Shiller’s and Roubini’s fears of Swedish housing bubble are justified

7 Dec, 2013 at 10:18 | Posted in Economics, Politics & Society | 15 Comments

It is widely agreed that a series of collapsing housing-market bubbles triggered the global financial crisis of 2008-2009, along with the severe recession that followed. While the United States is the best-known case, a combination of lax regulation and supervision of banks and low policy interest rates fueled similar bubbles in the United Kingdom, Spain, Ireland, Iceland, and Dubai.

nouriel-roubiniNow, five years later, signs of frothiness, if not outright bubbles, are reappearing in housing markets in Switzerland, Sweden, Norway, Finland, France, Germany, Canada, Australia, New Zealand, and, back for an encore, the UK (well, London). In emerging markets, bubbles are appearing in Hong Kong, Singapore, China, and Israel, and in major urban centers in Turkey, India, Indonesia, and Brazil.

Signs that home prices are entering bubble territory in these economies include fast-rising home prices, high and rising price-to-income ratios, and high levels of mortgage debt as a share of household debt. In most advanced economies, bubbles are being inflated by very low short- and long-term interest rates. Given anemic GDP growth, high unemployment, and low inflation, the wall of liquidity generated by conventional and unconventional monetary easing is driving up asset prices, starting with home prices …

With central banks – especially in advanced economies and the high-income emerging economies – wary of using policy rates to fight bubbles, most countries are relying on macro-prudential regulation and supervision of the financial system to address frothy housing markets. That means lower loan-to-value ratios, stricter mortgage-underwriting standards, limits on second-home financing, higher counter-cyclical capital buffers for mortgage lending, higher permanent capital charges for mortgages, and restrictions on the use of pension funds for down payments on home purchases.

In most economies, these macro-prudential policies are modest, owing to policymakers’ political constraints: households, real-estate developers, and elected officials protest loudly when the central bank or the regulatory authority in charge of financial stability tries to take away the punch bowl of liquidity. They complain bitterly about regulators’ “interference” with the free market, property rights, and the sacrosanct ideal of home ownership. Thus, the political economy of housing finance limits regulators’ ability to do the right thing.

Nouriel Roubini

Maybe something for both L. E. O. Svensson and Paul Krugman to think about.

In a post up on his blog, Paul Krugman writes about “Mysterious Swedes” (emphasis added):

The Riksbank raised rates sharply even though inflation was below target and falling, and has only partially reversed the move even though the country is now flirting with Japanese-style deflation. Why? Because it fears a housing bubble.

This kind of fits the H.L. Mencken definition of Puritanism: “The haunting fear that someone, somewhere, may be happy.” … The underlying deficiency of demand will call for pedal-to-the-medal monetary policy as a norm. But bubbles will happen — and central bankers, always looking for reasons to snatch away punch bowls, will use them as excuses to tighten.

This is, however, rather too simplistic a view of the problems facing the Swedish economy today. And just poohpoohing — has Krugman already forgotten what happened in the US back in 00:s I would recommend consulting another Nobel laureate, Robert Shiller, for freshening up his memory — deeply felt concerns and fears of a housing bubble with conspiracy theories (“excuses”), is debating economic policies analogous to playing tennis with the nets down.

L. E. O. Svensson – former deputy governor of the Riksbank – has repeatedly during the last year lambasted the Swedish Riksbank for having pursued a policy during the last fifteen years that has increased unemployment in Sweden:

The conclusion from the analysis is thus that the actual monetary policy has led to substantially lower inflation than the target and substantially higher unemployment than a policy that would have kept the policy rate unchanged at 0.25 percent.

larsThe Riksbank has more recently justified the tight policy by maintaining that a lower policy rate would have increased the household debt ratio (debt relative to disposable income) and would have increased any risks connected with the debt. But, as I have shown … this is not true. A lower policy rate would have led to a lower debt ratio, not a higher one. This is because a lower policy rate increases the denominator (nominal disposable income) faster than the numerator (nominal debt). Then the debt ratio falls …

In summary, the Riksbank has conducted a monetary policy that has led to far too low inflation, far too high unemployment, and a somewhat higher debt ratio compared to if the policy rate had been left at 0.25 percent from the summer of 2010 until now. This is not a good result.

