July 15, 2017

High house prices, besides a function of low interest rates, is a function of senseless bank regulatory favoritism

Sir, You write: “With or without a price crash, [resulting from interest rates rising] thinking about real estate must change… A house is not, after all, a productive asset. It is a shelter.”, “When property becomes a roof and a floor again”, July 15.

With Basel II regulators allowed banks, when financing residential houses, to multiply their capital with 35.7 times the net risk adjusted margin, in order to obtain their return on equity. When lending to an unrated SME or entrepreneur, those who could help create new jobs, banks were only allowed to multiply that same margin 12.5 times.

The only reason for that senseless distortion was and is that regulators, as did and do the banks, considered financing houses something much safer than financing some risky enterprises. 

Sir, compared to the case in which such regulatory differences did not exist, what gets much more credit than it should, and what much less? Or are you among those naïve enough to believe bankers have a responsibility, for the good of society, to overlook such skewed incentive structure?

Extrapolates that, and the logical result is the future, we would all end up sitting in ample homey shelters, but with no jobs to be able to pay mortgages, utilities or food.

Sir, such is the short-termism of regulators you have cared nothing about to understand and denounce. On the contrary, you have dedicated yourself to silence my warnings.

PS. By the way if an AAA rating was present, like in the AAA rated securities backed with mortgages to the subprime sector, banks could multiply that margin by 62.5.

PS. Where do you think fiscal sustainability is heading if house prices crash and much property tax revenues vanishes?