Is the Dutch Housing Market a Threat to the Country's Financial Stability?

The housing market in the Netherlands attracts international attention due to its eccentricities. Concerns about the risks this brings to the country's financial system are increasing.

Economist Rick van der Ploeg, a former State Secretary of Culture and now a professor at Oxford, warned recently in an op-ed in the NRC Handelsblad that the Netherlands is vulnerable to contamination in the euro crisis. Not because the budget deficit is so high, or that the national debt is so large, but because of the imbalances in the housing market. They are seen as a threat to financial stability.

His concerns are shared by institutions like the OECD and the International Monetary Fund.

The Dutch housing market is so exceptional that it plays a leading role in a recent international comparative study of the OECD. The housing market in the Netherlands is considered one of the most intensely regulated housing markets in the world - from the tax deductible mortgage interest for buyers to the rental markets' subsidies and regulation of rents and rent increases.

The OECD recently noted that the building of new homes in the Netherlands hardly reacts to price fluctuations. After the Czech Republic the lack of competition in this sector in the Netherlands is the lowest of 21 countries surveyed. This implies that complications occur more rapidly and the economy's performance is affected. The OECD estimates that the annual number of households moving in the Netherlands would increase by half if the building of new homes reacted as fast to price increases as in the average OECD country. And that would be good for the mobility of labor and the labor market's flexibility.

The Dutch housing market is exceptional in several other ways. Together with countries like Ireland and Spain housing prices in the country have risen more than 90% since the 1980's - the category defined as "very high" in the OECD study. The Netherlands - after Sweden - has the most regulated rental sector among the 21 countries surveyed. The country provides relatively the highest subsidies for mortgage loans - the difference between market interest rates and the net rate of financing is the largest in the Netherlands. The Netherlands is also champion when it comes to the number of tenants with leaking roofs. The number of tenants with severe space shortage is also high in the country. This is hardly surprising: rent regulation is often associated with reduced quality and quantity of housing.

Those problems have not gone unnoticed. The present government has plans to revamp the rental sector. But it will be a tough slog. Rents will be less regulated to better match supply and demand as well as stimulate a now almost non-existent market for more expensive high-quality rental properties. This would create a better link between buying and renting. The government also has plans to move more high-income individuals and families out of the low rent social housing they came into - and were eligible for before they became high-income.

But there's another part of the housing market - the buyers market - that the government reforms will leave untouched. As a matter of fact, this sector will be further stimulated by extending a temporary widening of tax deductibility and raising the level of the mortgage guarantee given by the Dutch government on new mortgages. Roughly 80 percent of new mortgages will receive government guarantee. An outside observer would think: doesn't that encourage risky behavior?

At the end of 2009 the government had guaranteed more than 108 billion euros of mortgage loans - nearly half the national budget. With such huge sums, it is understandable that economists are now worried about the risks to financial stability. Dutch households carry more mortgage debt than households in any other nation. If they get into trouble, then the banks here will in trouble as well - big time.

Late last year the IMF declared the housing market one of the weakest spots in the Netherlands' financial system. The IMF report said:

"The domestic risks from high indebtedness in the housing sector continue to require close scrutiny, though mitigating factors appear to offer reassurance. Nevertheless, the high loan-to-value (LTV) ratio, as well as elevated bankruptcies flag the vulnerability and need for continued vigilance."

"Macro-prudential instruments will be an important element to mitigate the likelihood of a recurrence of economic and financial turmoil. Amongst such instruments, limits on the maximum loan-to-value (LTV) ratio may be considered useful, especially given that in the Netherlands this ratio is amongst the highest in the world, exacerbated by generous provisions of tax deductibility. Measures may need to be introduced progressively, given the state of the housing market and of the economy, but perpetuation of the present arrangements would be unlikely to stand the Netherlands’ economy in good stead."