Is there a EU housing bubble?

13 Jul, 2017 at 16:14 | Posted in Economics | 5 Comments


Low interest rates are criticized by some economists as these should encourage asset price bubbles. Houses are our most important asset. Are house prices in the EU at this moment increasing too fast?

Not yet in Southern Europe … However … Swedish prices are of the chart. Dutch prices are rapidly increasing (and continued to do so during the first six months of 2017). German prices have, by now, increased with a third (house ownership in Germany is less common than in many other countries but the increase means that there will, quite soon, be a push to sell houses to renters – who of course have to borrow from the big banks). Yes, there is a northern European bubble. And it is rapidly inflating: during the last six months (not in the graph) prices have continued to increase …

House prices show continued increases which are way higher than the increases of nominal income of households … Actions have to be taken: a gradual increase (with clear forward guidance) of land value taxes (the money raised has to be used to lower VAT on labor), a gradual decrease of Loan to Value ratio’s (with clear forward guidance) and a gradual banishment of tax deductions of interest paid (with clear forward guidance).

It won’t happen.

Merijn Knibbe

Yes indeed, house prices are increasing fast in EU. And more so in Sweden than in any other member state. Sweden’s house price boom started in mid-1990s, and looking at the development of real house prices during the last three decades there are reasons to be deeply worried. The indebtedness of the Swedish household sector has also risen to alarmingly high levels:


In its latest report on Sweden, The European Commission warns Sweden about rising house prices and spiralling household debts:

The government’s 22-point housing market plan addresses some underlying factors for housing shortage, including measures to increase the amount of available land for construction, reduce construction costs and shorten planning process lead times. However, some other structural inefficiencies, including weak competition in the construction sector, do not receive appropriate attention. The housing shortage is exacerbated by barriers hindering the efficient use of the existing housing stock. Sweden’s tightly regulated rental market creates lock-in and ‘insider/outsider’ effects, but no significant policy action has been taken to introduce more flexibility in setting rents. In the owner-occupancy market, relatively high capital gains taxes reduce homeowner mobility. A temporary reform of the deferral rules for capital gains taxes on property transaction was introduced, but this will probably have limited effect. Lack of available and affordable housing can also limit labour market mobility and the effective integration of migrants into the labour market, and contribute to intergenerational inequality.

Yours truly has been trying to argue with ‘very serious people’ that it’s really high time to ‘take away the punch bowl.’ Mostly I have felt like the voice of one calling in the desert.

Housing-bubble-markets-flatten-a-bit-530Where do housing bubbles come from? There are of course many different explanations, but one of the more fundamental mechanisms at work is easy to explain with the following arbitrage argument:

Assume you have a sum of money (A) that you want to invest. You can put the money in a bank and receive a yearly interest (r) on the money. Disregarding — for the sake of simplicity — risks, asset depreciations and transaction costs that may possibly be present, rA should equal the income you would alternatively receive if instead you buy a house with a down-payment (A) and let it out during a year with a rent (h) plus changes in house price (dhp) — i. e.

rA = h + dhp

Dividing both sides of the equation with the house price (hp) we get

hp = h/[r(A/hp) – (dhp/hp)]

If you expect house prices (hp) to increase, house prices will increase. It’s this kind of self generating cumulative process à la Wicksell-Myrdal that is the core of the housing bubble. Unlike the usual commodities markets where demand curves usually point downwards, on asset markets they often point upwards, and therefore give rise to this kind of instability. And, the greater the leverage (the lower A/hp), the greater the increase in prices.

The Swedish housing market is living on borrowed time. It’s really high time to take away the punch bowl. What is especially worrying is that although the aggregate net asset position of the Swedish households is still on the solid side, an increasing proportion of those assets is illiquid. When the inevitable drop in house prices hits the banking sector and the rest of the economy, the consequences will be enormous.

It hurts when bubbles burst …


  1. I suppose it matters that the Swedish built practically nothing between 1992 and 2010, causing a huge difference between supply and demand. See curve for Stockholm at

  2. The housing bubble comes from the way sites of useful building land are being exploited by speculators. having bought a site in a place where growth is expected, the landowner and associated supporters or banks, have only to sit around for a few years until the competition for suitable places for new homes and work places, to drive up the price.

    The growth and development of the local infrastructure which tax payers are supporting through the government, add greatly to the land value.

    Then these speculators sell the site and make big profits for doing nothing but waiting. Speculation in land prices can be stopped effectively by a government which taxes land values instead of earnings. This kind of tax is an ethical one because it takes from the greater value of the site what the increasing density of the population has added to its value.


  3. “Where do housing bubbles come from? There are of course many different explanations, but one of the more fundamental mechanisms at work is easy to explain with the following arbitrage argument:”

    Arbitrage is an assumption of neoliberal economics that is violated on a massive scale by the biggest banks; for evidence, consider the persistent violation of Covered Interest Parity since 2008. Currency swap rates are negative, meaning that large market agents choose to swap into dollars and swap back at a higher rate than they would pay by borrowing dollars at money market rates. Arbitrage should eliminate the negative currency swap rates, because banks could borrow dollars at a lower rate and swap them for the higher rate. But for a decade, rates have remained significantly negative. What is the volume of dollar transactions that are being traded in violation of the arbitrage assumption? Surely in the hundreds of trillions of dollars, thus a very significant size of the world market.

    For more on the Covered Interest Parity violation, see “The dollar, bank leverage and the deviation from covered interest parity” by Stefan Avdjiev, Wenxin Du, Catherine Koch and Hyun Song Shin.

    My story about the most recent bubble is heavily influenced by Prof. Mehrling’s MOOC, Economics of Money and Banking. The banks create derivatives from mortgages and bid up the prices of the derivatives arbitrarily. Tranches strip out all the risk you desire, leaving AAA riskless assets with high returns and arbitrarily high notional values. Insurance can be figured out to pay for itself via linear algebra (and other advanced mathematical) perfect hedging techniques. I suspect much of High-Frequency Trading involves microtrades that have been found by a computer solving Ax=b. Risk is stripped out and return is high. The constraints of neoclassicalism have been relaxed by linear algebra, ingenuity, and financial innovation. In 2008, the insurance piece broke down because collateral stopped being accepted. AIG’s collateral was no longer good in the money markets to cover payouts, to Goldman Sachs for example. But the Fed made good on AIG’s promises with created money, and bought toxic assets which market panic had devalued to $0.

    Personal household debt had little to do with the 2007-2008 Financial Crisis. (Some mortgages defaulted and traders panicked unreasonably.) Derivatives based on household debt far outstrip the household debt itself in dollar valuation. Riskless slices of personal household debt trade at arbitrarily high values on markets, and downsides are insured. The insurance piece broke in 2008 but the Fed fulfilled the liquidity demand.

    That’s my story …

  4. Can we get a confidence interval on when the bubble gum will burst!? After all, we are all living on borrowed time since in the end we are …. all – you know (hehe).

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