Developing Housing Finance Systems

Veronica Cacdac Warnock

IIMB-IMF Conference on Housing Markets, Financial Stability and Growth

December 11, 2014

Based on Warnock V and Warnock F (2012). Developing Housing Finance Systems. Reserve Bank of Australia 2012 Conference Volume.

Motivation

• Housing

• Household’s largest expense and most important asset

• Sector impacts health and economic growth

• Need participation of private sector to housing problems

• A complex good in a complex system • Housing (rental and owned)

• Housing Market

• Housing Finance Market

• Land Use Regulations / Urban Planning

• Our focus: One pillar of a well-functioning housing sector, the market for housing finance (and the infrastructure that supports it).

Motivation • Housing finance in the global financial crisis

• Prominent role in the run-up to the crisis as well as in the aftermath

• Should housing finance be restricted in the name of financial stability?

• In most countries around the world the problem is not too much housing finance, but too little.

• Most countries have severe housing deficits.

• The provision of housing finance is, in many cases, a binding constraint that must be addressed for the sector to sustainably provide adequate housing.

• Housing is a major purchase—4 to 8 times annual income—that is affordable only when payments can be spread out over time.

• In this paper, a follow-up of Warnock and Warnock (2008 JHE), we examine factors that support the development of housing finance systems in an analysis of 61 countries.

Housing Deficits in Latin America and the Caribbean

HOUSING DEFICIT Count Total Housing Year Source

Argentina 3,500,000 2008 Titularizadora Colombiana (2010)

Brazil 5,572,313 2008 Martins et al (2010)

Chile 639,000 2008 Titularizadora Colombiana (2010)

Colombia 3,828,055 10,578,899 2005 DANE Censo General (2005)

Costa Rica 182,265 1,257,000 2009 Sancho et al (2010)

El Salvador 540,499 1,406,485 2008 Sancho et al (2010)

Guatemala 1,500,000 2010 Cuevas et all (2010)

Mexico* 6,000,000 2009 Titularizadora Colombiana (2010)

Panama 125,014 862,586 2009 Sancho et al (2010)

Peru 1,500,000 2009 Titularizadora Colombiana (2010)

Trinidad and Tobago** 40,000 2006 UN-Habitat (2006)

* The government estimate for the 2008-2013 period was 7 million units (Lopez-Silva et al (2011)) . **40,000 for the 2001-2006 period

Source: Housing Finance in LAC: What is Holding it Back? Research Program at IDB.

Motivation: Are these related?

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A Cross-Country Study of Housing Finance Systems

What are the fundamental determinants of the size of a country’s housing finance system? Note: The analysis is more long term (i.e., of fundamental factors) rather than about how mortgage markets vary with the business cycle.

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Source: 2009 Data compiled by authors.

Great variation in size of housing finance systems, even within regions.

Fundamental Ingredients of a Well-Functioning Housing Finance System

• Mortgage markets support the provision of housing by channeling savers’ surplus funds to households who need loans to finance the purchase of a home.

• How well mortgage finance systems function relates to a number of factors including:

1. macroeconomic stability

2. availability of funds for lending

3. ability of lenders to mitigate information asymmetries and credit risk

4. the legal-regulatory infrastructure

• Mortgage markets support the provision of housing by channeling savers’ surplus funds to households who need loans to finance the purchase of a home.

• How well mortgage finance systems function relates to a number of factors including:

1. macroeconomic stability:

• Stability → lower interest rates → affordability

• Stable rates → lenders more willing to offer fixed rates

• Otherwise, lenders more willing to offer variable-rate mortgages which shift the interest rate risk to borrowers

• What happens to households who borrowed at variable rates when the secular decline in inflation reverses?

Fundamental Ingredients of a Well-Functioning Housing Finance System

Fundamental Ingredients of a Well-Functioning Housing Finance System

• Mortgage markets support the provision of housing by channeling savers’ surplus funds to households who need loans to finance the purchase of a home.

• How well mortgage finance systems function relates to a number of factors including:

1. macroeconomic stability

2. availability of funds for lending:

• The basic financing problem in the mortgage market is how to mobilize funding sources to satisfy demand for home loans that are necessarily long term.

• Short-term deposits (if long-term fixed rate mortgages → bank has maturity mismatch, if variable rate mortgages → household has interest rate risk)

• Contractual savings schemes

• Housing provident funds

• Covered bonds

• Mortgage Securitization

Fundamental Ingredients of a Housing Finance System

• Mortgage markets support the provision of housing by channeling savers’ surplus funds to households who need loans to finance the purchase of a home.

