The mortgage risk

The BoI deserves unstinting support for at least trying to break the vicious cycle of rising real estate prices and low interest rates.

February 7, 2015 20:59
3 minute read.
Karnit Flug at her office on February 3, 2015

Karnit Flug at her office on February 3, 2015. (photo credit: MARC ISRAEL SELLEM)

The Bank of Israel last week repeated its warning that the housing market – more specifically, cheap mortgages – poses the single greatest threat to our financial system. In its Monetary Policy Report for the second half of 2014, the BoI continues to draw attention to an escalating risk – real estate prices are spiraling while mortgage rates are at a historical low.

This encourages borrowing by buyers who may not be able to repay what they owe. The upshot could throw the banks out of kilter, in which case none of us would remain unaffected.

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Just like any living body, the economy – or given segments thereof – can catch fever. For a long time the thermometer has been pointing to spiking temperatures in the real estate sector. This is nothing we can afford to overlook. As in physiology, one ailing organ affects the whole.

The BoI has sounded the alarm previously, most recently in its Financial Stability Report. Yet somehow public opinion appears unimpressed and unperturbed. If anything, populist pressure for cheaper housing and laxer mortgage controls only grows. This is patently dangerous.

The American experience, which spawned the subprime crisis of 2008 and subsequent global recession, should rob us of our peace of mind. Some of the symptoms presented in our mortgage markets are similar and can trigger dire consequences, even if not quite at the level of the US disaster.

Our mortgage system is significantly different from America’s. It’s impossible here to obtain a loan that covers 100 percent of the purchased property’s value. Buyers have to invest and often need guarantors. Still, transactions are disturbingly more leveraged than they had ever been. It is getting appreciably easier to obtain mortgages in Israel and this entices many to take out whopping loans by yesteryear’s standards.

First-time home-buyers can obtain a 75% mortgage – once inconceivable in Israel. Families upgrading their accommodations are eligible for 70%. Investors (including overseas buyers) – who are acquiring real estate not for their own residence – are entitled to borrow 50% of the total cost.

The latter category of purchasers, as distinct from home-buyers, accounts for at least a third of all real estate transactions in this country and their numbers are growing, sending prices spiraling upward.

The danger is that many of the borrowers may be getting in way over their heads. They may lack the wherewithal to ensure they can keep up monthly payments on their floating-rate mortgages in the event of interest rate hikes.

This is a precarious situation for the borrowers, for the lenders (the banks) and down the line it could damage the resilience of our banks, which need to amass the capital to secure the mortgages they liberally offer.

The culprit that overheats the housing market is low interest and the resultant attractiveness of mortgages.

A major incentive not to raise interest rates is to keep the shekel from being overvalued. Even marginally higher rates than the worldwide rock bottom would make Israel’s currency enticing for foreign speculators, because investment in the shekel could generate greater income than in other currencies.

This would perforce boost the shekel but in turn would make Israeli products and services more expensive in the international marketplace and, therefore, less competitive.

Unavoidably this would lead to loss of markets, business failures and massive layoffs. As Israeli exports are hurt, jobs are lost locally.

All this must be taken into consideration. Clearly, fiscal economics is foremost an ultra-chancy high wire act.

Even the slightest misstep can result in what Fannie Mae and Freddie Mac wrought to America. Israelis might not be overextending themselves quite as grotesquely as their American counterparts did, but – in a worrying departure from what was once common here – they are fast headed in that general direction.

This is hardly the exclusive headache of eager banks and impulsive clients. The country’s economic well-being hangs in the balance. The BoI therefore deserves unstinting support for at least trying to break the vicious cycle of rising real estate prices and low interest rates.

In combination, these are the classic ingredients for a mega-crisis.

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