Schäuble, the Bundesbank, and deflating bubble fears

The recent move by the European Central Bank to push interest rates to record lows elicited howls of protest from a phalanx of hardened German financial veterans, from Bundesbank board members to Berlin finance minister Wolfgang Schäuble. All view the ECB’s policy as a mission of madness that will only foster future asset bubbles and do little to encourage a genuine overhaul of entrenched bad habits.

Former ECB board member Jürgen Stark accused the current regime under Mario Draghi of operating a policy of targeting specific countries at the expense of the eurozone as a whole, and of micro-managing individual markets to resuscitate the flow of credit, none of which address the structural problems prevailing in the – mainly peripheral and broke – eurozone countries. In particular, by charging banks to leave their money with the ECB overnight, the Central Bank’s hope is that they will think better of it, and lend to businesses and individuals instead.

Not for the first time we find ourselves asking – do you have to work in a central bank to really believe this tosh? We think it’s more likely that banks will hold on to more of their overnight money in cash, and just pass the extra costs on to their customers. Take unnecessary risks? Not likely. Hold tight, rebuild capital, watch stocks rise and see property prices take off again, helping you out of that nasty bad debt exposure you’ve been nursing for the last few years. Yes, that’s the way to do it.

Naturally Draghi’s move, along with a new €400bn long-term refinancing fund and the prospect of further quantitative easing, sent the stock markets into ecstasy, and saw the DAX breaching the 10,000-point mark for the first time.

The problem in prudent Germany is that, for a nation of savers, even the most riskaverse can barely be persuaded by posters in their bank’s window of contented nuclear families feigning enthusiasm at the prospect of earning 1.4% annually on their nestegg. It’s no wonder they’re turning to the property websites to consider buying, after years of being contented tenants.

The steady rise in German residential property prices over the past four years has many economists worried. Even veteran finance minister Schäuble said last week he shared the concerns of Bundesbank president Jens Weidemann, who sees the dangers of a property bubble developing in Germany, and whose economists think property in the larger cities could be up to 25% overvalued. Germany’s second rank of large and mid-sized cities is now also squarely in the firing line, with noticeable price leaps as the wall of money comes to town. Schäuble said “the current situation is dangerous - there is too much liquidity and interest rates are too low.”

Nonetheless, rates are likely to stay low for the next 2-3 years. High employment and steady immigration are providing a new floor for rents in the larger cities, and it’s hard to see what could cause a collapse in the overall price level of residential property in Germany’s big cities. Buyers are taking the view –not unreasonably – that housing demand still outstrips supply, and despite more building activity, this is not about to change in the short term.

In Frankfurt, prices for newly-built apartments in the vast new city quarter Europaviertel have risen by 30% in the past two years. Thousands of young professionals are moving into these apartments, as buyers, and paying only modestly more than they were paying before as tenants – once they’ve stumped up their 20% deposit, of course. Their successors as tenants in the old apartment are almost certainly paying up to 30% more, if the landlord can get away with it.

The Bundesbank view is that, of the 125 cities it monitors closely, “most are 10-20% overvalued measured against long-term demographic and economic factors of influence, while in the largest cities we estimate an over-valuation of 25% on average.”

It’s the Bundesbank’s job, of course, to see the spectre of inflation hiding under every bed, and to warn, early and loud, of anything that could lead to instability. It is true that prices have risen rapidly - a recent report of a sale in Munich at a factor of 44 times annual rent does indeed send shivers down the spine - but buyers in Munich have always been prone to outbreaks of irrationality, without the market being in danger of collapse.

The Bundesbank also knows, better than anybody else, how much credit is circulating in the economy, since they largely authorise it. Property lending this year has risen by 1%. Hardly the stuff of a real lending bubble. The evidence is that borrowers are shelling out more in deposits, perhaps 23% instead of 20%, and managing their monthly burden through lower loan-to-value ratios and higher capital repayments, while locking in super-low interest rates for ten years and longer.

In our view, though, the most compelling argument against fears of a property bubble in Germany is the entrenched nature of the (by and large) smoothly-functioning rental market, which is what still affects the majority of German individuals in their daily lives. Despite the fears investors may have about the impending introduction of the Mietpreisbremse, or rental cap, the bulk of Germany goes about its business safe in the knowledge that it has the mutual protection of a rental agreement which protects both parties. The rental market works.

As we report in this issue, a number of studies show that every third tenant in Germany could afford to buy a house. A single family house costs, on average, five years of a household’s net salary. It depends, of course, on where you live – it makes sense to buy in the east, less so in Baden-Württemberg, where the prices are already sky-high. Low interest rates are now distorting the figure somewhat, but for many, renting continues to make abundant economic sense.

Germany’s low rate of property ownership still puzzles many outsiders, for whom property is a bulwark against inflation and a stable form of saving for one’s old age – perfect, in fact, for the risk-averse, inflation-fearing Germans. In fact, the balance between ownership and a healthy rental market may well be the guarantor of price stability. Should it surprise that countries with the highest rates of ownership, property lending, and transactional volume – Spain, Ireland, and the USA, for example – are not for nothing the most prone to inflating their own property bubbles?