Statistics Norway Shows Creativity

I know, I've been picking on Statistics Norway (SSB) quite a lot. But isn't it my duty as a taxpayer in Norway? What I'm going to say this time is most probably too arrogant, taken into account that I'm an amateur, whereas SSB is full of professionals. I've never even seen a "macroeconomic model" in real life. But due to some combination of luck and skill, when it comes to house price forecasts during the last 12 months, I've beaten the KVARTS model SSB uses. That's where the arrogance probably comes from. Don't get me wrong: I have not published any accurate house price forecasts but, unlike KVARTS model, I have at least seen the possibility for price decline given the current fundamentals.

I will now simplify things (but so does KVARTS), and you should take this as my guess at what has happened here:

We got a "sneak peek" at KVARTS in June this year, when SSB invited an economist from a private bank to test the model. He wanted to see what, according to KVARTS, happens to house prices (hot topic in banks as well, it seems) if Brent oil price drops to $50 and stays there for the next three years. You might think house prices would drop? So did the economist, but this is not the case. Like him, you've most likely underestimated the robustness of Norwegian economy, as this would only reduce the house price growth to 2,1 % for the three-year period 2014-2016. Ok, this sounds ridiculous, you might think. Surely they have not taken into account the psychological effects? Wrong again. Without the effect of negative sentiment, prices would climb 6,3 %.

There you have it. That's KVARTS (version 06/13). Unable to see a house price decline even in a scenario many would label "doomsday".

Well, it so happens that the housing market cools down fairly dramatically and house prices start to decline during the summer, and this without any drop in oil price nor a visible drop in the absolute level of any other fundamentals. What do you do with a model that doesn't match reality? You scrap it, or you adjust it. Taken into account the "robustness" of KVARTS I described above, it probably doesn't take a small adjustment to get the house prices falling? Remember, the absolute levels of fundamentals have not really changed. But SSB doesn't have the time or the resources to overhaul the whole model. No, this calls for something like the opposite of deus ex machina ("diabolus ex machina"?). Enter the "strongly negative sentiment".

Here you have KVARTS, version 12/13. Finally able to see a house price decline, although only as a consequence of people's irrational fear and pessimism. It's very convenient, because it means that you don't really need to change your model for it to match reality, do you? The model is pretty much correct as it was, but the problem is with the reality; there are some irrational short-term fluctuations caused by strongly negative sentiment. In plain English it means "people have got it all wrong", and in plain Norwegian something like "folk har tatt feil". Because this sentiment doesn't match the real reality (?) suggested by the fundamentals, the effects will be short-lived, and soon enough we're back on the upward trajectory suggested by KVARTS.

SSB, please correct me if I got it all wrong?

What I think has changed in the economy, in reality, is the rate of change in the fundamentals. Like I showed in my previous post, SSB knows this - everyone knows it. It's called "utflating" in Norwegian and it's been going on throughout the year, not just in the autumn when the sentiment became increasingly negative.  It's the flattening out that increases pessimism among (heavily indebted) people. It's fundamentals driving sentiment (although this smells like "the chicken or the egg"). People are not stupid. When the growth slows and turns even a little bit negative, they get more pessimistic - for a reason. People got pessimistic because of a suddenly cooling housing market and real house price decline, and the price decline was due to other fundamental factors which even a real estate broker has admitted. They also got pessimistic when they heard (last winter?) that economic growth is slowing down in Norway.

To me it seems the change in the rate of change in fundamentals is clearly not captured even close to the extent it should be in KVARTS. The "bust" in boom and bust is totally missing here? Again I point out, as my amateur opinion, that a model heavily informed by what happened in 2008-2009 might be too robust, especially if that's the only real "bust" that falls within the data period. As far as I know, KVARTS uses data back to 1995, and so ignores the housing bust of late 80s and the recession that followed it.

Ådne Cappelen and Thorbjørn Eika at SSB, please read some Hyman Minsky, will you? Especially the parts where he talks about how a stable, robust economy invites instability by making people take oversized risks through oversized debt? It seems to me that in your model you have build the most robust economy ever, and if it doesn't call for too much leverage, and thus instability, then I can't see what would? I know, you can't incorporate these things in your model, even though you might think there's something to it. Well... Fuck the model? At least it should come with the same warning stickers cigarette packs have on them. "The Norwegian people, in aggregate, are probably smarter than KVARTS."

Feel free to share this, because I'd really like to hear some opinions from experts on all this. (Twitter: @catonyourface)





(I can't resist the temptation to float a "conspiracy theory" here: Was the time and resources needed to adjust KVARTS the real reason for SSB not giving out a forecast in September? The timing might be a bit too early, though.)

The Death of Economic Cycles

I guess I could say I was born under a lucky star. In the year of my birth, 1979, Businessweek published as their cover story a now famous article "The Death of Equities". What followed was a revival of equities, culminating in the dotcom bubble of 2000. If you bought in 1979 and sold in early 2000, you made a fortune. The big picture is that the standard of living  in the Nordics has mostly been improving during my lifetime (there was a fairly deep recession and house price declines in the late 80s/early 90s, though). It seems that with higher standard of living comes higher house prices, and household debt. One could ask if we have had it too good.

But let's move to the subject. Mark Thornton, an economist, who wrote about the Norwegian housing bubble already in January this year (on my birthday, of all days!), has written a short update on the situation in Norway. In it he links to my blog reports as evidence that Norwegians have entered the "denial phase". I think he's right in that there seems to be a widespread denial of the possible - even likely - negative consequences of the house price decline that has just started.

 It seems that nearly every driver of economic growth is expected to flatten out. An extreme example of this is this Dagens Næringsliv interview with Rune Bjerke of DNB where the leader of biggest bank confirms that

• investments in new houses [due to declining house prices, I assume],
• investments in the oil sector,
• private consumption, and
• investments by companies in general,

...in other words all the main drivers of economic growth, will more or less flatten out ("flate ut"). "Flate ut" has become a real catch-phrase in Norway during the autumn! It reminds me of "boligfest", housing party, which was all over media just a year ago, but is now gone. It referred to the rising house prices and the related "wealth effect".

What Norway has gone through during the last 20 years could be described as some kind of "Golden Age". And especially the last 3 to 4 years - after the massive worldwide fiscal & monetary stimulus managed to turn the looming, deep downturn into a prolonged boom in Norway - have been seen even as unhealthy (for example, in the article Bjerke talks about healthier, more sustainable housing market and oil & gas sector, referring to the high growth rates of past).

All this takes me again back to Irving Fisher and the "permanently high plateau" of stock prices in 1929. After admittedly unsustainable, even unhealthy growth in house prices and oil & gas sector, what we should expect according to Bjerke and Statistics Norway (see my previous post) is a couple of years of simultaneous flat development in any imaginable indicator in the Norwegian economy, followed by... new growth. And the reason for nothing really going wrong in the coming years? I know I will be underestimating their intelligence, but it sounds to me like the reason is that things are so well in Norway today. Salaries will keep on rising at 3-4 % p.a. and continued work-based immigration will keep demand for housing high. All this despite lack of growth and investments, declining oil price and increasing unemployment. 

Like I mentioned, Statistics Norway even assumes that the oil price will decline over 20 % during the next two years. According to Bjerke and SSB, as well as many other experts in Norway, things just flatten out at all-time-high levels after a long period of substantial growth. There are exceptions, like Nordea Bank (who expect 15-20 % house price decline), but even in their forecast the word recession is nowhere to be found.

