Current Thinking on Housing Prices and Mortgage Markets
Global housing prices remain a popular indicator of economic activity. According to the latest surveys, US home prices rose 7.1% over the last year, still 13.6% below their peak. London home prices rose 9.4% in the past year, marking a new high. In Hong Kong, Chinese buyers and low dollar-linked interest rates have propelled house prices up 110% in three years.
But overall, recovery in global housing markets seems mixed. One comparison of the fair value of house prices, using rents and incomes as yardsticks, points to a sustainable revival in the United States. In Europe peripheral countries such as Spain and Italy, which experienced massive overbuilding, have struggled more than France or Germany. High unemployment rates and poor availability of mortgages cast a long shadow. But the United Kingdom, with its tight supply due to planning rules and easy availability of finance, is cushioned. Another large academic study found US prices were below their mean-reverting levels and at the lower end of their historical range. Equivalent UK and Japanese prices were actually at or slightly above their mean-reverting levels
While local factors exert some influence, it is no surprise that homogenous fiscal policies around the world to tackle a surfeit of debt are also affecting housing demand. Events of the past five years have also made it an opportune time to revisit mortgage market design in the quest for a more efficient housing system. Harvard economist John Y. Campbell reviewed current mortgage design and suggested alternatives to the standard offerings as possible solutions to asymmetry and conflicts of interest that are inherent in the current system.
On one branch of the home financing tree sit a tier of institutional investors trading bulk packages of mortgages. The author of another study developed a novel model that focuses on house prices and their distribution for application to mortgage valuation and risk measurement. The model takes a long view of future house prices to account for the long potential cash flows of mortgage assets.
In the background — rather like the generation of stock investors wiped out by the Great Crash of 1929 who vowed never to invest again — many home finance lenders and mortgage investors are still spooked about systemic and macrofinancial risks. Speaking at a recent CFA Institute conference in Prague, Nobel laureate Robert C.Merton argued that current financial system models used by economists and central banks to assess and manage economies are generally not capable of accurately analyzing and managing the macrofinancial risks because they assume linearity in credit risks — which often aren’t so linear. As a result, they cannot properly measure the changing degree of connectedness among financial institutions and sovereigns. A new approach for analyzing and managing macrofinancial risks integrates monetary, fiscal, and financial stability policies, and accounts for this interconnectedness and risk transmission.
Further reading from CFA Digest’s team of abstractors and other CFA Institute resources on home prices and related topics can be found below:
- Home Truths: Global House Prices: Recovery in global housing markets is mixed at best, with many economies still suffering. The author uses two price measures (price-to-rent ratios and a measure which divides prices by disposable income per person) to determine whether houses are expensive or cheap. Both measures point to a sustainable revival in US house prices because the correction that happened over the last few years has made houses inexpensive on a historical basis and monetary policy has been loose. Both measures point to undervaluation in the United States. Homeowners fared less well in Europe.
- Converging World: Countries’ Fiscal Policies Are Becoming More Similar: Since 1994, spending by developed countries has exceeded their tax revenue. Therefore, much of the developed world is facing a budget deficit. The author discusses this situation in developed countries as well as the fact that fiscal policies around the world appear to be converging.
- A Stochastic US House Price Model for Valuing Residential Mortgages and Other House Price–Dependent Assets: Kevin J. Stoll, CFA, develops a model that focuses on house prices and their distribution; he uses the model for mortgage valuation and risk measurement. The model takes a long view of future house prices to account for the long potential cash flows of mortgage assets, and the author is the first to provide this type of valuation tool.
- Mortgage Market Design: Residential mortgages are the largest liability in the finances of a typical household and a major portion of bank assets. Understanding design features of these contracts and how the United States can learn from other countries’ mortgage systems is the focus of the author’s research and analysis. Such a wide-ranging approach results in a more robust treatment and understanding of the seminal issues.
- On a New Approach for Analyzing and Managing Macrofinancial Risks: A framework for measuring and analyzing macrofinancial risk, particularly financial system credit risk and sovereign credit risk, is described, along with how one might go about monitoring the connections. The data suggest that the degree of connectedness across different types of financial institutions and sovereigns changes considerably over time. Current financial system models used by economists and central banks to assess and manage economies are generally not capable of accurately analyzing and managing the macrofinancial risks because they do not incorporate the fundamental nonlinear structures of credit risks. As a result, they cannot measure the changing degree of connectedness among financial institutions and sovereigns. A new approach for analyzing and managing macrofinancial risks is needed, particularly one that integrates monetary, fiscal, and financial stability policies and accounts for interconnectedness and risk transmission.
- Robert Merton: A New Approach for Macrofinancial Risks: Nobel laureate Robert C. Merton challenged traditional models used by investors to measure sovereign and financial system credit risk and proposed an alternative framework during a keynote session at the CFA Institute European Investment Conference.
- The Margin of Safety and Turning Points in House Prices: Observations from Three Developed Markets: Using quarterly data from 1960 (United Kingdom), 1963 (United States), and 1977 (Japan) through the second quarter (Q2) of 2010 (all three markets), the authors examined long-run mean-reverting relationships between house prices and inflation, disposable income, GDP, and rents. At the end of Q2 2010, US prices were below their mean-reverting levels and at the lower end of their historical range. Equivalent UK and Japanese prices were at or slightly above their mean-reverting levels.
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