Banks, Financial Services, Real Estate, Round Table
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Tuesday, 05.11.2024, 06:51
Relationship between the housing development services market and the mortgage lending system in Latvia
The article was prepared for the International
roundtable-seminar “Latvian banks: what lies ahead?” held in the Baltic
International Academy on 18 May 2016. Its organizers: Baltic International
Academy (BIA), Employers’ Confederation of Latvia (LDDK), Diplomatic Economic
Club (DEC) and online magazine baltic-course.com.
Mortgage lending has several definitions that differ
depending on the study purposes, legislation of the country concerned, and the
branch of knowledge is being analyzed. In terms of the economic substance, a
mortgage is a mechanism for securing an obligation by means of a pledge of real
property, the purpose of which is to increase funds under a long-term loan.
This means that the creditor, under the existing laws, can dispose of real
estate served as a pledge to pay off the borrower's arrears in the event of
bankruptcy or other factors thwart his debt service obligations [1].
Civil Law of the Republic of Latvia defines a mortgage as a
pledge of real estate with no transfer of ownership [2].
Mortgage lending is critical for both the household welfare and
level of development of the national economy, as a whole. Real estate (house or
apartment) is often the most valuable assets for most households, and a
mortgage, in turn, is their main source of additional borrowed funds, so presence
of the mortgage and its conditions have a huge impact on household finances
[3]. Recent studies have shown that presence of mortgages in households can about-turn
its marginal propensity to consume, as it reduces liquidity of real estate [4].
Empirical evidence suggests that lower interest rates ensure
an increase at the housing market, especially in purchase and sale sector. Increase
at the mortgage market in the early XXI century led to expansion of demand and
consumption, which, in turn, resulted in incurrence of heavy debts on mortgage
loans. The subsequent penalties in a form of alienation of real estate in favor
of banks caused serious damage to the household economics, as well as to the housing
market [5].
Thus, the relationship between the mortgage market and the
housing market can increase the impact of housing price shocks, increase the
impact of changes in mortgage interest rates on economic activity, and
sometimes can put the household wealth at risk (with potential consequences for
the national financial system).
Therefore, initial drop in mortgage rates can have an impact
on rising housing prices, and, hence, the households welfare and quality of
life. An increase in the collateral value of its assets can provide households
access to more loans on preferential terms (via the so-called “credit channel”
- a mechanism for transferring monetary policy into the real economy). This, in
turn, can contribute to increased demand for housing, and to additional
increase in housing prices [6]. Thus, a condition of simultaneous increase in
household debt and the market value of housing assets occurs. Resolution of such
situation can be made in two directions. On the one hand, households may use an
additional liquidity of their property to increase spending on consumer goods
or to invest in various financial assets. However, a further increase in
mortgage rates will expend household liabilities for accumulated debt, which
will exert negative influence on the market value of housing assets [7].
In the mid-1980s, such situation was observed in the Nordic
countries, where liberalization and deregulation of financial markets were
carried out, which caused expansion of crediting and led to excesses on the
real estate markets; stock prices rose, and asset price bubbles were occurred
[8].
Yet another example of the mortgage market and the housing
market impact is the Great Recession of 2008. Therefore, when in 2003 the
traditional mortgage market became saturated, the finance industry began to
combine low-rated mortgage loans – often subprime mortgages - to maintain and
increase financial flows. By 2006, more than half of the country's largest
financial companies were involved in the MBS (mortgage-backed securities at
risk) market [9]. As a result, such actions led to a downturn in the housing
and mortgage markets, which had an impact both on the US economics and on the
global economic system.
According to the research conducted in Russian regions,
mortgage rates has a significant impact on prices in the primary housing
market, however, degree of such impact depends on the housing market segment.
This impact is most strongly felt in the more favorable typical regional
housing markets located in regions with a high employment level and well-developed
infrastructure. In less favorable regions, such impact is observed to a lesser
extent [10]. It should be noted that only a decrease in mortgage rates can not
have a marked impact on prices for new housing constructions. Only a general
decrease in the price of borrowed capital can have a significant impact on
lowering prices at the primary housing market. At the same time, an increase in
mortgage rates makes significant corrections to existing prices, and, perhaps,
makes existing residential real estate more attractive in terms of investment
activity, but herewith less accessible to the most of buyers.
This empirical evidence suggests that, given the cyclical
nature of interest rates, government control over the mortgage market, as well
as timely indexation of mortgage payments can improve efficiency of the housing
market based on improving household welfare. According to the author, main role
of the mortgage market is to stimulate the housing market, which will lead to
an inflow of additional investments into the country, growth in employment and,
as a result, a welfare gain and solution of the most important social problem
of provision of housing.
- Chukanov, A. and Guchek, N.
(2017). MORTGAGE LENDING: A MODERN APPROACH. Journal of Tula State
University. Economic and legal sciences, 5(1).
- Pravo.lv. (2017). Civil
Law of the Republic of Latvia. [online] Available at:
http://www.pravo.lv/likumi/05_3_gz.html [Accessed 13 Sep. 2019].
- Campbell, J. and Cocco, J.
(2015). A Model of Mortgage Default. The Journal of Finance,
70(4), pp.1495-1554.
- Kaplan, G. and G. L.
Violante (2014). A Model of the Consumption Response to Fiscal Stimulus
Payments. Econometrica 82 (4), 1199–1239.
- Mian, A., A. Sufi, and F.
Trebbi (2015). Foreclosures, House Prices, and the Real Economy. Journal
of Finance 70 (6), 2587–2634
- Gao, Zhenyu, Michael
Sockin, and Wei Xiong. 2017. “Economic Consequences of Housing
Speculation.” Working Paper
- Ganong, Peter, and Pascal
Noel. 2017. “The effect of debt on default and consumption: Evidence from
housing policy in the great recession.” Unpublished Working Paper
- Fellman, S. (2019). Economic
development in the Nordic countries. [online] Nordics.info. Available
at:
http://nordics.info/show/artikel/economic-development-in-the-nordic-countries/
[Accessed 13 Sep. 2019].
- Coghlan, E., McCorkell,
L., Hinkley, S., McCorkell, L., Hinkley, S., Hinkley, S., McCorkell, L.
and Hinkley, S. (2018). What Really Caused the Great Recession?.
[online] Irle.berkeley.edu. Available at:
https://irle.berkeley.edu/what-really-caused-the-great-recession/
[Accessed 13 Sep. 2019].
- Kornilov, N. (2015). IMPACT
OF MORTGAGE RATES ON PRICING IN THE PRIMARY HOUSING MARKET. Statistics
and economics, 2.
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