More worries for the boycott-hit economy? IMF criticizes the Bank of Israel, warns of massive real estate bubble
The IMF implies in its annual report on Israel, published yesterday, that there is a real estate bubble in the country. It says that home prices are now 25% above their equilibrium value, after rising 80% in the past six years since 2007. Home prices relative to income and home prices relative to rents are 26% and 22% above the long-term level.
The IMF attributes half of the rise in home prices to the housing shortage, and half to the jump in mortgages, which is mainly due to the Bank of Israel's low interest rate policy in recent years.
The IMF says that home prices in Israel, both compared with other countries and compared with historic levels in Israel, are very high compared with their "fundamental" value; i.e. the value that can be explained by economic factors (supply and demand, economic growth, the interest rate, etc.). A bubble is defined as a severing of the actual value from the fundamental value; in effect, the IMF is warning that there is a real estate bubble.
Furthermore, the IMF made a comparative study with other developed countries, and found that the chances of a crash in Israel's home prices is over 20%, and therefore, "cannot be ignored."
The Bank of Israel said in response that the chances of a sharp correction are low because of the lack of supply.
The IMF says that the main variable indicating the chances of a crash in home prices is the mortgages/GDP ratio, which has risen by ten percentage points since 2007. It says that a correction in home prices will have real economic consequences: a 6.5% drop in home prices in one year will reduce private consumption, the growth engine of the Israeli economy, by 3%. The worrying figures come with a warning: a slow correction will allow the Israeli economy to avoid a recession, but will cause low growth rates for years; while a sharp correction will cause a recession that will take two years to recover from.
The IMF criticizes the Bank of Israel's policy on this point. It says that while the policy has succeeded in supporting the soundness of the financial system, its effect on mortgages and the real estate market was narrow and there is no proof that they succeeded in restraining home prices. The effect of the Bank of Israel's macro-prudential measures lasted just six months from the intervention.
The IMF found that the macro-prudential measures were able to reduce the proportion of investors in the real estate market, and it therefore recommends that if home prices continue to climb, the Bank of Israel should undertake direct macro-prudential measures. In effect, the IMF advises tightening mortgage terms, by increasing homebuyers' equity and the income/repayment ratio, measures which have been proven to be more effective than indirect measures, such as restrictions on the banks.
Here too, the Bank of Israel has reservations, saying that the way to lower home prices is to increase the supply.
The IMF is concerned by the scale of mortgages and loans to real estate businesses, which amounts to about 40% of Israel's banks assets. The Bank of Israel is being asked to continue closely tracking holding companies and construction companies according to the results and from the point of view of pressures created and indications of excessive leveraging in these sectors. The report also says that if interest rates rise then mortgage takers will be hit hard, and if apartment prices fall 20% and unemployment rates rise, many mortgage holders, mainly those with variable interest loans, will not be able to service their debt.
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