Housing prices in Amsterdam, corrected for inflation, have never been this high since recorded history. Next to low interest rates, the cause of rapidly rising prices is a feedback cycle between banks and consumers having become addicted to mortgage lending and ever-increasing prices.
From your conclusion, "Finally, in the Netherlands, and I suppose elsewhere, the most mentioned solution for unaffordable housing is to simply build more houses. This approach fails, because banks can always print money faster than anyone can build houses. The solution is to be found on the demand side, not the supply side.
I agree what you are saying here, but I think any solution is neither about demand or supply. Instead, I would suggest a solution is of a legal nature.
As you write, banks are able to create credit on the basis of their own balance sheet -- which in itself is not restricted by any deposits or other external funding (and so banks create credit 'out of nothing') -- yet the key understanding this accounting process is that banks always need a borrowers balance sheet to take collateral from. The question for banks is always about the collateral of borrowers.
Now, if you ask me, high bubbly prices are a consequence of <<future income>> having become the collateral basis for extending credit. This is what changed during the 90s.
When banks extend credit with houses as collateral, what happens when a mortgagee defaults? The house is sold and the mortgagee's debt is cancelled. Consequently, all financial risk are contractually borne by both debtor and creditor. Especially because banks will insist mortgagees put personal equity in the mortgaged house so that this equity functions as a buffer for banks to limit losses. (See Luigi Zingales Plan B for more how exactly so). Banks then are naturally inclined to refrain from over-crediting because at some point, they create future losses.
Plus another big benefit would be that all private contracts of credit, necessarily become self-liquidating by means of legal stipulation. Instead, they are shifted off to unrelated third parties, be it taxpayers due TBTF, not-so-savvy buyers of securitizations (pension funds and alike), or central banks printing ad infinitum to prop up markets.
What we have now in the Netherlands and elsewhere is very different because when mortgagees default, their houses gets auctioned off ('how many cents on the dollar..?') and the residual losses are entirely borne by mortgagees. Why? Their income has been taken as collateral. The house and its price, under this legal regime has always been beside the point when banks extend credit.
Because banks do not face a legal obligation of mutual risk-bearing, naturally, they maximize their profits by over-crediting, because "see, house prices can only rise", right?
...and you won't hear any Lawmaker complain about this in public, because this very same principle of collataralizing future income is exactly how they (mis)manage our public finances...
Hi Jacco, thanks for your comment. I'm glad I opened the comment section to all :-)
If I am allowed to be direct, your point is that the banking system has less exposure to the housing market than I portray because they have certain equity requirements for extending mortgages and take future income as collateral? And so there is a lack of mutual risk-bearing? I will read the following https://www.marketupdate.nl/columns/schuldherstructurering-werkt-luigi-zingales-plan-b/
by all means, be direct or otherwise, as Dutch as you can be. I for one am :)
I have to rephrase you (sorry). "because they take future income as collateral there is <<insert: NO>> mutual risk-bearing? My point exactly.
Equity requirements do not necessarily solve the problem. The point is that everyone should be able to walk away from credit when they can no longer afford it. It is in my understanding the only way to fix 'the demand side'. You would also enable debt-for-equity swaps should they be needed to fix a housing burst (Zingales Plan B still makes perfect sense).
For credit that banks create, understand that in terms of accounting, your future income is not a balance sheet item on your balance sheet. It is an extrapolation of the net present value (NPV) of your future profit & loss account. In contrast, a house is a balance sheet item with a known (historical) valuation. In the realm of finance, both are assets. Yet a house can be liquidated virtually instantly by simply selling the house to settle the outstanding debt. A net present value of an income stream simply can never be liquidated.
This difference is fundamental.
One cannot make future income appear here and now today, so instead your income is seized to settle the outstanding debt. You know as well as I know how ugly it can get here in NL. Even the tax authority makes (gross ab)use of this (insane) legal debt regime to recoup as much as possible.
I would even go as far to say, this reality bites with the European Treaty for Human Rights. Or let me phrase this issue as a question and hint to article 4: how does a person that is legally being held in a position of negative equity differ from a slave?
Really. Give it a thought..
My point in 'towards a trias pecuniae' (2019) is that when future income is removed from the equation of elligble collateral, all private credit becomes self-liquidating necessarily. And there are only upsides to it. It levels the playing field for all wealth, be it private or public. And it would also set gold free to settle any and all international imbalances. If not in quantity then in price (though that is all beside the point here, but the principle of abusing future income is just the same..).
Excellent article! I am shocked at Amsterdam's rate of increase in the last decades! But it reflects the same rate of increase that happened in my American town. Values more than doubled here since Covid.
I have good friends who live in a suburb of Amsterdam who watched as I struggled during the Great Financial Crime Spree of 2008. They couldn't understand why I was fighting so hard, nor did they understand what was happening to me. I should send them this article, but I think they may resent me for pointing out the same thing is building within their own country.
The banks should have been punished for their behavior in the lead-up to the Great Financial Crime Spree. Because they weren't, we see the same phenomenon happen all over again. It is so disheartening.
"Not only did the mortgage revolution “crowd out” credit for productive businesses"
That's not really true - banks don't lend existing deposits when they make loans. They create new deposits instead - which is how money gets created. The increase in mortgage loans is necessary from the ECBs perspective to generate enough new money to have a chance to reach the 2% inflation target.
In the US for example M3 grows 8% a year to reach 2% inflation. That's a lot of debt to add - and mortgages have the advantage of having good collateral. It does have its limits though. Private debt to GDP doesn't like to get much higher than 200%.
Banks prefer to lend mortgage credit (because of the good collateral). If they are allowed to lend "unlimited" mortgage credit, it makes them lend less to productive businesses. In the footnotes you can find a lot of scientific evidence of the fact this trend hurts economic growth.
