Housing prices have been rising in Israel for a long time. This is certainly not news. Until last week, the Bank of Israel insisted that prices were reasonable, that there was no bubble. Maybe there was concern, but nothing major. This was despite the public outcry cry, political intervention, and so on.
So the serious statements of the Bank of Israel disturb me. Why so extreme? What made the Bank of Israel go from zero to a hundred in less than a month?
To bring home the severity of the situation, here is one sentence from the introduction to the latest monetary policy report: "The upward trend of housing prices, which began in early 2008, was also reflected in recent data published during the quarter surveyed, and the rise over the past twelve months was at a rate of 16.1 percent. These developments raise the fear that the upward trend of housing prices - if it persists - will be enough to jeopardize the stability of both the financial and non-financial sectors of the economy. "
I have several theories about the fundamental change in the Bank of Israel's outlook.
The first is - that even those who work at the Bank of Israel are human. The person who edited the reports on the banks' financial stability until recently was Hizkiyahu, but not any more. Now there is a new Supervisor of Banks, David Zaken. It is very likely that Zaken takes a different view, and I have no criticism if he wishes to voice it.
Maybe he wants to strengthen his standing as regulator, and is looking for a strong leverage point, and perhaps this really is his opinion. Either way, his duty is to express his opinion as it is, even if it is different from his predecessor's, otherwise he has betrayed his office.
If this is so, nothing has changed in the economy, but only in the viewpoint of the regulator.
An alternative assumption would be that the new direction that the Bank of Israel has taken is the outcome of common thinking among the talented and experienced people in the bank's top management, people such as Karnit Flug, Barry Topf, Edward Offenbacher, David Zaken, and Fischer himself. So the question arises - what led to such a sharp change of mind?
Why should further interest rate rises undermine the stability of financial institutions and industrial companies? First, let us suppose instability among industrial concerns will result from the secondary effect of damage to financial institutions. If this is so, we must look more deeply at the question of what will happen at the financial institutions.
My own calculations show that the five largest banks, most of which own smaller banks, have an aggregate shareholders' equity of NIS 71 billion. The total of housing loans in 2011 is NIS 184 billion, a fast-paced 17% more than last year, according to the presentation by the Bank of Israel to the Knesset Finance Committee on May 3.
That presentation reveals that 86% of these loans are variable rate. What is the danger? That as the Bank of Israel raises the interest rate, it may reduce inflation (at least in theory, although a great deal of inflation is due to global prices not affected by interest rates in Israel), but it immediately raises the monthly payment for hundreds of thousands of borrowers in Israel. A rise of one percentage point in interest rates, on 86% of the NIS 184 billion, means that the public will pay an additional one billion, two hundred and eighty-two million shekels a year on its debt.
The rise in the monthly payment may make some debtors insolvent. For most of them, the mortgage is also not the only loan.
If we assume that at the current interest rates there will be a rise of one percent in mortgages payments not made, the banks will lose in a year almost two billion shekels.
Finally we get to the point: the Bank of Israel intends to continue raising interest rates sharply in order to maintain price stability at all costs.
Now imagine what will happen if 3% will not be able to make their mortgage payments. The banks will lose 6 billion shekels at least, leading to significant damage to their shareholders' equity and their capital adequacy ratios. Thousands of apartments will go to the receiver, the market will be flooded, stability will be undermined.
To reduce the risk of this happening, the Bank of Israel is trying to reduce the variable interest rate component of the national housing loan portfolio. At the same time, the central bank is pressing the government to build more, in order to curb inflationary pressures on the supply side, thereby allowing the Bank of Israel to moderate the interest rate rises it is planning.
Tal Zohar Avda is CEO of FXCM Israel.
Published by Globes [online], Israel business news - www.globes-online.com - on May 8, 2011
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