Four months before flying back to the United States, Bank of Israel Governor Stanley Fischer is taking measures to constrain the mortgages market. Why? He doesn't want the next crisis to be called a "banking crisis."
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As far as he’s concerned, any label would be preferable, even a "housing crisis." Just leave the word "bank" out of it.
His moves are consistent with previous ones, all intended to keep the banks as far away as possible from the doomsday scenarios lurking in the housing market. Fischer insists that the banks retain more capital as collateral for mortgages given to the public, so that when housing prices plummet, the banks will only take a minor hit.
This will protect the banks from looming dangers if housing prices do collapse, but it won't help borrowers. They will be the first to feel the hit of a declining market, and their capital will shrink or disappear entirely in proportion to their borrowing.
How will the banks be impacted? This will depend on the circumstances leading up to the burst of the roiling real estate bubble.
A gradual, slow and orderly release of air from the bubble will leave the banks high and dry. A loud and abrupt collapse will be more lethal, with unpredictable consequences. In contrast to the banks, which have increased their mortgage portfolios and exposure in recent years, Fischer is taking no chances. He isn't willing to wait around for the formation of a functioning government, and is in the meantime dealing with issues that are under his jurisdiction. The problem is that this is not enough to solve the housing market crisis. His moves resemble the unilateral disengagement from Gaza, carried out without a suitable partner.
At this stage, without a functioning government and with no sign of one in the making, Fischer stands alone. Prime Minister Benjamin Netanyahu has made only weak proclamations about his plans to bring down housing prices.
But Fischer is used to going at it solo. For three years, he has been the only active player trying to stem the inflation of the housing bubble. He recognizes that half of the financial crises over the last century were caused by a deadly cocktail of banks and real estate, and his actions are guided by this realization. He may feel a bit guilty over the Bank’s substantial contribution to the formation of the bubble, due to low interest rates that encouraged many Israelis to rush off and purchase real estate.
The Bank’s measures split the housing problem into two parts. One is the paucity of housing in general, stemming from a low supply of apartments and rapidly rising prices. The other is the financial stability of the lending banks. The first problem can only be tackled by the government, since it is the largest landholder and the regulator responsible for construction planning and the complex system of building permits. The second problem is the Bank of Israel’s to deal with, which is what Fischer is trying to do. At some point in the past he was still trying to stem the demand, but this was like a putting a band-aid on a bullet wound. He can no longer pretend to be in control of housing prices. He may have despaired of the government’s ability to act, which is why he is focusing on the stability of the banks.
He is not the only one in despair. The ever-increasing price of housing over the last five years attests to the fact that buyers no longer believe in the government.
Normally, such a prolonged trend of rising prices would have indicated great public confidence in the government. Here, the opposite is true. The government has been declaring for three years that it intends to increase the supply of land in order to bring prices down, but the public is skeptical. At one point in 2011 it appeared that things might be changing, but last year saw a drop in new construction. In the first three quarters of 2012, construction of 28,000 new apartments was started, a 20% decline compared to the same period in 2011. Anyone waiting for prices to fall was sorely disappointed.
According to the Central Bureau of Statistics, the last quarter of 2012 saw a sharp spike in housing prices, compared to the last quarter in 2011. In Tel Aviv and Beersheba, the price of four-room apartments rose by 9%, with a 7% and 3% increase in Haifa and Ashdod, respectively. The national average price increase was by 5%. The cumulative increase over the last five years was 30%-70%. As in any market where prices consistently increase, buyers may be lulled into believing that this can only continue. This concept is what bubbles are built on.
Over the last five years, bank mortgages grew by NIS 90 billion. Of all types of credit given by banks, this one grew far more than others. The credit given by banks to individuals totals NIS 338 billion, NIS 240 billion of which (71%) is devoted to housing. The banks didn't stretch their security blanket, namely the capital required as collateral to back this increased credit. The Bank of Israel is now demanding that they do so.
The increase in mortgage credit is not alarming in itself, providing the banks have sufficient capital. However, three factors must be considered. This credit portfolio was created at a time when interest rates are so low that they can only go up. Unemployment rates are also quite low and can only increase, and housing prices have been relentlessly increasing. All three factors can change.
Rapidly rising interest rates will make mortgages more expensive. Rising unemployment will hamper the ability of borrowers who took out loans in recent years at higher risk to meet their commitments. In addition, housing prices could fall if the economy worsens or if the government finally takes effective steps to increase the supply of apartments.
A final thought:
We’ve noted that the Bank of Israel is skeptical about the government’s ability to increase supply. The Bank actually prefers a limited supply to a market glut that could do damage to the banks. We also pointed out that the public doesn’t believe Netanyahu’s pledges to bring housing costs down. What about the Treasury? Does it believe anything can be done?
It turns out that one of the reasons for the large deficit in the 2012 budget, amounting to NIS 39 billion, was two erroneous working hypotheses. The Treasury believed that tax revenues from the housing market would continue to spike, and that public salaries would also increase. This is what happens to officials who are disconnected and, instead of responding to the public’s needs, are captivated by high tax revenues in the housing market, believing as buyers do that things will never change. If even the Treasury doesn’t believe that the government can handle the housing market, then Fischer is correct in his unilateral disengagement, trying to shield the banks from the mortgage bubble and from themselves.