Strategies to Develop Mortgage Markets in Transition Economies

Abstract:     
Factors that hinder the development of mortgage markets in transition economies and a proposed strategy to expedite their development.

The transformation of the planned economies of central and eastern Europe to market economies has focused on economic stabilization and liberalization, privatization, and financial sector development. The housing sector and the mortgage market have been factors in each of these processes but not always positive ones.

The authors analyze the factors hindering the development of mortgage markets in these transition economies and propose a strategy to expedite that development.

They show that banks in transition economies are reluctant to make mortgage loans because of the risks in mortgage lending (credit, interest rate, and liquidity risk). Together with the required primary market improvements, a secondary mortgage market is likely to help solve this problem. A secondary mortgage market separates the act of making mortgage loans (which can still be carried out by banks) from the act of holding mortgage loans (which can be carried out more effectively by capital market investors).

The authors emphasize the potential role of the housing finance system in being an engine of innovation for the rest of the financial sector. But, if the housing finance system is stunted, other nonmarket devices would develop for financing and subsidizing the housing sector - creating negative externalities for the rest of the system.

The authors point out that a market-based housing finance system is unlikely to emerge without initial government support. Moreover, the transition economies must first create an economic and legal infrastructure to support the long-term and complex market relationships and contracts that constitute a housing financial system.

This paper - a product of the Financial Sector Development Department - is part of a larger effort in the department to strengthen financial development in transition economies.

Working Paper Series