We may not be experiencing a real-estate bubble, but the risk of one is very real.
By DAVID ROSENBERGJerusalem construction 521(photo credit: Marc Israel Sellem)
When you look at the wreckage wrought by the property bubble in the US – and even more so in Ireland and Britain – it’s not hard to worry about Israel.That is especially the case if you are a central banker as worldly in outlook as Stanley Fischer. The fear is not just the extent of the damage from plunging property prices, bailed-out banks and accumulated debt, but the fact that so many of the best economists, experienced regulators and savvy bankers didn’t see it coming. The property boom and the easy money that enabled them created a veneer of prosperity that fooled almost everyone.Take Ireland – which, as a small hi-tech economy, mirrors Israel more than the US does – to experience the fear factor. Ireland is crushed under debt that may reach over 200 billion euros in the next five years, a sum that would be unpayable without significant aid (and, in all likelihood, even with the aid it has received so far). Six years of economic growth have gone down the drain, and a generation of Irish has little hope of ever regaining the standard of living they once enjoyed.Israel famously avoided the pre-2008 bubble by a combination of good policy and dumb luck. The good policy was not to let the banks run amok in an orgy of faith that the financial markets could police themselves. The dumb luck was that Israel’s property market is essentially a government monopoly that limits the supply of land and effectively prevents builders (who are no wiser than bankers when the money is easy) from erecting homes that no one but speculators needs. Property prices in Israel actually went down in the boom years. Builders like Lev Leviev and Yitzhak Tshuva couldn’t make money at home and went abroad, where they lost big when the real-estate markets went bust.While the American and Irish were speculating in real estate and then licking their wounds, Israel has been growing the oldfashioned way, by producing products and services that were actually needed and increasing its competitiveness. The question for Fischer – not to mention bankers and home buyers – is whether this real economy is being overtaken by the froth of record low interest rates that encourage needless building, property speculation and excessive risk.Israel isn't alone in asking this question. China – a somewhat bigger economy, but like Israel, one that avoided property blow-out – faces much the same dilemma. Just like ersatz economic growth, real economic growth produces prosperity that encourages people to buy ever-bigger homes and luxury cars, and hire pet psychologists. How do you tell the two apart? It’s not necessarily that easy.A lot of the data coming out of Israel certainly make the case that the frothy stage has arrived. Home prices have risen more than 40 percent since the start of 2008 after inflation. The value of new mortgages has risen at an accelerating, double-digit pace, so that home loans now make up more than a quarter of the banks’ loan portfolio.Macroeconomic data suggest much the same. The overall economy continues to grow very strongly, and exports rose 28% on an annualized basis in February-April. But the unemployment rate is falling and the economy is likely approaching full capacity. Even if domestic conditions remain solid, Israel is vulnerable to the continued financial crisis in Europe and instability in the Middle East.Bankers insist that they have their mortgage risk under control, which might have been a more believable claim pre-global financial crisis, when bankers and the market were considered infallible. But the mortgage business is highly competitive, and most banks are making so little money on home loans that the Bank of Israel estimates that if just 0.5% of mortgages default, the banks will be in the red. A lot of these loans are adjustable or linked to the prime rate of interest, which means if interest rates go up, so will the cost of repaying these mortgages and the rate of default. It’s this segment of the market the Bank of Israel is attacking.Politicians, particularly haredi politicians, insist that any clampdown will come at the expense of struggling young couples trying to buy their first homes. The problem is that in the current cheaploan environment, yes, they can afford it, but in five years they may well not be able to. The idea that everyone who wants to own a home should be able to buy one is a nice idea that proved horrendously wrong when America tried it. From a strictly financial point of view, haredim are the first people who should be escorted out of any bank loan department.
In spite of Fischer’s concerns, Israel does, in fact, suffer a housing shortage and is miles away from American-style overbuilding. Israel invests about 5% of its gross domestic product in residential construction, about the mid-range over the long term and certainly a reasonable level considering the long stretch that preceded when there was under-investment. By comparison, the US – a country with no housing shortage – was putting 6.5% of GDP into building houses at the peak in 2007. The fact that new-home construction in Israel has risen by 23% in the last three years is addressing a real need, not creating fodder for real estate speculation. Rising home prices reflect a real imbalance of supply and demand.In sum, Israel faces a very different situation than the US or Ireland on the eve of the bubble. We may not be experiencing a realestate bubble, but we do face a very real risk to the banking system. But if there is one and it bursts, the tsunami of red ink that ensued could be a disaster that Israel can’t afford.Fischer is in the unenviable position of many a policymaker taking preemptive measures – he gets blamed for the pain he is causing now, and will get no credit for preventing a crisis that, thanks to him, will likely never come.The writer is executive business editor at The Media Line. His book Israel: The Knowledge Economy and Its Costs will be published by Palgrave Macmillan in 2012.
