A comment on the procyclicality of mortgage lending

1. A comment on the procyclicality of mortgage lending Trond-A. Borgersen, Østfold University & Karl Robertsen, Agder University ERES 2009, Stockholm

2. Disposision • 1. Motivation • The Norwegain case • 2. Model • Regime shifts • 3. Empirical analysis (short) • Results/regimes 4. Conclusions

3. Norwegian housing market Nominal- and real house prices 12-mth. growth in house prices

4. Households: Debt-to-income ratio Source: Kredittilsynet (2008)

5. Debt-to-income, home-loan survey Source: Kredittilsynet (2008)

6. Home-loan survey: mortgage market developments • Share of home mortgage loans in various LTV categories • Source: Kredittilsynet (2008)

7. Home-loan survey: mortgage market developments • Loan periods for various LTV-ratios • Source: Kredittilsynet (2008)

8. Focus of the paper • Mortgage market developements: • Less weight given to debt-to-income and more weight given to collateral • How are these developments in the mortgage market related to the house price cycle?

9. Assume.. • Lenders are myopic, i.e. care only about next period expected return • Endogenous credit constraint governs lending • Exogenous house price process (for now) • Expectations are adaptive • The alternative rate of return impacts on mortgage lending

10. The housingdemandofcreditconstrainedhouseholds • Endogenous credit constraint • Housing investments • Financial savings • Liquidity contraint

11. Housing demand.. • Depend on: user cost (the inverse-) and households net worth

12. Regimes • Regime 1: Modest house price growth • That is: • Condition for :

13. Regimes.. • Regime 2: Strong house price growth • That is • Even so: It is possible that when

14. Empirical analysis • LSTR-modell (logistisk smoothtransitionregression, allowing for regime shiftsbetweenhousepricegrowth and the alternative rate ofreturn (theinterest rate) • National Accounts(1987k1 - 2008k3) • Focus: The relationshipbetweenhouseholddebt, collateral and debt-to-income at theaggregatelevel

15. Data

16. Empirical model • Model • Transision • Debt-to-income, relative to it’s average

17. Transision • Regimes: Situation (1): Strong house price growth . Situation (2): Modest house price growth

18. Conclusions/Results • LSTR-1 identifiestwo regimes for therelationshipbetweenthehousing market and the mortgage market • Regimes shift is significant for therelationshipbetween mortgage debt and debt-to-income: • Modest housepricegrowth, bothdebt-to-income and collateralimpacts mortgage debtnegatively • Stronghousepricegrowth, mortgage debtincreases in thedebt-to-income ratio • Even in theperiod 2004Q1-2008Q3 wheredebt-to-income is abovelong-termaverage • Credit driven housing market bubble

19. Conclusions • Potential regime shifts in mortgage market structuresaccording to thehousepricecycle • due to endogenouscreditconstraints and adaptive expectations • LTV-ratios <100 % whenhousepricegrowth is modest, and LTV-ratios >100 % whenpricegrowth is strong • Whenarepro-cycliceffectslikely? • weakinternal guidelines for risk assesments and/or increasedcompetition for mortgage market shares • adaptive expectationsareallowed to governboththedemand for housing and thesupplyof mortgage financing • Highlightstheimportanceofstronginternal guidelines for credit risk assessments ,taking intoaccountbothcollateral and debt-to-income