In my amateur opinion, based on the decline in nearly all indicators, the base scenario for Norwegian economy in 2014 should be a recession. Unless, of course, one assumes that the economic cycles are dead.

I must finish with a side note. The Norwegian people, experts and media are looking for reasons behind the house price decline, and as I have already mentioned, pessimism is very high on the list of suspects. It's the negative media and all these "doomsday prophets" (forecasting a 15-20 % house price decline makes you one) that are causing the negative spiral. Am I seen as an enemy of the public? Who knows.

The truth is that you need "pessimists" (people suspecting a bubble), and many of them, to avoid a bubble. And you need them to feel free to air their opinion in the media, early on when the prices have taken off, without being branded as doomsday prophets or pessimists. And some people actually need to heed this advice. This has not been the case in Norway, and as a result the public opinion has been the most complacent I've ever witnessed. This complacency, lack of concern, is one of the reasons for what is most likely a housing bubble. Two years ago the previous prime minister, Jens Stoltenberg, tried to warn against a bubble. He tried to affect the sentiment that was too positive. But it seems no one paid attention. Now the widespread concern for "too pessimistic" media coverage just speaks for the underlying concern for a housing bubble. A change in sentiment doesn't take a healthy market down, but it will always help to bring down a bubble.

Reality Hits Statistics Norway

As I reported earlier, Statistics Norway didn't have the resources needed to perform a house price forecast in September, just when it started to be clear that the prices are heading down. Fortunately they have put their house in order and came out with a forecast last week:

Source: ssb.no (in Norwegian) (Sep'13 forecast is my assumption of what it could have looked like...)

It seems they have abandoned all hope for a price increase in 2014. But Norwegian "wealth effect recipients" don't need to worry, as SSB has also abandoned their linear extrapolation. It's going to be a nice little dip, a lot less steep than in 2008-2009, and then the sky is the limit again?

I read the report, searching for a good explanation for the shortness of the dip, and this is what I found:

The Norwegian economy is going to perform sub-par ("lavkonjuktur") throughout the forecast period (2014-2016), with GDP growth at 0,7 %, 2,1 %, 1,9 % and 2,5 % in 2013, 2014, 2015 and 2016, respectively. But despite this sub-par performance, income growth will remain high, which will give new support to house prices when the usually short-lived (according to SSB's model) psychological effects wear out.

I have to note that SSB expects (Brent) oil price to decline gradually throughout the period and to end up at around USD 90 per barrel in 2015. I will not go into more details, but the overall picture is that nearly everything seems to just flatten out nicely. More about this in my next post!

An Answer To Christian Vammervold Dreyer

Christian V. Dreyer, the leader of an association for Norwegian real estate brokers (EFF), writes in his latest blog post about the falling house prices. He himself has worked as a real estate broker/agent in the past. Now, is there any sense in arguing with a real estate broker about a housing bubble? After all, Dreyer and EFF are not hiding their agenda, which is to work for the benefit of real estate brokers. Real estate brokers usually lose jobs if house prices drop in any significant way. House prices can drop in a significant way if the majority of people expect them to do so. Dreyer and EFF thus have all the reason to tell people that house prices will not drop in any significant way and so it's safe to buy.

I write this post for two reasons. One is that Christian Dreyer is presented as an expert even by the financial media in Norway, and so gets his message through to people. The other reason is that many other experts, or "experts", are using arguments similar to Dreyer. It's like the whole country is full of real estate brokers? Perhaps that's what you get when over 80 % own the house they live in and are lured by the "wealth effect" of ever rising prices.


An Answer To Christian V. Dreyer

In his post Dreyer first goes through some reasons for the current price decline:

1. Strong and sustained house price increases which have lead to high household indebtness.
2. Higher bank capital requirements set by the authorities.
3. Increased inventory of dwellings for sale, due to slower demand and a glut of finished new home projects where speculators/"flippers" (!) want to sell and people moving in sell their old homes.
4. First-time buyers having difficulties with entering the market (due to high prices and increased equity requirement, I assume).

I mostly agree with these, so I won't go through them in more detail. It's nice that we can agree on something. But then comes the conclusion. Dreyer argues that the above-mentioned factors have led to the media taking a negative view on the housing market, and this media coverage and the effect it has on sentiment are the real culprit behind the price decline. Sure, psychology is an important driver of the market, like I have mentioned on many occasions. But I don't understand why Dreyer goes through all these more fundamental reasons for the decline only to say that in the end it comes to sentiment (psychology), while at the same time he admits that this change in sentiment is a result of the more fundamental factors he just presented?

Or perhaps I understand. After having put all the blame on sentiment, he goes on to argue that the strong fundamentals of Norwegian economy will in the end win over the negative sentiment. There has never been more people at work in Norway, never have we had more purchasing power. Low interest rates, low investment in new housing and low unemployment, he argues, will make sure that the prices will soon rise again.

So, no matter how high the prices have got, they are safe from a significant decline because of strong economic fundamentals? The problem is that bubbles are never formed when the economic fundamentals are weak. Currently strong fundamentals can never be an argument against a bubble that can burst in the near future. Quite the opposite, you get a bubble when the absolute majority of people think like Dreyer thinks - that this can't be a bubble. And that happens when the fundamentals are at their strongest and the future at its rosiest, just when the Dreyers of this country think that nothing can go wrong.

What Dreyer also forgets here is that sentiment affects fundamentals, just as well as fundamentals affect sentiment. A positive feedback loop between sentiment and fundamentals has taken us to where we are in Norway today. But you can't have the cake and eat it too. So when the sentiment turns more and more negative as it has done now (and this is not just true about house prices but also about the economy), it will start to affect the fundamentals as well. Anyone with a basic understanding of bubbles should know this.

My conclusion is that Dreyer has no valid arguments when it comes to the question of if this is a bubble that has started to burst or not. At best, he manages to present many facts that actually speak for a bubble.

This Is Not a Peter Schiff Fan Blog

I want to bring this subject out of the shadows of the comments section on my previous post and open up my thinking on money and credit.

This is not a Peter Schiff fan blog. But this will neither be a fan blog for "serious, academic economists", who in my opinion have been dangerously out of touch when it comes to the implications of the massive credit expansion of the last 30 years, credit which has been used increasingly for purposes of pure consumption or, at best, low/negative return investments. My limited understanding is that we have been bringing forward a lot of future growth through this credit expansion. Excess "borrowing from the future" is made possible by the fact that no one knows how much growth lies in the future. What we can be sure of is that a) it's less of it there now that we have brought it forward, and b) it only takes some greed and optimism - basic human characteristics - to borrow too much of it. This is my "big picture", which makes me quite pessimistic about future growth (if we first don't see creative destruction à la Joseph Schumpeter), and it makes me see more "bubbles" around the world than the average person.

I recently read a speech by Adair Turner ("Credit, Money and Leverage: What Wicksell, Hayek and Fisher knew and modern macroeconomics forgot") and it was an important confirmation to me that I've been onto something in my thinking the last couple of years - and it made my thoughts more structured. (I found it thanks to Buttonwood/Philip Coggan of The Economist who linked to this speech in his blog post.)

If there is one writer I seem to agree with surprisingly often, it is above-mentioned Philip Coggan. His book, Paper Promises, reflects quite well my thoughts on the subject. I can highly recommend it.

