(Conjectures on) macro implications of structural idiosyncrasy

Transcription

1 European mortgage markets (Conjectures on) macro implications of structural idiosyncrasy DG ECFIN Conference 21 November 2005 Hans-Joachim Dübel copyright with the author Finpolconsult.de, Berlin

2 Structural idiosyncrasy incompleteness in European mortgage markets and efficiency Incompleteness in the credit dimension Adjusted price 1 vs. completeness Adjusted Price (bp of loan amount) IT 120 Efficient frontier UK PT ES NL 90 FR 80 DK DE 70 Market improvement in completeness and price 60 40% 50% 60% 70% 80% 90% Completeness Index 1. Adjusted Price is nominal price (including fees) adjusted for interest rate risk, credit risk and prepayment options Source: Mercer Oliver Wyman/European Mortgage Federation, Duebel co-author.

3 Demand potential through higher completeness - credit dimension Comments Factors High-LTV: Excessively conservative regulation Government programs distort Subprime Only UK with serious credit impaired market. Older households, free-lancers rationed. Usury rules. Empirical results: MOW/EMF study calibrates benefits. Higher completeness: domestic channels 5-10 bp, cross-border channels bp LE study confirms.9% GDP growth potential, completeness major factor Maximum demand potential by credit risk segment Source: Mercer Oliver Wyman.

4 Structural idiosyncrasy the market risk dimension Comment Interest rate mechanics of 3 basic products 3 products suffice to reach a sufficiently complete set of interest rate risk features: Fixed rate, no call protection ( callable ) Loan Value Non-callable Fixed rate, call protection ( non-callable ) Adjustable rate ( par loans ) Callable Par (adjustable) ALL EU MARKETS ARE INCOMPLETE, except Denmark. Contract Rate Current Interest Rate Source: Dübel

5 Market risk profiles the Equity Release side Price impact of interest rate decline Empirics Prices of Housing Bonds Loan pools Houses Noncallable Callable (pool) Floating = individual call Coupon Interest rate EQUITY RELEASE POTENTIAL Allan Greenspan s consumption and house price boom in the U.S. 02/4. In 03, 60% of new mortgages were due to prepayments (callables dominant) Floating rate market booms in Europe (Spain, Ireland, U.K.) 02/4 German house price diet (non-callables dominant) and a nice historic Danish case.. Source: Duebel, upcoming paper with Boyce/Baeckmand

6 Example: Denmark s Equity Release boom in 1994 Rates and prepayments Gdp change Prepayments in million dkk, l.h.s Money market interest rates Denmark OECD Europe month interbank lending rate f year government bond yield 10-year mortgage bond yield House price index, Incoming government provided some additional fiscal stimulus (est at 1% of GDP for 94). Prepayment seen as major factor supporting 94 boom, turn-around of moribund housing market /I 1993/II 1994/I 1994/II 1995/I Source: Dübel and Lea (2000)

7 Market risk profiles the Lock-in side Empirics Price impact of interest rate increase Floating: UK default crisis X, and perhaps 05-0X?? U.S. S&L crisis 80s, 05 upcoming new crisis? Reason is positive maturity transformation risk as callables extend their duration (prepayment in U.S. only at par!!). Denmark: delivery option of BOTH callable and non-callable avoids lock-in. Germany: yield maintenance prepayment indemnity generates par structure lock-in. Prices of Housing Bonds Loan pools Coupon Houses Non-callable (Germany) Callable (Denmark) Non-callable (Denmark) Par (U.K., Spain) Callable (U.S.) Interest rate LOCK-IN & DEFAULT POTENTIAL Source: Duebel, upcoming paper with Boyce/Baeckmand

8 Example: Lock-in effect imposed by yield maintenance prepayment indemnities (non-callables) Debt service before & after prepayment Comments Indemnity model Debt Service after Prepayment Debt Service after Prepayment New 7 Year Mortgage New 10 Year Mortgage Debt Service before Prepayment Market price model New 7 Year Mortgage New 10 Year Mortgage Debt Service before Prepayment Market price model superior pricing policy over indemnities; stimulates bond markets. Especially as rates must be expected to stay flat or rise in the decades following the historic disinflation; indemnities create distortions. Lock-in imposes substantial threat to labour market adjustment. Source: Duebel (2005)

9 Conjectures All European mortgage markets are incomplete. This has direct implications for consumer utility and welfare levels. Incompleteness on the credit side is compensated by traditional housing policies (rental), which are often very expensive. Riding the credit curve may unlock efficiency reserves and put the European economy on a higher growth path. From the market risk perspective, almost all European mortgage markets generate idiosyncractic macro signal pass-through biases. Many markets, by relying on single products, are prone to shocks. Vulnerability is highest in markets with the most intense banking sector intermediation, and least product differentiation/choice. Vice versa, the mortgage market can be (ab)used as a pump-priming vehicle (U.S., Denmark). Dynamic consistency questionable. The risk of asymmetric shocks hitting European economies via mortgage product incompleteness is non-negligible and has EU-wide implications for macro, monetary and exchange rate policy.

10 END Hans-Joachim Duebel Finpolconsult.de Esmarchstr. 15 D Berlin