Member of the Board Sinikka Salo: Opening remarks in the SUERF seminar 4 June, 2009 House of the Estates, Helsinki
Puheet ja haastattelut Puhe perjantai 17.7.2009, 0.00
This time the topic of the seminar relating housing markets is particularly well timed. The current turmoil in the global financial markets and world economy has put focus on the US housing markets with its subprime loans, and again strengthened policy-makers interest on housing market and housing finance issues more generally. There is a need to better understand the functioning of the housing markets, its cyclical character and the emergence of bubbles. Buying a home is the most important investment of a household during its lifetime and in that sense well functioning housing markets are important from household’s welfare point of view, too.
Housing markets are interesting in the sense that they consist of several different mar-kets: The real estate markets where prices of old houses /dwellings are set and markets for new dwellings. In the short run, supply of housing - existing stock of housing – cannot be quickly increased, which means that level of house prices is mainly determined by demand, and as Tobin’s q-theory tells, the secondary markets for old houses also have an impact on level of new production.
Over the longer term, of course, price developments of the whole housing stock are to a greater extent also affected by supply factors.
Supply of housing, on the other hand, is highly dependent on how well land markets and markets of inputs for production, are performing, as well as on availability of labour, and thus functioning of labour markets.
Because a dwelling is not as a rule purchased without housing loans, and because housing is also an investment objective, housing markets are closely linked to financial markets.
In the rental markets households buy housing services at a price that is linked to finan-cial markets, because rents should correspond to the yield from alternative investment objectives.
Against this background, tailoring of appropriate policies is a challenging task.
In my remarks I thought it would be interesting to present you some characteristics of the Finnish housing markets. This may be taken as an example illustrating the different possibilities where policy tailoring can go wrong.
Our housing markets in Finland are rather volatile: we have experienced house price bubbles – the largest one emerged and burst in the beginning of 1990s − and fluctua-tions in housing production and prices are rather deep. We may say that housing mar-kets in Finland are not regarded as particularly well-functioning. (I personally am of the opinion that they are functioning rather badly as a result of “bad policies”.)
Finnish housing policy has traditionally been focused on the demand side and moti-vated by the belief in the need for the “protection of consumers”. For example, efforts to stimulate owner-occupied housing have constituted an overriding guideline until very recently – interest on mortgages is still deductible in taxation, albeit to a lesser extent currently as this benefit has been cut somewhat; the increase in the value of a home is not taxed – neither implicit income from housing. There are still some interest rate subsidies and state guarantees for first time home buyers etc.
House price controls have also been used and still exist in some corners. Pervasive rent controls, on the other hand, were largely abolished only in 1990s.
In the past – until mid-1980s – housing finance was prone to credit rationing under the circumstances of capital controls and highly regulated financial system then prevailing in the Finnish economy. In those times, average maturity of a mortgage was less than 10 years. After deregulation, a house price bubble developed alongside with the credit-driven, overheated economy which then burst in the deep depression of the early 1990s.
Joining the EU in 1995 and, later, the euro area meant low and stable interest rates, and households wanted to raise their housing standards by taking (floating rate) mort-gages with the maturity of 15-20 years now available. During past 15 years, average indebtedness of households has increased rapidly to around 100 % of disposable in-come, which, although less than the EU average tends to be concentrated among young couples.
What is the problem?
First some indicators to illustrate the welfare aspects:
- Despite the fact that we live in the most sparsely populated country in Europe (only 19 inhabitants per km2 ), our homes are small. The average size of a Finnish home is 78 m2 , which does not compare well with the other Nordic countries: 35 m2 smaller than in Denmark and 20 m2 smaller than in Sweden. Also preferences of households do not match with available supply of dwellings – Finns would like to live more in one-family or terraced houses, while the bulk of the supply consists of flats in apartment houses - only 38% of dwellings are one- family houses. Also the rental market is not functioning properly – the size of private rental markets is indeed too small.
- The problem is accentuated in the metropolitan area (Helsinki-Espoo-Vantaa, comprising approx. 1.5 mill. inhabitants), in particular in Helsinki with its 600 000 inhabitants and with 60 % of its dwellings being studios or 2-room apartments.
- Finns, however, spend approx. 20 % of their disposal income in housing – i.e. the same proportion as other EU15 countries − but they get much less for their money. Housing is expensive in Finland, in particular in the metropolitan area.
In addition, as I already mentioned a few lines ago, production of housing is volatile, and there have been house price bubbles, the most serious one emerged in late 1980's and burst in the beginning of 1990s, although recently the rise in prices of dwellings has been more modest than in the EU15 on average.
To summarize: housing markets in Finland do not seem to function well. Why?
Certainly, many reasons are due to factors explored in the papers to be presented in this conference. Let me suggest also some which I regard as very important. They are related to neglect of supply side of the markets in the design of policy measures.
Some figures to illustrate further the Finnish case: the price of (developed) land in the Helsinki area has tripled during the last 15 years, whereas real construction costs have remained relatively stable or grown much less. In short, there is a shortage of available land for development purposes.
All these factors will affect the supply side of the housing market. In recent studies – for example those surveyed by Gyourko – supply side factors are analyzed more care-fully and given a more prominent role than earlier in explaining key features of the housing markets, like fluctuations in housing prices and production.
This research indicates that factors affecting the price elasticity of supply, can have a decisive impact on housing market dynamics, house price dynamics in particular. These factors are related to the functioning of markets for rental and owner-occupied housing, structure of competition in the markets, role of subsidized housing, land use and its regulation, development of land, quality standards for construction etc.
Empirical estimates of the price elasticity of supply are not yet very robust, but some studies – mostly concerning US data – suggest that the price elasticity is clearly smaller in metropolitan areas than outside these regions. There is also evidence which supports a proposition that emergence of price bubbles is more likely in the housing markets characterized by low supply elasticity. Of course bubbles may emerge even in markets with more elastic housing supply, but these bubbles seem to be smaller and last shorter.
For large and long-lasting bubbles to emerge, it is necessary that rising house prices continue to support expectations on higher prices also in the future, which is more likely in less (price-) elastic housing markets.
My judgment would be that in the case of the Finnish housing markets, policies should pay more attention to the functioning of the whole housing markets – in particular focus should be on supply side factors.
And there the functioning of the market for land plays key role. It may sound odd to you that in the metropolitan area of Helsinki there is clearly a shortage of developed land for housing, in particular for small houses that households preferably would like to have. When you look at metropolitan area of Helsinki from the sky, from the window of an airplane arriving to Helsinki, you see that there is, indeed, plenty of space!
The problem is that development of land – which is monopoly of municipalities – does not progress smoothly enough. Despite generous space we do not have enough developed land, and it does not come easily to the market even though municipalities have a right to expropriate land for development purposes . Hoarding and speculation with land is not rare. There, of course, tax policies also have a potential role to play: taxes could be used more actively to provide incentives for land-owners to sell land for development purposes, and also more pronounced use of tax on real property, including, in particular, land might be considered.
With regard to the question in the title of the conference “Whether housing markets constitute a shelter from the storm or source of shocks”, my tentative answer would be that housing markets can be both: it depends on how successful policy makers have been and continue to be in improving the functioning of housing markets using various policy tools. The Finnish case I briefly introduced to you hopefully illustrates this!
Against this background it will be, indeed, interesting to listen to the presentations of the conference covering the various aspects of the housing markets and related policies.
With these words I once again welcome you to Helsinki and wish you all the success for the conference!