I also appreciate hedge fund legend Ray Dalio and his thinking on the subject of money and credit. You can find his original text "How the Economic Machine Works: A Template for Understanding What is Happening Now" here, and a simplified Youtube version here.

These are just random examples of people who have influenced me greatly through their writing, and I should definitely mention Bill Gross (of PIMCO), Howard Marks (of Oaktree Capital) and Nassim Nicholas Taleb as well.

So, overall I think we have too much debt in the world. The moral hazard related to no one possibly knowing how much growth lies in the future and so no one being able to set a limit to how much of it we can bring forward through credit-driven consumption and commitments related to pensions and health care has enabled us to live way beyond our means. (I'm not exactly repeating anyone I know, so I don't know if I've got it all wrong)

I just think that there has been a deficit in "sound money" thinking in the world during the last thirteen, if not thirty, years. There will no doubt come a time when we will have a deficit in "loose money" thinking. But because of the experimental, exceptionally massive fiscal and monetary stimulus we saw in 2008-2009 (and one might argue we've seen since 2000), we never really saw that deficit in loose money thinking take place (at least not for more than a couple of months). We have opted for fighting problems related to excessively loose money with even looser money. People wiser than me argue that it's the right thing to do, while other people wiser than me say it's wrong. I'm just very suspicious of this strategy because it is 100 % compatible with avoiding short-term pain, which is something that is very much hardcoded in our brain but often leads to inferior long-term gain.

Does this make me an "Austrian"? You decide. But I don't want to hold on to any school of thought, at least not indefinitely. To me the answer, like usually, lies somewhere in between.

Norges Bank Prepares Public For Downward Reaction In House Prices

Central bank governor Øystein Olsen in a Bloomberg interview:

Olsen signaled the bank is ready to tolerate sustained house price declines in response to Norway’s financial imbalances. The public should be “prepared” for a “downward reaction” in house prices, he said.

“It’s important to realize, especially for households, there could be a reaction downwards in prices over a longer period without the economy entering into a recession,” Olsen said. “Even a drop on a yearly basis on house prices doesn’t have to spur any chain of negative impulses throughout the Norwegian economy.”

I must say I experienced a relatively strong déjà vu feeling, being familiar with what Ben Bernanke and other Fed governors thought about the U.S. housing market in 2006-2007 (for instance, see here and here). I naturally appreciate (surprise, surprise...) the tough stance Olsen takes against further house price and mortgage growth, evident in his comment from the same interview:

“We’ll be concerned if housing prices and debt levels continue to grow. It doesn’t have to be a concern with a moderate downward reaction in housing prices.”

I already expressed my concern with this in a post on March 17, 2013: "As far as I know, the authorities around the world have always been several steps behind in these situations. To me it makes sense that since it's so hard to tell a bubble (otherwise we wouldn't have them), at the time the authorities are confident enough to take tough actions the bubble is already too apparent, and so the actions from authorities serve rather as a pin to burst the bubble. In trying to be counter-cyclical, the authorities many times end up being pro-cyclical."

The big question is: What will happen to the economy when a people with a debt to disposable income ratio of over 200 % faces a "sustained house price decline" after an all-time housing bonanza? It might be that we don't need to wait for that long to find out. Meanwhile, we'd better pray that slowing oil sector - not to mention oil price - won't give us a "double whammy".

Public Service To Public Employees

Dagens Næringsliv writes today about the Norwegian Public Service Pension Fund's (Statens pensjonskasse, SPK) mortgage offering for the members of the fund. There are around 500 000 members (10 % of Norwegian population) who all have access to a mortgage rate of 2,227 % which is 1-1,5 percentage points below what private banks are offering. Whole 83 % of the loans SPK has extended are refinanced mortgages originally from private banks, and SPK lending has grown by 47,2 % during the last year.

I'm sure there is a perfectly good explanation for this, but I can't avoid the feeling that something might be wrong here?

I googled a bit. When you search for "statens pensjonskasse", the top search result links directly to their mortgage page, not the start page (which comes as second). Funny? There it says that the maximum loan amount per member is around $290 000, and twice that if there are two members in a household. So there's a limit, which is good - but you can top that loan with a loan from a private bank. You only get loan worth 80 % of the market value, so you have to come up with the 20 % yourself - at least I hope so, but I wouldn't be too surprised if there are ways around this (the comments field is open for people who might know something about Husbanken?).

I'm not an expert in political life, but I would assume that this is a way to reward the public employees while keeping their base salary in check? What I don't fully get is

• why the state is inflating the housing bubble through this measure while trying to restrict the bubble by raising the equity requirement in private bank loans from 10 % to 15 % and setting a higher risk-weighting for mortgages in private banks?
• why the equity requirement (20 %) is higher than the one the state wants private banks to apply, leading to a higher hurdle for employees with more limited means?

If I was a public employee with 15 % of equity on my savings account, I would ask why I should go to a private bank and pay 3,7 % interest or more, while my colleague with 20 % of equity gets 2,227 %. But I'm not. That's why I just ask: Wouldn't it be better that the public employees would all get a raise and  go to the private market when they need a mortgage?

Deposit Insurance Doesn't Cover The Market Value of Your Home

One often hears that paying back a mortgage is a form of saving. And I won't argue against that. What I will argue is that it's far from the same thing as putting your money on a savings account, a mistake which many people seem to make when they analyse the costs related to renting vs. buying.

Again, it helps to understand this if you see that it's possible that house prices will one day decline. Yes, you save by reducing your debt to the bank. And after each payment, you might think that you now own a slightly bigger portion of your own home, and that it's the home where your savings go - like into a huge piggy bank. But it's a piggy bank you one day might find empty, reminding you of the time when your big brother was badly in need of some cash.

Many people accept the rule that you should not see your home as an investment, and you should not look at the market price and calculate how much "profit" you have made. You anyway have to live somewhere, so it's hard to take any profits out, given that you're not willing to start renting. So if you have bought your house for $300,000 and now the market price is somewhere at $400,000, you should not conclude that your net worth / savings have increased by $100,000. The market price might not be at that level when you're going to sell, or your next home might cost $600,000 whereas the price of the same dwelling was $450,000 when you bought your first home. So you might actually be worse off because of the overall price increase in the market. In that case it's hard to see how your savings would have increased due to the increase in the market value of your home?

If this is so, then surely the same logic has to apply to your oversized piggy bank? It would mean that its financial value to you is not connected to the market value in any straightforward way. And this is why you should look at your mortgage amortization rather as honoring the promise to pay the bank the borrowed sum in full, and keep that balance separated from your savings balance. After all, when the market value of the house equals the amount you still owe to the bank - which was reality for many Norwegians last time in early 1990s - your piggy bank is empty.

It's good to have savings when the rainy day arrives. But when dark clouds start hovering over Norwegian housing market, the savings you thought you had in your house might not be there.

Two Nobel Prize Laureates Have "Seen It Coming"

If the Norwegian housing market turns out to be a bubble, we're not able to say "No one saw this coming!". Not just one, but, as of today, two Nobel Memorial Prize laureates in Economics have warned that from what they have seen, it looks like there is a housing bubble in Norway! (As far as I know, no one has asked the other laureates what they think...)

Robert Shiller, who got his Nobel Prize today, expressed his concern already one year ago.

In May this year it was Vernon Smith's turn to warn Norwegians about a housing bubble while on a lecturing tour at University of Oslo.