Jan, as per usual quality analysis.
One point of constructive criticism though.
From your conclusion, "Finally, in the Netherlands, and I suppose elsewhere, the most mentioned solution for unaffordable housing is to simply build more houses. This approach fails, because banks can always print money faster than anyone can build houses. The solution is to be found on the demand side, not the supply side.
I agree what you are saying here, but I think any solution is neither about demand or supply. Instead, I would suggest a solution is of a legal nature.
As you write, banks are able to create credit on the basis of their own balance sheet -- which in itself is not restricted by any deposits or other external funding (and so banks create credit 'out of nothing') -- yet the key understanding this accounting process is that banks always need a borrowers balance sheet to take collateral from. The question for banks is always about the collateral of borrowers.
Now, if you ask me, high bubbly prices are a consequence of <<future income>> having become the collateral basis for extending credit. This is what changed during the 90s.
When banks extend credit with houses as collateral, what happens when a mortgagee defaults? The house is sold and the mortgagee's debt is cancelled. Consequently, all financial risk are contractually borne by both debtor and creditor. Especially because banks will insist mortgagees put personal equity in the mortgaged house so that this equity functions as a buffer for banks to limit losses. (See Luigi Zingales Plan B for more how exactly so). Banks then are naturally inclined to refrain from over-crediting because at some point, they create future losses.
Plus another big benefit would be that all private contracts of credit, necessarily become self-liquidating by means of legal stipulation. Instead, they are shifted off to unrelated third parties, be it taxpayers due TBTF, not-so-savvy buyers of securitizations (pension funds and alike), or central banks printing ad infinitum to prop up markets.
What we have now in the Netherlands and elsewhere is very different because when mortgagees default, their houses gets auctioned off ('how many cents on the dollar..?') and the residual losses are entirely borne by mortgagees. Why? Their income has been taken as collateral. The house and its price, under this legal regime has always been beside the point when banks extend credit.
Because banks do not face a legal obligation of mutual risk-bearing, naturally, they maximize their profits by over-crediting, because "see, house prices can only rise", right?
...and you won't hear any Lawmaker complain about this in public, because this very same principle of collataralizing future income is exactly how they (mis)manage our public finances...
Hi Jacco, thanks for your comment. I'm glad I opened the comment section to all :-)
If I am allowed to be direct, your point is that the banking system has less exposure to the housing market than I portray because they have certain equity requirements for extending mortgages and take future income as collateral? And so there is a lack of mutual risk-bearing? I will read the following https://www.marketupdate.nl/columns/schuldherstructurering-werkt-luigi-zingales-plan-b/
Hi Jan,
by all means, be direct or otherwise, as Dutch as you can be. I for one am :)
I have to rephrase you (sorry). "because they take future income as collateral there is <<insert: NO>> mutual risk-bearing? My point exactly.
Equity requirements do not necessarily solve the problem. The point is that everyone should be able to walk away from credit when they can no longer afford it. It is in my understanding the only way to fix 'the demand side'. You would also enable debt-for-equity swaps should they be needed to fix a housing burst (Zingales Plan B still makes perfect sense).
For credit that banks create, understand that in terms of accounting, your future income is not a balance sheet item on your balance sheet. It is an extrapolation of the net present value (NPV) of your future profit & loss account. In contrast, a house is a balance sheet item with a known (historical) valuation. In the realm of finance, both are assets. Yet a house can be liquidated virtually instantly by simply selling the house to settle the outstanding debt. A net present value of an income stream simply can never be liquidated.
This difference is fundamental.
One cannot make future income appear here and now today, so instead your income is seized to settle the outstanding debt. You know as well as I know how ugly it can get here in NL. Even the tax authority makes (gross ab)use of this (insane) legal debt regime to recoup as much as possible.
I would even go as far to say, this reality bites with the European Treaty for Human Rights. Or let me phrase this issue as a question and hint to article 4: how does a person that is legally being held in a position of negative equity differ from a slave?
Really. Give it a thought..
My point in 'towards a trias pecuniae' (2019) is that when future income is removed from the equation of elligble collateral, all private credit becomes self-liquidating necessarily. And there are only upsides to it. It levels the playing field for all wealth, be it private or public. And it would also set gold free to settle any and all international imbalances. If not in quantity then in price (though that is all beside the point here, but the principle of abusing future income is just the same..).
Excellent article! I am shocked at Amsterdam's rate of increase in the last decades! But it reflects the same rate of increase that happened in my American town. Values more than doubled here since Covid.
I have good friends who live in a suburb of Amsterdam who watched as I struggled during the Great Financial Crime Spree of 2008. They couldn't understand why I was fighting so hard, nor did they understand what was happening to me. I should send them this article, but I think they may resent me for pointing out the same thing is building within their own country.
The banks should have been punished for their behavior in the lead-up to the Great Financial Crime Spree. Because they weren't, we see the same phenomenon happen all over again. It is so disheartening.
Excellent. Why not be more transparent? Good point. It helps quash the doubters which is important.
Did you mean to comment this on another post perhaps?
"Not only did the mortgage revolution “crowd out” credit for productive businesses"
That's not really true - banks don't lend existing deposits when they make loans. They create new deposits instead - which is how money gets created. The increase in mortgage loans is necessary from the ECBs perspective to generate enough new money to have a chance to reach the 2% inflation target.
In the US for example M3 grows 8% a year to reach 2% inflation. That's a lot of debt to add - and mortgages have the advantage of having good collateral. It does have its limits though. Private debt to GDP doesn't like to get much higher than 200%.
Banks prefer to lend mortgage credit (because of the good collateral). If they are allowed to lend "unlimited" mortgage credit, it makes them lend less to productive businesses. In the footnotes you can find a lot of scientific evidence of the fact this trend hurts economic growth.