Why have housing prices gone up? We're all familiar with the standard explanations, topped by the housing supply shortage and sharply declining interest rates in recent years that have led to a lower cost of money for regular buyers and a drastic reduction of alternatives facing investors. The latter examine various investment channels and ultimately conclude that the best one today is real estate. But is this all? Absolutely not.
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According to Bank of Israel studies, part of the increase in housing prices – particularly in 2010 - cannot be explained through normal economic means. So it's best to also look where irregular economic forces are at work.
We're talking about money hidden from authorities in tax havens. It is estimated that $4 trillion not reported to authorities, and for which no tax has been paid, is hidden in Switzerland alone. Due to tightened controls in recent years some of these tax havens – notably Switzerland, Austria and Liechtenstein – have been subject to turmoil, forcing owners of illicit funds to move their money from place to place. A look at the periods when events took place that the Bank of Israel has a hard time explaining using regular financial tools shows that some of these tax evaders had good reason to spend large sums buying property in Israel.
The first event that caused a sharp movement of funds from the Swiss tax haven occurred between 2005 and 2007. During these years the names and secret bank accounts of customers in the Swiss banking system were leaked to the tax authorities. As a result, many tax evaders in France, the United States and other countries discovered that the tax authorities had obtained information about the money they had hidden in secret accounts. A large proportion of these customers tried to, and even succeeded, in smuggling their money to new tax havens, so there's a definite possibility that part of the unexplained reasons for prices rising in the housing market in 2007 is that one of the new tax havens – mainly for Jews in the U.S. and France – was Israeli real estate.
Israel has a lax legal system that allows the use of trusts and other devices by the wealthy to buy property without it being registered in their name. It was easier for the same people who didn’t want to keep their money in Switzerland or have it found to turn it into apartments in Netanya and Jerusalem.
During the same period there were even rumors that some banks set up units specializing in foreign languages to help those buyers purchase the homes discretely. While information on the amounts spent by foreign investors on Israeli real estate is unobtainable for these reasons, it can be assumed that these sums merged with other trends influencing the market and helped bring about a surprising rise in prices following more than a decade of declines.
The second event causing acute fluctuations in black market money occurred at the end of 2009 when a wave of investigations against Swiss banks reached a new apex. U.S. authorities fined UBS nearly $800 million and forced it to reveal the names and account details of thousands of customers. Wegelin & Co., another Swiss bank, declared bankruptcy to avoid exposing its customers. During this time there were also expectations that authorities in the U.S. and other countries would gain widespread access to information on Swiss bank customers. As a result, billions of dollars were once again moved out of Swiss bank accounts in 2010, escaping in every possible direction.
Surprisingly or not, precisely at the same time housing prices in Israel skyrocketed about 30%, and again there was much talk about a wave of foreign investors. As in 2007, it is unlikely this money initiated the trend of rising prices, but it is indeed likely that many of the homes purchased as an investment in Israel and helped boost prices were bought with illicit money. If this hypothesis is true then the Bank of Israel was more correct than it meant to be when it reported that the entire rise in prices was hard to explain using normal economic methods.
Conclusions for the future can also be reached from this. In recent months there seems to have arisen another wave of turmoil among illicit deposits in Switzerland: Information on thousands of customers has been leaked this year to German authorities and to Wikileaks. Meanwhile, in June the Swiss parliament rejected a deal for disclosing information to U.S. tax authorities which, in response, threatened to file lawsuits against Swiss banks and their customers.
In order to defuse the emerging crisis, a Swiss court subsequently handed down a ruling permitting Swiss banks to reveal data about suspected tax dodgers. Consequently, over the upcoming year another flight of money from Swiss banks to tax havens elsewhere is expected to take place. It is likely that only a small percentage of these funds will make its way to Israel since most of the money destined for the country has probably already arrived.
But the amount being tossed about as likely to move out of Switzerland is $200 billion at the minimum. Only a tiny portion of this reaching Israel would be sufficient to affect housing prices here. Therefore the change in prices in 2014 will probably be influenced more by government decisions on non-economic issues, such as tightening the laws pertaining to trusts and the reporting of real estate holdings, than by Bank of Israel decisions on economic matters such as interest rates or mortgage limitations.
Dr. Avichai Snir is an economist at Netanya Academic College.