What makes this even more serious is that these gentlemen have devoted much of their time to studying bubbles and market mechanisms that lead to bubbles. So we're not talking about opinions expressed outside their domain - these are some of the foremost "bubble experts" in the world. It's not like Paul Krugman sharing his opinion on the Scandinavian snus (tobacco) producers' finances.

Come on, Torbjørn Eika and Jan Ludvig Andreassen! Can't you even admit that it could be a bubble?

Warning To First-Time Home Buyers

There are a lot of smart, young people out there who are finishing their studies, starting in their first jobs - and buying their first apartments. Buying your first apartment as soon as you have a salary slip to show to the bank is an important ritual, especially in Norway. Like I mentioned in my recent post, only students and other people who can't afford to buy are thought to be on the rental market. It's always smart to buy. Why would you pay back someone else's mortgage? Real estate is a safe and sound investment.

This is something that very few young people question nowadays. And I don't blame them for that. Their parents don't question it, having lived through the 20-year (so far) bull market in house prices. The Norwegian media doesn't question it - neither do most of the experts they interview. And neither do the politicians question it: the new government wants to reduce the 15 % equity requirement connected to purchases, just to help first-time buyers to get on the market.

But if you are one of these young people, I want you to think of the following.

First: If you rent, most of the money you pay to your landlord goes to pay the interest on her mortgage and the monthly common costs - exactly the same costs you would pay as the owner of the apartment. In many cases this can be close to 70-80 % already, perhaps 90 % at extremes, as the rental prices have not been following the overall house price appreciation.

Second: If - and no one in their right mind can deny the possibility - there is a price decline in real estate in the coming years, you might very well be a lot better off by waiting, renting and saving equity for the future purchase. In the worst case scenario, where house prices would decline by 30-50 %, you would be making the costliest economic decision of your life by rushing to buy now. So the 15 % equity requirement might be there also to protect you. And the people who say they want your best by taking it down might actually end up hurting you. This includes people like Erna Solberg and Christian Dreyer who say they are concerned about you not getting on the market. I consider them idiots for saying that, and it makes me really angry when I see this nonsense repeated time after time in the media. The whole idea of helping people to buy is based on the assumption that house prices will keep on rising significantly while young people are renting and saving for their first home. This is so 1995-2012. It's not the case anymore. You can afford to wait. In addition, house price bubbles are made of this shit - helping people to buy. It happened in the US around 2000-2006, and a lot of the people who were "helped" to buy actually got hurt.

Third: A possible house price bubble will hurt the first-time buyers the most, always. Not just have the older generations "robbed" you by awarding themselves generous pension plans that you're going to pay. They are trying to rob you - and most probably have already succeeded - by selling their overpriced homes to you, having themselves bought them cheap decades ago.

Fourth: If you can overcome the stigma related to renting (you need to be strong), you should be able to look at all the positive things that come with renting. Possibilities to test different parts of the city before settling down. Freedom to move abroad on a whim and not look back. And no financial risk if something goes wrong with the house.

I'm living in a rental apartment and saving for my own first home. And I'm concerned about you. Not because you might buy, but because you are not getting the balanced advice you deserve. Because all these more experienced people are taking the risk that they might actually end up hurting you.

Sometimes it's smart to rent. If you agree, why not give it a try - you have very little to lose.

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UPDATE 1:

I will continue my list of "idiots" after reading this article:

http://e24.no/makro-og-politikk/slik-maa-solbergs-regjering-overkjoere-finanstilsynet/21604510

Michael Tetzschner, Christian Tybring-Gjedde, Ola Elvestuen, Hans Olav Syvertsen, Peter Batta, and once again, Christian Dreyer. I find this disgraceful, politicians teaming up with real estate agents to help people with limited means buy homes so that there would be no "class differences". This brings to my mind the infamous case from the US where Mexican strawberry pickers got to buy a house for $720,000...

If the government really wants to help first-time buyers, it should fund a building program - lower prices, not bigger loans, are what these young people need. There is of course a big risk that this would deflate the bubble and lead to a recession... So better keep on granting bigger and bigger loans and hope the bubble will never burst? Unfortunately it will always burst in the end.

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UPDATE 2:

http://www.businessweek.com/news/2013-10-01/norway-to-tackle-record-consumer-debt-with-tax-breaks-for-savers

“I don’t think that we have too large of a private debt problem in Norway but we will create tax relief on savings,” Erna Solberg, leader of the Conservative Party and incoming prime minister after winning the Sept. 9 election, said yesterday in an interview after agreeing to form a minority government with the anti-tax Progress Party. “The policy will be to get more people saving for the future.”

Thank you, Erna! 

Mainstream Media Spread News About House Price Decline

It has been a busy day for Norwegian media. Stories about the new minority government (revealed last night) have naturally taken most of the space, but throughout media there has been another fairly big story: House prices are declining. (see for instance here, here and here) The amount of coverage suggests that this will probably have a real effect on the market. There will surely be follow-up coverage in the coming weeks and months (experts speaking for, and against, a price correction) which will reach the audience even better than today.

The narrative has changed totally in such a short period. There is no more easy money to be made. And there's more and more stories about declining rental prices in face of oversupply. Just wait until some investors get in a hurry to sell at the top, like I mentioned in March.

There was another top story: Olav Nils Sunde, a shipping magnate, has bought a 1187 square meter apartment in Tjuvholmen, Oslo, paying a record $33,200 per sq m, for a total price of $39,400,000! Time will tell, but he has a chance of becoming a legend by marking the top of the 20-year bull market in Norwegian house prices.

Today's "No reason to panic" explanation for price decline came from Christian Dreyer of EFF (a national agency for real estate agents): He says (in my own words) that prices are not going down because of reduced demand but because of increased supply, in other words the market is functioning well.

Whatever is the reason, it's good to remember what is the most relevant indicator for future price increases: recent price increases.

(I believe I'm quoting perhaps the foremost expert on housing bubbles in the world, Robert Shiller, but I can't find the source at the moment - please see his great article on house prices here)


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In case someone missed this last year, Robert Shiller has had a look at Norwegian house prices:

Robert Shiller, professor of economics at Yale University and co-creator of the S&P/Case-Shiller home-price index said that the Norwegian government "should start worrying now."

"This is a reason to expect an unpleasant end to this bubble in Norway. That is what I told them then, " Shiller told CNBC on Tuesday, alluding to a presentation he made in the Scandinavian capitals of Oslo, Copenhagen, and Stockholm in January in which he warned of the impending housing bust.

Rather than learning from its European neighbor Spain — where a real estate bubble saw home prices rise 44 percent from 2004 to 2008 before the bubble burst, leaving not only eerily empty properties and Spanish ghost towns , but domestic banks with billions of bad loans — Norway is letting its economic success go to its head, Shiller said.

"My suspicions are Norwegians are infected with a success story for their own country that makes high home price increases seem plausible to them, " a success only aggrandized when compared to its economically ailing euro zone neighbors, he said.

"They feel smug in their superiority with regard to the European crisis. They didn't even join the EU, let alone the euro. They don't have to bail out any irresponsible southern countries, " Siller said. "They have North Sea oil . They have low unemployment . [In short] they are doing everything right, and lots of people want to come to Norway."

However, Shiller notes that there is a paradox in the Norwegian success story.

