Thursday, January 9, 2014

Paul Krugman vs. Erna Solberg

Paul Krugman has managed to stir some public debate again. He came to Norway and stated what almost any economist would state at this point -- pretty much what Robert Shiller had said already in 2012 and Vernon Smith in 2013 --, namely that this looks like a housing bubble. That makes it now three Nobelists. Krugman, who is not exactly a person who tries to avoid confrontation at all costs, must have been nevertheless surprised by what followed:

No other than the prime minister, Erna Solberg, replied to Krugman and denied the existence of a bubble. Norway is different and foreign economists don't understand it. The usual stuff.

And this time Krugman wasn't even provocative in his comments! It seems in Norway mere mentioning the word "bubble" is provocative enough? This reminds me of what Jeremy Grantham of GMO, a renowned investor, said in a Wall Street Journal interview:

"America is a very, very optimistic-biased society, as I believe, incidentally, Australia is, for whatever that means. We're the two great optimistic societies. You can have a conversation about a housing bubble in England, and they'll say, 'oh, is that right? Let me see the data.' If you have one in Australia, you have World War III! They hate you. They hate you for years! [laughs] The idea that you could suggest that they were having a housing bubble. [laughs]"

I'd say Norway compares with Australia in this matter. Overall, there's of course nothing bad in being optimistic. One could argue even the opposite. It's just that it's not really helpful if your goal is to avoid a bubble, is it?

Not surprisingly, it didn't take long until the "propaganda machine" of real estate brokers and homebuilders was lined behind the prime minister. I've got to say it amuses me how these guys, many of whose business has started to cool down and who believe in the "it's the negative sentiment, stupid" story (and continue to be proponents of the "we're not building enough" story), start tearing their hair out when faced with bubble suggestions and come out with their often weak arguments. Another clear sign of a bubble?

Guys, you can't argue against a bubble by just presenting the factors that prove that Norway is different. To argue against a bubble you need to show us how much higher price level those factors can support and that that price level is not yet exceeded. It's the price where the bubble always is. Your arguments could (and probably would) be used as well to justify a price 50 % above the current level.

The foreign economists look at indicators like price-to-rent, price-to-income and debt-to-income exactly because they don't want to get entangled in country-specific factors. You are denying the warning messages derived from these common indicators by relying on nothing else than country-specific factors. That often leads to a conclusion that "this time is different", and that's what these economists have learned to be afraid of.

So if you tell me Norway is rich, I say it's probably reflected in the price level already. Incomes are high? Debt-to-income is already around 210 %, close to world record levels. You say you're not starting to build new houses before 70 % of them are sold in advance? I say that this practice keeps the supply fairly tight, and a tight supply leads to higher prices. You think you can avoid a substantial fall in prices by keeping the supply tight? It's hard when you've contributed to the bubble with the very same practice. In addition, it's very hard to forecast the future need for housing, as work-based immigration to Norway is of cyclical nature. And forget the "people are moving into cities" argument. It's been the same in every country that has experienced a housing crash during the last 10 if not 30 years. This argument might very well have contributed to the bubble, like the bigger-than-national price decline now experienced in Oslo suggests.

In the article Erna Solberg is quoted arguing against a bubble by saying that in Norway there is one asset people put their savings in and take loans against, and it's housing. Isn't this a weakness, not a strength?

Denying a bubble outright is not smart. Being afraid of a bubble is smart. Former contributes to a bubble, the latter helps in avoiding it. So which one do you choose? Denying a bubble is of course a natural reaction from someone who is shit-scared of a bubble and thinks that negative sentiment can lead to a crash.

Let's face it. The government is obviously "very concerned with the housing market", as the outspoken new finance minister, Siv Jensen, told in October (neither denying nor confirming a bubble). This is fully in line with the concern for a bubble the previous prime minister, Jens Stoltenberg, aired already more than two years ago. So either Erna Solberg's comments were based on her private opinions, or then she is trying to calm people down. If the latter is true, we all should be worried. This is what Krugman probably referred to when he said that it's a sign of a bubble that politicians come out and say everything is OK.

I have a message to these people who use their expert -- or authoritative -- position to directly or indirectly push people to buy their first home or invest their savings in a rental apartment: If this turns out to be a bubble and there's a 20-40 % decline in the coming years, you should be ashamed. What you are telling people who are facing a big and very risky financial decision is that there's not really any risk there.


