Falling Swedish Housing Prices Again

I think it's about time I updated the English version of my Swedish housing bubble diagram and analysis from September 2007.

The following is based on articles from my Swedish language blog from the past year or so.

At the end of 2010 real house prices in Sweden fell quarter over quarter for the first time since the first quarter of 2009. According to Statistics Sweden's "Fastighetsprisindex småhus" and CPI, inflation adjusted house prices fell from the third to the fourth quarter of 2010. The falling prices have continued during the first quarter of 2011. See diagram below for prices in the whole country and in the Stockholm area.

For comparison I've also included real wages. The Swedish housing bubble is credit driven, as you can see if you compare housing prices, wages and household credit. In 2007 I thought we had seen the top, but during the financial crisis of 2008 the Swedish central bank, Riksbanken, took interest rates down sharply, and since Sweden was relatively mildly hit by the crisis the Swedes started bidding up housing prices even more using borrowed money at low interest rates.

The question now is - have we seen the real top in the Swedish housing market this time? I find it hard to see any factors that could inflate the Swedish housing bubble further, so this time I definitely call it a top.

There are always "fundamentalists" who argue that there is no housing bubble in Sweden, citing for instance supply and demand showing that there is not enough housing in for example Stockholm. However, housing price increases in Sweden are not limited to the large cities. Percentage-wise prices have even increased more in some smaller towns. Sweden also has among Europe's largest dwelling area per capita, even compared to neighbours such as Finland.

What the "fundamentalists" also miss is that this is really a household credit bubble, which happens to manifest itself in housing prices. It also manifests itself in household consumption, which continues unabated in Sweden, though there are recent signs of a softening. This of course drives the strong Swedish GDP increase, which however is largely driven by credit-fuelled household consumption. If household credit expansion should stand still, Swedish GDP will no longer increase.

Now it's not just Sweden that still has an unpopped housing bubble. Our neighbours Norway and Finland also do. Denmark's bubble popped in 2007, however, which has caused the demise of nine smaller Danish banks, but has so far left the large banks relatively unscathed.

Norway's bubble is bigger than Sweden's, and Finland's is smaller, using 1993 as the base year. All the Nordic bubbles are larger percentage-wise than the American one. One cannot help but wonder what will happen to the Norwegian bubble, considering that Norwegian oil production has been falling for about ten years now.

Also read the Australian blog Macrobusiness' recent analysis of the Swedish housing bubble.

Swedish Housing Still a Bubble

My view is still that Sweden is in a housing bubble, like most western European countries. Signature "ju" asked me on a forum why I don't compare to incomes, which have risen in Sweden over the last years. So I did some more number crunching, and here's an improved version of my Swedish housing bubble graph, with a green line for inflation adjusted mean income. I've also included housing price data up to Q2 2007 and trend lines (thanks to "Kons" for suggesting trend lines).
(Data source SCB. FPI=Fastighetsprisindex småhus, Mean Income=Sammanräknad förvärvsinkomst. 1975=100 for housing prices, 1999=100 for incomes)
As you can clearly see, housing prices in Sweden have risen much faster than the average income (I only have income data for 1991-2005), so while inflation-adjusted incomes have indeed risen, we are still in a housing bubble. How far will housing prices fall?

• A fall down to the trend line is about 30%.
• A fall down to the average for 1975-2003 is about 45%.
• A fall down to the lows of the early 1990's is about 55%.

This is the whole of Sweden, and obviously the bubble is worse in "hot" housing spots. So I've made a corresponding graph for housing prices in the Stockholm area (thanks to "Kons" for suggesting this).
As you can see the graph is slightly more "bubblish" than for the whole of Sweden.

• A fall to the trend line is about 30%
• A fall to the average for 1975-2003 is about 55%
• A fall to the lows of the early 1990's is about 65%!!

Many people will of course say "it can never happen, there will always be a strong demand for housing in our capital city", but I boldly predict today that inflation-adjusted housing prices in Stockholm will probably on average go down by 65% over the next few years. Be warned, and don't forget where you heard it first. And I might even be optimistic. Considering the excesses on the upside, we could very well have similar excesses to the downside when the bubble finally bursts. And if you don't believe it could happen, don't forget that history has proved that all bubbles eventually burst, even though few believe it is possible when on the upward slope of the bubble.