"Norway is just about the last country to expect a housing bubble to appear, at least not a rational bubble, since it has so much empty land, " he said. "If home prices get elevated, there should be a prompt supply response, new houses will be built, bringing prices down, unless there is some kind of political or zoning problem. Even such political problems tend not to last forever. "

http://www.cnbc.com/id/49443611 

Statistics Norway Unable To Forecast House Prices - Lacks Money

No, seriously. According to this article, Statistics Norway (SSB) has exceeded its budget (due to budget overrun in new SSB website development) and can't publish forecasts in 2013 as often as it's done before. While waiting for Torbjørn Eika to come out and let us know what he thinks of the house prices going forward (which he must do, as this is an eagerly anticipated report?!), I'll extend SSB a helping hand:

SSB House price forecast for 2013-2016 - September 26, 2013

A significantly weakening sentiment in the real estate market during the summer has collided with a strong increase in supply of new dwellings, causing SSB to lower its forecast for 2013-2016 house price growth. Still, in stark contrast to the growing number of fear-mongering bloggers and so called "experts" (employed by banks) who anticipate falling prices, SSB expects a healthy growth in house prices during the next three years, driven by strong Norwegian economy and low interest rates.

So the party is not over, there's still enough punch in the fridge (which was upgraded last week, btw, thanks to a "reverse mortgage") to fill the bowl and no one can take away the hard-earned wealth of the Norwegian homeowner. We call this a democratic triumph, as 83 % of us own a house and the trickle-down effects will take care of the less fortunate 17 % - this is truly a tide that lifts all the boats. Hurra! Hurra! Hurra!

To Be or Not To Be (In The Market)

If you ask almost any Norwegian, everyone should be "in the market", i.e. own their home. To "enter the market" is the first goal of young people after they have secured a job. Only students and poor people are on the rental market. There is no place for price in this thinking, in the sense that it could very well be cheaper to rent a similar dwelling and still you just have to be on the market. Unfortunately I'm not even exaggerating, this time. Taken into account the extent to which taxation and society in Norway favors home ownership, it's hard to disagree with the masses on this. And in longer term, I don't. In shorter term, this is one of the most harmful versions of "conventional wisdom" I'm aware of.

This is what Wikipedia has to say about conventional wisdom:

Conventional wisdom is not necessarily true. Conventional wisdom is additionally often seen as an obstacle to the acceptance of newly acquired information, to introducing new theories and explanations, and therefore operates as an obstacle that must be overcome by legitimate revisionism. This is to say, that despite new information to the contrary, conventional wisdom has a property analogous to inertia that opposes the introduction of contrary belief, sometimes to the point of absurd denial of the new information set by persons strongly holding an outdated (conventional) view. This inertia is due to conventional wisdom being made of ideas that are convenient, appealing and deeply assumed by the public, who hangs on to them even as they grow outdated. The unavoidable outcome is these ideas will eventually not match reality at all, so conventional wisdom will be violently shaken until it doesn't conflict reality so blatantly.

"[I]deas that are convenient, appealing and deeply assumed by the public". Having an answer readily at hand without any need for thinking is convenient. Easy answers are also more and more appealing in a world where we face such an abundance of options, starting from how you want to have your sandwich or eggs. It's hard enough to choose the dream home, the best not just out of those available on the market but also out of the ones that might come to the market soon. It's almost impossible to spot the price bubble even if you have a master in economics, let alone if you'd have hard time explaining the word "inflation". It's not a consideration for laymen. All they can do is leave it to authorities to make sure that there will be no bubbles.

The idea that "it's always smart to buy" has very strong roots that have been strengthened along the way, not least during the last five years. If we start in 1987, the last time that Norwegian house prices crashed, how has the future treated those who bought at the top? Most of them survived and have done very well in the ensuing race to the current price level. No hard feelings there, it all ended well, and time has healed the wounds - wounds that felt no doubt a lot more real back then than they do now. So not even with these people does the story of a dangerous bubble live on.

No doubt it emerged people in 2008 who said you should wait with buying, and did so. And how wrong they were! The lesson is: "Just buy. Period." The models Statistics Norway uses are most likely heavily informed by this experience as well. Everything went wrong - oil price got decimated and financial system nearly collapsed - but house prices got only a small dent and recovered fast, and have not looked back. We are around 40-50 % above the bottom of that dip now. That's a very frightening thought, but only for people like me who think that the higher we get the bigger the fall later and the worse the consequences for Norwegian economy.

Taken into account what I write above, I understand how there are few like me. It just doesn't seem to make any sense to wait for the prices to decline. To suggest that is, if not stupid, just wishful thinking.

But none of this speaks against a bubble, does it? The conventional wisdom that it's always smart to buy is just plainly wrong as we know from history. It eventually leads to a bubble and will be violently shaken.

A Substantial Shift

I wrote my first blog post exactly one year ago, so I think it's time for a comeback after a long (slightly longer than even the Norwegian average) summer holiday. This time I have an excuse for my radio silence: my partner in life is now an honorable, respectable woman, and we don't live in sin anymore.

I feel tempted to say that the summer of 2013 marked a turning point also in the Norwegian housing market. The coming months will prove me right or wrong, of course. But consider this:

• The main banks (Nordea, and also DNB) see flat/negative price development in 2014 and 2015
• Real estate agents talk about "stabilizing" market with increased supply and less bidding
• Norwegian economy shows clear signs of slowing down and oil service industry is not expected to grow in 2014, compared with double-digit growth during last years

All this has brought us an environment where no one dares to take house price appreciation for granted anymore. Bi-annual research by Nordea (see above article) shows that while just six months ago 70 % of households expected prices to rise, in August only 32 % did so. I see a huge shift compared to just a year ago, when the general (SSB) expectations were for a 30 % price increase in the coming three years. It will be interesting to see where SSB will land in its next forecast.

Like I surely have mentioned before, SSB and the chief economists of the main banks will be among the last to tell you about falling house prices. It's just not in their interest to do so, and on top of that, they are the worst herd animals around - it's "If you're wrong and the others are right, you're out!" vs. "If you're wrong but the others are wrong too, who cares?". So it's safe to assume that they are fairly convinced of the price fall already.

When it comes to the talk about this "being good for the market, with supply finally meeting demand", I just ask: Weren't the sky high prices explained first and foremost by supply not meeting demand (see for example post about Erna Solberg, the new prime minister)? If supply finally meets demand, what will be the next thing supporting the all-time-high price level of  _____ (add here any - ANY - price per square metre)? Oil? New government? Unicorns?

Everyone has known for long that the prices are crazily high, but at the same time they have believed that there is a rational explanation, and that the prices will keep on climbing up. When all this is suddenly questioned, there will be consequences. Make no mistake about it.

Statistics Norway Calls The Housing Party Off?

In September last year I criticized Statistics Norway (SSB) for reckless behavior. I was more or less pissed at their forecast of around 30 % house price increase for the coming three years, because in my opinion it fed the overly rosy picture of Norwegian (1st and 2nd) home buyers and was helping to inflate a dangerous bubble. Well, a lot has changed since then:

It's hard to tell if they have decided to heed my advice, or if they have started to see some clouds in the sky, but I'd bet my money on the latter option. In just nine months SSB has moved from "Up, up, up!" to "Down, down, down.", when talking about the growth prospects.

