Erbas: We undertook this study because Pierre Dhonte, Deputy Director of the IMF’s Middle Eastern Department, made some very basic and challenging observations about the connections between demography, poverty, and the state of housing in the Middle Eastern countries. Living standards—which are fundamentally dependent on where people live—are not particularly good in the countries we’re looking at, in large part because of a lack of good housing (see table).
There is a lot of pent-up demand in these countries, and the governments have not been able to meet this demand, at least not with the existing government institutions. For all intents and purposes, these five countries have no mortgage market for low- and middle-income families. Developing mortgage markets, as a part of financial sector development, will presumably stimulate growth, at least through the construction sector, because availability of mortgage financing can make it possible for more people to buy homes.
NOTHAFT: Much employment is based on businesses, and many small businesses are sole proprietorships, in both developed and developing countries. Credit is generally a little bit more available for large corporations and well-to-do individuals. Financial sector reform means trying to provide better access to credit for other individuals and small businesses. A more developed mortgage market can also provide access to credit for moderate-income families, many of whom own small businesses or sole proprietorships, and it might be the way to assist them in buying credit to develop their small businesses, too.
Erbas: When our paper was reviewed by our peers, they often asked about crowding out. They wondered if general savings channeled into housing would be siphoned away from something else. This is not the case in developing countries, where people often get negative rates of return on their savings. If you can give them a positive rate of return, it will bring savings out of the woodwork and put them to productive use. This is how growth is produced.
Erbas: Low-income families save, too. The question is, where do their savings go? For example, your wife could be wearing the savings—gold bracelets—on her wrist. Or a person living in a shack might have a wide-screen color television. It’s evidently fashionable to have cell phones, however poor you are. How can such savings be channeled into better living standards, into the housing market? How can such savings be given greater incentives and, to some extent, be subsidized for low-income groups?
NOTHAFT: Everyone lives in some form of a house. The issue is the quality of the house. Having access to credit enables people to improve their homes or acquire homes with more amenities, like sewerage. If a family vacates one house, it becomes available to another family. So, in both cases, the overall quality of the country’s housing infrastructure is improved. As Nuri mentioned, there are shortages of affordable housing in these countries. Providing the financing and credit to families is one way to address this problem.
Nothaft:Affordable housing has long been a component of public policy in the United States. The rationale is that promoting home ownership leads to a variety of positive externalities. For example, homeowners generally maintain the housing stock better than renters do. Research on social issues that relate to home ownership shows that neighborhoods with a high rate of home ownership also tend to have more active community involvement.
Erbas: Mexico and Turkey were chosen as middle-income comparators. In general, we can say that Mexico has more developed financial markets, and mortgage markets, than Turkey. Turkey is experiencing many of the same problems as the countries in our study, whereas Mexico appears to be more advanced in the development of financial arrangements, at both the institutional and the grassroots level.
Erbas: Generally, no. Islamic banking exists in some of those countries, but, in principle, it is not a deterrent to developing mortgage financing. Mortgage financing through Islamic banking can be accomplished through profit-sharing arrangements. But this is a secondary issue. The primary issue is the existing banking standards in these countries, which, if reformed and given the right legal and economic incentives, can address mortgage requirements in the standard way.
Nothaft: t’s worth noting that mortgage financing arrangements in line with Islamic banking principles are already available in the U.S. market.
Erbas: In these countries, high-income groups can readily buy housing. For example, in Cairo, you can buy a $1 million apartment in two weeks, but you can’t find a $50,000 apartment. The idea is to extend this facility, make it affordable to lower- and middle-income groups. It may be true that upper-middle-income and middle-income groups will come into this scheme much earlier than lower-middle-income and lower-income groups, but there’s nothing wrong with that. There will be transfers. If better housing is built for middle-class people, they move out of less good housing, and people who live in shacks can move up. Furthermore, the construction It is an enormous employer, especially of lower-income individuals.
Nothaft:Generally, higher-income people don’t have as many problems accessing home ownership or credit. If you look at the U.S. experience, home ownership was about 40 percent 60 years ago, and today it’s 68 percent. Over that time, the federal government was committed to promoting home ownership and affordable mortgage credit. Who were the homeowners 60 years ago? They were disproportionately middle- and higher-income people. By providing affordable credit, the United States has disproportionately helped middle-income families, but higher-income people have benefited, too. But it’s not exclusively benefiting higher-income individuals. The availability of home ownership to a much larger part of the population is a lesson to be learned from developments of the last 60 years in the United States. So the U.S. experience is proof that improving mortgage financing helps not only the middle- and upper-income groups but lower-income groups, too.
|(thousands of housing units per year)|
Erbas: They do, but with some exceptions—Jordan, maybe as a result of recent reforms, and, to some extent, Tunisia—the housing finance schemes have been a failure. They created specialized public institutions that produced low-quality, high-cost housing that essentially ended up being sold on the market to higher-income groups. The schemes did not serve their purpose. In fact, most of those institutions and specialized government-owned banks are insolvent—a relic of the old public enterprise days. In most of the countries, even the construction materials sector is a public monopoly, which means construction costs are higher. Also, the presence of monopolies precludes importation of such products as cement and steel. You might end up waiting months or years to get these materials.