  1. I'm convinced that the people who insist that everything is fine know that they're lying and are just trying to wring every last kroner they can out of the suckers before everything goes to shit.

    1. Yup.
      Regarding the tendency of the Norwegian media to quote real estate brokers for their opinion that of course there is no bubble and it's an ideal time to buy a house, there is a very relevant saying: never ask a barber if you need a haircut.

  2. Does anyone know a place where, as a rule, a young graduate approaches bank with the first pay slip, for a loan? Maybe a Gulf country, but even there it wouldnt be related to the first pay slip, rather sudsidy would be in the form of grant(s) I guess?

  3. Is there any way to tell what the real estate speculators are doing right now? I have a feeling that the recent "reassurance" in the media about the housing market is an effort from the investors to dump their assets onto the market before the bubble pops.

  4. Since long before the norwegian election in 2013, I've felt that in his heart of hearts, Jens Stoltenberg is relieved to pass the prime minister job on to Erna, he has long since seen the indicators point towards a severe economic contraction.

    I think Erna knows this as well, but since she isn't an economic pro like Stoltenberg, she can fool herself along the lines of: Well, the contraction/soon to burst bubble isn't _certain_, and as long as it isn't, I better play the game of optimism, that may indeed turn out to solve things, by itself, in the end!

    And then she pours herself a drink;)

    A final point about Norway being "special": Because of the oil exports and an independent currency, Norwegian kroner has by and large been in demand since 08, which meant that our central bank kept the interest rate artificially low, in order to avoid a sky high Krone and thus dwindling exports. (QE-)money on the run from a world in economic contraction, pressured our krone, kept our interests rate down, and fed the norwegian bubble. And our status as oil exporter (and shallow media, and all the rest...) made it possible for this to go under the radar these past six years. And now, when things finally have begun to turn, we are in a worse position than we would have been, if the contraction had started in 08, when our housing prices and household debt were already too high. So we're special in the sense of having prolonged the party and intensified the coming hangover. Another drink, Erna! Cheers.

  5. Hello, fellow blogger! :)
    I has been in Oslo in 2003/4 during my exchange. It was a lovely city. Since then I have kept eyes on things going on in Norway. This blog open a new window for me. Thanks a lot. Currently I am studying finance in M. Phil level in Netherlands so I think it would be interesting to trace "bubble-alike" topic.
    Ok, brief introduction is done. let's get the question start!
    I am wondering whether foreign investors would be the major reason for this price surge. Asset prices are valued, with my understanding, its expected cash-flow and discounted rate(reflecting the risk). As many can see, the EU zone has been sluggish for long time and has been in short of investment opportunities. Nordic regions and its currencies, i.e. NOK, SEK and DDK are presented as a good alternative. When foreign investors convert their EUR to Nordic currencies, what they will put in next? Stock market is one, housing is another. Not to mentioned that in housing market they could take leverage to enhance return.
    So, if what mentioned above is true, then high price-to-rent, price-to-income and debt-to-income might be the result of foreign investment, not the result of a "bubble". When Case and Shiller(2003) mentioned about what bubble is they describe it as "excessive public expectations of future price increases cause prices to be temporarily elevated"

    I cannot read Norwegian yet. However, this is my question to ask: "Do local Norwegian people really expect the future price will increase and then have the anxiety to buy the house NOW? or they might be aware of the foreign investment influx and realize such price surge is merely temporary effects?"

    If the former one prevails, then it is really more like a bubble, otherwise, people do realize that such price level would some ebb away (when EU zone gets better) and then enjoy the low rent given in the current situation. Then, not really bubble is. It is just a shift among investors.

    And that is why I consider those ratios might not be indicative. Price-to-rent would naturally high since they are abundant housing supply and most Norwegian still do not need to buy house. Price-to-income would naturally high since those housing are not meant for local investors/buyers. Debt-to-income are certainly high since most debts are not carried by local individuals, they are carried by foreign investment vehicles, or covered by alternative names.

    I am not trying to say, "there is no bubble" or "price will continue to rise". What I would like to point out is, if there were a bubble and there were about to bust, where shall we looking at? Where was this price surge originally from? and would that vanish sooner rather later?