By applying the same "linear extrapolation" that SSB presumably used for its Sep'12 forecast, to the rate of change between SSB's forecasts, you get an idea where we might be within the next nine months. But take into account that its latest forecast still assumes GDP growth of 3,0 %, 3,3 % and 3,2 % for 2014, 2015 and 2016, respectively, for Norway...

http://ssb.no/

Norway Is Not Alone

Norway is in a league of its own. Norway is special. Norway is lucky, for sure, but that luck is here to stay. It's the oil, stupid? We are all special - at least according to our mothers. And it's natural to find the explanation in the differences: "Yes, to an outsider it might look like a bubble, but...". But let's forget the differences for a while and take a look around the world.

Could it be that the biggest reasons for high house prices in Norway are similar to what other countries are experiencing around the world? Could it be that Norway is not that different after all?

New Zealand (with a population of 4,4 million) has fared well thanks to Chinese growth and, hence, the strength of Australian economy. This is what they write about the housing market there:

* RBNZ [central bank] sweating on housing bubble as prices hit records

* RBNZ mulls bank lending restrictions

* Rate hikes might be needed but would fuel soaring kiwi

* Loose global monetary policy pours capital into NZ

Sounds familiar? Can't raise interest rates because of the strength of the currency: check. Loose global monetary policy is the culprit: check. Bank lending restrictions: check. Central bank sweating on housing bubble: check. Prices hit records: check.

Canada, in many ways in a similar situation to Norway, having experienced a commodity-led economic boom, is seeing the housing market turn as we speak:

Mr. Carney said rapidly rising prices experienced in Canada over the past decade are “certainly not normal” and Canadians shouldn't count on home prices to be their main source of wealth gains.

“Real wealth is built through innovation, and it’s gained through hard work,” Mr. Carney explained in an interview taped before this weekend’s G20 finance ministers and central bankers meeting in Moscow. “It’s not through some magical asset inflation.”

           [...]

Canada’s housing market has been slowing since mid-2012. Housing starts and homes sales have come down, while prices appear to have peaked in many once-booming markets, such as Vancouver.

Canadians are continuing to add to their record debt levels – mainly through home mortgages and lines of credit – but the rate of increase has slowed substantially.

           [...]

Ottawa has tightened mortgage rules several times since 2008 to cool the market. But interest rates still remain at rock-bottom levels, as do borrowing costs.

And talking about the "Dutch Disease", it might be useful to look to the Netherlands in search for a possible future scenario for Norway:

Private homebuyers, for example, could easily find banks to finance more than 100 percent of a property's price. "You could readily obtain a loan for five times your annual salary," says Scheepens, "and all that without a cent of equity." This was only possible because property owners were able to fully deduct mortgage interest from their taxes.

Instead of paying off the loans, borrowers normally put some of the money into an investment fund, month after month, hoping for a profit. The money was to be used eventually to pay off the loan, at least in part. But it quickly became customary to expect the value of a given property to increase substantially. Many Dutch savers expected that the resale of their homes would generate enough money to pay off the loans, along with a healthy profit.

More than a decade ago, the Dutch central bank recognized the dangers of this euphoria, but its warnings went unheeded. Only last year did the new government, under conservative-liberal Prime Minister Mark Rutte, amend the generous tax loopholes, which gradually began to expire in January. But now it's almost too late. No nation in the euro zone is as deeply in debt as the Netherlands, where banks have a total of about €650 billion in mortgage loans on their books.

Consumer debt amounts to about 250 percent of available income. By comparison, in 2011 even the Spaniards only reached a debt ratio of 125 percent.

I'm sure we are all aware of the dire situation in Denmark and the talk about curbing lending in Sweden, so I don't need to go there.

In the end, it's all about loose global monetary policy and exchange rates. Like I've mentioned earlier, when countries like the US and Japan need to keep rates low and use unconventional measures (QE) to loosen the monetary policy even more, it has a big effect on countries like New Zealand, Canada and Norway, countries who have fared better than the US so far. You can call it "collateral damage" and rest assured that Messrs. Greenspan and Bernanke don't care about it. You have to save yourself.

I have an action for you today: Google "norwegian housing bubble" and have a look at the results. Isn't it a bit alarming that so many people around the world find the housing market of a country of 5 million people so interesting that they want to write about it, and not just that, but think that their readers find it interesting too? They are probably not aware of the peculiarities and strength of the Norwegian economy, so they find it amusing how a bubble of these proportions can go unnoticed by the home buyers and authorities, especially given that we all should know better after what has happened around the world during the last six years.

The Real Question

If someone says that arguing whether it's a bubble or not is most of the time retarded, I have to agree. But when the discussion really turns into nonsense is when the arguments for it not being a bubble are just arguments for prices being high at the moment. The usual stuff about continuing high demand and "them building not enough houses", you know. You can argue for hours about the future demand and supply, and the best you can arrive at is some kind of understanding of if there is a "bubble" in demand, i.e. the current demand is not sustainable in the future, or if there is shorter-term supply issue that will be solved (by building more houses in the coming years). But in no way does this address the real issue: the bubble in the prices.

Having seen how one-sided the public discourse on house prices in Norway is, I think it's best to explain a bit further. A financial bubble (in house prices, in stock prices, in tulips - you name it), or what I'd like to call simply too high prices, is always a result of high demand against a supply that doesn't fully meet the demand (supply that fails to keep the prices stable). If bubbles are a result of high demand vs. low supply, how can you tell a bubble or non-bubble by focusing on how demand exceeds supply?

The real question you need to answer to detect if it's a bubble or not is this:

What is a fair, reasonable price to pay for a house, and where does the market price stand in relation to this fair price?

It is a hard -if not impossible- one to answer. So, as Daniel Kahneman has taught me, we might substitute this hard question with an easier one focusing on the demand and supply, and by answering that question we think we have answered the ultimate question about if it's a bubble or not. But we haven't.

Try to ask someone what is a reasonable price for a house in Oslo. I don't have any accurate answer to it. But I can tell it's not

• what the market asks for,
• whatever amount the bank (including government & parental subsidies) is willing to give you,
• "any price" because real estate is always a safe investment in the long-term, or
• "any price" because Statistics Norway says house prices will go up until at least 2016 and I'll sell in 2016.

If you have no idea of a reasonable price, and instead rely on the bullet points above when deciding to buy a house, you risk paying way too much. Let's say during 25 years out of 30 it's fairly safe to buy. That might help you sleep at night, but it's still a big gamble to take when we talk about the biggest financial decision in many people's lives.

I have to admit that I don't try myself to answer the real question in any detail. I think you just can't know the answer. Instead I rely more on the "second-level thinking" I introduced earlier, trying basically to understand to what extent the buyers are being blind to the price (= follow the bullet point criteria above). Understanding this and the price of, and access to, credit is crucial in my opinion.

Beware The Hockey Stick Graphs

                               

                                (Source: SSB.no)

A shortage of supply or excessive demand? These are two sides of the same coin, so there is no sense in arguing which one is the primary cause of the house price appreciation of last 10 years in Norway. From the "hockey stick graph" above we can see that there has been a big increase in net migration, timing of which coincides with the economic boom in Norway (which in turn coincides with oil price appreciation). This net migration has lead to a rise in demand for housing.

The supply side of housing is always slower to adapt to a change in the market, so it shouldn't surprise us that there has been a lot of talk about "not building enough". This is the classical housing bubble cycle: Demand goes up - supply doesn't follow fast enough - prices go up. Supply follows with a lag, supply misses (due to the lag) the flattening of or decline in demand, which leads to oversupply and falling prices. As if it wasn't enough with this natural lag causing imbalances in the supply and demand, you can add to the equation the rising speculative demand due to rising (paper) profits through investing in a second or third (or 6th) house. And just like with the equity market, we have the biggest number of speculative buyers when the prices reach the top.

