Why has housing been the main driver of recent financial crisis in ECE?


On the basis of Bohle’s 2014 paper and the data of the Hungarian Central Bank

At first I want to state that housing was the main driver of the 2008 financial crisis in every aspect. Since we know that the unprecedented growth in housing prices in the United States were the reason why the subprime mortgage market was born.
In ECE, especially in Hungary and Estonia, the root of the problem was the same (housing finance) but the actual ill-advised effects are different since the financial markets in the area are not as developed as in the US. Therefore there’s no sufficient demand for such financial products as mortgage backed securities, this means that derivatives are not able to gain momentum so big to pose systemic risk.
Unfortunately the underdeveloped financial markets did not rescue ECE from tapping into the recent financial crisis, they become involved indirectly.
As Bohle argues the risks of foreign currency (FCY) denominated loans were unattended by the government, banks and individuals. On the other hand the FCY loans offered way lower interest rates than HUF denominated loans. This was the result in the differing base rates of the ECB, Swiss Central Bank and the National Bank of Hungary (MNB). The MNB was keeping high his interest rates in order to force fiscal rigor. Fiscal strictness was needed because governments from 1998 till 2004 were using populist, pro-welfare methods to boost the domestic economy, this further derailed the country’s fiscal position.
The difference between interest rates and the unattended FCY rate risk resulted in a FCY denominated housing credit boom. Which is illustrated on the following chart, showing the total amount of housing loans between 2003 and 2015 (most recent) in billion forints. The steep rise of FCY denominated loans can be observed between 2003 and 2008.


The other fact worth to mention is that the HUF is not a pegged currency it’s managed in a given range. This means that if a certain shock occurs the MNB is not ensuring a given exchange rate and does not start to spend it’s FCY reserves. For example in a case when, on the global financial markets, the trust against emerging economies becomes weaker, investors flee into reserve currencies like the dollar, euro or the swiss franc. It’s easy to concede that in this case the demand for selling forint is high ergo the price of the HUF falls, meaning that one euro (from the HUF holder perspective) is more expensive than before. In this situation, the residents who’s income is a HUF cash flow but they own an FCY denominated loan, pay a higher proportion of their income to pay the monthly interest and principal. This means less disposable income and lower consumption. If the scale of this setback is systemic it can also mean a major threat to economic growth and financial stability of the country.
It’s again easy to concede that if the FCY denominated loans are present in the economy in this extent (9,3 % of the GDP in it’s peak), as the chart shows, it’s a systemic risk.
The exact same scenario happened to Hungary in 2008 what I written before. The unhealthy subprime mortgage and mortgage backed security portfolios had it’s direct effect on the US. But serious concerns arised regarding countries with not-so-stable fiscal positions, for instance Hungary. Investors started to flee into the reserve currencies by selling the HUF. Unfortunately in the case of Hungary the FCY denominated loans posed a serious risk on the residents and therefore the consumption. We can say that the main transmission mechanism of the crisis in Hungary was the HUF exchange rate through the elaborate FCY loan portfolio.


One thought on “Why has housing been the main driver of recent financial crisis in ECE?

  1. My data and the WSJ blog in Nov 2014 indicate it was the Bush Admin asset forfeiture “sharing” with its confiscation/nationalization of cash and real estate that caused the depression. Look at the increase in looted GDP in 2007…


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