Swedish Housing Surges to Unsafe Value as Debt Soars


Sanna Andersson was looking for new digs. The 23-square-meter (248-square-foot) studio apartment that she shared with her boyfriend in Soedermalm -- the central Stockholm district best known outside of Sweden as the backdrop for Stieg Larsson thrillers -- had grown too cramped.

In May, after months of fruitless searching, the couple found the perfect place: a 69-square-meter (742-square-foot) three-room apartment on the top floor of a 1970s building with ample light, Bloomberg Markets will report in its January issue.

Listed for 3.995 million kronor ($623,000), it was within their budget -- barely. Two other couples were interested, and a bidding war ensued. Phone calls and text messages shot back and forth between bidders and broker as the price spiraled upward in leaps of 10,000, 50,000 and 100,000 kronor.

“We had a maximum amount we wanted to pay, and we passed it three times,” says Andersson, 28, who works in marketing and public relations.

Twenty-four hours later, she and her boyfriend, Christofer Ranman, an account manager for a telecommunications company, emerged as the winning buyers, paying 4.3 million kronor.

“It was nerve-racking,” she says. “It is just insane how expensive it is.”

Bidding wars, once unheard of, are now the norm in Stockholm, says Filip Abrizeh, an agent with Swedbank Fastighetsbyraa AB, Sweden’s largest real estate brokerage.

‘Dangerously Overvalued’

Apartment prices in Sweden rose 14 percent in the 12 months through Oct. 30 after having more than tripled since 2000, according to the latest data from Svensk Maeklarstatistik AB, a private group that tracks real estate prices.

While buying has been particularly frenzied in Stockholm’s popular residential districts, such as Soedermalm, Oestermalm and Vasastan, similar increases have taken place in Goeteborg, Malmoe and other locales.

“The Swedish housing market is dangerously overvalued,” says Bengt Hansson, a researcher at the Swedish National Board of Housing, Building and Planning (Boverket).

In October, he estimated house prices were 25 percent above fair market value, with apartments even more overvalued.

As prices have risen, buyers have taken on more and more mortgage debt, aided by record-low interest rates and interest-only mortgages. Household debt soared to 173 percent of disposable income at the end of 2012, after having hovered between 90 and 100 percent throughout the previous decade.

‘Inevitable Crash’

“A large number of Swedish households are very exposed to the risk of a drop in house prices,” says Par Magnusson, head of Scandinavian macro and rates research at Royal Bank of Scotland Group Plc in Stockholm.

As debt balloons, Swedish politicians, policy makers and bankers are feverishly debating whether they face a bubble and what, if anything, should be done to deflate it before it pops. The issue has been the subject of a half dozen parliamentary committee hearings; has split the executive board of the Riksbank, Sweden’s central bank, and has occupied acres of newsprint.

“It’s very, very important that debt doesn’t go up further,” Riksbank Governor Stefan Ingves, who’s also chairman of the Bank for International Settlements’ Basel Committee on Banking Supervision, told Sweden’s parliament in October.

“This is a problem we need to address today,” says Uldis Cerps, executive director for banking supervision at the Swedish Financial Supervisory Authority (FSA), the country’s bank regulator.

Sweden is experiencing a housing bubble and will face an inevitable crash, Nobel laureate economist Robert Shiller said in an interview with business newspaper Dagens Industri published on December 7.

Swedish Model

The idea of a bubble belies conventional thinking about this Nordic country, whose response to a real estate–fueled meltdown in 1992 was lauded by economists as a model of how nations should respond to the 2008 financial crisis.

The prospect of a bubble has led Swedish regulators and international bodies, including the Organization for Economic Cooperation and Development and the International Monetary Fund, to scrutinize Sweden’s banks.

The biggest -- Nordea Bank AB, Skandinaviska Enskilda Banken AB (SEB), Svenska Handelsbanken AB and Swedbank AB -- hold assets amounting to four times Sweden’s gross domestic product.