The existing setup in these countries has not addressed housing shortages created by expanding population and pent-up demand. A lot of people end up living at home even after marriage—extended families grow, so you add another floor, and so on. There’s a lot of potential out there. Reform of mortgage financing is essential to meet this potential.
Nothaft:There are a couple of different approaches governments can take. They can subsidize the construction of housing directly, but that’s a relatively inefficient way of promoting the creation of affordable housing. Subsidies generally end up being costly, and there are issues with monopolies and overall control of the production process. The alternative way to go—or it could be a complement—is to promote reforms in the financial sector generally and in the mortgage market specifically. That helps target credit toward the families who can use the credit to improve their current homes or acquire better-quality housing. This allows the free housing market to work to create additional affordable housing, which addresses some of the shortages in these countries. It’s really about providing incentives to make the housing market work more effectively by reforming the financing part of the market.
Erbas: Whether you are building a dam or financing a home, the money ultimately comes from domestic or foreign savings. Foreign savings represent foreign borrowing. And domestic savings are not necessarily what people are saving at home, but what is being saved through better budgetary practices. Instead of providing blanket subsidies, you rationalize those subsidies and make them incentive based, so that people will save.
If the market opens up, and there is movement in this market, then companies will come in and start building, creating financing opportunities for lower-and middle-income people. This has been the experience in many countries. By the same token, why can’t a foreign creditor or a foreign financial institution operate in these countries? At present, foreign banks operate in these countries, but they are in the government bond business. The financial sector is far deeper than trading government bonds, especially when it comes to turning a hard-earned profit. Actual banking requires lending to businesses, lending to housing, lending to construction. This is what financial sector development is, and this is what we mean by financial sector liberalization. There are a number of important prerequisites for these countries before this can happen. One, countries have to pursue legal reforms. Often, property rights, entitlement, eviction, and loan recovery are on questionable legal grounds. Second, banking and finance laws have to be liberalized. NoTHAFT: That’s absolutely right. Property rights have to be clear and enforceable. If they aren’t clear, mortgage contracts can’t be enforced. If you can’t enforce lawyers’ contracts, then if people default, you can’t move them from their homes.
In terms of where the financing is coming from, it’s the capital markets, global or domestic. In some sense, it may not matter. Ultimately, financial sector reform would promote savings and more use of the banking system by families. If families have savings accounts at financial institutions, that provides the financing that banks can use to make additional loans, whether for mortgage credit, commercial credit, or what have you.
Erbas: There is a very high population growth rate in these countries, and the populations are also very young. We cannot overemphasize the magnitude of demand. But this is precisely what such development would aim to address. Developing mortgage financing means developing the housing sector, making housing available to a larger number of people. There’s no short solution; this is not a short-run program but rather a medium- to long-term agenda.
NoTHAFT: I agree that it’s a long-term agenda. You may start seeing some benefits in the first year or two, but really it’s a much longer-term process. Look at the U.S. experience. It took a long time to raise the home ownership rate from 40 percent to 68 percent. It takes a while for people to become comfortable with the reforms that have been put in place, to believe that these are permanent reforms and that they’re not somehow going to lose their homes or their savings by participating in the program. I suspect there would be some latent concerns about how committed the government ultimately would be. When we did the simulations in our paper of the benefits to overall economic growth and housing construction, we looked at a 10-year horizon because it takes time for the effects to work their way through the economies.
Erbas: Egypt is in the process of adopting reforms. Even Algeria, where the housing sector has been particularly stagnant, is moving toward reform. In Jordan, there are some efforts at privatization. So there has been some movement, but these countries should probably give priority to the financial sector reform and liberalization programs that the IMF looks at. Mortgage financing is a very deep and fundamental reform of the financial sector, and it has a cascading aspect. The construction sector is not only putting on a roof, it’s also financing and insuring it, building infrastructure, and insuring and financing the buyers. These numbers add up—in the United States, to about 12 percent of GDP. That’s about $1.2 trillion.
Erbas: I see this as a part of medium- to long-term basic reform in these countries. Mortgage market reform is one aspect of financial sector liberalization. There are a lot of blanket subsidies, and budget reform needs to create incentives. You can’t give preferential interest rates to certain public enterprises. These distort the financial market. In financial sector development, development of mortgage financing is probably a longterm reform. It would be a good idea to highlight it in IMF programs. A mortgage financing market will attract foreign capital, but this may have a downside in the balance of payments—construction sectors in these countries have a large import component. If the housing sector is going to grow, you have to watch your balance of payments. If you allow the construction materials sector to develop and eliminate monopolies, the balance of payments will take care of itself.
NoTHAFT: There’s a variety of empirical evidence, primarily for developed countries, to support the concept that financial liberalization promotes economic growth in the longer term. It pertains to developing countries, too. Mortgage market reform would be particularly useful for these developing countries because it really provides access to credit for all families, not only to address shortages of affordable housing but also to extend financial reform to the small businesses that are the crux of most of the employment in these countries. So much of the employment is with small businesses and sole proprietorships that cannot get access to business credit.
Copies of Working Paper 2/17, The Role of Affordable Mortgages in Improving Living Standards and Stimulating Growth: A Survey of Selected MENA Countries, by S. Nuri Erbas and Frank E. Nothaft, are available for $10.00 each from IMF Publications Services. See page 72 for ordering information. IMF’s website (www.imf.org).