The biggest crisis to rock the global economy in over 80 years was related to a crash in subprime mortgage lending in the United States, and the new IMF research sheds light on how housing finance can roil financial markets and hurt a country’s economy.

 

In the years before the crisis, lax lending standards and an overabundance of money led to an increase in mortgage credit growth, which in turn spurred the house price boom and bust of the 2000s.

 

“No matter which way housing is financed—covered bonds, securitised products, or just old-fashioned on-balance sheet bank loans - the depth of the bust is related to the underlying quality of the loans,” said Laura Kodres, chief of global stability analysis in the IMF’s Monetary and Capital Markets Department, in a press conference to launch the study.

The research looked at housing finance systems in some advanced countries, including the United States, Spain, Ireland and the United Kingdom, and how they contributed to financial instability in the recent crisis.

The IMF found that government intervention in housing finance, such as subsidies to first-time homebuyers and capital gains tax deductibility, exacerbated house price swings, and amplified mortgage credit growth in the years before the recent crisis in advanced economies. The study also concluded that countries with more government involvement experienced deeper house price declines in the bust.

A common way to limit the destructive leverage associated with mortgage loans is a limit on the loan-to-value ratio. For advanced economies, limits on these ratios do seem to play a role in attenuating housing price booms and busts, but when emerging economies are added to the sample, the effectiveness is not apparent. This may be because some mortgages are not in the data as they are originated outside the official sector, or that more people make large down payments, making a tightening of the ratio irrelevant.