Report from the mBank-CASE seminar: Is a bubble inflating on Poland’s housing market?

On Jan 23, 2020, the 164th mBank-CASE seminar was held; its subject, addressed by Dr. Adam Czerniak (Polityka Insight, SGH) was the question of “Is a bubble inflating on Poland’s housing market?” In light of the recent very fast growth in home prices –9.6% year on year in the third quarter of 2019 – the choice of subject certainly met the standard of timeliness.

Dr. Czerniak began his presentation by establishing the concept of a price bubble, which he defined as an imbalance on an asset market consisting in rapid growth in prices, to levels that are unsustainable over the long term. We can identify three phases of a price bubble: 1) initial price growth as a result of the action of fundamental factors (e.g. fast economic growth, wage growth); 2) further price growth, driven by irrational expectations on the principle of a positive feedback loop; and 3) a sharp drop in asset prices. Though a price bubble can be recognized only in its final phase, there are statistical and fundamental indicators that allow us to estimate the likelihood of a bubble. The first group includes metrics of the pace of price growth and their cyclical deviation from the trend, as well as metrics of the stationarity of time series, while the second group includes various relative indicators (e.g. the relation of prices to rents or prices to incomes), metrics of the deviation of prices from a reference level and early-warning (EWS) models. In the introductory part of his presentation, Dr. Czerniak described the most important sources and data that he used for his calculations, i.e. transaction prices provided by the NBP for the new- and existing-home markets, and a deflator in the form of the harmonized index of consumer prices (HICP) published by Eurostat.

Dr. Czerniak stated that the results of these measurements didn’t give a clear answer to the question posed in the title of the seminar, but he argued that we currently have the conditions for incubating a bubble, and he stressed that the likelihood that one will emerge, based on the estimates of his EWS model, is 100%. This diagnosis is supported by the levels of indicators that suggest a bubble: fast growth of real GDP (3.9% year on year in the third quarter of 2019) and real home prices (see above), and a significant deviation (3.6 percentage points in November 2019) of interest rates from the so-called Taylor rule, which describes their optimal level depending on the level of defined macroeconomic variables. This deviation translates into access to low-interest mortgage loans, whose value in the second quarter of 2019 rose by 14.4% year on year. What’s more, we can also see factors that catalyze a price bubble: a high share of homes rented out by their owners, a low ratio of mortgage loans to GDP (19.8% in the third quarter of 2019), as well as a regulatory environment that supports it. Additionally, the values of the statistical metrics calculated for province capitals suggest the existence of a bubble: for the new home market this is indicated by two of five selected metrics, and for existing homes, four of five.

The speaker called particular attention to the phenomenon of flipping: buying houses, raising their standard by renovating or redecorating them, and then quickly (within 6-18 weeks) selling them on. Flipping, which is financed by the buyer’s own funds and by high-interest loans (8-20% per annum) taken out in the gray zone (e.g. through social media or at housing conventions), brings annual profits on the order of 15-20% and may contribute to a price bubble on the housing market by creating speculative demand.

Dr. Czerniak concluded his presentation with three recommendations for political decisionmakers, all of them related to information policy. First of all, they should begin as fast as possible to scrupulously monitor the situation on the housing market to watch for the emergence of a price bubble. Secondly, they should gather data on market expectations for prices, and thirdly, data on flipping, including its scale and financing. Monitoring the gray zone of financing for real estate purchases is in the public interest: it protects the financial safety of people supplying capital to the market. In addition to the Finance Ministry and the National Bank of Poland, the Financial Supervision Authority should also join in analyzing the situation.

If in the coming quarters, price expectations remain in the double digits despite a clear economic slowdown, it will then be necessary to apply measures restricting further price growth. The group of economic policy tools that can be applied is very broad: from interest rate increases, through a tax on real estate transactions, to an ad valorem tax on second and additional homes.

After the presentation there was a debate on the conclusions, methodology and implications of the research. Former Deputy Finance Minister Stefan Kawalec, invited to comment on Dr. Czerniak’s work, began the discussion. (Due to illness, the second invited commenter, Professor Jacek Łaszek, couldn’t take part in the seminar.) Referring to Carmen Reinhart and Kenneth Rogoff’s 2009 book This Time Is Different, Kawalec pointed out that the emergence of a price bubble is always accompanied by attempts by market participants to rationalize the rising prices. He stressed that the current growth in housing prices isn’t driven by excessive lending, but results to a large degree from the lack of good alternatives for investment, in the light of which an increase in interest rates isn’t the right mechanism to limit the bubble (and according to Dr. Czerniak could even contribute to violently popping the bubble). Kawalec indicated that the proper solution, also proposed by Dr. Czerniak, could instead be an additional tax on short-term transactions on the housing market or an ad valorem tax starting from the second home. In the rest of the debate the subject of the ad valorem was developed further, including with a mention that work on it has been going on for many years and is a politically sensitive question. Dr. Czerniak also referred to Kawalec’s comments on market participants’ attempts to rationalize bubbles, stating that the factor driving them is “stories” circulated by word of mouth on the ability to make easy money.

Questions from the audience, which constituted the last part of the seminar, included whether for a bubble to occur on the housing market it is a necessary condition not only to have price growth, but also growth in the volume of sales (according to Dr. Czerniak it isn’t, because low supply may also be a cause of price anomalies); which cities are most threatened by the emergence of such bubbles (the smaller province capitals are); and whether the capital market is able to act as a shock absorber (according to Dr. Czerniak theoretically yes, though the circulation of negative “stories” about this market may make this impossible).

While because of the nature of the phenomenon it addressed, the seminar couldn’t deliver an unambiguous answer to the question of whether a bubble is inflating on the Polish housing market, it supplied a great number of facts on the subject of the current condition of that market, possible directions for its future development, threats related to irrational housing valuations and possible ways of counteracting them.


Written by Krzysztof Głowacki