mortgage contract design, monetary policy, and financial ... · variable- vs. fixed-rate mortgages...
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Lars E.O. Svensson Stockholm School of Economics and IMF
Web: larseosvensson.se
Mortgage Contract Design:
Implications for Households, Monetary Policy, and Financial Stability
Federal Reserve Bank of New York,
May 20-21, 2015
Mortgage contract design, monetary policy, and financial stability
The views expressed in this presentation are those of the author and
do not necessarily represent those of the IMF or IMF policy.
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Outline
Co-ownership: Princeton University Tenancy-in-
Common Program
Variable vs. fixed mortgage rates
Transmission mechanism of monetary policy
Financial stability considerations
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Example of co-ownership:
Princeton University Tenancy-in-Common Program
PU website: “[An] arrangement, in which the University pays for and owns up to one-third of the property, leverages buying power and enhances flexibility to help eligible individuals purchase homes that meet their needs and family circumstances.”
Low tax on benefit; sizable subsidy
Buy 50% larger house
Risk sharing of capital gains and losses
Appraisal
Negotiations about extensions and remodeling
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Variable- vs. fixed-rate mortgages
Sweden: 73% of new mortgages are ARMs (57% of
stock of mortgages)
Monetary policy more effective with ARMs
• Very good in Sweden and Norway during recent crisis
Individual incentives for ARMs
• Lower average rate but more risk
• Penalty for getting out of FRMs
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Variable- vs. fixed-rate mortgages
Do ARMs make households more vulnerable?
• Variable rates provide business cycle insurance (reduces risk!)
• Do households have too optimistic mortgage-rate
expectations?
• Stress tests of households’ repayment capacity and resilience
towards disturbances!
• Tests of house prices in line with fundamentals
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Swedish household mortgage-rate expectations are
higher than actual rates
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Swedish FSA’s Mortgage Market Report 2015:
Example of a stress test
For a given increase in mortgage rates, what share of new borrowers would then have a deficit in a left-to-live-on analysis (may have to sell)?
Modest increase in share
New borrowers are quite resilient
Old borrowers are likely to be even more resilient
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Swedish FSA’s Mortgage Market Report 2015:
Example 2 of stress test
Assume: (1) 10 pp increase in the unemployment rate and (2) 20% housing price fall
Q: What share of new borrowers do then have (1) a deficit in a LTLO analysis (may have to sell) and (2) an LTV ratio > 100% (must realize a loss)?
A: Less than 2%
Q: What if housing prices fall by 40%?
A: About 3%
New borrowers are very resilient
Old borrowers are likely to be even more resilient
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Swedish housing prices have increased as much as disposable
income; 10-yr interest costs have fallen much below
Interest costs for 100% loan-to-value ratio
and 10-yr mortgage rate Housing prices
Interest costs
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Extra slides
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Cost-benefit analysis 1
Riksbank estimates MPR Feb 2014, Schularick-Taylor
2012, Flodén 2014
Consider cost and benefit in terms of unemployment of
1 pp higher policy rate for 4 quarters
Cost: 0.5 pp higher unemployment next few years
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Cost-benefit analysis 2
Benefit 1: Lower probability of crisis
• 0.25% lower real debt in 5 years (RB)
• 0.02 pp lower probability of a crisis (ST), 5 pp higher unemployment in crisis (RB)
• 0.001 pp lower expected future unemployment
Benefit 2: Lower increase in unemployment in crisis
• 0.44 pp lower DTI in 5 years (RB)
• 0.009 pp lower increase in unemployment in crisis (Flodén)
• Assume high probability 10% of crisis (ST 4%)
• 0.0009 pp lower expected future unemployment
Total benefit: 0.0019 pp lower expected future unemployment
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Cost-benefit analysis 3
Benefit: 0.0019 pp lower expected future unemployment
Cost: 0.5 pp higher unemployment next few years
Benefit/Cost ≈ 0.4%
Cost/Benefit ≈ 250
Additional cost: Inflation below households’ expectations increases real debt burden
The real value of a given nominal debt taken out in Nov 2011 is now more than 6 percent lower than if inflation had been 2%
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Household debt-to-income ratio
(% of disposable income)
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Household debt and assets (excluding collective
pensions), % of disposable income
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Household interest payments, % of disposable income
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Household debt ratio, data revisions
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Inflation below household’s expectations
Note: Dashed lines are 5-year trailing moving averages
Inflation surprise
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The real value of an SEK 1 million loan taken out in
Nov 2011, actual and for 2 percent inflation
6.5
% h
igh
er r
eal
deb
t
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Percent increase to February 2015 in the real value of a given
loan, compared to if inflation had been 2 percent
(depending on when the loan was taken out)