What we can learn from Sweden

Australia likes to think of itself as exceptional. We’re different. We’re lucky. The troubles of the world do not reach us.

It’s true by and large. We have avoided most the world’s worst afflictions, including much of the global financial crisis and its impacts on house prices.

But we’re not quite as different as you might like to think. Other nations had very similar experiences before and after the GFC, with asset prices just as robust and the imbalances that come just as troubling.

Sweden is one nation that we might do well to take a closer look at.

Sweden’s housing market shares a lot of similarities with Australia after its financial system was deregulated in the mid-1980s, which led to a house price boom and then correction as the Swedish economy entered recession in the early-1990s.

However, whereas Australia’s banking system was almost brought to its knees via widespread corporate losses, Sweden experienced a banking crisis in the early 1990s after house prices crashed, as well as the bailout of Sweden’s banks by the government.

And like in Australia, since then Sweden also experienced a large house price boom that ran from 1996 to 2010, whereby prices rose by about 165 per cent in real (inflation-adjusted) terms, before falling by about 6 per cent since their peak:

Swedish authorities also implemented a range of measures to stimulate the housing market and maintain the flow of mortgage credit during the onset of the GFC.

While the Australian government increased grants to first home buyers, in Sweden tax breaks were implemented in 2008 for homeowners wishing to renovate newly purchased properties.

Like in Australia, the government also stepped up the provision of liquidity to the banking sector, guaranteeing the funding of the banks and mortgage institutions, as well as establishing a long-term stability fund to deal with any future solvency problems.

Like Australia’s, the Swedish tax system encourages house purchase over other investment options. In general, owner occupiers can deduct 30 per cent of mortgage interest from their marginal rate of tax. Although there is also a capital gains tax of 30 per cent on two-thirds of any price rises, this can be deferred as long as another owner-occupied property is bought, and the rule applies to heirs as well.

Access to mortgage credit has been particularly loose in Sweden. In the years leading up to the GFC, loans were typically granted up to 95 per cent of property value, although 100 per cent-plus loans were also available.

Moreover, loan amortisation periods are particularly long in Sweden – at 100 years for houses and 200 years for tenant-owner apartments. Like with Australian banks, this huge loan growth was funded by an increasingly large reliance on wholesale funding.

The Swedish planning system is also highly restrictive, resulting in home building rates near the bottom of European countries.

These similarities have, according to the IMF, put both Sweden and Australia close to the top of the list of the most indebted households in the world:

But there is one area where Sweden and Australia are less alike. Swedish authorities are tiring of the housing situation, and are looking to dampen demand by strengthening safeguards on excessive mortgage lending.

In October 2010, Sweden’s financial regulator, the Financial Supervisory Authority (FSA), capped mortgage loan-to-value ratios (LVRs) at 85 per cent, a move that helped slow annual mortgage growth from more than 10 per cent between 2004 and 2008, to 4.5 per cent in December 2012.

However, this rate of mortgage growth remains too high for the FSA’s liking, and it is now seeking to impose further LVR limits, as well as increase capital adequacy requirements on Swedish mortgage lenders.

From Bloomberg:

“Sweden’s financial regulator says it’s ready to tighten restrictions on mortgage lending to stop banks feeding household debt loads after a cap imposed during the crisis failed to stem credit growth …

“The FSA is ready to enforce a cap limiting home loans relative to property values to less than the 85 per cent allowed today, [FSA director general Martin Andersson] said. Banks may also be told to raise risk weights on mortgage assets higher than the regulator’s most recent proposal, he said. The watchdog has other measures up its sleeve should these two prove inadequate, he said.

“As most of the rest of Europe grapples with austerity and recession, the region’s richer nations, including Sweden, Norway and Switzerland, have been battling credit-fuelled housing booms …

“Switzerland this month ordered its banks to hold 1 per cent additional capital against risks posed by the country’s biggest property boom in two decades. Norway in December proposed tripling the risk weights banks must use on mortgage assets to 35 per cent …

“The regulator last year also proposed tripling the risk weights banks apply to mortgage assets to 15 per cent. While the pace of credit growth has eased, household debt still reached a record 173 per cent of disposable incomes last year, the central bank estimates.

“That far exceeds the 135 per cent peak reached at the height of Sweden’s banking crisis two decades ago. Back then, the state nationalised two of the country’s biggest banks after bad loans wiped out their equity.”

Australia is yet to even debate the merits of macroprudential tools beyond a few dismissive utterances from the Reserve Bank. Yet these tools are enabling Swedish authorities to more specifically target areas in the economy that need to grow, without triggering further destabilising asset price growth.

Sweden has a weakening economy, in part a result of an overvalued currency (though less so than ours). Nonetheless, the Riksbank, Sweden’s central bank, has slashed interest rates by 75 basis points to 1 per cent in the past year and is successfully forcing down the krona, the local currency, to boost export-exposed industries.

This a lesson for Australia. The balance of using macroprudential tools (controlled here by APRA) to manage credit issuance along with falling interest rates (controlled here by the RBA), could also work for Australia and could materially lower the dollar without increasing the risk of housing assets inflating or deflating too rapidly.

Meanwhile, the dollar would dramatically increase Australian competitiveness in the tradeable sectors, which would grow over time to offset our asset-price and household debt imbalance.

Australian authorities need to look at Sweden.

Leith van Onselen is the chief economist at MacroBusiness. The site offers free 2013 forecasts for the Australian economy, the Australian dollar and the top ten share picks for the year.

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