All That Glitters

Israel’s Mortgage Mania Won’t End Well

Even if none of the banks runs into major trouble, the entire economy could still find itself in a deep recession because of the flood of lending to the property sector

Ofer Vaknin

When you ask an Israeli bank manager if he is worried about the amount of credit his bank has granted to the real estate industry, including for mortgages for home buyers as well as credit for businesses such as developers and contractors, the answer is always “completely negative.” The banks answer that the collateral they hold on the assets is excellent, and the ratio between the value of the loans and that of the assets is one of the lowest among Western nations, and every bank examines very carefully the ability to repay and cash flow of the borrowers.

But even if no Israeli bank runs into trouble because of real estate loans, the entire economy can still find itself in a recession because of too much credit and loans – and this will be a recession that is very hard to escape from.

Earlier this month, the new data for September was released and showed the continued growth in mortgage lending – from the beginning of the year over 50 billion shekels ($13 million) in mortgages have been taken out, an almost 30% increase compared to the same period of last year. These figures should make the economic decision makers quite worried.

A British View

Economist Adair Turner, the former chairman of Britain’s Financial Services Authority, feels that we must be very careful about an excess of credit. Lord Turner claims in an article he published earlier this month on the Project Syndicate website that the problem of most developed economies that have fallen into a recession or economic downturn since 2008 is because of the creation of too much debt (and investment) in the real estate market.

“We are caught in a trap where debt burdens do not fall, but simply shift among sectors and countries, and where monetary policies alone are inadequate to stimulate global demand, rather than merely redistribute it. The origin of this malaise lies in the creation of excessive debt to fund real-estate investment and construction,” he writes.

In support of his claims, Turner brings the story of the Japanese real estate boom in the 1980s, a period in which the value of real estate loans quadrupled and land prices rose 2.5-fold in just four years; but afterwards the country fell into a an economic crisis that it has still not recovered from. The interest rates in Japan have been close to zero for over 20 years and the public debt is now over 230% of GDP – more than in any other developed nation. Japan may be aggressively printing money through a program of “quantitative easing,” but is still finding it difficult to bring about higher prices and economic growth.

A similar scenario occurred after the crisis in the United States and in some European countries in 2008, he says. Too much credit for real estate created a crisis and the governments tried to reduce debt creation, but were at the same time forced to increase the public debt – and created large budget deficits.

On a global level, the business sector private debt in developed countries may have fallen, but it has only gone down from 167% to 163% of GDP. In his article, Turner shows how similar phenomena occurred in the United States, Europe and now in China, which chose to respond to the 2008 crisis with an enormous amount of credit for construction and real estate: “That boom has now ended, leaving apartment blocks in second- and third-tier cities that will never be occupied, and loans to local governments and state-owned enterprises that will never be repaid. Growth in China’s industrial production may be close to zero, even if the official figures suggest a less dramatic decline.”

The solution many of these countries have chosen, quantitative easing and the creation of new money, cannot create the consumer and business demand that these countries so desire, warns Turner. “At the global level, exchange-rate devaluation must be a zero-sum game. ... Buoyant domestic demand might offset the deflationary impact on the U.S. economy, but only if interest rates stay low enough to stimulate a resurgence of private credit growth, potentially taking us full circle, to the kind of run-up in leverage that preceded the 2008 crisis,” he writes.

What About Israel?

So what is the solution? According to Turner, an economist with rather unconventional opinions – or maybe he just is not afraid to say what others are thinking – there is no choice but to implement more radical policies. “Seven years after 2008, global leverage is higher than ever, and aggregate global demand is still insufficient to drive robust growth. More radical policies – such as major debt write-downs or increased fiscal deficits financed by permanent monetization – will be required to increase global demand, rather than simply shift it around,” he says.

Turner does not mention Israel in his article, and the level of private and public debt in Israel is actually significantly lower than that in developed nations on the eve of the 2008 crisis, and even more so as compared to their debt levels today.

There is no need for a national debt forgiveness plan in Israel, for example. But a trend is still a trend, and the longer it lasts, the more it could well become a problem at some stage. The data for the past few months and the last year show that the Israeli public has no faith in the ability (or desire) of its government to lower housing prices, and that is why Israelis continue to take out more and more debt – and raise housing prices in Israel higher and higher.

There is no doubt: The Israeli public is first of all worried about the insane level of housing prices, and has no interest in macroeconomic nightmare scenarios. The fact that an entire generation of young people cannot afford to buy an apartment without mortgaging a huge part of their disposable income in order to pay off a 30-year mortgage is nothing less than demoralizing. The response of some of the decision makers, which lately has included raising their hands in surrender and declarations that housing prices will not fall (in other words, not during their present terms), is also depressing.

The Bank of Israel is worried too about the pace of taking out mortgages, because of the implications of this level of leverage in case of a financial crisis, and the effect of such a scenario on the stability of the banking system. Just a year ago then-Supervisor of Banks in the Bank of Israel, David Zaken, published a requirement for the banks to increase their equity because of their mortgage exposure.

“The experience around the world teaches that crises in the banking system develop many times as a result of the banks’ exposure to housing debt and the real estate sector, and in particular in light of the accelerated expansion of the scope of mortgages,” Zaken said at the time. But after speaking out, the pace of new mortgage lending climbed by another 30%.

Beyond the despair of young people and questions of banking stability, the public’s reaction: Taking out enormous mortgages, immediately and right now, before the prices rise even more – could well have much broader economic implications in the long term. Israel too can fall into a situation in which the economy has too much debt, credit and interest payments are moving in circles and from place to place – until they strangle demand, consumption and the entire economy. It happened in a few Western nations, it can happen here too, and this scenario must set off warning signals in the Bank of Israel and the Finance Ministry.