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European property crash no longer seen likely

It was supposed to be a time-bomb striking fear into the hearts of European lenders as a property bubble looked ready to burst and leave banks holding billions of dollars worth of bad debt.

But with property prices still rising from Dublin to London to Madrid, although at a slower pace than earlier in the decade, signs are that a soft landing may spare banks the hefty debt write-offs that followed a market meltdown in the early 1990s.

Even as interest rates rise in the United States and Europe, the latest tightening in monetary policy may not be as severe as in previous counter-inflationary cycles.


"Although rates are rising, they are still affordable ... What matters to borrowers are monthly (mortgage) payments, and these are at relatively reasonable levels," said Simon Whalley at the European Mortgage Federation in Brussels.

Mainstream lenders also appear to have been more cautious in their lending policies than in the past.

"Risk management techniques have improved since the early 1990s after the crash. If one mortgage payment is missed, banks want to see what is going on straight away," said Whalley.

In Britain fewer borrowers have taken on 100 percent mortgages than in the late 1980s boom, leaving them less exposed to the risk of "negative equity", when the price of a property sinks below the value of the loan taken out to buy it.

In Ireland, where house prices are still rising by 15 percent a year, economic data show that households are saving about 12 percent of their disposable income, a high ratio that gives many borrowers leeway as interest rates rise.
"You will see more arrears, but you will not see a hard landing," said a London-based banking analyst with a European investment bank.


HISTORICALLY LOW INTEREST RATES

A sharp surge in interest rates may still derail many mortgage-holders, but economists say the chances of a stringent tightening in monetary policy look remote at the moment.


"If you pause and look at Federal Reserve rates of around 5 percent and look at where we expect European Central Bank rates to go, we are talking about peak interest rates which are very low in a historical perspective," said Christel Aranda-Hassel, a senior economist at Credit Suisse in London.

"In the early 1990s interest rates went to 14 percent in Britain," she said. The Bank of England raised interest rates for the first time in two years last month to 4.75 percent, and many economists do not expect them to go much higher.

Aranda-Hassel said she expected ECB interest rates to peak at 4 percent, up from 3.25 percent at the moment.

Doomsters who forecast that interest rate hikes will eventually puncture property prices may have underestimated the inflation-dampening influence of a flood of cheap goods and services from emerging economies such as India and China.

"The combination of buoyant growth and high oil prices should have resulted in much higher inflation rates. Thanks to globalisation, this time round these are being contained ... so there is no need for central banks to go into restrictive gear."
THE RECKONING

Spain, where 600,000 new homes were built in 2005 alone, may see falling prices as a construction booms runs out of steam, but banks there have high provisions - partly a legacy of the bailout of Banesto, a bank that ran into difficulty in the 1990s and was later acquired by Banco Santander (SAN.MC: Quote, Profile, Research).

But even high provisions may not be enough in a slump.


"The trouble is that when things happen, they tend to happen very fast, and it's difficult to say the extent to which existing provisions will be enough," said a bank analyst based in Madrid.

France, Belgium and Denmark, where house prices also have risen fast, are seen as less exposed because price increases started accelerating only recently.

Some economists say the key to house price movements lies in long-term interest rates, which are exceptionally low at the moment. "The yield on a long-dated British inflation-proof bond is 3/4 percent, which is an extraordinarily low number," said David Miles, chief UK economist at Morgan Stanley.

"When one looks in the euro area, real yields in France are not as low, but are 1.5 percent for the longest-dated inflation-proofed euro bonds."

Miles believes a rise in long-term interest rates cannot be ruled out and would have an impact on property prices.
"I think they are an important driver of the right value of housing. Will these low long-term interest rates persist in the future? I am a bit sceptical, and the explanations for why they are so low don't add up."

The ECB earlier this year warned that sooner or later there could be a reckoning, saying high prices "could entail substantial price corrections and balance sheet problems for the households concerned".

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