• How well mortgage finance systems function relates to a number of factors including:

1. macroeconomic stability

2. availability of funds for lending

3. ability of lenders to mitigate information asymmetries & default risk:

• To assess creditworthiness of borrowers

• To assess value of property

• To reduce default risk by requiring property to be put up as collateral

Fundamental Ingredients of a Housing Finance System

• Mortgage markets support the provision of housing by channeling savers’ surplus funds to households who need loans to finance the purchase of a home.

• How well mortgage finance systems function relates to a number of factors including:

1. macroeconomic stability

2. availability of funds for lending

3. ability of lenders to mitigate information asymmetries, and interest-rate and credit risks

4. legal-regulatory infrastructure

• Collateral laws

• Ease of foreclosure

• Property registration

Fundamental Ingredients of a Housing Finance System

• Mortgage markets support the provision of housing by channeling savers’ surplus funds to households who need loans to finance the purchase of a home.

• How well mortgage finance systems function relates to a number of factors including:

1. macroeconomic stability

2. availability of funds for lending

3. ability of lenders to mitigate information asymmetries and credit risks

4. legal-regulatory infrastructure

Empirical Analysis Housing Finance Demand & Supply Framework

• Demand for Housing Finance • A Derived Demand

• Housing demand is influenced by income levels and rate of household formation.

• Transaction costs

• Supply of Housing Finance • Willingness and ability of lenders to invest funds in housing

• Information on the borrower

• Ability to determine value of property

• Ability to secure collateral in case of default

• Macroeconomic stability

• Sources of funds: deposits, mortgage bonds and securitization

Empirical Analysis Housing Finance Demand & Supply Framework

• Demand for Housing Finance • A Derived Demand

• Housing demand is influenced by income levels and rate of

household formation. *

• Transaction costs *

• Supply of Housing Finance • Willingness and ability of lenders to invest funds in housing

• Information on the borrower *

• Ability to determine value of property

• Ability to secure collateral in case of default *

• Macroeconomic stability * • Sources of funds: deposits, mortgage bonds and securitization

* INCLUDED IN OUR

EMPIRICAL ANALYSIS

Empirical Model

Size of Mortgage Market • Fundamental Explanatory Variables

• Credit Information

• Legal Rights for Borrowers and Lenders

• Ease of Registering Property

• Inflation Volatility

• Control Variable

• Country Size

IFC/World Bank Doing Business database description and chart

Most countries score well (either 5 or 6) on the depth of credit information .

Across countries, great variation in the strength of collateral and bankruptcy laws.

Across countries, great variation in the ease of property registration.

While global inflation surged in 2007 (prior to the crisis), inflation volatility is low for most countries in our sample.

Same Information as Regional Averages

Regression Results: All countries (column 1)

Across 61 countries, those with stronger legal rights (bankruptcy/ collateral laws), greater ease in registering property, and less inflation volatility have larger mortgage markets.

Regression Results: EMEs (column 2)

In EMEs, similar results – strong legal rights and low inflation volatility associated with larger mortgage markets – but ease in registering property is marginally insignificant and depth of credit information system matters.

Regression Results: AEs (column 3)

In AEs, where legal rights are high and inflation volatility is low, deviations in the size of mortgage markets are associated with variation in the costs of registering property.

Additional Regression Results: Private Credit

Private Credit and Mortgage Debt are clearly related. Columns 1-3: Many factors impact the provision of housing finance above and beyond their effects on private credit. Col. 4: Mortgage market size is associated with variation in the costs of registering property, the volatility of collateral (i.e., house price volatility), and instrumented private credit.

Basic Findings of Empirical Model examining the fundamental ingredients of HF systems

We show empirically that countries with

stronger legal rights,

better provision of credit information,

greater ease in registering property, and

a less volatile macroeconomic environment

have larger housing finance systems.

This supports the policy prescription of establishing needed institutions and systems to enable well-functioning housing finance systems.

Summary • Key Question: How can governments enable the private sector to play a

more important role in expanding access to housing finance while maintaining financial stability?

• In general, how well mortgage finance systems function relates to a number of factors including: • macroeconomic stability • availability of funds for lending • ability of lenders to mitigate information asymmetries and credit,

interest rate, and liquidity risks • the legal-regulatory infrastructure

• From our cross-country study, to promote the development of housing

finance systems, countries should • strengthen legal rights for borrowers and lenders (i.e., bankruptcy and

collateral laws) • enable (mandate?) better provision of credit information • Improve the functioning of the housing market by making registering

property less onerous • maintain a stable macroeconomic environment.

Thank you.