Mortgage Risk

Sweden’s banks, totems of a society that supposedly exemplifies the prudence and probity of northern Europeans, often rank among the world’s strongest. They boast an average Tier 1 capital ratio -- a key measure that compares equity and retained earnings to risk-weighted assets -- of 18 percent.

That’s well above the 4.5 percent the Basel committee currently mandates. Yet until 2013, Swedish banks assigned residential mortgages risk weights -- the percentage of a loan’s value that determines how much capital they have to hold to cover potential losses -- as low as 5 percent.

The Riksbank said in 2012 that in calculating mortgage risk, Swedish banks weren’t taking into account reductions in unemployment benefits since the 1990s that could mean more defaults in a future recession.

In response, Swedish regulators tripled the requirement to 15 percent in May 2013. Even that’s well below what most countries require.

“Sweden’s numbers for residential mortgages are surprisingly low compared to elsewhere,” says Paul Glasserman, a Columbia Business School professor who studies risk management.

‘Regional Problem’

Almost a decade ago, the Basel committee recommended an international standard of 35 percent. In the U.S., residential mortgages carry a risk weight of 50 percent or, for less credit-worthy borrowers, 100 percent. That’s one reason U.S. banks tend to securitize mortgages and sell them off to investors.

In Europe, because risk weights are lower, banks can afford to keep mortgage loans on their own balance sheets. Riksbank Deputy Governor Per Jansson says Sweden’s banks should raise their mortgage risk weights to 35 percent.

Because Sweden’s banks operate across the Nordic region, a financial crisis there could easily spill across the country’s borders, says Helge Berger, an adviser in the IMF’s European Department and its Swedish mission chief.

“This would immediately be a regional problem,” he says. On Nov. 14, the FSA said it may increase the risk-weight floor to 25 percent if household debt continues to grow.

‘Very Strange’

The debate over a potential bubble is a vindication for Boverket’s Hansson, a soft-spoken researcher who toils in a tiny office on Norrlandsgatan, a boutique-lined Stockholm street. Hansson became troubled by the rapid increase in house prices in 2007.

“The real value of owner-occupied houses in Sweden had been stagnant for almost 50 years,” he says. Suddenly, prices jumped 80 percent from 2000, with the going rate for apartments rocketing up almost 150 percent. “Something very strange was going on,” he says.

Hansson began publicly warning of danger in 2008. Many bankers disagreed with him then -- and still do.

“Our basic view is that there is no bubble,” says Gregori Karamouzis, head of investor relations at Swedbank, Sweden’s largest mortgage lender.

Karamouzis says high prices are due to a lack of supply: Unlike recent housing bubbles in the U.S. and Spain, there has been no speculative construction in Sweden in the past two decades.

Strict Planning

According to the Riksbank, housing starts, about 20,000 units in 2012, are less than half what they were during the late 1980s and early 1990s, when the government provided builders generous subsidies and tax incentives.

Meanwhile, demand continues to rise. Sweden’s population, currently 9.5 million people, has expanded rapidly due to immigration and higher-than-expected birthrates, according to Statistics Sweden, a government agency. In 2012, the population grew by 67,000, or 0.7 percent, and Statistics Sweden forecasts it will increase by more than 80,000 per year during the next five, the fastest rate ever.

Strict planning and environmental rules that mean it can take a decade to build new apartments in Stockholm have scared off developers, Karamouzis says.

In addition, the combination of government rent control and a prevalence of co-op buildings (called federations in Sweden) reduces incentives for developers to build and constrains the supply of rental units, compelling more people to buy.

‘Lutheran Tradition’

Jan Haggstrom, chief economist at Handelsbanken, says concerns about the housing-price run-up are overblown.

“You should look at house affordability, not just prices,” he says.

Robert Bergqvist, SEB’s chief economist, says not to look at debt in isolation. Real disposable incomes in Sweden grew 58 percent during the past decade. Even though household debt is almost double disposable income, total household assets are more than three times as high, he says.