By the way, the latest report The Swedish Economy by the National Institute of Economic Research includes a very interesting special study, ”The Riksbank has systematically overestimated inflation,” which may be important in this context. In an analysis of the Riksbank’s inflation forecasts, the NIER shows that Riksbank forecasts have systematically overestimated inflation. The NIER concludes that “[t]he Riksbank’s overestimation of inflation has contributed to overly tight monetary policy with higher unemployment and lower inflation than would have been the case if, on average, its inflation forecasts had been on the mark.”

Why the majority of the Executive Board so systematically has exaggerated inflation risks so systematically is a question that may be worth returning to.

The Swedish Riksbank has according to L. E. O. Svensson been pursuing a policy during the last fifteen years that in reality has made inflation on average more than half a percentage units lower than the goal set by the Riksbank. The Phillips Curve he estimates shows that unemployment as a result of this overly “austere” inflation level has been almost 1% higher than if one had stuck to the set inflation goal of 2%.

What Svensson is saying, without so many words, is that the Swedish Fed for no reason at all has made people unemployed. As a consequence of a faulty monetary policy the unemployment is considerably higher than it would have been if the Swedish Fed had done its job adequately.

So far, so good — I have no problem with Svensson’s argument about the inadequacy of the Swedish inflation targeting policies.

However, what makes the picture more complicated than Krugman — and Svensson — wants to admit, is that we do have a housing bubble in Sweden — it’s not just a figment of imagination the “bad guys” use to intimidate us with. [That said, I, of course, in no way want to imply that central bank  interest rate targeting (and/or accommodations) is the best way to counteract housing bubbles. Far from it.]

The increase in house loans – and house prices – in Sweden has for many years been among the steepest in the world. Looking at the development of real house prices since 1986, there are obvious reasons to be deeply worried:
Swedish Real Estate Price Index to 2013 (q3)
Source: Statistics Sweden

The indebtedness of the Swedish household sector has also risen to alarmingly high levels:
Swedish household debt as perc of disp income to 2013
Source: Statistics Sweden

As a result yours truly has been trying to argue with “very serious people” that it’s really high time to “take away the punch bowl.”

If Svensson and Krugman aren’t impressed by yours truly’s or Roubini’s reasoning, they will maybe at least listen to a Nobel laureate. Robert Shiller is in Sweden now — collecting his fresh Nobel prize — an commenting on his earlier warnings on a Swedish housing bubble he says he still sticks to his warning.

I think that people here in Sweden have an illusion that increasing prices is a lasting trend, but that is more suggestive of a bubble.

Svenska Dagbladet December 7

Given Shiller’s track record on the issue, I think there’s every reason in the world to take his warning seriously.

Added December 8: L. E. O. Svensson is — surprisingly enough — not impressed by the arguments presented here. His comments are here (and in Swedish here). And in a couple of days another bubble denier — Eugene Fama — will receive his “Nobel prize” …


  1. […] having pursued a policy during the last fifteen years that has increased unemployment in Sweden: Shiller’s and Roubini’s fears of Swedish housing bubble are justified | LARS P. SYLL Sweden is not in the Eurozone. But Swedish monetary policy mirrors Eurozoen monetary policy. […]

  2. A keynesian economic solution might be for the state to underbalance the budget to finance a lot of new appartment houses in the places where the prices for buying homes is highest. The inflation would help the indebted to pay their loans, the demand for construction and building material etc. would compensate the Construction and housing buisness. The only loosers would be the financers – but they would not loose all as in a crash.
    Employment would get boosted and so would consumption as well as tax income.
    The only good argument against is Kaleckis “Political aspects of full employment” I suppose? If so, Keynsiansim in any flavour is not a leader, only a follower after the political business cycle.

