Thought for the Dutch: “don’t mention the houses!”
from Merijn Knibbe
The Netherlands will be next. Everybody is thinking and writing about the problems of Ireland and Spain. Soon, they will be thinking and writing about the Netherlands. Check it out:
Banking is a relatively large chunk of the Dutch economy. In 2009 and probably also in 2010, Dutch banks received a large windfall profit (1% of GDP, according to the Centraal Bureau voor de statistiek) as ECB interest rates went down while Dutch interest rates did not (or only to a limited extent). One day, this will end.
After 1990, total long term households debt (read: mortgages) increased with about 600 billion Euro, twice 2009 disposable income of households. Twice. During the last decade, these were increasingly ‘interest payments only’ mortgages – people do not build equity anymore. During the last decade, these were increasingly ‘top-mortgages’ of 110% or even 125%. That is: these mortgages were ‘under water’ right from the start. Yes, that did happen, in the Netherlands. It still happens, though 125% is not possible anymore. In Germany, it never happened. Dutch households are ‘exposed’, the 30 to 40 billion a year Mortgage-money boost to the economy which was characteristic for the nineties and the ‘Zero years’ will end (in 2005 the boost was even 54 billion, or about 20% of disposable income of households, according to the National Accounts) will end – it has not jet ended, in 2009 ‘leveraging’ of households still was 25 billions – while real disposable income fell.
After 1990, house prices increased with about 270%. Corrected for inflation this means a 220% increase.
• Economists ‘explain’ this by rising incomes, low interest rates and rising real rents. But the most significant short term explanation of house prices is, as always and everywhere, hysteresis. The best predictor of prices in a year are last year prices. What does that mean? When people buy a house, the bank looks at their income (which still happens in the Netherlands, standards did deteriorate but not as much as in the USA). But the buyers mainly look at prices of other houses – keeping up with the Van der Veldens. In Germany, where incomes and the like showed comparable developments, prices did not increase.
• Real household incomes did not increase that much (15 -20% after 1970). Lower interest rates, rising house rents and hysteresis did the trick. How?
• I’ve tried a ‘real world monetarist’ explanation (too long to publish in a blog): does the increasing (and after 2008: decreasing) amount of ‘Mortgage money’ available after 1990 explain increasing house prices (Mm*V = PT with V=1, P is house prices and T is number of houses sold)? This increase, made possible by neo liberal deregulation (yes, it is getting boring), does explain the larger part of the price increase. It does not explain the post 2008 price decrease of only 6% (nominal): in the downward phase of the housing cycle, credit restrictions, mainly imposed by households themselves (!) do not cause lower prices but less transactions (the decrease in T being the active part of the equation, I guess). A kind of ‘Minsky moment’ can also happen to borrowers: irrational expectations of the development of the value of houses suddenly change. If the monetary explanation does ‘explain’ the increase, this means that the laxer standards banks used to check income indeed enabled a higher amount of Mortgage-money (a ‘social money’ definition of money, by the way) and larger price rises: demand side inflation. Seems a good explanation of the Dutch-German difference in house price development: ‘it was a credit boom, stupid’. Prices were not just fuelled by income, but also by irrational expectations of permanent income including expected increases of the value of houses (and yes, we can put in some Georgism. Real building costs of houses did not increase that much, the bubble was very much a land-prices bubble).
Dutch government debt has increased quite a bit after september 2008, not because government deficits were high (2008 actually shows a surplus) but because the government bailed out some banks and nationalized some others (there were reasons to do this, by the way). A part of this money has already been returned (with a handsome profit). At this moment, it is however likely that quit a bit (tens of billions of Euros) will never be show up again, it evaporated.
The Netherlands always used to have low net international debt, as government deficits were financed by domestic (pension) savings. Comes in: neo liberal Zeitgeist. Pension savings were not invested in Dutch debt anymore, but in USA mortgages and international shares… Yes, that was my money. At the same time, mortgage debt increased with ever laxer limits. As a result, Dutch international debt is almost at par with Irish and Spanish debts.
AFter 1990, sale of land increasingly funded local government expenses. Short story even shorter: cities like Amsterdam and Eindhoven are already in (big) financial trouble as they can not sell land anymore.
Even more neo liberal zeitgeist
Just today I read in the newspaper that the obligatory ‘Odysseus and the sirens’ collective insurance building companies always had and which enabled them to pay their employees part of their income when the weather goes really bad has been abolished. ‘That can be left to the market, private companies will step in’. Short story short: individual building companies listened to the sirens, did not insure themselves, used the money to cover their losses (building is in a deepening slump, at the moment) and as soon as it the weather goes bad building will stop, payments to the building companies will be postponed, liquidity runs out as they still do have to pay part of the income of their workers and they will go bust – while the building projects as such are profitable! Peter Radford asks: what do we tell our students? Should we teach them Greek tragedy? No, this is in fact more like a Laurel and Hardy comedy – you can see it coming though it makes you cry, not laugh. And it’s, just like the consequences of laxer and more flexible lending standards, and exapmpe of the Eggertsson/Krugman ‘paradox of flexibility’.
