4 HISTORICAL DEVELOPMENT
We will now discuss the crisis using Hyman Minsky´s model.
Displacement
The strong optimism towards the end of the 1800s, the increase in export, and the industrialization led to a displacement in the market. Migration to the capital was extremely high and grew by 23.8 % from 1895 to 1898 (Søbye, 2000). The new law of full halt in the construction industry accelerated this process. Additionally, the monetary policy changed from a quotient to a differential system.
i. Overtrading
When the housing law was enacted in 1893, the nominal housing prices rose by 12 %, and the prices was far above the trend line. The Norwegian economy was rising, and the globalization made sure of an increase in housing demand. House prices increased significantly in the coming years even though the construction was high. This would indicate a lower supply than demand.
ii. Monetary expansion
A sharp fall in the interest rates between 1892 and 1898, in addition to increased wages, ensured a higher demand for money and credit (Knutsen, 2008). This led to establishment of new banks, and from 1895 to 1900, 40 new commercial banks were established in Norway (Eitrheim et. al., 2003).
Competition among banks pushed the interest rates to a lower level, which contributed to a strong growth in house prices. A fall in the interest rate, optimism, and growing credit- and money supply led to a tremendous boom.
iii. Revulsion
Christophersen & Co went bankrupt in the end of 1899, and the business cycle changed.
Unemployment increased, and housing supply was significantly higher than housing demand. The construction boom from 1883 resulted in 5 000 unoccupied houses in the main capital (Søbye, 2000). This indicated that house prices were driven by speculations and not a lack of housing.
iv. Discredit
Optimism quickly changed to pessimism. As a result of the recession and economic losses, banks started to lower their credit level, and implemented a more restrictive lending policy. To compensate for the increased risk, the interest rate was set to a higher level. The growth in credit levels dropped significantly at the end of the 1800s, and had virtually no development in the following years. The money supply followed a similar trend. The result was a comprehensive housing- and banking crisis.
Parikrisen in the 1920s
The second big crisis happened in the 1920s. The nominal aggregate housing price index rose by 72
% from 1914 to 1920, while the consumer price index rose by 197 % during the same period (The Central Bank of Norway, 2015). As a consequence of a higher proportion of money supply in circulation relative to goods, Norway experienced large price increases. An expansionary monetary policy and the shortage of goods led to an increase in inflation. As a result, the government increased the interest rate and led a contractionary monetary policy in the period between 1920 and 1928. The development changed and Norway experienced deflation and appreciation, in addition to bankruptcies in banks and a significantly fall in housing prices (SNL, 2015a).
Displacement
In 1914 the Central Bank of Norway had to redeem the fixed relationship between money supply and the amount of gold reserves (Hodne and Grytten, 2002). This led to a macroeconomic shock that caused a displacement.
i. Overtrading
People had more optimistic expectations for looser monetary- and credit policies. The willingness to pay increased and housing prices grew.
ii. Monetary expansion
Banks received a considerable proportion of the money supply due to a repeal of the gold standard and increased money supply. Production was low compared to the money supply, which led to inflation and speculations. The inflation increased, and peaked at 40 % in 1918. This resulted in a real interest rate of -30 %, and triggered the desire to invest. A consequence was widespread speculations of equity, bonds, and the housing market (Hodne and Grytten, 2002). Norway experienced excess demand after the war, due to a shortage of goods. Optimism and easy access to money led to high consumption.
iii. Revulsion
In 1920 the trend changed, and Norway was now facing a period of recession. Simultaneously, in order to get the currency in par value relative to gold, the Central Bank of Norway introduced a more defensive monetary policy. Inflation turned in to deflation and the real interest rate turned from negative to positive. Lower supply of money made it more expensive to invest, and homebuyers had lower willingness to pay. Consequently, the housing demand fell in 1921, and the housing crack was now a reality (SNL, 2015a).
iv. Discredit
Fall in demand led to a reduction in the income level, which led to massive strikes. Unemployment rose and the banks had to carry heavy losses due to the expansive monetary policy.