Now housing bubbles burst slowly, so the process will take a few years to play out. I expect "experts" to call a bottom in housing many times during the coming years, but prices will still keep on falling.

Now what effects will such a large fall in housing prices have on the economy? Large effects, of course. Many people will be stuck with loans way bigger than the value of their home. But maybe we should ask the question the other way around - what economic events could trigger such a large fall in housing prices? Read what I have previously written on this blog about potential dangers in the world economy, and you will get some hints about what might cause such a powerful recession.

Speaking of housing bubbles, the top economic advisor of the Spanish prime minister came up with some unbelievable quotes last week:

A residential real estate slump in Spain, where prices have almost tripled since 1997, is "unthinkable," the top economic adviser of Prime Minister Jose Luis Rodriguez Zapatero said. [...]
"To talk about severe adjustments or a meltdown in prices is ridiculous," Taguas said in response to reports pointing to an end of the Spanish real estate boom. "That sort of crisis is unthinkable." [...]
The Spanish banking system is also solid enough to withstand rising financing costs triggered by the fallout from the surge in defaults in the U.S. subprime mortgage market. A run on mortgage- lenders such as Newcastle, U.K.-based Northern Rock Plc or funding difficulties like those at Countrywide Financial Corp. in the U.S. are "unthinkable" in Spain, Taguas said.

Remember those quotes and remind Mr. Taguas about them in a few years' time!

Extreme Events

For now, the global financial markets seem to have calmed down. But the "background noise" of bad news is still there. Since late 2006, 159 US mortgage lenders have already broken down in some way, and new ones are added to the list every week. Housing prices are still falling in the US, and the bubble seems to be about to pop in Europe too, where Spain and the UK seem to be first in line for a major housing bubble correction. Prices of oil and cereals are still rising sharply. The US dollar continues its fall. The interbank rate (e.g. LIBOR) is still well above 6 percent. Many businesses find it hard to get loans or to roll over their loans. Bloomberg reports:
"The U.S. commercial paper market shrank for a sixth week, extending the biggest slump in at least seven years"
"Commercial paper investments have declined $354.5 billion, or almost 16 percent, since the week ended Aug. 8"

I can't believe that everything is now well after a number of extreme events in August and September:

• At the beginning of August, some banks obviously had major problems, and central banks all over the world had to inject liquidity to keep the wheels going, on a scale not seen since September 2001, and in some cases never seen before.
• The US FED unexpectedly lowered the discount rate by ½ percent on 17 August.
• There was a "run on the bank" in British Northern Rock 14-18 September. When was the last time we saw a run on the bank in Britain? This was so serious that US Treasury Secretary Henry Paulson suddenly decided to fly over to London to meet the British Chancellor of the Exchequer Alistair Darling. On 18 September the British Government announced that they would guarantee all deposits at Northern Rock. Whew! Crisis averted for some time.
• Little more than a month after Ben Bernanke said that inflation was his main worry, he lowered the Fed Funds rate and discount rate by ½ percent on 18 September. This of course caused the US dollar to fall like lead.
• Saudi Arabia did not lower the interest rate this time. They have so far followed interest rate changes in the US, and their currency is pegged to the US dollar. This of course raises fears that they will now unpeg their currency from the US dollar, which would cause mass exits from the US dollar and possibly a dollar collapse.

So what are we in for next? Crude oil is now definitely above $80/barrel. The US$ has dropped about 3% in one month. Foreclosures in the US jumped up by 36% in August, which is up 115% from August 2006! And there are still loads of ARM mortgages awaiting interest rate resets over the next couple of months.

I guess there will be a few weeks of calm before we see the next extreme event. How many extreme events can the world financial markets handle before an avalanche is set off? Don't forget that everything is tied up by trillions of dollars in derivatives.

If we get bankrupts increasing because of the problems for companies to get loans, we will see a test of the credit default swaps (CDS). The amount of CDSs outstanding is equivalent in size to total world GDP. It's already doubtful whether many issuers of CDSs can live up to their promises. And who holds all these CDSs? Default by a big enough company somewhere in the world could thus cause a cascade of bankrupts and defaults, since both the issuer and the holder of a CDS might go down, in their turn bringing down other holders and issuers of CDSs.

