Crowdsourcing Housing Bubble Prevention

An economist at the Bank of International Settlements looked at 60 countries and found the most common housing policy changes over the last few decades.

#1. Minimum Down Payment Percentage

• 27 countries introduced minimum down payment requirements
• 29 countries that already had minimum down payments increased them

#2. Maximum Debt-to-Income Ratio

• 22 countries introduced a maximum debt-to-income ratios

Both policies dampen real estate bubbles by dampening the expansion of credit and home prices increases.

Credit and home prices feed off each other. When the amount of money people can borrow to buy homes increases, home prices have a strong tendency to increase and when home prices increase, the amount of money people can borrow to buy homes has a strong tendency to increase.

In both the United States and Switzerland, for example, surges in credit expansion coincided with rapid home price appreciation.

Macroprudential regulations. Countries have these policies - minimum down payments and maximum debt-to-income ratios - to dampen real estate booms and busts. Real estate busts very often lead to major economic recessions.

Canada, I know, has a minimum 5% down payment rule and Canada did not have a real estate bubble last decade when many other countries did.

Better for dampening booms. The article I linked to above points out that maximum debt-to-income regulations are better at controlling credit expansion during booms because they don’t increase your maximum available credit when home prices increase. The maximum amount of money you can borrow is tied to your income and total debt. You can’t borrow more money just because home prices increased.

Minimum down payments, on the other hand, don’t control credit expansion as well. When home prices increase, you can borrow more money as long as you also have the extra cash needed for the higher down payment.

Better for dampening busts. I’d like to add, however, that minimum down payment regulations are better at preventing real estate busts.

Many studies of the U.S. real estate bust found that low and zero down payment mortgages were the first and most likely to default and be foreclosed on during the bust.

Minimum down payments are a nice double-edged stabilizer, dampening booms and, especially, busts.

We learned during the U.S. real estate bust that foreclosures have a huge negative externality.

When foreclosures are above a certain level, they bring down home prices for everyone in an area and that has huge negative economic impacts on every homeowner in the area and the economy as a whole.