Negative credit accelerator from the fall in France’s housing market

The French housing market transaction volume declined by 25% last year, according to Century21. The fall in the French housing market is just beginning. And given the macro problems in France and the previous run up in house prices, the housing sector will take on increasing importance in France as a credit decelerator as France struggles with the sovereign debt crisis.

The underlying issue in France as everywhere in the euro zone is that France, having given up its currency sovereignty to join the euro zone, must decrease spending or increase tax receipts to cover deficits or it must turn to the bond markets to cover those deficits. There’s no printing press in France now. That makes the country beholden to the bond market like any other ordinary private sector currency user with a negative cash flow. The ratings agencies are onto this and have downgraded France. At the time Moody’s downgraded France in November, the Economist was running a piece about France being a ticking time bomb given its debt problems. In response, I wrote “Question: can France get away with continued high deficits when Spain and Italy are cutting?” Here’s my thinking.

The French government’s budget for 2013 is not very austere. There are not a lot of budget cuts forthcoming. In fact, President Francois Hollande has lowered the state retirement age in France back down to 60, something that means budget deficits will be higher in the future. So any deficit shortfall in France must be made up via tax increases or bond sales. Hollande has tried to tax the wealthy. Some like Gerard Depardieu have threatened to leave the country. And Hollande’s efforts have also been rebuffed by the courts. Hollande has pledged to hold to his tax increase stance but clearly we are likely to see large bond sales to cover deficits unless and until this happens. With France a currency user, the country is vulnerable to the bond vigilantes.

And that takes us full circle back to the deficits. In order to meet the demands of the bond market given France’s 4.5% deficit and desire to get down to the 3% hurdle in 2013, we will have to see tax increases and budget cuts beyond what has been achieved so far. Failure to achieve these goals will see France partially couple to the periphery and crisis would then ensue.

This is where the housing market is relevant. Some have talked about an “unprecedented crisis” in France’s housing market. And I wrote about this in September. At that time, I pointed to the marked slowdown in single family home construction which is negatively impacting employment and GDP. But transaction volumes for existing homes has been in freefall in France throughout 2012 with transaction volume down 25% while house prices are down only 1.6%. What does this mean? If you know your housing collapses, it is always transaction volume that gives way first because sellers, still in the boom psychology, pull their listings rather than accept lower bids as the market softens. See this 2010 post on that psychology as the US market declined.

If the housing slump is accompanied by a long enough economic slump, then desperation begins to set in, forced sales mount, and the psychology begins to change in favour of buyers. We saw this occur in the US, in SPain, Ireland and the UK. And we have also seen it in Denmark and the Netherlands. Of the markets that receive little attention due to housing problems, the downturn in the Netherlands and in Denmark are well-advanced. The downturn in France is the next most advanced followed by Australia. Canada has not really turned down after the initial 2008-09 slump.

I see the housing market in France adding a negative credit accelerator to the already poor economic forecasts for the country. The recent relaxation of the implementation of Basel III bank capital accounting rules highlights the precarious financial situation of French (and German) banks. To the degree the housing slump in France interacts negatively with the austerity-led economic slump, we should expect this to further impair French bank balance sheets and thus further restrict credit in France, particularly in the mortgage sector. Given the need to cut deficits, the housing slump will be worsened by an economic slump that then creates a negative feedback loop with the housing market. In the absence of some positive macro trend to counterbalance these effects, I would expect a deterioration in France’s macro outlook as 2013 progresses.

Source: L’Expansion