Stopping Bubbles via 'Regulation'

Sweden's Riksbank was one of the first central banks to impose negative interest rates on deposits with the central bank. Not surprisingly, a credit and asset bubble has been set into motion that has now become so large that Sweden's authorities are getting cold feet. However, instead of simply coming to the conclusion that it may be a good time to abolish the central bank and instead institute free banking based on traditional legal principles, it has been decided to fight the bubble with additional regulations. After all, according to a speech delivered by Ben Bernanke in early 2010 (who as an eminent economist should know about such things), everybody has been made aware of the fact that asset prices, especially those of houses, have absolutely nothing to do with the central bank's interest rate policy. Instead, mortgage credit and housing bubbles are supposed to be the result of 'not enough regulation'. In 2012, Bernanke reiterated that interest rates and home prices have nothing to do with each other


Apparently economic theory is rewriting itself in the new millennium. After all, there is allegedly 'evidence' (according to Bernanke) that suggests so! It is not quite clear just yet why the housing bubble decided not to migrate to even less regulated sectors of the economy, as we are still waiting for the wizard to reveal that particular mystery to us.

Anyway, they apparently heard him in Sweden, as the credit and asset bubble there is going to be subjected to regulatory brakes:

“Sweden’s financial regulator says it’s ready to tighten restrictions on mortgage lending to stop banks feeding household debt loads after a cap imposed during the crisis failed to stem credit growth.

“Swedish households today are among the most indebted in Europe and we cannot have household lending that spirals out of control,” Martin Andersson, the director general of the Financial Supervisory Authority, said in an interview in Stockholm. “If that would happen, we can utilize the two tools we do have again, or look at other alternatives.”

The FSA is ready to enforce a cap limiting home loans relative to property values to less than the 85 percent allowed today, Andersson said. Banks may also be told to raise risk weights on mortgage assets higher than the regulator’s most recent proposal, he said. The watchdog has other measures up its sleeve should these two prove inadequate, he said.

As most of the rest of Europe grapples with austerity and recession, the region’s richer nations, including Sweden, Norway and Switzerland, have been battling credit-fueled housing booms. And with southern Europe sinking into a state of deeper economic decline, the prospect of monetary tightening remains remote. That’s adding to pressure on Swiss and Scandinavian regulators to counter the effect of low interest rates on their markets.”


Sweden has already pushed through stricter lending rules as policy makers try to avoid a repeat of the nation’s 1990s real estate and banking crises. The FSA in October 2010 introduced its 85 percent loan-to-value limit, a move that helped slow borrowing growth from more than 10 percent between 2004 and 2008, to 4.5 percent in December. That’s still too fast a pace, according to Finance Minister Anders Borg, who argues credit growth shouldn’t exceed 3 percent to 4 percent.

The regulator last year also proposed tripling the risk weights banks apply to mortgage assets to 15 percent. While the pace of credit growth has eased, household debt still reached a record 173 percent of disposable incomes last year, the central bank estimates.

That far exceeds the 135 percent peak reached at the height of Sweden’s banking crisis two decades ago. Back then, the state nationalized two of the country’s biggest banks after bad loans wiped out their equity. Nordea Bank AB is the product of a series of state-engineered mergers born of that crisis.


(emphasis added)

We have no doubt that tightening the loan-to-value limit from an astonishingly lax 85% to something more conservative will have an effect on mortgage credit growth. However, it is way too late to “avoid a repeat of the nation’s 1990s real estate and banking crises.” With household debt today at 173% of disposable income compared to 135% in 1990, that horse has long ago left the barn.

Why was and is monetary tightening out of the question for Sweden just because the euro area periphery is in recession? Sweden is not even a member of the euro area, so it could have decided to tighten monetary policy regardless of what the ECB was doing. The authorities very likely feared a strengthening of the Swedish Krona, as if the country would suffer if its currency were actually able to buy more rather than fewer goods and services. However, this is the neo-mercantilistic creed followed everywhere today: one's currency must not strengthen under any circumstances (if investors had any sense, they would trip over each other right now to buy more gold).

In any case, Sweden's housing bubble has begun to wobble of late and it may be destined to follow the path the bubbles in Denmark and the Netherlands have taken. The government of the Netherlands has recently bailed out a bank, although it appears that in this particular case, the bank was felled by its exposure to Spain's housing bubble collapse. However, it goes to show that if/when house prices fall further in the Netherlands, trouble will likely strike other banks as well.



Sweden housing bubble

Sweden's house price index – the bubble is beginning to look wobbly lately.



Sweden housing bubble-rate-of-change

At the annualized rate of change  of Sweden's nominal and 'real' prices house prices (real prices are calculated according to government's 'inflation' statistics and must therefore be taken with a grain of salt). As can be seen, this indicator has now turned negative.



It is of course better to try to stop a bubble late rather than never. Since the damage can no longer be avoided, it is surely best to keep it as small as possible. However, we still predict that this will turn into a case of 'be careful what you wish for' from the perspective of Sweden's authorities.

This is easy to foresee, as there will be a lot of wailing and gnashing of teeth once house prices begin to fall more precipitously. With households and banks exposed to debt like never before, a crisis is already assured, even if its precise timing remains uncertain (however, it appears that the point of crisis is no longer very far away).

There will be a considerable political backlash when that happens. With the Riskbank's repo rate already at a mere 1%, the central bank will find it difficult to 'reflate' the bubble once it bursts in earnest. Sweden can probably look forward to 'interesting times', in the Chinese curse sense.




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