  3. I would have agreed with Sjohuvud, that medium-term, the solution is to devalue the currency, so that ultimately wages can increase in local terms to pay off this enormous debt. However, much of the banks’ financing is on the inter-bank market and done in dollars. The Riksbank knows this and is trying to ween them off the inter-bank market, but it’s not easy to do. The amounts are too high. If the currency devalues too much, several of the banks will be in trouble. Really, I don’t see a solution anymore, just a crash coming. Hard to say when, but within 5 years. Probably earlier, if Russell Napier is right about coming deflation in 2014.

  4. Great post. Dr. Syll; just reposted on Naked Keynesianism. It wouldn’t be too far-fetched to suggest that Stefan Ingves is a dogmatic monetarist, correct?

    • Thanks David 🙂
      Re Ingves — I don’t know about “dogmatic,” but as most other central bankers and board members of BIS he certainly has strong monetarist leanings.

  5. Märkligt hur du blandar ihop korten. Krugman attackerar ofta bubbelförnekare. Men nu är det ju uppenbart att det itne är en bubbla i bostadspriser i stockholm och då ska man inte heller kalla det för en bubbla. Chiiller och co är helt enkelt inte tillräckligt insatta. Skulle dom ta del av Svenssons förklaringar skulle dom självklart ändra sig.

  6. The Swedish wages 1993-2012 (Compensation per employee as percentage of nominal gross value added per person employed according to Eurostat) is about 10 percent below the average level 1975-1992.
    The reason the consumption has not fallen as much, was at the beginning of the period (ca 1993-2004) more hours worked in average per employed (according to National Accounts). Towards the end of the period the reason seems to be growing indebtness. I would say that the rising prices on housing has made housing a continually bigger and better security for loans for other purposes. A houshold credit bubble wich has been necessary to avoid economic stagnation.
    But sooner or later I Think the lower compensation rate for work will slow down the consumption. And then probably “the chickens will come home to roost” in a big way.
    I have been Reading Monthly Review for at least 15-20 years, and when the crash came 2008 it was no surprise to me.
    What has been somewhat surprising is that the Swedish economy still seems to be going at pre-2008 speed. I suppose what the Swedish banks has taken in from the Baltic states must be a part of the explaination.

  7. OK, let’s assume there is a housing market bubble in Sweden. Prices will start collapsing at some point. Can people still repay their loans? If they can, them the banks will have no problems. In USA the problem was not due to the housing bubble directly but because of inability to service the loans. In short, I think that a housing bubble without a commodity bubble may not be a great danger. It was the commodity bubble in the US that made most consumers unable to repay their loans and default rates in MBS increased, triggering defaults in CDS. What do you think?

    • Of course they won’t be able to pay off he loans if the price goes down; the amortisation period is 140 years.

      • I would agree only if salaries are tied to home prices. But at a nominal rate of inflation of 1% the price of the home would lose half of its present value in about half of the amortization period while salaries should double.

  8. What is fascinating to me is that housing bubbles are popping out all over the world and especially in the northern countries like Canada, Sweden, Norway, etc.

    Also it looks like Swedish housing bubble is ENOURMOUS compared to the one that happened in the US.

    If you look at second chart on the article below (thats US) and the 3rd last graph is the one for Sweden.

    • Indeed worrying.
      Nice post you have there. Very handy and informative for making cross country comparisons 🙂

  9. The debt-to-gdp ratio is a great deal higher than before the previous Swedish housing crisis in the 1990s and the average amortisation period on Swedish mortgages is 140 years. Sure, they have introduced LTV restrictions, but the problem is lack of amortisation on the loans, and LTV doesn’t address that.

    My guess is that we might see the Krona devalue in the next 5-10 years.

  10. Reblogged this on 06cedmuho.

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