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Thursday, 12 July 2012

Worrisome reports by ABN Amro Economic Bureau

Today I got knowledge of two great reports of the Economic Bureau of ABN Amro via two different channels.

The first report I read via the site (, edited by the intelligent and very sympathetic Arend van de Kamp, whose articles are always a must-read.

ABN Amro supports the opinion that the Dutch housing market will sink by another 14%, but will not make a nosedive. I happen to agree with that, but for different reasons.

Here are the pertinent snips of the IEX-article, accompanied by my comments. Some parts have been translated to English by me:

We believe that policy changes, decreasing affordability and a worsening economic climate will push house prices further south. Our economists forecast another 14% drop in house prices in the coming two years (6% in 2012 and 8% in 2013). This will partly be driven by the higher mortgage servicing costs post policy changes and partly because of a worsening economic climate.

Real housing prices vs. realistic housing prices
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Click to enlarge
In my key article Ernst’s Confessions: the housing prices are not so overpriced… I argued that if you leave the inflation out of the housing prices and you realize that the real income of Dutch people hardly changed since the seventies (when corrected for inflation), the interest rate (leveraged by the Mortgage Interest Deductability) almost completely decides the housing prices in The Netherlands. The black line in this graph represents the realistic housing prices, based on the interest rate from 1975 until 2011 and the red line is the real housing price. Please read the article for full understanding of my calculation methods.

At this moment the real housing price and the realistic housing price are almost equal, due to the very low (leveraged) interest rate. Still I noticed that in times of economic hardship the real housing prices will be lower than the realistic housing prices for a number of years. People don’t dare to buy a house and banks don’t dare to lend people money, although they can actually afford the current prices. As the economic hardship will remain for at least 3 or 4 years, the 14% price decrease of ABN Amro sounds fair to me. The effect is, however, that houses will then be relatively cheap.

No nosedive

The expected 14% is of course a firm setback – especially for houseowners that are already underwater – but according to ABN Amro there is no need to panic for the general public, as the Dutch housing market is firmly supported: 
  • Dutch households have substantial assets (over 500% of GDP) to balance the high mortgage debt (108% of GDP). 
  • The Netherlands has Europe’s highest tax advantage on mortgages and hence heavily incentivises homeowners not to pay down mortgage debt. 
  • Foreclosure rates are very low and because of low unemployment and generous initial social benefits, will remain low going forward. 
  • Weakness in the housing market is almost fully demand driven. Supply is not the issue, virtually no stock of uninhabited houses exists in the Netherlands 
  • Low interest rates and a large proportion of government guaranteed mortgages help to brighten the picture

The first bullet is true, but there is an important ‘but’. Most of these assets are not in the hands of the Dutch people but in the hands of semi-government bodies for social security execution and pension funds. This is by no means 'cash at hand' for the people to compensate their mortgage debt.

The second bullet is also true, but everybody and their sister knows that this situation will not last forever anymore. I suspect this to change within two years.

Third bullet: the number of private and corporate defaults is soaring (see 2nd part of article) and the unemployment will IMO rise to 8% at the end of this year. I’m sure that the number of foreclosures will soar too. Although the social benefits are still quite generous, this generosity is expected to disappear when the number of unemployed and retired people will soar.

Fifth bullet: the official interest rates are still extremely low, but the banks are more and more reluctant to pass this benefit to their customers. People that need to pay more interest run a bigger risk of defaulting.

Impact of housing market weakness will mostly be felt in consumer spending. More of the disposable income is directed towards higher mortgage servicing costs. Increased savings to make up for the incurred wealth loss. We estimate this will result in a 7% drop in discretionary consumer spending in the coming 5 years.

I have nothing to add to this.

We believe that the expected decline of Dutch house prices is unlikely to affect the mortgage book and funding of ING, Aegon, Delta Lloyd, SNS Reaal en Van Lanschot materially. Default rates will remain manageable and RMBS bondholders will not be faced with losses. We anticipate loan losses of ~15bps per annum for 2012 - 2013 compared to historic peak levels of ~30bps.

