Romanians are the prisoners of the financialization of the economy by the National Bank

Călin Rechea (translated by Cosmin Ghidoveanu)
Ziarul BURSA #English Section /

Illustration by Make

Illustration by Make

Adrian Vasilescu, strategy consultant at the NBR, has caused outrage in the press and in society through his statement madea the end of last week, that Romanians affected by the introduction of the new degree of indebtedness " should get 2-3 jobs" to be able to get a mortgage loan.

The NBR official admitted that the "solution is cynical", but did not pursue the reasoning further.

The reason is understandable. Had he done so, then he couldn't have avoided the phenomenon of the financialization of the Romanian economy, which the NBR is responsible for.

The process of the events is described by professor Daniela Gabor, of the University of the West of England of Bristol, in her book "Central Banking and Financialization: A Romanian Account of how Eastern Europe became Subprime".

Daniela Gabor writes that the NBR followed strictly followed the recommendations of the NBR concerning the "management" of the exchange rate, and that has led to the transformation of the Romanian economy into a "subprime economy".

Furthermore, the regulatory framework has allowed foreign banks to grant loans directly into foreign currency raised from the foreign markets or from the parent banks, a situation which has allowed the full offloading of the currency risk on the debtors.

"The attractiveness of loans denominated in foreign currencies to debtors has been determined by the lower interest rates and the expectations that the national currency would continue to strengthen", Daniela Gabor writes, and the Central Bank could have prohibited foreign denominated loans, but there was a desire to avoid "testing the resistance of the European Commission, which was placing an emphasis on the functioning of the markets".

Under these circumstances, the administrative measures of tempering lending, such as the raising of the minimum required reserves for liabilities denominated in foreign currencies, had limited effects.

The author also says that, the introduction of the inflation targeting monetary regime, amid the full liberalization of the capital account, resulted in "the consolidation of a financialized monetary regime", where "commercial banks have replaced traditional long term lending with market investing activities".

The financialization has also involved the conducting of the transactions of banks amid the market operations of the central bank, increased exposure to government bonds, as well as the financing of the speculative bubbles at the level of real estate and consumer loans.

Among the most visible results of these "lending policies" is also included the speculative bubble of the second half of the last decade, characterized by median prices which were over 10 times higher than the average annual income of the households.

One of the determining factors of the real estate bubble, not just in Romania, continue to produce their effects today. It is the framework for the management of bank risks, built on the basis of the Basel accords, which provide a preferential treatment to mortgages over corporate loans, by granting lower risk weights and implicitly the setting of lower capital requirements.

The collapse towards "normality", characterized on the developed markets by median prices of the residential properties which are at most 4 times the annual household incomes, has been halted through the launch of the "First Home" program, a "gift" offered to the financial institutions to prevent the implosion of their balance sheets.

The phenomenon of financialization, which in the West has "evolved" for several decades, in Romania has happened in just a few years, especially after the joining of the European Union.

What was the situation prior to the financialization and the cutting of the tie between the dollar and gold, in 1971?

Historical data in the United States shows that a new home would sell for about 13,000 dollars in the beginning of the 60s, as the median household income was about 5,300 dollars, a new car would cost 2,600 dollars, and a liter of gas would cost almost 7 cents.

As can be noticed, the price of a home was about 2.5 times bigger than the annual median income, and a house was very accessible, as the duration of a household mortgage only very rarely exceeded 10-15 years.

Since then, things have changed radically. If in 1970 the main activity of banks was lending to non-financial companies, in 2007 "banks in most countries have turned into mortgage lenders", according to the article "The Great Mortgaging: Hous2ing Finance, Crises and Business Cycles", published in 2016 by the Economic Policy magazine.

The result was the "setting off" of a vicious circle between mortgage loans and the "value" of residential properties, which has made mortgages increasingly inaccessible to a growing segment of the population.

The issue has recently been broached by Josh Ryan-Collins, head of research at Institute for Innovation and Public Purpose of University College London (UCL). His book, "Why can't you afford a home? (The future of capitalism)", shows the true reasons why some important social layers have been "removed" from the residential real estate market.

"The fundamental promise of the capitalist economies, that you can own your home if you work hard enough, no longer applies", the British professor writes. In his opinion, the "classic" explanations, such as the system of the granting of permits, immigration or the situation in the construction sector do not explain the increasingly lower accessibility of a home.

"In order to understand the home crisis today we can't look just at the supply and demand ratio", Ryan-Collins points out, as the demand for homes also includes a major component with a special characteristic, namely the demand for real estate properties as a financial asset.

The rising weight of this component as part of the total demand for homes has been possible as a result of the creation "of a positive feedback loop between lending and prices", backed by the creation of money by banks as part of the lending system.

The process is largely described in a study of the Bank of England of 2014, which thus "dismantles" the theory of financial intermediation.

Professor Josh Ryan-Collins points out that "when a bank grants a loan, it thus creates both a financial asset, the loan, as well as a liability, the deposit pertaining to the borrower", and "the money isn't borrowed from somewhere else in the economy".

Under these circumstances, "the main limit in the creation of money is the banks' confidence that the loan will be repaid", and the mechanisms of the positive feedback loop between funding and prices become obvious.

The building of new homes with the help of real estate loans will lead to the entry of new money into the economy, but the real estate loans also allow the buying of already existing homes. The competition for their acquisition will lead to the increase of the prices of existing homes and for land, which will further increase demand for real estate loans.

As Ryan-Collins writes, the positive feedback between financing and the prices on the real estate market represent a phenomenon which contradicts the standard economic theory, according to which the increase in the offer of a good will lead to the drop of its price.

Why? Because we are talking about a special relationship between loans and land. "Bank loans are very elastic and essentially infinite, whereas land is very inelastic, amid its limited availability", the UCL professor states.

Thus, "the demand for land and homes can extend beyond the population's income or the companies' profits, especially if there are expectations that home prices will increase faster than incomes".

In another book of his, "Rethinking the Economics of Land and Housing", Ryan-Collins writes that "nowadays macroeconomics is modeled on the interaction between land, ownership and the financial system", as "land has been financialized", and the result is "the breakup between the price of homes on one hand, and the economic growth and revenues on the other, at the level of the national economy".

Under these circumstances, it is very easy to go, within a rather short delay, from the need for 2 - 3 jobs to get a mortgage loan to 4-5 jobs for the same thing.

It is obvious that the phenomenon cannot continue forever. The British professor claims that a solution would be "the political leaders rising up against the interests on these markets, so that homes would return to their primordial role and lose their role of financial assets".

Unfortunately, the hope of the political leaders "rising up" is completely unrealistic, given their "character", not just in Romania, but in Europe as well.

Other proposals, such as "turning finance towards more productive goals" destined to "residential and transportation infrastructure, which would stimulate economic growth and consumption, amid the reduction of the pressure on cities", seem to be just as illusory.

Thus, there is no escape from the trap of the financialization of the economy, even if the monetary and fiscal authorities know, or ought to know, what the solution is, but it can't be even be "contemplated" due to fear.

All that's left is the "solution" proposed by the strategy consultant of the National Bank of Romania and some luck, so that the "2 - 3 suggested jobs" don't multiply soon.

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