Sunday, April 22, 2012

Has the Variable Rate Mortgage saved the European Mortgage Market?

Just as in the United States, many European countries have had large run-ups and crashes in house 
prices. Consider the data from the European Central Bank below: one sees in particular large price increases and declines in Spain and Ireland.

Remarkably, default rates in Ireland and Spain in 2009, while high by historical standards at 3.6 and 2.9 percent respectively, were substantially lower than in the United States, where the default rate was 13 percent (see Fiorante and Mortgage Bankers Association of America).  Dwight Jaffee has argued that this difference in performance is the result of the fact that mortgages in Europe give lenders recourse to the borrower.  I find it plausible that recourse matters, but not that it matters quite so much.  For example, while purchase money loans in California are non-recourse, refinance loans are not.  The preponderance of mortgages in California are refinance loans, and California's default rate is extraordinarily high.

So why haven't borrowers in Spain and Ireland defaulted more?  According to the European Mortgage Federation, more than 80 percent of loans in Spain and Ireland are variable rate mortgages.  As a consequence, as market interest rates fell, so too did mortgage interest rates.   The typical mortgage borrower in Ireland and Spain is currently paying considerable less than 4 percent on their mortgage.

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 This has almost certainly been beneficial to Europeans, and suggests that robust TARP 2 program, where underwater borrowers can refinance their loans at lower interest rates, could help mitigate default.  On the other hand, as interest rates rise in Europe, we might have reason to become very, very concerned about defaults there in the months to come.

14 comments:

Unknown said...

The variable rates might have given minor assistance in the downturn, particularly in the UK, but this is to miss the point entirely.

Firstly, the UK suffered very badly in the 90's when high inflation forced very high interest rates on homeowners SVR's.

More Spain & Ireland are suffereing badly simply because their booms were so bad.

And this is the nub of the problem with your post. Germany, where VR mortgages are rare, didn't have a housing boom. And the US's first ever nationwide boom happened a shortly after you moved from fixed to variable rates as the norm.

Variable rates cause housing booms, primarily by transferring interest rate risk first to the home buyer, and ultimately to the state.

For background evidence see:
Andreas Hess, Dr Arne Holzhausen -
The structure of European mortgage markets (

https://www.allianz.com/static-resources/en/images/wp_europaeische_hypothekenmaerkte_eng.pdf

For more discussion see:

Willis - Pricing, liquidity and the control of dynamic systems in finance and economics - Section 6.

http://mpra.ub.uni-muenchen.de/31137/

Variable rates got us into this mess, they should be illegal in any self respecting democracy.

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takeshi007 said...

Having a good mortgage rates can also make a good mortgage market cash flow and if the rates are stable there is a possibility that the number of home buyer hat get a mortgage to purchase a home is increase.

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