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The Right Weights for Mortgage Risks

ABU DHABI – Ever since hunter-gatherers started to build their own dwellings some 14,000 years ago, homeownership has been a mark of high social and economic status. Today, the United States has built a mammoth financial bureaucracy to promote homeownership, and economists, bankers, politicians, and of course homeowners themselves keenly follow house-price indicators. But, as we have recently witnessed, unless mortgage risks are properly calculated, the dream of homeownership can all too easily become an economic nightmare.

Mortgage debt has become households’ biggest liability throughout the developed world. In the decade preceding the financial crisis, US mortgage debt increased almost threefold, while the real economy grew by only one-third. At its 2007 peak, US mortgage debt stood at $10.6 trillion – more than double the combined GDP of China and India.

The six major banking crises in the advanced economies since the mid-1970s were all associated with a housing bust. A real-estate price crash has also been a key cause of emerging-market crises, such as the 1997-98 Asian collapse. Research shows that lost output during recessions accompanied by a housing bust is double or triple what it might otherwise have been had real-estate prices held up. Moreover, housing busts tend to prolong recessions by almost three years.

Given the enormous social and economic costs when high levels of mortgage debt meet a crash in house prices, one would expect regulators to be fully engaged on the issue. Unfortunately, they are not. Although the Basel Committee on Banking Supervision, the primary global benchmark for bank regulations, proposed reforms after the 2008 crisis that are aimed at strengthening the financial system, mortgage regulations have changed little.