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US mortgage crisis - implications for Bulgaria
submited on 24.08.2007 in category Political stability | Fiscal affairs | Monetary policy | Regulated markets | Privatisation | Macroeconomic developments
submited on 24.08.2007 in category Political stability | Fiscal affairs | Monetary policy | Regulated markets | Privatisation | Macroeconomic developments
?he mortgage-backed securities crisis in the US is a practical demonstration of the monetary theory. The monetary expansion triggers a business cycle, which induces growth of aggregate demand – not only for consumer goods but also for investments in long-term assets. In reality, we witness expansion of economic activity, as long-term projects turn out profitable. Interest rate cuts reduce the opportunity cost of the resource invested, thus increasing the relative profitability of business projects, which otherwise would not have been launched (due to the lower relative return compared to alternative investments). The result is growing investments on one side, and employment improvement and income growth on another – this is the formal excuse for central banks to intervene on money markets.
In the globalizing economy however, internal employment and income are loosely affected by monetary expansion – i.e. when credit is more accessible, it is more probable investments to be made in new factories in China, rather than the US. The international competition among “tradable” goods does not allow for price changes, resulting from artificially boosted demand. This is the reason why electronics and apparel, for example, do not become more expansive, regardless of monetary policy. “Non-tradable” goods however (including real estate), do become more expensive as a consequence of the “cheaper” money.
Interest rate hikes, or restrictive monetary policy, induce the opposite effect. Long-term investment projects need to be restricted, and the already started – to be postponed. Credit becomes more expensive on a micro level as well, so that fewer people could afford buying a house. Hence, housing demand declines and consequently – equilibrium prices.
All this happened in the US in the recent months. It is a result, to a great extent, of the loose monetary policy of low interest rates in the last 8 years to 2005-2006, and it was expected from macroeconomists. Whether this could happen in Bulgaria also is a matter, requiring additional clarification.
Generally speaking, the ECB policy is more cautious – changes in interest rates are slight and at slower rates. For example, ECB maintained 2% interest rate (corresponding to 1% interest rate in the US), and now the interest hike is up to 4% (5.25% in the US). That is why; the business cycle is weaker in the Euro area and the countries, using the Euro as the main reserve and credit instrument.
US financial services are considerably more fragmented than European. This means a larger diversity of players and products. The gains are the usual competitive advantages – broader consumer choice under better conditions and risk diversification. Because of the latter, the crisis would not affect the future of the American economy. But this does not necessarily imply that some financial intermediaries and their clients have not misinterpreted market developments. This is the reason why, some loans are turning into bad credit, debtors bankrupt, and collateral (real estate) under lower prices lead to a loss for the creditor.
The Bulgarian market is not by default immunized against such a development. Banks here also finance themselves through issuing mortgage-backed securities. There are, however, some differences. Currently in Bulgaria there are two processes bearing opposite effects – on one hand, banks’ access to financial resources is becoming more expensive due to rising interest rates on international markets, but on the other hand, competition and innovation allow for Bulgarian banks to operate at lower expenses and therefore reduce interest rates for clients. When the effect of the latter process begins to diminish, interest rates here will start following changes in the Euro area. The other difference is the relatively low penetration ratio of mortgage financing in comparison to the US – considerably more people own a house without using credit. Commercial banks themselves still operate rather carefully, although there are products, which could be classified as sub-prime credit.
Higher interest rates and the more difficult obtaining of credit however would affect foreigners, who now buy investment property in Bulgaria. If financing these purchases is harder, demand will shrink. Reaching higher prices in Bulgaria would also contribute to this result. This process will mainly affect vacation property, but probably will have a certain effect on residential housing as well.
In the globalizing economy however, internal employment and income are loosely affected by monetary expansion – i.e. when credit is more accessible, it is more probable investments to be made in new factories in China, rather than the US. The international competition among “tradable” goods does not allow for price changes, resulting from artificially boosted demand. This is the reason why electronics and apparel, for example, do not become more expansive, regardless of monetary policy. “Non-tradable” goods however (including real estate), do become more expensive as a consequence of the “cheaper” money.
Interest rate hikes, or restrictive monetary policy, induce the opposite effect. Long-term investment projects need to be restricted, and the already started – to be postponed. Credit becomes more expensive on a micro level as well, so that fewer people could afford buying a house. Hence, housing demand declines and consequently – equilibrium prices.
All this happened in the US in the recent months. It is a result, to a great extent, of the loose monetary policy of low interest rates in the last 8 years to 2005-2006, and it was expected from macroeconomists. Whether this could happen in Bulgaria also is a matter, requiring additional clarification.
Generally speaking, the ECB policy is more cautious – changes in interest rates are slight and at slower rates. For example, ECB maintained 2% interest rate (corresponding to 1% interest rate in the US), and now the interest hike is up to 4% (5.25% in the US). That is why; the business cycle is weaker in the Euro area and the countries, using the Euro as the main reserve and credit instrument.
US financial services are considerably more fragmented than European. This means a larger diversity of players and products. The gains are the usual competitive advantages – broader consumer choice under better conditions and risk diversification. Because of the latter, the crisis would not affect the future of the American economy. But this does not necessarily imply that some financial intermediaries and their clients have not misinterpreted market developments. This is the reason why, some loans are turning into bad credit, debtors bankrupt, and collateral (real estate) under lower prices lead to a loss for the creditor.
The Bulgarian market is not by default immunized against such a development. Banks here also finance themselves through issuing mortgage-backed securities. There are, however, some differences. Currently in Bulgaria there are two processes bearing opposite effects – on one hand, banks’ access to financial resources is becoming more expensive due to rising interest rates on international markets, but on the other hand, competition and innovation allow for Bulgarian banks to operate at lower expenses and therefore reduce interest rates for clients. When the effect of the latter process begins to diminish, interest rates here will start following changes in the Euro area. The other difference is the relatively low penetration ratio of mortgage financing in comparison to the US – considerably more people own a house without using credit. Commercial banks themselves still operate rather carefully, although there are products, which could be classified as sub-prime credit.
Higher interest rates and the more difficult obtaining of credit however would affect foreigners, who now buy investment property in Bulgaria. If financing these purchases is harder, demand will shrink. Reaching higher prices in Bulgaria would also contribute to this result. This process will mainly affect vacation property, but probably will have a certain effect on residential housing as well.
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