Download European housing crisis

The financial and housing sector correction in Canada
and Europe: Why so different? What does this mean
for recovery?
March 9, 2009
Millan L. B. Mulraine
Economics Strategist
Key takeaways
•
The spark for the global financial and economic crises was the sudden and
dramatic correction in the U.S. housing sector
•
Seeds of the crises were sown in the post-tech bubble era of easy credit
•
It could be argued that the European housing market bubble was much
bigger than in the U.S.
•
Exposure to the Central and Eastern European economies (CEEE) has
added another dimension to the European banking system crisis
•
The Canadian banking and housing sectors have been spared the sudden
correction that has plagued their European counterparts
U.S. housing bubble
•
Housing
– NINJA (No verification of INcome, Job status, or Assets) loans
– High risk borrowers offered exotic loans
– Speculation in home prices
•
Financial alchemy
– Old mortgage lending model discarded
– Mortgages bundled and sold
– The securitization of mortgages led to loose lending standards
•
The bottom fell off
– Mortgage defaults and foreclosures skyrocketed (jingle mail)
– Value of mortgage-backed securities (MBS) plunged
– MBS went from exotic to toxic
The bursting of the bubble
U.S. Home Prices
20
15
10
5
0
-5
-10
-15
-20
70
74
78
82
86
90
94
98
02
Median Price of Existing Single-Family Homes (y/y % chg.)
06
Banks take it on the chin
Writedowns Due To U.S. Housing Crisis
US$ 'billion
1,000
900
$850B
800
700
600
$494B
500
400
$327B
300
200
100
$29B
$12B
Asia
Canada
0
Worldwide
Source:
Americas
Europe
Why no Canadian banking crisis?
•
Market structure
– Deposit-oriented
– Conservative lending practices
– Captive market (oligopolistic in nature)
– Competition vs stability
•
Regulatory environment
– No allowance for domestic mergers (or foreign takeovers)
– Deposit and mortgage insurance helpful
•
Hit from subprime crisis manageable
– Limited exposure to U.S. MBS
– Modest domestic housing correction
Canadian Housing Price Correction Remains Modest
2005:6 = 100
135
125
115
105
95
85
75
65
Feb-99
Apr-00
Jun-01
Aug-02
Source: Teranet, National Bank
Oct-03
Dec-04
Feb-06
Apr-07
Jun-08
Canadian Mortgage Arrears Remain Low
%
0.75
0.65
0.55
0.45
0.35
0.25
0.15
Jan-90
Feb-92
Source: CBA
Mar-94
Apr-96
May-98
Jun-00
Jul-02
Aug-04
Sep-06
Oct-08
The bursting of the bubble
Canadian Home Sales Crash
' 000
45
40
35
30
25
20
15
Jan-90
Feb-92
Source: CREA
Mar-94
Apr-96
May-98
Jun-00
Jul-02
Aug-04
Sep-06
Oct-08
European banks being squeezed
US Housing
Crisis
European
Banks’ Pain
CEE Economic
Crisis
Domestic
Housing Crisis
European housing crisis
•
Housing boom
– Housing sector bubble bigger than the U.S
– Deregulation in the 1980s and 1990s, and Euro introduction
• Non-banks were able to issue mortgages
• Application procedure loosened
• Low interest rates
– Ireland, Spain and the U.K. main culprits
– Spain built more homes in 2006, than Germany, France and
(combined)
•
Credit-powered growth
– Credit binge bolstered economic growth
– Banks were more leverage than their U.S. counterparts
– EU lacks institutional framework to handle banking crisis
UK
1983
Source: IMF
1990
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Mortgage Debt to GDP
%
120
100
80
60
40
20
0
2006
European Real Home Prices
1997 = 100
300
Ireland
250
France
Spain
200
150
United Kingdom
Euro Area
100
50
1995Q1
Source: IMF
1997Q3
2000Q1
2002Q3
United States
2005Q1
2007Q3
Source: IMF
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House Price Gap
%
35
30
25
20
15
10
5
0
-5
-10
Economic contagion
•
CEE growth opportunity
– Credit-starved economies seen as “green pastures”
– Credit binge: credit flowed like water (over US$1.7T borrowed)
– Housing sector boom ensued
– Unhedged foreign currency loans soared (Euro or SWF popular)
•
The hangover
– CEE economies slowed
– Domestic currencies plummeted
– Debt-ridden consumers default
– Impact on Western Europe is expected to be profound
Liabilities To Foreign Banks
% of GDP
160
140
120
Others
100
Italian
Austrian
80
German
Scandinavian
60
40
20
Source: IMF
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Response betrays crisis
•
Fiscal response to CEE crisis
– Support for CEE economies an imperative
– Political vs economic costs
– Fortunes of East and West intertwined
•
National response to financial crisis inadequate to resolving a Euroean
problem
– Exposes soft under-belly of the EU financial sector
– May be a factor in exacerbating the problem
– Small countries suffer from inadequate scale and resources
The way forward
•
Coordinated fiscal response required
•
Canadian model has virtues that may be relevant
•
Unified regulatory/supervisory framework a necessity
– Financial
sector supervisory and regulatory functions remain
fragmented and need to be consolidated
– “Beggar thy neighbour policies” will lead to “race to bottom”
•
European financial stability fund?
– A number of countries has similar funding vehicles
The bottom line
•
Canadian housing and financial sector correction is expected to be modest
•
Mitigating the adverse impact of the economic crisis in the CEE will require
significant financial resources
•
Despite the aggressive actions so far, further losses and bank failures
remain likely
•
The way forward for Europe will be increased coordination in both fiscal and
prudential policies
•
A turning point in the financial crisis will come about when home prices
begin rising