Mortgage Markets in a New Financial World: Market Structure & Infrastructure.

1. Mortgage Markets in a New Financial World:Market Structure & Infrastructure. Bertrand RENAUD BRenaud@cal.berkeley.edu Joint AREUEA-AsRES International Conference Seoul,KOREA, 4-6 July 2002.

2. FOUR QUESTIONS 1. Why so many small housing finance systems? 2. What drives financial liberalization? 3. Impact of market structure? 4. What SMM market infrastructure?

3. 1. WHY ARE SOME HOUSING FINANCE SYSTEMS SO SMALL?

4. HOUSING FINANCE DEPTH VARIES GREATLY Very large differences in housing finance depth across regions and countries: • EAST AND SOUTHEAST ASIA: one of the widest dispersion across world regions • LATIN AMERICA: Highly urbanized region, but low levels of financial intermediations • MIDDLE EAST: A surprisingly low development of housing finance systems • EUROPE: Euro conundrum: one monetary policy + 15 very different housing channels

5. Housing Finance Depth: EAST & South-East ASIA circ. 2000 Financial Depth: Ratio of Outstanding Mortgage Loans to GDP

6. Housing Finance Depth: LATIN AMERICA, cir. 1998

7. Housing Finance Depth: MIDDLE-EAST, cir. 2000

8. Housing Finance Depth: EUROPE, 1998

9. WHY THESE DIFFENCES IN HOUSING FINANCE DEPTH? • Levels of urbanization and per capita income affect the depth of housing finance system. Smaller HF systems are expected in less urbanized, low income countries. • Macroeconomic volatility also impacts interest-sensitive housing finance systems HOWEVER, • Legacy of economic and financial policies are dominant factors. • Financial market infrastructure is also key.

10. 2. WHAT DRIVES FINANCIAL LIBERALIZATION?

11. POST WW-2 FINANCIAL POLICIES Leading government role in financial system: • Ceilings on interest rates on bank deposits • High reserve requirement on banks • Government directed bank credit • Micromanaging banks, little autonomy • Restrictions on entry, especially foreigners • Restrictions on capital flows

12. Why Strong Government Control? • Dim views of private sector actions before and during the Great Depression. • Strong recovery under government-led policies, World War 2 and afterwards. • Apparent success of central planning during the 1950s and 1960s. • Economic development is equated only with rapid industrialization. • The financial system should merely be an instrument of industrial policy.

13. THE STIGLER CRITIQUE Choosing nationalization and government controls over the financial system against private enterprise and an autonomous financial system was like: “AWARDING THE MUSIC PRIZE TO THE SECOND PLAYER AFTER HEARING ONLY THE FIRST ONE!”

14. STATE BANKS & SOE PROBLEMS • Politicized governance • Market structure: monopoly • Weak incentives to be efficient • Soft budget constraint • Low rate of innovation

15. FINANCIAL LIBERALIZATION Relaxation of financial constraints : • Elimination of interest rate controls • Lowering of bank reserve requirements • Reduced interferences with bank management decisions (focus on risks) • Privatization of nationalized banks • Foreign bank competition • Facilitation of capital inflows

16. TRANSITION CONCERNS: Financial Soundness Issues • Interest rate decontrol: predatory bank competition and risk of failures • Bank reserves: were not only a central bank revenue but a safety pool for banks • Poor government monitoring of banks may facilitate fraud and excessive risk taking • Privatizated banks may fall under the control of a few large business group • Foreign banks: may out-compete domestic banks and weakened them • Capital flows: can be destabilizing

17. 3. IMPACT OF MARKET STRUCTURE ?

18. Types of Financial Systems The potential of housing finance, especially of SMM growth differs across financial systems when: • Bank-based (+ NBFIs) • Market-based • Underdeveloped

19. BANK ASSETS/ GDP (1990s) MEAN: Ratio across 70 Countries

20. MARKET CAPITALIZATION / GDP

21. HOUSING FINANCE SYSTEMS THERE IS NO SINGLE DOMINANT MODEL: • Mortgage banking • US type • European type • Commercial banks • Mutual Lenders • State banks and national funds

23. 4. WHAT INFRASTRUCTURE FOR SECONDARY MORTGAGE MARKETS ?

24. WHY PRIVATE DEBT MARKETS? • Governments are increasingly unable to finance the massive investments required for: • major infrastructure projects • Utilities • housing • Privatization and deregulation have intensified the need for long-term investment sources. • Private domestic debt markets help reduce interest rate, foreign exchange, and refunding risks. They mitigate problems seen during the 1997 Asia crisis.

25. BOND MARKET DEVELOPMENT

26. BENEFITS OF PRIVATE DEBT MARKETS • Diffuse stress on the banking system by diversifying credit risks across the economy • Supply long-term funds for long-term investment needs • Provide long-term investment products for long-term savings of institutional investors (pension, insurance, others) and achieve lower funding costs with lower liquidity premium • Provide flexible products meeting specific needs investors and borrowers • Facilitate the entry of non-bank financial institutions into housing and real estate finance

27. DEVELOPMENT PATH OF MORTGAGE MARKETS Gradual evolution toward the more advanced securitization stage • No capital market: • only retail funding • Growing capital market: • Centralized funding • Decentralized funding

28. MORTGAGE MARKET FUNDING OPTIONS

29. MARKET STRUCTURE ISSUES Government debt and mortgage debt markets are interlinked: • building a “benchmark yield curve.” • developing a primary market for securities then a secondary market. • developing the investor base: commercial banks, contractual saving sector (pensions,insurance) collective investment funds (mutual funds). + Non-financial investors.

30. BOND MARKET LEGAL ISSUES The legal framework is the foundation: • Regulator of the bond market • Market structure and regulation of trading and transparency • Clearing and settlements system rules • Market conduct rules • Regulation of intermediaries • Role of self regulatory organizations (SRO)

31. TAXATION ISSUES • Tax treatment of interest and capital gains on securities: • Taxation of interest • Withholding tax • Treatment of accrual versus realized income • Inflation adjustments • Tax treatment of different instruments –including tax exemptions – will shape the development of the markets • Taxation of security holders • Tax incentives for financial instruments

32. MORTGAGE MARKET ISSUES The retail (primary) mortgage market is the cornerstone of the entire system: • Land registry system • Effective bankruptcy law • Efficient foreclosure procedures • Reliable property valuation • Proper mortgage loan underwriting • Modern technology in loan processing and servicing

33. Housing Finance Depth: EAST & South-East ASIA circ. 2000