The Relationship between Mortgage Markets and House Prices: Does Financial Instability Make the Difference?

Abstract

During the late 1990s and up to 2007, several countries experienced sharp increases in house prices. These episodes are usually mentioned among the causes of the world’s recent economic and financial turmoil. The dramatic growth in bank lending during this period has been held broadly responsible for these market dynamics. However, the empirical relationship between mortgage credit and house prices remains largely unexplained. This paper analyzes the relationship between house prices and mortgage credit in Spain, where house prices and mort­gage credit have experienced high growth in recent years prior to the financial crisis. We employ a quarterly database from 1988Q4 to 2008Q4. Using cointegration analysis and vector error–correction (VEC) models, we find that both house prices and mortgage credit interact in the short and long run. The results also suggest that a regime shift in mortgage lending occurred in 2001 in Spain — where mortgage credit securitization substantially grew — that increased the economic significance of mortgage lending’s impact on house prices.

Keywords: house prices, mortgages, banks

JEL Classification: R21, G12, G21