The banking crisis in the 1980s
The political objective after World War II was to give residential construction a wide space in the reconstruction work, as it had been disastrously neglected during the war. The embattled areas were to be prioritized first, to ensure appropriate settlement with the aim of obtaining good and sufficient spacious homes for all residents (SNL, 2015b). Some of the political guidelines that were implemented to achieve this goal were direct government support for householders, indirect support through the deductibility of mortgage interests, VAT compensation and low property taxes. These political objectives left its mark on the Norwegian housing market in many years after the war, and have most likely in some way continued to affect the Norwegian housing market until today, with a
higher proportion of homeowners than in many other European countries (Sørvoll, 2011). The proportion of homeowners in Norway was 51 % in 1945, compared to 80 % in 2015.
House prices increased relatively steadily, except from slight fluctuations, in the period after World War II until the late 1970s. However, this has to be seen in context with the new regulations. The housing- and credit market was deregulated in the beginning of the 1980s, as well as pre-emptive and price-fixing regulations slowly, but surely, was removed (Lundesgård, 2012). The housing market could operate as a free market, without government interference. The deregulation during the Willoch-government (1981-1986), in combination with a substantial growth in the Norwegian economy, low unemployment, increased access to credit, as well as high inflation (which resulted in a negative real interest rate in some parts of the period), made it very lucrative to invest in the housing market (Lundesgård, 2012). The nominal house prices in Norway increased with as much as 60 % in the period between 1984 and 1988, when they experienced a period of expansion (The Central Bank of Norway, 2016).
Low interest rate in combination with the credit liberalization8 explains a lot of the development in house prices in the period between 1970 to mid-1980. The oil adventure and subsequent investment willingness among financial players, led to credit-financed consumptions and demand for houses.
Both the real and nominal house prices increased significantly.
In 1986, Norway entered a period of recession with low oil prices and a weaker export industry.
This was met with a devaluation of the Norwegian Krone with the purpose to improve competitiveness. A high interest rate was necessary to counteract expectations of a new devaluation (The Ministry of Finance, 2013), and the consequences were a crisis in the financial industry in the late 1980s. Households struggled to repay loans they had incurred during “Jappetiden”9, combined with a historical high real interest rate of 7-8 %. Additionally, new lending regulations were
8 Norway’s Prime Minister Kåre Willoch disengaged the credit market, and the Norwegians went crazy, as they could
borrow almost as much money as they wanted to.
9 It was a great emergence of ambitious, dynamic and individualistic people, with attitudes that more than ever acted for personal gain. These people were known as yuppies (”japper”)
implemented by the banks. This contributed to increased interest expenditures for households by more than 30 % from 1985 to 1986.
In 1985 and 1986, house prices grew by an average of 30 % each year, but when the bubble burst in 1987, the prices fell with over 40 % in four years. Norway entered a new recession that lasted until 1993.
Displacement
In the late 1970s, Norway followed international liberalization trends and got a more international economy. Financial- and credit markets were the most liberal. The housing market was subjected to deregulations, and thus the housing prices did not follow their natural growth path.
i. Overtrading
Changes in macroeconomic factors resulted in optimism and future profits, also called “Jappetiden”.
ii. Monetary expansion
During the 1980s the inflation in Norway was approximately 10 %, which is extremely high. Due to the high inflation, real interest rates were low and occasionally negative at the beginning of the 1980s. Although the real interest rate increased, the desire to invest was relatively high. In context to the deregulation of the credit market, the increase in real interest rate was undermined and the house prices continued to increase. The expansionary monetary policy led the Central Bank of Norway to increase the money supply considerably. This resulted in a doubling of the money supply in the period 1980 to 1986 (Hodne and Grytten, 2002).
iii. Revulsion
Norway was highly affected by the decline in oil prices in 1986. Norwegian Krone was devalued by 12 % and the exchange rate was unchanged (Hodne and Grytten, 2002). The currency was weakened as an investment object, and the interest rates increased until the beginning of the 1990s.
This led to a turn in the investment growth, and the unemployment rose.
People were defaulting on their loans, the banks guarantee fund was not large enough, and the authorities had to be proactive in order to save them. From 1987 to 1992, house prices fell by 40 %, a reduction that certainly can be characterized as a bubble bursting.
iv. Discredit
Prices fell below its natural growth path after the bubble burst in 1987.
The period from 1993 – and a new banking crisis in 2007/2008
The recession lasted until 1993 and Norway had a continuous economic upturn until 2008, except from 2002 and 2003. The rapid growth in house prices from Q1 of 1993 to Q3 in 2007 was in total equal to 198 % (in real prices). This period is characterized by expansionary monetary policy, a low interest rate as a result of the low inflation, strong wage growth, low unemployment and a high rate of migration to the cities. Banks and creditors led an expansionary monetary policy to get more customers. The introduction of interest-only loans and low-deposits made it possible to reach as many borrowers as possible.
