Reframing of policies to prevent financial bubbles in the economy

Housing prices around the world have experienced an uninterrupted boom because of the global financial crisis [1]. However, the extent of the housing boom shows considerable variation across countries.

In Albania over the last 12 years (2010 – 2022), after a correction of 15 percent in the middle of the period, real estate prices have increased by 113 percent since 2010, thanks to rapid growth in income and costs of construction businesses. However, the economy and the financial market are now amid sweeping reorganizations that have a significant impact on all asset prices, including most importantly, housing prices.

Housing price growth gained further momentum during the pandemic, with an average increase of 40 percent between the end of 2020 and the end of 2022[2], due to a host of factors including greater demand for space, low costs of borrowing and the presence of more informal money in the market [3], and the increase in the level of remittances in Euros [4].

The sudden and widespread increase in consumer prices after decades of low and stable inflation has forced the Bank of Albania to tighten monetary policy even against the growing risk of economic slowdown, which poses a clear threat to the real estate market.

The housing price cycle in early months of 2023 is showing light signs of correction, which are affected by the higher interest rates of loans, the decrease in demand in the housing market, the maintenance of the low level of the currency exchange rate for the euro mainly, but also the increase lower income due to the decrease in demand due to rising inflation for all goods and services leaving less or very little room in the budget of most consumers for savings and investing in real estate.

While the real housing price index in 2022 continued to grow at an annual rate of 21 percent in Tirana (calculations from ALTAX), housing prices in the rest of the country have started to fall in real terms, with the sharpest decline in suburban areas of the country, excluding from this decline the coastal areas and some areas that have been transformed into touristic ones, being also influenced by investments with budget or foreign funds in infrastructure and urbanization.

The housing price correction is even more pronounced and widespread when we focus on the housing price-to-rent ratio. In a recent analysis[5], we show that the influence of informal money in excess and the influence of the increased regulatory burden together with inflation, which we already include as an added element in the influence of costs in the construction process and therefore also in the transfer directly to the sale price may push annually real housing prices to a minimal increase compared to the increases in the last two years.

What can policy makers and influential actors do now?

Before starting to correct the behavior towards the housing market, the Bank of Albania, coordinating with the institutions that directly affect the housing market (regulatory and fiscal) should perform/require stress tests for banks and other non-bank financial institutions that have high exposures to real estate and possibly require higher provisions for mortgage loans for those found to be vulnerable based on the results of the analyzes according to the tests.

Overall, housing prices are determined by a combination of demand-side factors (such as income and capital, remittance flows, foreign financing and investment, real interest rates, credit availability, the level of informality, and demographic developments) and supply factors (such as the availability and current state of the housing stock).

On the other hand, based on the analysis of the asset price of the real estate market, it is necessary to make an analysis as soon as possible to identify the impacts of an unrealistic economy that is based on an artificial inflation of prices in construction and with consequences of the temporary artificial increase of prices beyond any real and sustainable value. In order not to wait for the consequences to turn into a real estate bubble, based on the fact that with the increase in the formalization of the economy, prices will fall and, consequently, demand, then one should not let the fictitious “bill” grow by letting it flow this phenomenon without direct intervention to informal money (demand) and the artificial increase of costs on the other hand (offer).

The results in the absence of intervention could be further reductions in business (non-construction) and household spending, and a downturn in the economy to financial crisis levels, as speculative demand, rather than intrinsic value, drives inflated prices. , which directly affects a decrease in sales in the sector.

Although many of our analyzes show that the informal economy generates a “buffering” effect, which reduces the pressure of demand shocks on inflation, the impact on the market from an irrational increase in housing sales prices will produce an even worse situation in the moment evasion will be fought with incorruptible will and the pyramid of current politicians will start to fall in no time.

This at least two decades of real estate price growth at a rapid pace with no fundamental basis to justify the price increase is a false and misleading signal for economic growth as well.

This unjustified increase is easily observed, if you verify some of the financial statements of large businesses in the construction sector, but also in the sale of real estate in general, the value of the assets is less than the net present value of the cash flows that the owner of the asset is entitled to receive. So, in other words, they have more debts than real estate/bank and cash balance, or expectations to receive money from customers.

This conclusion is easy to say, it is not easy to put into practice for investors, regulatory institutions, or banks. The reason is the deviation of the market year after year, where it has been partially allowed to continue in this situation due to inaction by the institutions, already transforming into a bigger problem than the will of any institution to fight it, due to insufficient capacities and lack of for political support in these circumstances.

In the exposition of the risks, the construction sector is presented in our analysis as an example of the sensitivity of politics and the government to the need for a readdressing of the problems that have already emerged as a challenge.

This is an extremely important moment for the reframing of updated policies and programs to cope with new and increased risks, not only in the construction sector.

