Capital inflows, real estate booms and mortgage crises: An international perspective

Real estate has traditionally attracted the attention of academic researchers and policy makers because of its peculiar characteristics: it is highly cyclical and it represents a significant part of total wealth. Nevertheless, real estate booms and the related financial crises are not new nor unique to developed countries. Developing countries have also suffered from such crises at an even higher scale.; In this study a macroeconomic perspective is used to explain the dynamics of housing markets. Our main hypothesis is that capital inflows play an important role in explaining real estate cycles. The magnitude of the mortgage credit expansion that has been observed in many countries and the related booms in real estate, could not have taken place without obtaining and using resources from abroad.; The empirical and econometric analysis confirmed a long-term relationship between the price of houses and capital inflows. It is common to find in the recent history of many emerging market economies important movements in capital inflows; these economies move from periods of capital abundance to periods of important outflows. These movements affect not just housing rents but also the price of houses. These price changes are important by themselves because of the existence of wealth effects. Nevertheless, houses also serve as collateral, and changes in the relative price of real estate assets can thus have an impact on the financial system as a whole.; We used a two state transition probability matrix, that depends only on the loan to value ratio, to model the evolution of the default ratio in Mexico. The probability matrix provided a similar pattern to the one observed in Mexico, which supports our hypothesis that the probability of default is not constant over time. If this is the case, the timing of the mortgage credit expansion is crucial.; The empirical and theoretical analysis presented provides evidence of the relative importance of capital inflows in housing booms. The issue is relevant because a small open economy with a liberalized financial system is subject to changes in capital inflows, and hence to the related real estate cycles. Consequently, the banking crises that have been observed during the past two decades can be repeated.