Both Norwegian and Danish banks converted to Basel II regulations in 2007, which implied that the requirements for the risk weights of the banks decreased (The Ministry of Finance, 2011). The Norwegian Ministry of Finance does not exclude that this has a correlation with the growing debt burden in the beginning of the 2000s. Before the introduction of Basel II, several banks took higher chances and approved more, in addition to a greater degree of risky loans, as they already in 2004 knew that they would have a greater lending capacity in a few years. In other words, the banks secured their market shares in advance. The transition period kept going until 2010. The vulnerability of the Norwegian financial system increased towards the financial crisis, but the Central Bank of Norway and the Financial Supervisory Authority did not consider the situation as critical (The Ministry of Finance, 2011).
The demand for Norwegian goods declined as a result of the financial crisis, and the growth in the Norwegian economy decreased towards 2008 (The Ministry of Finance, 2011). Housing prices in Norway dropped in the wake of the financial crisis, but they recovered relatively short after. In 2008 the prices reached a bottom. However, the real house prices were back to the same level as prior to
the crisis already in the second quarter of 2010. This may be due to an operating and ongoing expansionary monetary- and fiscal policy stimulus during the financial crisis, to keep the wheels turning in the Norwegian economy. It is argued that the experiences from the banking crisis in the 1990s were helpful in this period, especially given the banks’ customization and the government’s design of rules (The Ministry of Finance, 2011). The budgetary rule may be avoided with a certain margin in order to prevent financial crises, and government spending increased sharply in relation with the recession.
Displacement
The inflation was 1.3 % in 2002, due to strong product growth and a number of supply shocks. In addition, the key interest rate reached a peak of 7 % by the end of the year. The Central Bank of Norway therefore began strong and frequent interest rate changes to strengthen the economy so that inflation would be at the desired level10.
Already at the end of Q1 of 2004, the key interest rate was 1.75 %, which was historically low. A sharp reduction in the key interest rate, in addition to several supply shocks, can be characterized as a macroeconomic shock. This led to growth in house prices.
i. Overtrading
The macroeconomic shock led to optimism, which in turn increased expectations of future earnings.
ii. Monetary expansion
The low interest rate led to higher demand for money. As a result, the willingness to issue loans increased, and the competition between lenders became harder. Homebuyers got increasingly favorable terms on their loans, and could thus afford to invest more in houses.
iii. Revulsion
The problems began during 2006 and 2007 when the international economy turned. Unemployment increased, and more borrowers were unable to pay their installments. As a consequence, the
investment banks in the US, and in turn investors throughout the world, began to experience large losses on their subprime portfolios. House prices decreased and banks were forced to sell homes below the original value. The Norwegian housing market started to react to these changes, and the pessimism led to a drop in demand for money and credit. House prices declined significantly, and in the latter half of 2007 we could see the first sign of what many thought would be a protracted decline in house price.
In the end of 2008 the Norwegian economy seemed to be negative. The Central Bank of Norway was criticized for not following up the prospects by reducing the key interest rate and increase spending. However, on October 15th 2008, the Central Bank of Norway reduced the key interest rate by 0.5 percentage points. They continued to reduce it even more, and in June 2009 it was historical low, 1.25 %.
iv. Discredit
Unlike the other periods, there has not been any discredit for the house prices in the period after 2008. What looked like a period of profit taking until 2009, changed when the house prices started to rise again. New optimism and sharp reduction in interest rates resulted in an increase in house prices after a short fall in 2008. This is not normal for the last periods in Minsky’s model.
A short summary of the Norwegian housing market history
The Norwegian housing market has experienced three cracks, and in this section we have looked at the history and some repercussions of these. The level of inflation, interest rates, borrowing policy and credit growth largely affect a boom or a bubble. However, it is difficult to foresee a bubble, and even more difficult to predict when the bubble will burst. Although Norway has experienced strong growth in house prices since 2009, it gives us no basis to say whether or not we are in a housing bubble. However, the development in house prices gives us a basis of further analysis as to whether or not the prices can be explained by fundamental factors. We do not know if the housing market today should be similar as previous periods, markets are constantly changing and adapting to new equilibrium.