Learn to love the Swedish housing price bubble

The issue of the runaway Swedish housing price bubble has been well known for a while, and the problem just keeps growing bigger. At this point, however, any attempt to tackle it could make things worse.

Almost a year ago, European credit rating agency Scope Ratings warned that rising home prices in Sweden posed huge risks for the country’s banks. Since then, house prices have continued their upward trajectory. In October last year, they had advanced by 18% year on year.

A recent paper by International Monetary Fund (IMF) experts has looked at the issue and concludes that, if for the short term the rise in Swedish house prices has been caused by low interest rates, over the longer term high house prices are driving up the debt of households.

That’s because rising house prices increase the value of collateral that can be submitted for other loans, creating an upward spiral of rising guarantees and rising debt.

That’s all well while it lasts, but what happens if/when house prices stop going up? The IMF paper is quick to point out that “both housing prices and household debt are estimated to be moderately above their long-run equilibrium levels” and that “the adjustment toward equilibrium is not found to be rapid.”

Of course, the last thing the IMF wants to be accused of is spooking the markets and bursting a bubble. So let’s try to read between the lines and see what the paper is really warning about.

First of all, take a look at this chart:

The Swedish housing price bubble pushed debt to record highs. Source: IMF

The Swedish housing price bubble pushed debt to record highs. Source: IMF

Household debt has really taken off with house prices, and has now reached historic highs. If you believe in mean reversion, this chart is very scary indeed. Especially if you look at the black line, which represents disposable income. It’s clear that a lot of Swedes have lived way above their means for quite a while.

The paper explains how this was possible: “When house prices appreciate, households who own housing may perceive that their higher wealth allows for greater lifetime consumption, inducing households to borrow and spend more. At the same time, the higher value of housing assets expands the value of collateral against which borrowing is generally much cheaper than unsecured credit.

Can this situation be reversed? More importantly, should it be reversed? Sweden is an extreme case, but house price bubbles are inflating all over the developed world (look at London, New York, Amsterdam, etc.).

The rises in house prices were caused by record low interest rates and money creation by the major central banks. The classical definition of inflation is too much money chasing too few goods, so a lot of the money went into housing, where supply is relatively inelastic.

For the moment, these bubbles are among the few things growing in a world of commodity price deflation and downward readjustment. This is why we should learn to love them, rather than try to put an end to them.

In the “famous last words” of former Citigroup head Charles Prince, “As long as the music is playing, you’ve got to get up and dance.” For all our sakes, Sweden, as well as other housing price bubble locations, must keep dancing until some better source of growth comes along.

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