Besides, says Johan Andersson, SEB’s chief risk officer, Swedes almost never default.

“There is a good deal of good old Lutheran tradition here that you repay your debts,” he says.

Hansson says oceans of easy credit have eroded that tradition. His research shows that only a fifth of house price increases can be explained by population growth outstripping the housing supply.

Cheap Credit

Income growth explains at most a further 50 percent. The real culprits behind overvalued housing are cheap credit and interest-only mortgages, he says.

“We stopped amortizing and took equity out of our homes,” he says.

Hansson’s view began to gain support in 2010 after the Riksbank appointed a special commission to investigate the housing market.

While the commission dodged the question of whether there was a bubble, it emphasized the risk posed by burgeoning household debt: If interest rates rose or house prices fell, consumers would cut back on spending to meet mortgage payments, damaging the economy.

Even the perception of a bubble might lead international investors to stop lending to Swedish banks, precipitating a financial crisis.

A growing chorus -- from the IMF and OECD to credit-rating firm Standard & Poor’s -- has since echoed these warnings. The popularity of interest-only loans means it takes 140 years on average for a Swedish household to pay off its mortgage, according to FSA calculations.

Potential Crisis

In essence, borrowers rent from the bank, while betting house prices will rise enough that when they sell, they can pay off the loan and still make a profit. (If borrowers die, heirs inherit the mortgage or sell the house to pay the bank.)

Sweden’s first attempt to rein in household debt came in October 2010, when the FSA ordered the loan-to-value ratio of new mortgages capped at 85 percent. Prior to that, a third of borrowers exceeded that threshold. The FSA’s mandatory cap temporarily slowed the expansion of household credit.

Since then, the pace of borrowing has again accelerated. The coalition government led by the center-right Moderate Party has focused on Sweden’s banks as the key to avoiding a potential crisis.

Financial Meltdown

Peter Norman, Sweden’s financial markets minister, has proposed a raft of measures, including higher capital buffers and reserves, in an attempt to avert a possible financial meltdown. Similar policies in neighboring Norway have resulted in a drop in house prices.

Norman has singled out the banks because doing so plays well with voters ahead of parliamentary elections in September 2014, says Thomas Oestros, executive director of the Swedish Bankers’ Association.

A Social Democratic minister when his party held power in the late 1990s and 2000s, Oestros says the Moderates won’t eliminate rent controls to encourage construction because it might cost them votes. Nor, he says, will the government reverse its popular 2008 decision to scrap property taxes or eliminate the tax deductibility of mortgage interest, even though those actions might brake runaway house prices.

One sure way to deflate a housing bubble would be for the Riksbank to raise interest rates.

‘Way Forward’

According to minutes of the executive board, the central bank has been reluctant to raise rates for fear of hurting economic growth, which expanded just 0.1 percent in the quarter ended September 30, the latest period for which figures have been released.

With the Riksbank hamstrung, Hansson says, “amortization is the best way forward.”

The Swedish Bankers’ Association already recommends that borrowers pay down their mortgages until they have at least 25 percent equity in their homes.

However, the guidance applies only to new loans, not existing ones, and an FSA survey found that just 40 percent of households continue to make payments toward their mortgage principal after meeting the 25 percent threshold.

The FSA said in October it would consider mandatory amortization if borrowing keeps rising. Hansson says the FSA shouldn’t delay.

“Many people say that we have to be careful, but if we wait another two years, we’re increasing the risk of a hard landing,” he says.

His message has gotten through to at least one buyer: Andersson opted against an interest-only mortgage on her new apartment.

“Even though it is a monthly cost, sooner or later the interest rates are going to go up, and I want my mortgage to be paid down a bit by then,” she says.

Hansson says she’s wise: Sweden’s whole economy is living on borrowed time. And you can’t refinance the clock.

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