The housing market.
In the Netherlands, there has not been a housing boom, partly because of rather strict regulation (it’s a densely populated country). There has been an ‘offices’ boom. House building and office building both are in a deepening slump, right now. House building will, one day, recover – office builders have to switch to the demolishing business. When it comes to sales of existing houses, ‘real’ turnover has decreased with forty percent and is declining. Interestingly (and consistent with Georgist ideas), real prices are at this moment down only about 8%, while sales are down 30% (and declining). As the stock of houses for sale continues to increase, house prices will in the end go down – and more and more mortgages will be ‘under water’. Especially more expensive houses are a very hard sell at the moment. Real estate brokers are complaining that especially people who inherited a house do not want to lower prices: a morbid stickyness of prices. Divorces, disability and long term unemployment will however force prices down.
What does the government do?
They do not speak about it too much, but all kind of signals show that especially the Dutch Central Bank (DNB) is keenly aware of the problem. The government/DNB want to restrict the right of people with a median income to rent a house (yes, you just did read that), they want house rents (already the highest of Europe) to increase, workers have to pay larger amounts into their pension funds, the tax deduction of mortgage interests has to be kept intact at all cost (even a higher government deficit, nothing else escapes austerity but this item)– I expect that there already is some kind of plan B which will force the Dutch pension funds to finance exploding government deficits when a milder, but in the case of a double dip still very serious, Irish scenario sets in (even more bailing out of banks and increasing interest levels on government bonds). Plan B is probably as follows: the DNB already forces Dutch pension funds to use an artificial, uber-low ‘Fantasia’ interest rate when they calculate 2040 reserves. It’s in fact the lowest rate since 1560, when published Dutch interest series start. This, of course, causes 2040 reserve-projections to be alarmingly low, which causes the DNB to force pension funds to increase (obligatory) worker payments into the funds. This increases funds which, in case of an Irish-style emergency, are available to, directly or indirectly, bail out the banks (which officially do now own the DNB, but, well, you know). I’m in favor of ‘conservative’ accounting. I’m even of the opinion that a large part of the present problems are the result of accounting that was not ‘conservative’ enough – there really was no room for bonuses and conservative business accounting would have shown that. I do agree that pension funds do have to use an artificially low interest rate to calculate future reserves. But at this moment there are plenty of possibilities in the Dutch capital market to make (very) long term loans (up to fifty years) at a much higher interest rate than the ‘Fantasia’- interest rate – even conservative rates must be realistic.
What should the government do?
Almost nothing. Pension fund money must not be used to bail out banks, directly or indirectly. Mortgage interest rates already contain a ‘risk premium’. Yes, this premium has been wasted as ‘bonuses’ and high banking wages – not my problem. Let the banks go bust (or let them at least shrink and wither away, starting today). People should get the right to (partly) refinance (part of) their mortgage debts by borrowing the money they already paid to their pension funds at a rate which is lower than what the banks charge for mortgages but which is much higher than the ‘Fantasia’ interest Dutch pension funds are supposed to make. But that’s not up to the government, that’s up to the pension funds. (This of course sounds good, but this will sometimes require that pension funds, as long as the bank mortgage is not yet paid down in its entirety, get a lien on pension rights)! There are however things which the government can do. In case of emergency, the 6% sales tax on houses has to be abolished – which will of course decrease government receipts. And they might ponder about a tax deduction for marriage counseling, to lower the amount of divorces. Prepare for it.
I do not want to be too pessimistic. During the 2008 panic, the then minister of finance, Wouter Bos, with his team managed to beat the markets by outsmarting them, outrunning them (almost literally, putting in a string of 48-ers, 48 hours that is), outfunding them and out-knowledging them. It can be done! One day, you leave the office as an overpaid employee of a private bank, literally the next day you return as an overpaid employee of a government bank whose job is suddenly at stake. He bought us time, which the Netherlands used to sort out the mess and to restructure banking and domestic and international debts! Or – did we? Indeed, I do not want to be pessimistic, but….
Beware: I’m as a rule not in favour of state banks. But sometimes, that can be the better solution. And I did learn that the payment system is indeed something like a ‘public good’, like the drinking water and sewer system in the Netherlands (which is working close to perfect, by the way – while the english are only starting to replace their Victorian sewer system, we have already largely replaced our system from the fifties. Three years ago, I happened to be in Victorian station in London at the exact time of the ‘torrential downpour’ – it did give me a smell of the imperfections of the english system).
By the way: this was a Georgian, real world monetarist, ‘topsy turvy’, institutional, social money, irrational expectations, simple math, economic history, national accounting, market analysis of the Dutch situation. I did leave out neo-classical economics – can’t use it.