also become more stringent this year. While these tools were designed to make lenders and borrowers more resilient by curbing debt growth, the case for using them to directly control house prices is weak.
Macroprudential policies have a long history and encompass a wide range of levers, such as capital and reserve requirements and direct controls over loan rates and quantities. Policies aimed at the housing market may include restricting the amount of loans that banks can make at a high loan-to-value ratio (LTV) or loan-to-income ratios. LTV the tools are the most common: in Europe, more than 20 countries deploy them, and their use has increased considerably since the global financial crisis of 2007-09 (see graph).
These controls, by limiting credit growth, may well have been one of the reasons that last year’s covid-induced recession did not trigger a financial crisis. Since growth in household borrowing and growth in house prices often feed off each other, it might be tempting to tighten credit controls in order to improve affordability. But there are three reasons why this policy would be wrong.
The first is that research suggests that the effects on house prices do not appear to be large enough to make a big difference in affordability. An intriguing example is a recent article by Steven Laufer of the Brookdale Institute and Nitzan Tzur-Ilan, then of Northwestern University, who studied a LTV policy introduced in Israel in 2010. Faced with soaring inflation in house prices, the central bank has asked lenders to hold additional capital against loans with LTV ratios of over 60%, but only for loans over NIS 800,000 (approximately $ 220,000). This allowed the authors to compare the growth in house prices subject to the measure with that of the rest of the market. The measures were found to reduce the overall price of Israeli housing by no more than 0.6%.
In addition, loan control usually makes mortgages more expensive for affected borrowers by rationing credit. So even if prices do drop slightly eventually, homes may not be more affordable. A study of European countries, for example, shows that average mortgage rates rise when LTV policies are tightened.
The third reason why macroprudential policies are inadequate to improve accessibility is that LTV controls can affect disadvantaged households disproportionately. The Israeli study found that the biggest negative effects on house prices were in the less desirable parts of the more expensive cities, which they say occurs because households constrained by credit tend to buy in these areas. A previous article by Ms Tzur-Ilan concluded that affected borrowers in residential areas around Tel Aviv had to travel an average of 4-7 km away from their workplace after LTV-tightening policies and up to an hour a day of additional travel time. These side effects can be justified if the ultimate goal is a more resilient financial system. But if policies were aimed at reducing house prices to help poorer households, they could prove to be counterproductive, reinforcing existing inequalities.
Over the past decade, macroprudential policies, including housing tools, have played an important role in reducing borrowing growth in some countries, making the financial system more secure. But the tools were never designed to improve housing affordability and are ill-suited for this job. People frustrated with skyrocketing house price increases may be better off putting pressure on governments rather than financial regulators to fix the problem. ■
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This article appeared in the Finance and Economics section of the print edition under the title “Truths at Home”