If you want to see a financial train-wreck happen in slow motion, now might be time to take a look at Germany.
The European Central Bank looks to be blowing a property bubble there that could eventually shatter the fourth largest economy in the world. As that TV ad used to say, it won’t happen overnight, but it will happen. When it does, the world will shake.
The Financial Times called it the war of Mario Draghi versus the (German) banks, this week. That pretty much sums it up.
But before we look at the cause, perhaps we better analyse the symptoms.
Property prices are rising in Germany. In fact, since 2010, German real estate prices have increased 5.6% a year. That’s an average rise, too. If you like at the big cities, prices are rising much faster. Berlin prices rose 14.5% in 2015 alone.
A recent article put it like this:
‘In Germany’s amped-up real estate market, prices are doubling every few years, buyers are sometimes gobbling up properties blind without stepping foot inside, and bankers are practically force feeding loans to customers.’
Sound familiar? Well, if you’re thinking about the US before 2008, well yes. But for Germany, no. You have to remember that in Germany in property prices basically went nowhere in real terms in the preceding 40 years.
The German economy has been remarkably stable since the Second World War. Yep, imagine that — a place that delivers affordable housing and high wages at the same time. It was nice while it lasted.
Rents are currently following prices up. In Munich, they’re up 40% since 2007, by way of example. That begins to become a social issue when you have the lowest home ownership rate both in the European Union and the developed world.
And importing one million refugees despite no democratic vote on the issue probably can’t help the local housing supply and demand balance.
Germans historically have had little affinity with home ownership. That’s because the banking and tax system didn’t incentivise the local population to invest or speculate in housing and land in quite the way we would recognise. So the allure of the mythical property ladder didn’t take root in the same way.
Here’s why. German banks didn’t look to aggressively expand into real estate. In general, they required 20% deposits for real estate loans. They didn’t use a market appraisal to determine the size of the loan either, but a mortgage lending value.
That reflects the minimum price of the property and bank prudence to protect their downside should property prices fall. Home equity loans are not common.
Also, Germans culturally haven’t liked to play Monopoly with their cities. They treat their land policies and rezoning decisions with more care. That’s why they haven’t had the same boom bust cycle that ripped through the UK, Spain, Ireland and United States in 2008. Real estate booms precede and predict banking crises.
In fact, in terms of your daily read, Germans are staggeringly boring. They save over 10% of their disposable income. They keep their money in cash, bonds and annuities. They avoid real estate and share investments
Their banks finance productive enterprise. Hence why Germany’s current account balance is enormous, its unemployment low and standard of living very high.
The question is, is the European Central Bank out to destroy this system? You see, it’s largely the German banking system that is the bedrock of the country’s powerhouse business and export sector.
Now, I don’t pretend to be an expert on Germany. But its banking system is quite a different model to the UK/US/Australian model.
Germany’s banking system is not concentrated into big national banks that are ‘too big to fail’. The top five institutions only hold a market share of 32%, according to the Financial Times.
It’s actually small community savings banks and credit unions that dominate most of the country. These invest in local business and finance local jobs.
These are often not for profit and required by law to lend into their local communities, and to reinvest their profits there also.
However, the European Central Bank’s low interest rate policy is crushing these banks (and insurers). Not to mention the German savers, who rely on fixed income.
The net interest income these small banks make is shrinking because the ECB pins the short term rate down and suppresses longer term rates via Quantitative Easing. This is known as a flat yield curve.
The negative interest rate policy on reserves is also effectively a bank tax. So costs are going up while revenue is coming down.
This is leading to bank mergers, staff cuts and branch closures. But there is a more insidious effect. More and more bank debt is flowing into the property sector. Not only that, but investors worldwide are putting their money into German real estate because Eurozone bonds yield nothing.
This will push real estate higher and higher. The higher real estate goes, the more unstable it becomes. And the German banking system will have higher exposure to this collateral.
A banking expert called Professor Richard Werner recently put it like this:
‘The property bubble which the ECB policy has indeed been creating in Germany will in turn result in a banking crisis that may well become the last nail in the coffin of the community banks, likely to cause them to disappear after all in the coming decade, if current ECB and EU polices are not reversed.’
At that point, the ECB might leverage the crisis to give itself the same control over Germany as it has over Greece now. That could make the head of the European Central Bank the financial dictator of Europe, more than they already are is now.
Editor, Money Morning