Evidence Suggesting Source of Housing Crisis Not U.S.

A Freddie Mac study showing Western Europe had a more gaudy housing mania and collapse than the U.S. leads its authors to the conclusion that the bubble was not an American export. No mention is made of the role of the world's most powerful central bank holding rates at 1% for several years.

The Boom, the Bubble, and the Bust Abroad

By Chief Economist Frank Nothaft on February 14, 2011

The housing crisis this country has experienced over the past four years has been the worst since the Great Depression. That comes as no surprise to most Americans; as home prices fell, the country saw a vigorous debate about the crisis, and about the laws and regulations that have emerged to help prevent another one from happening.

What is surprising is how often the debate here characterizes boom-bust cycles in housing prices as though they are uniquely American. They aren't.

Real House Price Growth in Selected Countries 1996-2009
Country (Source)	1996 - Peak	Peak - 2009
Notes: Prices deflated using the standard consumer price index for each country
Germany (BulweinGesa)	n.a. (Prices fell over entire period)	-13%
United Kingdom (NBS)	152%	-17%
Ireland (ESRI)	182%	-25%
France (INSEE)	108%	-9%
Italy (Nomisma)	51%	-5%
Spain (MVIV)	115%	-10%
USA (FHFA)	47%	-15%

As the table above shows, most European countries saw a huge run up in real (inflation-adjusted) home prices followed by sharp declines.

In Europe, where the five-year, fixed-rate mortgage is king, middle-class families surged into the housing market as global interest rates reached historic lows and fast-rising home prices fueled a frenzy. A similar story unfolded in the U.S., especially in states like Nevada and Florida, where borrowers were more likely to eschew conforming conventional (i.e. 30-year fixed rate) mortgages in favor of 2/27's, 3/28's, and other short-term subprime and non-traditional mortgage products. On the other hand, the presence of the 15-30 year mortgage may be one reason the U.S. home price bubble did not reach the same stratospheric levels as in some other countries.

But the key question posed by the table above is this: why didn't German borrowers respond to low interest rates like the borrowers in the U.S., United Kingdom, or Spain? A few reasons suggest themselves.

First, the hurdles to homeownership are higher in Germany. While long-term prepayable mortgages with down payments of 20 percent or less are standard in the U.S., they are virtually unknown in Germany. Borrowers there can expect to make 30 to 35 percent down payments on mortgages with terms of 10 years or less, and also agree to stiff pre-payment penalties equal to the interest they would have paid had the loan amortized to full maturity.¹

Second, Germany's mortgage terms also reflect a housing policy that has primarily targeted public support towards middle-class rental housing as opposed to owner-occupied homes. The homeownership rate in Germany is 42 percent versus 67 percent in the U.S. and more than 80 percent in Spain.

Third, Germany did have a housing price bubble. But it took place a decade earlier, following re-unification. German home prices rose much faster than incomes as the country merged, and were coming off their peak at the start of the 21st Century. As a result, they are now back in line with neighboring countries.

Even so, Germany wasn't immune from the financial aftershocks that followed when the housing bubble popped in 2007, according to a recent report from the Congressional Budget Office.

"In some (European) countries, the government bailed out issuers of covered bonds, and in early 2009, the European Central Bank launched a €65 billion ($84.5 billion) program to purchase covered bonds in an effort to restore liquidity to that market," the CBO writes, and "Spain and Germany guaranteed another €300 billion ($390 billion) worth of covered bonds issued by mortgage lenders" to shore up their housing finance systems.²

The bottom line: just as a housing price bubble wasn't unique to the United States, neither was the coincident financial bust that followed.

¹ "The American Mortgage in Historical and International Context," Green and Wachter, Journal of Economic Perspective, Fall 2005.

² "Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market," Congressional Budget Office, December 2010, p. 50.