If the bubble bursts, it won't be devastating: the indicator ignored in 2008 that is now reducing real estate fears

BarcelonaFor a bubble burst to be catastrophic, it's not enough for prices to be skyrocketing, as is happening in the Catalan and Spanish housing markets, which have been reaching record highs for months. A large amount of hidden debt is also necessary. With the precedent of the 2008 crisis still fresh in the collective memory, the big question has resurfaced in recent months: Is there a housing bubble?

Few voices remain unconfirmed, and the consensus on the answer is overwhelming: there is a boom, but not like the one that swept the entire country away 18 years ago. A few days ago, Luis de Guindos, Vice President of the European Central Bank (ECB), ruled out that the rise in housing prices is caused by a bubble of easy credit, as happened in the 2008 crisis: "It's not credit that's driving up prices," said the former Minister of Economy in Mariano Rajoy's government. Last week, the Bank of Spain expressed a similar view: "There is no evidence of systemic vulnerability associated with excessive construction activity; on the contrary, the restraint in new housing production has contributed to putting pressure on prices," it stated in its latest report.Financial Stability Report

The truth is that the relevant question is not whether there is a bubble, but whether it is a credit bubble, which is what the latest comments from central banks have focused on. In fact, in 2015 the prestigious magazine Journal of Financial Economic –top three worldwide in financial economics– goes They published a study that established this framework after analyzing real estate and equity market bubbles in 17 countries over the past 140 years. "History shows that not all bubbles are the same. Some have enormous costs for the economy, while others dissipate. We demonstrate that what makes some bubbles more dangerous than others is credit," the study stated. paper academic.

And how do we differentiate it?

While in the 2008 crisis prices rose due to strong demand financed by credit, and families also fueled an over-indebted construction sector, now they are rising due to a lack of supply.

For the moment, there seems to be some consensus that there is a price bubble in the housing market. Experts consider that a market is experiencing a bubble when prices are disconnected from fundamental economic variables, such as wages or economic growth. To answer the question of whether there is a bubble similar to that of 2008, it is necessary to evaluate the role of credit, which leads us to the realm of debt and housing price indicators.

And credit?

The truth is that the measures the Bank of Spain has used to assert that there is no housing bubble like the one in the 2000s may not be entirely useful. After the 2008 crisis, banking and financial regulators reached a consensus: macroprudential regulation was necessary to prevent everything from exploding again. This meant, according to the International Monetary Fund (IMF), using prudential tools to ensure that imbalances in the financial sector did not lead to systemic risk. The chosen indicator was a very specific one: the ratio between the mortgage loan and the value of the property, known as the loan-to-value (LTV).

"One of the preferred macroprudential tools is to put a limit on the loan-to-value ratio (LTV, for short). loan-to-value"of mortgage contracts," explains Sergi Basco, professor of economics at the University of Barcelona, in his book Housing Bubbles: Origins and ConsequencesThe paradigmatic example is the current 80% limit on this LTV ratio: the loan that the bank gives (loan) cannot exceed 80% of the appraised value (value) of housing. This policy has been promoted by the IMF and several countries have implemented it. But what if this measure is not enough to prevent another bubble?

The problem with the indicator

Now, that 80% limit in the loan-to-value The macroprudential tool that was used after the crisis to prevent the systemic risks of a potential bubble, and which continues to be used by institutions such as the Bank of Spain, is being questioned.

"We have data at the municipal level and we see that the loan to value During the boom period, it was consistently below 80%, so we can say that a bubble formed despite this requirement being met. Therefore, the loan to value "It's not a good indicator for predicting a credit bubble," Basco explained to ARA. This is the conclusion he and Bank of Spain researcher David López-Rodríguez reached after analyzing the effect of the loan-to-value (LTV) ratio a few years ago. Even with a larger real estate bubble, this indicator did not exceed the 80% threshold. "If it's a bubble indicator, it should grow more where there was a greater increase in credit, and if you compare the two regions—where there was a bubble and where there wasn't—the LTV is that ratio," this researcher stated. He added that it's not a good indicator for predicting a credit bubble.

The role of the appraisal price

And that's where a suspect in the real estate boom that broke records this November comes into play: the appraised value of homes. Given the growth of this variable, it's even more pertinent to ask about the existence of a credit bubble. "There's a suggestive aspect to an appraisal—it indicates expectations of price changes in the near future. If there's a very high increase in appraised values, it could sound alarming, considering what happened in the 2008 crisis": one of the causes of the increase in mortgage lending during 2003-2007, the 80% limit of loan-to-valueIf the bank wanted to extend more credit, but the loan-to-value ratio (LTV) couldn't exceed 80%, there was only one way to circumvent the rule: inflate the appraised value. This is exactly what happened: agencies linked to the banks appraised properties above market value because this increased the 80% LTV, allowing them to extend more credit. This caused the appraised value to grow faster than the sale price.

And this could be determined using a more reliable indicator than the loan-to-valueand that instead of comparing credit and value, it compared value and sale price. This is known as value-to-price. "It's basically because, on the one hand, the level of this indicator did increase during the 2003-2007 boom in Spain - that is, the value grew more than the price - unlike the loan-to-value —which remained stable. On the other hand, because it did so more in the regions that registered the greatest price increases,” Basco asserts.

So, is there a credit bubble?

Now, sale prices are skyrocketing and appraised values are also rising, but the former are increasing faster than the latter, the exact opposite of what happened from 2004 to 2007. "What we're saying is that this indicator, which relates appraised value and sale price, reveals that there may be a price bubble, as some people suggest, but it's not caused by an increase in credit. 2015, when a bubble bursts accompanied by credit, has devastating effects on the economy," Basco concludes.