The danger of a price bubble in Sweden

On Sweden, the new IMF report says that:

“The robust economy and low interest rates, together solid population growth and inelastic housing supply, boosted housing prices and hence household debt:

  • As a percentage of disposable income, household indebtedness has almost doubled since 1996 and now stands at about 180 percent, with a growing share of new borrowers taking on high debts relative to income. The growth in debt has primarily reflected rising housing prices owing to prolonged supply demand imbalances exacerbated by low amortization, low interest rates, and tax incentives to hold real estate and to finance it with debt.
  • House prices have also doubled in real terms since 1996 and Swedish homes are highly valued from a historical perspective. The price-to-income ratio is 40 percent above its 20-year average—highest among the OECD countries. Model-based estimates of overvaluation are notably smaller, at about 10 percent, but are subject to significant uncertainty.

Cheap wholesale funding, from a mix of Swedish and foreign sources, including in foreign currency, has underpinned mortgage growth. Customer deposits represent around 40 percent of banks’ total funding since Swedish households invest a large proportion of savings in mutual funds rather than bank accounts, in part reflecting high mandatory contributions to pension funds (Figure 2). With banks having one of the highest loan-to-deposit ratios in European countries (about 200 percent), the long-maturity residential mortgages rely on wholesale funding, such as covered bonds, unsecured bonds and commercial paper, giving rise to refinancing risks. Nonetheless, a substantial portion of this wholesale funding comes from Swedish pension funds and insurance companies, who may be less flighty investors. About half of the wholesale funding is in foreign currency predominantly in euro and USD. The Riksbank estimates that about 25 percent of the major banks’ foreign funding is used to fund Swedish assets. The banks use currency swaps to hedge this funding to match their SEK denominated loans.

Home ownership financed by high levels of mortgage debt make households vulnerable to falling house prices. Although the immediate effect of a potential decline in housing prices on Swedish household default rates appears to be contained, the indirect macroeconomic impact can be sizeable. Analysis by Sweden’s National Institute of Economic Research finds a 20 percent drop in housing prices would lead to a recession-like impact on household consumption and unemployment, with an even greater impact if this drop coincided with a global downturn. In an extreme but plausible scenario, this can combine with a broader loss of confidence in housing collateral and potentially higher funding interest rates. Given the high interconnectedness among the Nordic-Baltic financial systems, such a shock could also have significant cross-border spillovers.”