The past several months haven’t been easy on Sweden’s central bankers. Despite low interest rates and a growing money supply, Sweden has experienced on-and-off deflation since November 2012. Those same low interest rates seem to have Swedes borrowing hand over fist to get in on hot property markets, and policymakers fear a credit bubble is inflating. Keeping with the rhetoric among the world’s central banking elite, they’ve decided to “fix” it before it pops on its own—or, in the jargon du jour, use macroprudential regulation to take some air out. Will it help? Or make that pesky deflation worse? Other central banks are watching with bated breath to see how it works—and if they can replicate the strategy. But in our view, it’s all a bit foolish. Central banks don’t have any special abilities to spot asset bubbles—something investors should keep in mind as central bankers from London to Beijing to Washington stay on the lookout for bubble trouble.
It’s certainly fair to say Sweden’s housing market looks hot, hot, hot! Bidding wars are driving even small apartments’ prices to millions of krona. Folks fear rising property prices mean Swedes will take on too much housing debt—if they haven’t already—creating a credit bubble, which will eventually *pop*! Followed by a credit *crunch*, and hitting the broader economy with a resounding *thwack*. At first blush, the numbers probably seem scary: Debt doubled as a percent of disposable income over the last two decades, hitting 174% in mid-2013. For those with mortgages, debt was 370% of income. But rising home prices and mortgage lending aren’t inherently bubble trouble—why they’re rising matters more.
In Sweden’s case, the conditions don’t seem very bubbly. Demand is high; supply is tight—so prices are rising. Persistent supply shortages aren’t usually the norm in bubbles. Bubbles usually feature supply gluts, fueled by developers trying to capitalize on high prices. Supply growth far exceeds demand, setting up the eventual crash. If Sweden were in a housing bubble, construction and supply would likely be soaring, and euphoric buyers would still pay a pretty penny. Today, developers are just breaking ground. Housing starts jumped in Q4, but fell in Q3 after a few years of fairly subdued growth. New construction today simply helps ease the shortage. As for prices, we see few signs folks believe Swedish housing is a sure thing. And the amount of outstanding mortgage debt, on its own, doesn’t much matter. Stats like a 370% debt-to-income ratio are eye-popping, but meaningless—whether borrowers can pay their mortgages is what matters. Even falling home prices wouldn’t automatically jeopardize this—being under water doesn’t impact debt affordability. Factors like continued employment and steady income are what ultimately weigh—regardless of where home prices go or how much total debt is outstanding.
Yet in this post-2008, central-bank centric world, the notion of pre-emptive bubble defusing is trendy, and the Riksbank believes the market needs cooling. But with the economy weakening and CPI flat or falling since late 2012, they don’t want to use normal monetary policy tools to battle one small, allegedly overheating area. Instead of rejiggering interest rates to reduce loan demand, they’re using regulatory tools to limit loan supply. Sweden’s tack thus far includes capping mortgages (banks can’t lend more than 85% of a home’s price) and increasing mortgages’ risk weighting from 15% to 25%. They’re increasing capital ratios, too, hoping more localized intervention can rein in mortgage lending without impacting broader credit markets, like business lending.
The Riksbank appears to be banking on a risky strategy, in our view. Since mid-2012, household lending has led while business lending has fallen steeply. Deliberately crimping mortgage lending is no guarantee banks turn around and lend that money to businesses instead—that decision depends on a host of other criteria. They could very well just sit tight, which doesn’t help anything. Without more business lending, firms have trouble getting financing, commerce has trouble accelerating, and growth can easily sputter further. *Whack* mortgage lending on top of that, and real estate’s contribution wanes, weakening and already anemic economy.
Now, this is all localized to Sweden, which is about 0.7% of the world economy. But this saga matters for investors. Why? Sweden may be the first to try pre-emptive pricking, but the Fed and BoE have both said macroprudential regulation will be part of their arsenal from now on. Post-2008, central bankers have decided bubble hunting is a must.
But to us, macroprudential policy misses the forest for the trees. For one, there isn’t any proof central bankers are much good at spotting bubbles. If they were, far fewer bubbles would happen! Yet we still saw the 2006 US housing bubble, 2000 Tech Bubble, Sweden’s 1990’s housing bubble, Japan’s real estate bubble in the late-80s and the 1980 US energy bubble—to name a few. Even if bankers did have Super Bubble Vision X-Ray Specs (TM pending), macroprudential policy seems an iffy solution. China has tried to use its own brand of macroprudential to address sky-high real estate prices for years, to no avail. If the world’s biggest command economy can’t pull it off, we struggle to see how it can work in freer markets (and that’s a good thing). Plus, focusing too narrowly on one data point, company, index, etc., can lead central bankers to miss or mess up the greater economic picture. In our view, we’d all be best off (and markets happiest) if central banks just stuck to the basics: keeping the money supply growing at a stable, predictable rate and acting as lender of last resort. Those are arguably more meaningful for future economic growth.
For now, with only Sweden taking the plunge in the developed world—and no countries terribly hot on its heels—market risks are minimal. Headlines might urge the BoE to do something about sky-high London home prices, but for now, officials are demurring. However, if more central banks ultimately hop on the bubble-hunting bandwagon, investors will have far more and more complex policy moves to weigh, and markets will have more variables to grapple with. Only time will tell whether any actions prove wise.