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?