It is just impossible to know for sure where the above graph will continue, although it does seem that it is flattening out and there is also talk about increasing unemployment. I have touched the subject of oil price in my first posts, and that will have a big effect on the timing. But not just that. Even if the oil price stayed at the current levels, you will eventually get a decline in migration. That's because economic cycles never die.

My point with this post is that the current house prices are not based on stable, long-term developments. They are based on cyclical factors that have been quite extreme in the past 10 years. The outlook for European and world economy has rarely been as foggy as it is right now (many experienced investors can confirm this). This is a time to build some "nest egg" and prepare for a roller-coaster ride - not a time to count on a rosy future and get indebted like never before?

I end with an anecdote: Perhaps a year ago I read from Dagens Næringsliv of some experts who were expecting the prices in downtown Oslo to become so high that only rich people can afford them. They were drawing parallels between New York, London, Tokyo and Oslo. Downtown Oslo can end up like Manhattan, they were basically saying. We are now talking about a city which is surrounded by huge forests not more than a couple of kilometres from the city centre, and where they only now have started to build houses on a former airport, a 15 minutes' bus ride from the city centre.

I know that spotting a bubble is not this easy. I know it looked like a bubble already in 2006. But what we can be sure of is that if the bubble is going to burst during the next couple of years, we will have no shortage of ridiculous examples of how blind and stupid people were and how everyone should have seen this coming!

Of Banks And Politicians

To show you that I'm not politically motivated, I will now pick on the current Norwegian government led by Labor (Arbeiderpartiet). Oh, looking at the news it's impossible to miss the fact that the general election is approaching!

At least since 2011 the Prime Minister, Jens Stoltenberg, and the Finance Minister Sigbjørn Johnsen, have not been hiding (here and here) the fact they are very concerned about a possibility for a housing bubble. And even now they don't deny it, even though they might try to downplay it somewhat (you don't win an election by telling people living in a bubble that they are living in a bubble?). Anyway, the government has been working hard to make mortgages less profitable for banks, and legislation to achieve this is already on its way. Basically they are telling the banks that "if it's a bubble, you need to save yourselves, the government can't foot the bill". Well, how does an investor like a bank respond to increased risk? They ask more compensation for bearing the risk, in this case through higher interest rates on the mortgages.

How does the government respond in an election year when many banks tell their clients that they will take mortgage rates up 0,3 %-points initially (and that more may follow) and that it is due to demands from the government? The government gets furious! And the Finance Minister says banks are doing so good that there's no need to increase the mortage rates.

Do not expect any responsible behavior from the politicians before autumn 2013! And like in this case, if they have behaved responsibly earlier, expect them to deny it at least three times.

By the way, this news spells a lot of "bad blood" between the banks that compete for mortgage customers in Norway. Skandiabanken, which is a subsidiary bank of a Swedish insurance company, is reporting that during the last two weeks they have received a huge flow of mortgage clients from the banks (for example the giants DnB and Nordea) who warned about increases in their mortgage rates by 0,3-0,35 %-points. Skandiabanken tells that they are not thinking about increasing the rates, hinting that the doors are open for new customers.

This might get dirty?

Erna Solberg Lives In a Bubble?

 This interview is already 10 months old, but I stumbled upon it now and can't believe what I read:

Norway isn’t in the grip of a housing bubble and a shortage of supply in the property market will prevent prices from falling, said Erna Solberg, the leader of the Conservative Party and the front-runner to take over as prime minister in next year’s election. 

“I argue against a housing bubble because a housing bubble is an influx of prices without demand; in Norway it’s demand that’s the biggest reason,” Solberg, 51, said yesterday in an interview in Oslo. “I don’t think house prices will fall.”

When it comes to economic bubbles, if this is the level of understanding of a possible future prime minister, what can you expect from the people in general? (I know, many of you might say that you should expect more...)

How could you ever have a housing bubble without demand? Wasn't it too strong demand that took Norwegian housing prices to a bubble heights in the 80s? Wasn't it too strong demand that took the "dotcom" share prices to ridiculous levels in the late 90s?

Speculative demand is "the usual suspect" behind economic bubbles, and I'm quite confident that when the day comes that Norwegian house prices will lose 20-40 % of their value, people will point fingers at speculative demand fed by a common and - on the surface - a coherent story adopted by majority of Norwegians: "House prices will not decline because there is a shortage of supply".

There might be a shortage of supply, but the only thing that it has to do with a housing bubble is that it is the single biggest reason why the prices have reached a "bubbling" level. "Shortage of supply" means that demand has been and is right now bigger than supply. When people assume that this will not change in the near future, they assume that this situation needs to be corrected by increasing the supply, i.e. building more, and that it will take years. They make an assumption that demand will not get lower, which would of course be the other way to solve the problem of shortage of supply.

So people keep on lifting demand by buying "second houses" (to let) because it is clear to them that the prices will not get lower any time soon, and that buying now and selling when the prices flatten out is a smart move. Eventually supply picks up (you can witness this for example in Fornebu/Snarøya in Oslo) and more houses are built just so that more people could buy a second house, until there is an oversupply of houses for rental (and remember, it's smart to buy, not rent...). Suddenly, demand is the side of the equation that moves unexpectedly lower, because it doesn't any more make sense to buy the second house. It actually makes more and more sense to sell it instead, and so the supply increases while the demand decreases.

As you see, the process above is fully possible without any steep increase in interest rates or unemployment. That's why it is impossible to predict when it is going to take place. Perhaps just expectations of higher interest rates and higher unemployment is more than enough to bring down an overheated market?

The Problem With Basing Worst-Case Scenario On a Past Extreme

I will start with a quote from one of my favorite authors: Nassim Nicholas Taleb. In his new book, Antifragile, Taleb writes

[R]isk-management professionals look to the past for information on the so-called worst-case scenario to estimate future risks – this method is called “stress testing.” They take the worst historical recession, the worst war, the worst historical move in interest rates or the worst point in unemployment as an exact estimate for the worst future outcome.

But they never notice the following inconsistency: This so-called worst-case event, when it happened, exceeded the worst case at the time. I have called this mental defect the Lucretius problem, after the Latin poetic philosopher who wrote that the fool believes that the tallest mountain in the world will be equal to the tallest one he has observed.

You might ask what does this have to do with house prices in Norway? It's hard to blame anyone limiting their imagination to past extremes, when real house prices, ratio of house price to rent and ratio of household debt to income keep on breaking past records with nearly every month that passes. For more on these statistics, see a great paper, "Housing Bubbles and Homeownership Returns", from Marius Jurgilas and Kevin J. Lansing (2012) of Bank of Norway / San Francisco Fed. It's essential reading for anyone interested in the current situation. And by the way - and this applies especially to the "post-Reinhart-Rogoff era" - if an economics writer concludes that "Time will tell whether things turn out differently for the Norwegian housing market", you can fairly safely assume he/she suggests it's a bubble. They can't say it clearer than that if they don't want to risk public humiliation in the case the prices keep on soaring for five more years.

Now back to the title of this post. What I refer to with the "past extreme" is the banks' losses on mortgages in the last house price crash of the late 1980's. Despite a 40-50 % price decline, the credit losses for banks were minimal. You can call it "high Nordic morale" or "bad legislation favoring creditors", but people here will try to meet their loan commitments as long as they can afford to buy some food (or perhaps they would even steal food rather than miss a payment to the bank?).