There are even more interest rate swaps and currency swaps than CDSs. What happens to the issuers of these when interest rates and currencies start to move quickly and in unexpected ways? And don't forget that many hedge funds speculate in these kinds of financial instruments.

Like the Chinese curse says: "May you live in interesting times..."

The R Word

Some really bad US job statistics hit the news this Friday. Non-farm payrolls were -4000 jobs instead of the expected +100,000. This is the first time in four years that job growth was actually negative. On top of that the preliminary figures for June and July were revised downwards substantially. And, to make matters worse, 592,000 people left the workforce, meaning that they have probably given up trying to find a job. Now the "R word" is sure to come any day soon - recession.

Treasury Secretary Henry Paulson's comments on the job statistics are priceless. He's desperately trying to instill comfort when this news has probably convinced even the most hardened optimists that the US economy will make a hard landing, and pessimists now predict a crash landing. Some quotes:

"it takes a while for confidence to return"

"A while" - ha - it will probably take years to sort this mess out.

"The economy will continue to grow in the second half of the year"

Oh yeah? That would be sensational. First this "unexpected" drop in jobs, and then he expects us to get another surprise when we suddenly see job growth again in September or October. Does he actually believe this himself?

Paulson, who had a regular breakfast meeting with Fed Chairman Ben S. Bernanke today, said he had "great confidence'' in the central bank.

"Helicopter Ben" is probably glad to hear that there's still at least one person who has not lost confidence in him.

"But I feel quite strongly that we have a resilient economy."

Well, let's hope that, but don't bet on it. Things might break quicker than Paulson can say "resilient economy".

The Mortgage Situation
Higher unemployment will of course lead to more people falling behind on their mortgage payments. Foreclosures have already hit an all-time high of 0.65 percent during the second quarter of this year, making this the third consecutive quarter in which a record is set. Delinquencies are also up - 14.82 percent of subprime loans are behind in their payments, but delinquencies in the prime area are also up from 2.58 to 2.73 percent. Expect this to turn worse.

Housing prices are sinking, partly because it has become much more difficult to get a loan. More foreclosures will also mean more houses for sale on an already saturated market. Expect housing prices to sink much more.

To make matters worse for the poor foreclosed home-owners, if the house sells below the amount of the loan, and the rest of the loan is forgiven by the lender, the amount forgiven is taxed as income for the borrower. This could lead to really serious problems for many people who are already in trouble.

There have been proposals (notably from George W. Bush) to bail out home-owners in some way to alleviate the effects of the current housing mess. However, with a recession coming on, where is the government going to find funds for such a bailout? A recession means less tax money coming in, so the only alternative is to borrow money. But borrow from whom? Most Americans don't have any surplus to put into US bonds, and foreign investors will be unwilling to invest more in US government paper if there is a major inflation risk. And that brings me to the subject of...

Inflation
Apart from moving the stock markets down, the bad jobs news on Friday also took the US dollar down by more than 0.6 percent. The US dollar index (against other currencies) is now definitely below 80 and has now broken its 15-year low. Expect it to fall further unless some miracle news turns up. This means that all imported stuff will be more expensive in the USA.

To counter this bad trend for the US$, the only thing the FED could do would be to increase the interest rate, but what's really needed to alleviate the current domestic economic situation is an interest rate cut, which is what everyone expects the FED will announce on September 18. So the FED basically has its hands tied behind its back when it comes to fighting inflation.

Besides, there are two inflation factors over which the FED has no control - food and energy. I know that the "core inflation" figures the FED prefers to watch exclude food and energy, but in the real world food and energy prices have strong effects on the economy. People just cannot live without them. Food prices are rising sharply, as I have said before, due to a global shortage of wheat and other grains. President Bush could do something about this inflation factor, however, by cutting all subsidies to the grain-to-ethanol business. Of course this would mean a disaster for that business, but it would probably be a big help in fighting inflation. Though I don't expect him to do this, since he's too committed to it.

