Economists will be drawing lessons from the US housing bubble and bust for many years to come. Not only can the experience be applied to future cycles in the US, but it can also be a telling lesson for other countries. The popular comparison is to relate the US housing bubble to the current run-up in home prices in Canada or Australia, but Norway is another country that is seeing perhaps unsustainable home price appreciation. A recent San Francisco Fed paper compares the experience in the US to that of Norway and concludes on a worrisome note.
A bubble is naturally very hard to identify in real time and there are always ways to justify asset appreciation. One can argue that appreciation in home prices is driven by investors who have rationally low risk premiums. But, the authors argue otherwise and show evidence that the gain in prices in Norway is hard to justify, just as it was in the US. Comparing home prices to rents in Norway shows that prices are almost 350% of rent, which is double the last peak achieved nearly two decades ago. In addition, leverage has increased dramatically with household debt at 210% of income. Moreover, homeowners in Norway believe that prices will continue to climb – a recent report by Norway’s Financial Supervisory Authority (FSA) found that 70% believe prices will continue to rise compared to just 10% in 2008. These are concerning signs for the Norway housing market.
“… Lessons learned from the United States may help determine whether housing bubbles exist elsewhere. Norway is an instructive case. Figure 1 plots real house prices in the United States and Norway from 1890 to 2011. It shows that real house prices were relatively stagnant in both countries for most of the 20th century. Norway and other Scandinavian countries experienced a major house price boom in the late 1980s, followed by a crash in the early 1990s. The crash triggered a financial crisis throughout Scandinavia, resulting in numerous bank failures (see Allen and Gale 1999). Interestingly, this earlier boom-bust pattern in Norway is similar in magnitude to the recent pattern in U.S. house prices. After peaking in 2006, U.S. real house prices have dropped nearly 40%. Starting in the late 1990s, Norwegian house prices experienced another major boom, but so far no bust. On the contrary, real house prices in Norway have risen nearly 30% since 2006.
Figure 2 plots price-rent ratios in the United States and Norway since 1960. The U.S. ratio peaked in early 2006, but has since fallen to its preboom level. The price-rent ratio for Norway has continued to trend upwards and currently stands about 50% above its last major peak achieved two decades ago.
Figure 3 compares household leverage ratios in the two countries. The U.S. ratio of household debt to disposable personal income peaked at about 130% in 2007. The leverage ratio in Norway has risen dramatically over the past decade and currently stands at around 210%.
Recent Norwegian housing market trends have raised concerns about financial stability. The Central Bank of Norway (2012) identifies the household sector as having a high level of risk or vulnerability to shocks. A report by Norway’s Financial Supervisory Authority (FSA) (2012) emphasized the risks posed by growing debt burdens relative to incomes, high loan-to-value ratios, greater recourse to interest-only borrowing, and a widespread belief among Norwegians that house prices will continue to rise. Figure 4 plots the results of a recent FSA survey. It shows that the percentage of Norwegian households that believe property prices will keep rising over the next year has gone from a low of 10% in 2008 to around 70% in 2011. Like U.S. housing investors, Norwegians appear to expect high returns on housing even after a sustained run-up in the price-rent ratio. This is directly at odds with the idea of rationally low risk premiums, but is consistent with investor behavior during bubbles.
In a report issued earlier this year, the International Monetary Fund (2012) concluded “[F]undamentals appear to explain part, but not all, of the house price boom in Norway. In particular, fundamentals such as higher income, population growth, and tax changes have all boosted demand. Additional pressures on prices have come from the slow adjustment of supply. However, nonfundamental factors such as optimistic price expectations—which are unlikely to be sustainable and could change quickly—have also played a role…. On balance, model-based estimates…suggest that Norwegian residential property prices may be misaligned by 15 to 20%.”
Source: SF Fed (authors: Marius Jurgilas and Kevin Lansing)