With this part I don’t agree. This is a historical crisis that will trigger high unemployment which might last for a number of years. I do expect the financials to suffer from deteriorating housing prices, especially when the number of foreclosures will soar.

Additionally, the weakness in consumer spending will negatively impact the quality of SME and corporate loan books of banks. Construction companies (BAM, Heijmans, Ballast Nedam) will face at least another two years before volumes in residential construction pick-up. As a result, Property development margins will remain subdued and there is the risk of additional landbank write downs.

I don’t agree with this part too. The CRE (Commercial Real Estate) market is still a disaster with about 17% structural vacancy. The RRE-market is also in dire straits with a heavy lack in demand for newly built and existing housing. If the crisis will last for another three or four years, due to slow, reactive government policy and the depth of the economic trough, it will take at least 3 to 4 years before the Dutch housing market picks up again, maybe even longer. Besides that, my expectation is that at least 30% of the Building and Construction companies must disappear, before this industry gets healthy again. There is no way in hell that the B&C market will pick up with the current amount of suppliers, unless a fullblown Keynesian approach is chosen by the government in The Netherlands. This would really be a disaster.

The second report of ABN Amro is also a great report. This was presented by a spokesman of the ABN Amro Economic Bureau at BNR Business Radio (

A tidal wave of defaults is coming to the Dutch business world. This is predicted by the Economic Bureau of ABN Amro.

‘Shortly there will be hardly any growth in the number of companies’, according to Jacques van de Wal of ABN Amro.

The banks expects 20% more defaults than in 2011. In that year 7140 companies defaulted. When ABN Amro’s prediction is true, the previous peak (8040 defaults) of 2009 will be surpassed.

’ Most entrepreneurs went already through two economic crises and better times don’t seem visible at the horizon. More austerity will hardly be an option for a large part of the industries’, according to ABN-economist Van de Wal.

‘The economy is still in trouble. During the first five months of 2012 the number of defaults in the B&C industry grew by 40% and in the logistics industry by 25%-30%. This growth is really the result of the slump in different industries. However, this is a lagging figure’. This means in theory that the economy could be growing again.

Don’t count on the last sentence. It is hardly surprising that the number of bankruptcies in the Building and Construction industry is growing. This industry has an enormous overcapacity of at least 30%-40%. This will not be a healthy industry, unless this overcapacity disappears.

The Dutch Central Bureau of Statistics stated recently that The Netherlands is formally out of the recession by a whisker, but the outlook remains bad. Year-on-year the economy contracted by 0.8%. The 2012Q2 data will, according to Van de Wal, again show contraction.’Besides government spending, only Transport and Distribution showed some growth in the past months. Especially in this industry growth is slowing down again’.

The CBS data that showed a small growth in Q1 were IMO really ridiculous. These data were based on corrections, due to revisions and showed small growth, almost totally accounted for by the government, except for the mentioned growth in Transport and Distribution. It is worrisome when the government is almost the only driver for jobs in a country.

Also unemployment is increasing surprisingly rapid since mid-2011, ABN Amro states. The number of unemployed in 2012M5 is with 489,000 personns more than 20% higher than in May, 2011. Van de Wal thinks that this was the results of almost finished students that studied a little bit longer to avoid unemployment. Due to the negative outlook, the number of unemployed might be rising for the time being.

For me, the rising unemployment was not very surprising. Companies kept excess personnel in service in 2009, due to the Part-time Unemployment Benefit and their reluctance to fire personnel that soon might become scarce again, as a consequence of the aging process in The Netherlands. In 2009, I already reckoned (unfortunately I didn’t blog it), that this excess personnel would be fired after all when the crisis didn’t end soon. In 2011, I noticed that my prediction started to become reality and it does so until this day.

The funny thing is that the first report of the ABN Amro is still quite positive on the Dutch housing market, while the second report is quite negative on the Dutch economy. In my humble opinion, both can’t be right at the same time.

My take is that the second report is much more realistic in its contents than the first one. That I still agree with the 14% price drop of the first report, is only based on the current average housing prices, compared to the current interest rates. This equasion is fairly balanced at the moment.

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