Saturday, 17 August 2013

One of the Richest Countries on Earth has Turned its Citizens into Debt Slaves: House Prices and Debt Growth in Norway

In July, Norwegian house prices fell by 2.1% (1.2% seasonally adjusted) compared to June according to a monthly report by the EFF (an organisation for real estate agents in Norway). House prices were still up 3.9% compared to July last year while average prices in 2013 as of July was 5.7% higher compared to 2012 average prices. But perhaps more importantly, the 12 month growth rate fell below 5.0% for the first time since 2009.

We have previously brought attention to what we consider to be primarily a debt fueled increase in house prices in Norway, driven by low interest rates in the country following the "financial crisis" in Europe and the U.S. (see herehere and here).

Finanstilsynet, the financial supervisory authority of Norway, has for some time been concerned about escalating house prices and household debt and its potential risk to bank balance sheets. As a result, required equity for house buyers were increased from 10% to 15% last year. In addition, increases in the risk weights for banks on their mortgage portfolios could be increased. In their Risk Outlook 2013 report published at the end of April they write,
Bank regulation is largely harmonised across the EEA, and the process will continue further once the new capital and liquidity requirements are adopted by the EU. Agreement has been reached in the EU on the new capital adequacy framework (CRD IV). The Ministry of Finance has on this basis proposed new statutory rules on capital requirements for Norwegian banks with a view to entry into force on 1 July 2013 and a gradual step-up in the period to 2016. There will be scope for national adjustments to accommodate specific national characteristics and economic conditions. This applies in regard to requirements on systemic risk buffers, which can be set for groups of institutions; to capital requirements for systemically important banks; to increases of the risk weights used in banks' models; and to supervisory authorities' determination of capital requirements through pillar 2. This scope will be utilised by Finanstilsynet to foster well capitalised, liquid Norwegian banks.
Since the financial crisis in 2008 international interest rates have been extremely low. International rates are expected to remain low for some time, as reflected in the Norwegian rate level. Low unemployment, strong income growth and low interest rates have contributed to record-high house prices and household indebtedness. The growth in house prices and debt continues to outstrip growth in household incomes. A significant portion of household debt is interest-only, and the great majority of mortgages granted carry a floating interest rate. These factors render households vulnerable both to increased unemployment and higher interest rates. An interest rate hike will significantly increase households' interest burden. Very many households would need to devote a large portion of their income to interest and instalment payments.
Households' expectations of lasting low interest rates, high employment, a high oil price and strong income growth could readily turn to pessimism and economic setback. Weakened confidence in the Norwegian economy could lead to a fall in house prices or intensify an incipient decline, triggering substantial financial consolidation in the household sector. Knock-on effects to the wider economy may be substantial, and banks' loan losses will rise. In recent years substantial labour immigration has increased the demand for housing. Developments elsewhere in Europe show that large numbers of labour immigrants are mobile and relocate in response to changing economic conditions. Such development in Norway could trigger or exacerbate a negative trend in the housing market.
There is some evidence that these measures implemented by Finanstilsynet now are perhaps starting to have the "desired" effect on home mortgage lending. According to data released yesterday by Statistics Norway, growth in lending by mortgage companies fell to the lowest level based on data going back to 2009 (data not published prior to this).

Unfortunately, the above mentioned tightening measures and the reduction (for now) in the growth of lending likely will prove too little too late: the damage has already been done through a tremendous growth in overall credit to households for more than a decade. For the 10 year period ending June 2013, annualised growth in overall credit to Norwegian households was 9.0%, peaking at 10.8% in June 2009. 

Nominal household income growth has been nowhere near those levels during this period. After-tax income grew by 2.8% p.a. from 2004 to 2011 in real terms (see table here). Adding the 2.0% p.a. CPI inflation during the period yields a nominal increase in household income of 4.8% p.a. during the same period. Household debt grew by 9.1% p.a. during the same period, almost twice (1.9x) the income growth. That such a development is unsustainable should be obvious. As a result, household debt to income has increased significantly. During the 2004 to 2011 period, debt as a multiple of pre tax income for households has changed as follows,

As the table clearly suggests (for some reason overall debt/income ratio is not reported), debt to income has clearly increased (deteriorated) during the period. In fact, in 2011 there were 7.5% more households with a debt to income ratio of 2 times or higher compared to 2004. The numbers for 2012 are yet to be published, but there is little reason to expect an improvement in the ratios as household credit grew by 5.2% in 2012.

Household debt relative to income is therefore very high in Norway. Norges Bank (Norway's central bank) explains it as follows (here),
In Norway, the ratio of household debt to disposable income is high by international standards. In 2011, it had reached around 200 percent. Only Denmark, the Netherlands, Iceland and Ireland had higher levels, while household debt relative to income in most English-speaking countries, Japan and Europe, excluding the Nordic countries, was lower. 

Household debt and house prices could of course head further upwards going forward, but there are now some real constraints at work to stop both. And when the real brake enters, namely an increase in interest rates, things could get ugly not only for the housing market, but for the Norwegian economy as a whole.

This unsustainable situation, with soaring house prices, mounting debt and salary increases pushed through by greedy labour unions (in partnership with the government ) for many years, has been brought about by disastrous central bank policies which have not promoted financial stability for the long term by keeping interest rates artificially low for too long (to keep the Norwegian currency low) and Keynesian type spending by prime minister Stoltenberg and the Norwegian Labour Party led coalition government. The government has run record deficits for mainland Norway (which excludes oil and gas revenues) especially since the 2008 "financial crisis" (here), even when it didn't need to - and that is from a Keynesian perspective which is not exactly a conservative one! The Keynesian spending policies applied during the financial crisis was never reined in, even as the economy grew in the aftermath driven by oil and gas production. Instead government spending has not only increased pretty much every year since, but increased dramatically since 2008 hitting a new record high this year according to the 2013 budget (the Norwegian Labour Party's election budget). As a result, the fiscal deficits for mainland Norway (which excludes loan transactions and the Government Pension Fund Global/oil and gas income - see chart below) has kept growing. This is nothing short of a lack of fiscal leadership by the prime minister, not to mention prudence. And it's not a stretch to call it outright irresponsible.

But the prime minister might have bought himself some more votes for the upcoming elections. It's easy to spend money when it's not all yours. Ole Asbjørn Ness today writes in the paper copy of Finansavisen, a Norwegian financial news paper, that Norwegians today live in a country where more than 850,000 people work in the public sector (viz. more than 1 in 3 employees) and where 700,000 people are recipients of some form of social security. All happening in a small country with only 5 million citizens.

Too much consumption in Norway has been borrowed from the future turning the average Norwegian, who lives in one of the richest countries in the world, into a debt slave. This will have negative implications going forward, in one way or more, for Norwegian households and the economy in general. The level of interest rates will largely determine when and to what extent.