Gloomy economic forecasts from the lack of multi-year political stability, informality and the permissibility of a weak financial and fiscal culture aided by irresponsible low-tax policies, increased cash flows from crime and corruption, as well as political patronage and lack of independence and institutional integrity have made predictions for the future very uncertain and now construction is a challenge.

This situation requires not only considerable expertise, but also continues to be subject to great uncertainty about the future values ​​of the factors that affect the price of the asset.

For example, in 2019, with the information available at the time it was difficult to make a clearly plausible case that soaring prices of goods and services would be a major risk in the next two years and beyond.

Although there have been warnings and some price speculation influenced by the factors mentioned above, considering such complications, construction industry players often used asset price estimates based on comparing current prices with historical averages.

However, here the government and its institutions must be parallel in its predictions.

Thus, if the current prices exceed the long-term averages by a large enough margin, then the institutions themselves based on the technology they already have in excess should present a warning signal that an abusive and dangerous trend may be present and further analysis is done. whether there is a risk of causing a crisis or not, calming the market as well as the citizens.

In recent years it has become clear to us that the preventive tools of “ex ante” policy have been insufficient to deal with the rise of systemic risk. Policies aimed at ensuring market stability through institutional supervision do not seem to be sufficient. to prevent the underestimation of the risk and the excessive growth of risks that may come to the economy from financing that exceeds the possibility of borrowing from construction businesses, but not only. Although the banks seem healthy, the system is more fragile than ever.

According on special analyzes carried out by institutions starting from the Bank of Albania, the Ministry of Finance and several committees for national security and economic development/risk prevention, a review of their duties is needed to orient the focus to the coordinated establishment of systems for the combined prevention of risks and ensuring the integrity of the financial system and beyond.

Even based on the Basel III Standards [6], new policy reorganizations must be positioned against financial imbalances and the increased risk of asset prices.

new policy adjustments should be positioned against financial imbalances and increased asset price risk.

So, knowing that (a) construction together with the sale of real estate constitute 15.2 percent of domestic production [7], (b) with an increased impact on economic growth from the real estate sales market is with where:

• the focus of the political leadership and the government to the economy that circulates large liquidity (and the financing of construction and sale of real estate) to be one of the main focuses of law enforcement institutions,
• to replace behavior with passivity (inaction) in actions to increase the identification and detection of negative effects that are produced within large economic sectors,
• to enable national programs that must be developed as a comprehensive approach to combat transactions and the informal market, which is estimated to be 25% more than the formal market that is presented today as part of domestic production.

But monitoring and analysis should be part of a regulatory framework through better provisions of analysis of liquidity and capital in the economy (especially construction). In these dimensions, the regulatory framework applied until today seems to need to be further updated, as it is not enough to have only a sound financial system with liquidity, but mostly a sound business environment. environment.

Meanwhile, the current monetary policy address has the potential to orient in a much more elastic way the financial imbalances associated with the excessive growth of money and credit. Although the monetary policy is focused on the medium term and gives a special role to the analysis of monetary and credit developments, it should plan the increase of the portfolio for investments in agricultural infrastructure, but also those that manage to generate medium-term returns. For example, access to agricultural, livestock or aquaculture areas and forest and rural areas should be studied by the financial sector for an increase in credit and guarantee of investment.

In this approach, strengthening the requirements for the financial discipline of the private and public sector for the transparency of guaranteed and formalized funds for the financing of construction projects [8], as well as the implementation of transparency for the financiers of construction projects would curb speculative profits by reduce the need for investors to provide financing for easy and informal benefits.

[1] https://www.imf.org/en/Blogs/Articles/2021/10/18/housing-prices-continue-to-soar-in-many-countries-around-the-world
[2] https://www.monitor.al/cmimet-e-apartamenteve-shtrenjtohen-deri-ne-40-brenda-nje-viti/
[3] https://top-channel.tv/2022/11/11/parate-e-pista-ne-call-center-miliona-euro-u-hodhen-ne-ndertim-askush-nuk-verifikoi-blerjen-e-pronave/
[4] https://euronews.al/remitancat-1-1-mld-euro-nga-emigrantet-25-e-parave-nga-italia/
[5] https://altax.al/tregu-i-qerase-se-apartamenteve-ne-tirane-dhe-rritja-e-cmimit-ne-vitet-e-fundit/
[6] Focusing on increasing the resilience of the financial system to shocks in several important ways:
– Higher capital and liquidity limits
– Increasing the quality of banks’ capital by focusing on loss-absorbing liabilities such as common equity
– Increasing banks’ reliance on “conditional debt”, debt instruments that convert into equity when individual or system-wide solvency deteriorates beyond pre-set levels.
[7] http://www.instat.gov.al/media/9739/produkti-i-brendshëm-bruto-final-2019-dhe-gjysmë-final-2020.pdf
[8] Preventing the use of borrowed capital for investment, based on the expectation that the profits from the investment will be greater than the interest payable. So the ratio of a company’s debt to the value of its capital should be significantly less than 1.