Oil prices are also rising, in case anybody failed to notice. On this Tuesday (11 September) OPEC will have a meeting to decide their production quotas. It is highly improbable that they will increase their production, since they probably cannot (this has been thoroughly analysed at The Oil Drum). OPEC will probably keep production at the current level, thereby keeping world market prices high. This means that the slightest disruption in this tight market could send oil prices upwards. Goldman Sachs already expects oil prices to hit $95/barrel this year (they're at about $75 now).

Many Companies in (Potential) Trouble
The current credit crunch is also a severe threat to the economy. Even if the FED lowers its rates, many loans (commercial and private) are tied to the LIBOR. The 3-month LIBOR is currently up to 5.70 percent, thereby increasing interest payments for all loans tied to it. It has also become much harder to actually get a loan. Outstanding commercial paper has contracted by nearly $300 billion over the last four weeks (source: Credit Bubble Bulletin). So many businesses will have a hard time due to either higher interest payments, lack of funding, or both.

Of course, all businesses connected to the housing boom are in even worse trouble. For example home builder Beazer received notices of default this week from a bondholders' group, while luxury home builder Hovnanian reported losses for the fourth quarter in a row.

For mortgage lenders you can watch the Implode-o-meter to see them going down one by one. The biggest one, Countrywide Financial, announced on Friday that they will cut 12,000 jobs (20% of their workforce).

Countrywide also seem to have been into some shady stuff too. They even seem to have neglected sending required paperwork to the IRS. Is this the beginning of another Enron-style scandal?

It is also getting harder for mortgage lenders to get funding. Citigroup announced that their First Collateral Services unit won't accept new clients for "warehouse" credit lines, which provide cash to mortgage banks so they can fund home purchases and refinancings. Does this also imply that Citigroup sees problems with their current clients? How many bad housing loans are actually connected to Citigroup in some way?

Citigroup also might have other troubles. Like many other banks, they have so-called SIVs (Structured Investment Vehicles) and conduits, which operate separately from the bank and are not on its balance sheet, but generate investment profit (hopefully) for the bank. According to Wall Street Journal, Citigroup "owns about 25% of the market for SIVs, representing nearly $100 billion of assets under management". If these SIVs start going bad Citigroup might have to help them out or take on some of their losses. Now according to Wikipedia, Citigroup, apart from being the world's largest bank is also the world's largest company (by assets), so hopefully they can sort out quite large amounts of problem debt.

And Europe?

It seems that U.S. financial institutions have managed to export some of their worst tranches of subprime loans to Europe. This can be seen from the size of the interventions by the central banks. On Thursday last week the European Central Bank had to inject €95 billion in liquidity into the markets (about $130 billion), whereas the U.S. FED only had to inject $24 billion. We still don't know the whole map of who sits on what bad credit, but it will be revealed eventually.

It is now obvious that the subprime mortgage mess is not "contained" in any way, and is definitely not contained within the country of origin, the U.S.A.

There has been a lot of news lately about U.S. housing and mortgages, but I expect all this to turn up in Europe too. Housing prices have been rising like a bubble here too, and many people are up to their ears in mortgages, and have no margins in their economy. Inspired by Robert Shiller's graph of inflation-adjusted U.S. home prices, I compiled one for home prices in Sweden. Unfortunately I could not easily find data before 1975, but here it is:
I've taken the FPI (Fastighetsprisindex småhus) divided by KPI (Consumer Price Index) and multiplied it by 1000 just to get some nice round numbers (figures from SCB). You can see that the prices have gone up and down in waves more or less like the U.S. prices from 1975 to 2000. Then, just like in the U.S. since 2000 they have risen above any previous tops, though the bubble is not as big as in the U.S. The situation is similar in most other western European countries - worse in some (notably UK and Spain), maybe better in others.

Now that lending standards have suddenly tightened up, I expect housing prices to fall in Europe too, and soon we will have our own version of the subprime mess. All major Swedish banks have said last week that their exposure to U.S. subprime mortgages is minimal, which I believe. What they do not mention is their exposure to the Swedish mortage market, which could quickly turn sour.

We definitely haven't seen the last fallout from the global tightening of credit. There are lots of pockets of bad credit all around the globe and in all kinds of markets, just waiting to pop up.