The fact above has been widely applied as a kind of worst-case scenario, leading to a conclusion that the banking system is robust despite all-time-high household debt levels. Where does a conclusion that the banking system is robust and that mortgages have never created significant credit losses lead us? It leads to

1. low risk-weighting (loss expectations) for mortgages,
2. banks lending more and more (and more) to these "AAA-rated" households (banks make their profits mainly through lending, after all), and
3. finally to testing if the previous worst-case was really the worst possible (even if it was, see the problem I brought up in a previous post).

I applaud the latest move from Norwegian government to raise the mortgage risk weights to 35 % as an essential action to curb lending, but I remain very skeptical when it comes to the relevant question: Is it already too late in order to avoid a bubble? As far as I know, the authorities around the world have always been several steps behind in these situations. To me it makes sense that since it's so hard to tell a bubble (otherwise we wouldn't have them), at the time the authorities are confident enough to take tough actions the bubble is already too apparent, and so the actions from authorities serve rather as a pin to burst the bubble. In trying to be counter-cyclical, the authorities many times end up being pro-cyclical. But perhaps this time is different?

The Bubble Is Finally Confirmed?

Petter Northug Jr, the cross-country skiing hero of Norway, has finally shed some light on his plans for life after skiing career:

"It's likely I'm going to study. Most probably something related to real estate, since I think it's fun."

I think the irony lies in the fact that when he is done with the studies, the market might very well offer low prices again, which translates to good investment opportunities - but it's not fun anymore. Good times are fun. Bubbles are fun.

There are some rumors that Northug is investing in Florida real estate with a group of Norwegian investors. At least it's a lot better idea than investing in Oslo real estate, which I hope he has avoided. But even with Florida, I suspect that spotting the bottom of the market is not as easy as it currently seems. A good idea for the long run, surely, but it seems people are expecting quick wins. Charlie Munger of Berkshire Hathaway has said about investing:

"It's not supposed to be easy. Anyone who finds it easy is stupid."

 Fun and easy. As long as it lasts.

Slow, Second-Level Thinking

Many of you have probably, if not read, at least heard of the bestseller "Thinking, Fast and Slow" by Daniel Kahneman. For the purposes of this blog post, I just mention that "slow thinking" is something that is called for when making certain decisions where "fast thinking" is vulnerable to different kinds of biases - in other words, it's needed so that we don't get fooled by ourselves. It is thinking that requires sometimes considerable effort. That's the slow-thinking part of my title today.

What is a lot more relevant to this post, and comes from a book that should in my opinion be read by every person who wants to make investments, is "second-level thinking". It is something that Howard Marks, a renowned investor, calls for in his book "The Most Important Thing: Uncommon Sense for the Thoughtful Investor" (not as catchy a title?). This excerpt from the book explains the concept:

First-level thinking says, "It's a good company, let's buy the stock". Second-level thinking says, "It's a good company, but everyone thinks it's a great company, and it's not. So the stock's overrated and overpriced; let's sell."

By the way, Daniel Kahneman is also one of the gurus in the field of "behavioral economics", which

[studies] the effects of social, cognitive, and emotional factors on the economic decisions of individuals and institutions and the consequences for market prices, returns, and the resource allocation.

Very well. Now that we're in the world of slow, second-level thinking, let's examine how the situation in the Norwegian housing market looks like:

• The vast majority of people agree that real estate is a safe investment
• The vast majority of people also expect the house prices to continue their climb in the coming years
• There are very good explanations for the rise in house prices, presented daily by experts in newspapers, telling that there is no bubble and we shouldn't worry
• Mortgage rates are at historic lows and expected to remain low for years to come
• You'd struggle to find an economist in Norway who would publicly admit that there could be a bubble - the "no bubble" consensus among professionals seems to be very strong
• Norway is a rich country, so we can't be the next Ireland or Spain - oil has brought us well-being for decades to come

First-level thinker looks at the bullet points above and says: "It's a safe investment, there is no bubble, so let's take out the cheap loan and buy our dream house.".

Second-level thinker looks at the evidence and says: "Everybody thinks it's a safe investment, everybody says there is no bubble, so everybody takes out the loan and buys the dream house, and not just that, but also a second house to make some easy money. If no one thinks of the price, if no one fears a bubble, and the mortgage rates are at historic lows, then there must be a bubble."

The First Concrete Sign Of The Trouble Ahead?

First, I want to sincerely thank those of you who have given me feedback in recent weeks. Being realistic (some call it pessimism) is a heavy duty, and you need a break now and then. I'm happy to say that I'm back in business and full of realism ;-) Since my last post, there has been some interesting developments on many of the points I have brought up, and I can't wait to write about it. But I want to start with what I view as possibly one of the first real signs of the trouble ahead. As always, if you don't agree (or have something to add), feel free to share your views in the comments.

On February 16th, the "FT.com of Norway", DN.no, wrote about a downward pressure on rental prices in Oslo (Google Translate helps if your Norwegian is not yet strong enough). In brief: Nikolaos Farmakis, who has been interviewed for the article, works for a well-established rental broker Utleiemegleren. He tells about a case where he expects to be forced to lower the rental price by 20% for an apartment situated in one of the most popular neighbourhoods in Oslo when the apartment comes back to the market in April. This anecdote is supported by a study by Opinion Perduco showing that rental prices flattened out during Q4/2012 and that more prices are lowered than increased when looking at the price adjustments taking place on the leading rental website Finn.no. Farmakis also talks about the unrealistic rental price expectations of private, non-professional investors who are new to the market, causing some heated discussions between the broker and the house owner, and ending up in a disappointment for the investor.

To me it seems that there might be a worrying development underlying this downward pressure in rental prices.

If you combine a) the current, almost incredibly strong trust in increasing house prices among Norwegians with b) the easy access to credit and c) the fairly low return (although I'm very satisfied with the 3,7% I currently get) on savings accounts, you could expect that many households with extra savings (a rarity in these times) would be willing to become rentiers? This article is a prime example of what I'm talking about. Professional, experienced investors must have noticed that the return on rental investment is currently very low (DN.no recently wrote about how it makes more and more economic sense to rent instead of buying a home, and the article above has a calculation that shows you get more on savings account "risk-free" than you get by renting out an apartment), so I assume the main motivator for these investments must be the "total return", i.e. rent + expected increase in value over time. Some of these amateur rentiers might be counting on finding - a couple of years down the road - the famous "Greater Fool" who will offer them more than they paid, or then they just sincerely think that the prices will always appreciate.

There are at least two direct consequences for this kind of speculation that are already in effect:

1. These "second house" investors have increased demand for - and thus prices of - apartments on the already hot market.
2. They also reduce the supply of houses/apartments to own, and this increases prices when practically everybody wants to own, not rent.

What these two articles and the study might very well show is that we may already face the further consequences:

1. Speculation leads to oversupply of rental apartments while there has not been corresponding increase in demand for rentals.
2. This leads first to downward pressure in rental prices and, through lowered return for rentier, it eventually increases the supply of dwellings for sale when it makes less and less sense to rent out instead of selling and cashing in the value increase of previous years.
3. The supply of dwellings for sale increases while lower rents cause more people to rent instead of buying, leading to cooling house prices.

Makes sense? To me this kind of mismatch between rental prices and house prices is a classic sign that something is wrong in the market.