Following the boom and bust of the 2000s, there is widespread agreement that residential real estate is a key source of vulnerability in advanced and emerging economies alike. Housing accounts for a significant fraction of wealth, especially for people in the middle of the income distribution, who are much less likely to own risky financial assets (see our earlier post). Furthermore, housing is highly leveraged, creating risks to both homeowners and their lenders.
In the United States, real housing prices have rebounded by nearly 40 percent from their 2012 trough. Today, they are only about 10 percent shy of their 2006 peak. As such, it is natural to ask whether we are once again facing a heightened risk of a crash. Enter “House Prices at Risk” (HaR)—a new worst-case metric created by the IMF to assess the likely scale of a housing price bust conditional on a bad state of the world. Consistent with the IMF’s previous work on “GDP at Risk” (see our earlier post), we view HaR as a valuable addition to the arsenal of risk indicators that allow market professionals and policymakers to monitor financial vulnerability….
Do changes in U.S. dollar interest rates have a material impact on financial conditions elsewhere in the world? The answer is a resounding yes (see the paper one of us presented at this month’s IMF Annual Research Conference). When the Federal Reserve eases, the result is a dramatic increase in financial system leverage in other countries. Not only that, but the impact is larger than that of domestic policy changes.
The outsized cross-border impact of U.S. monetary policy creates obvious challenges for policymakers abroad aiming to maintain financial stability. Governments in the countries most affected have few options to limit the risks created by cyclical changes in dollar interest rates. The available mix of prudential measures includes more stringent capital requirements, limits on foreign currency liabilities, and restrictions on cross-border capital flows. The alternative of trying to counter U.S. monetary stimulus through higher policy interest rates abroad may backfire….
Housing debt typically is on the short list of key sources of risk in modern financial systems and economies. The reasons are simple: there is plenty of it; it often sits on the balance sheets of leveraged intermediaries, creating a large common exposure; as collateralized debt, its value is sensitive to the fluctuations of housing prices (which are volatile and correlated with the business cycle), resulting in a large undiversifiable risk; and, changes in housing leverage (based on market value) influence the economy through their impact on both household spending and the financial system (see, for example, Mian and Sufi).
In this post, we discuss ways to assess housing risk—that is, the risk that house price declines could result (as they did in the financial crisis) in negative equity for many homeowners. Absent an income shock—say, from illness or job loss—negative equity need not lead to delinquency (let alone default), but it sharply raises that likelihood at the same time that it can depress spending. As it turns out, housing leverage by itself is not a terribly useful leading indicator: it can appear low merely because housing prices are unsustainably high, or high because housing prices are temporarily low. That alone provides a powerful argument for regular stress-testing of housing leverage. And, because housing markets tend to be highly localized—with substantial geographic differences in both the level and the volatility of prices—it is essential that testing be at the local level….
To borrow a phrase, a crisis as deep as the 2007-2008 collapse of U.S. housing finance is a terrible thing to waste. Yet, nearly eight years after investors shunned their debt, Fannie Mae and Freddie Mac remain in federal conservatorship. And there is no end in sight to the government’s dominant role in housing finance: securitizations by the GSEs and federal agencies still accounted for nearly 70% of originations in 2015 (with qualifying loan-to-value ratios as high as 97%). Despite this extensive government intervention in mortgage finance, the U.S. home ownership rate fell to 63.6% last year, its lowest level since 1966.
To say that U.S. housing finance is both inefficient and risky seems a dramatic understatement...
