A week ago the Diocesan Commission for Justice and Peace (an organism within the Archdiocese of Malta) issued a report in which it expressed concern about the cost of residential property, which according to other sources increased by something like 50 per cent. The report pointed in no uncertain terms to endemic and speculative practices which seem to be pushing up prices. Such prices appear to be unsustainable, especially for first-time purchasers, with the consequence that they will suffer a deterioration of their standard of living, and possibly falling into the poverty trap, seeking to cope with interest payments and loan repayments while their income is not increasing at a pace that would allow this to happen.
I would tend to share the view of this organism, which is essentially social in its dimension. However, I also believe that all this property development is good for the economy in the short term, but harmful to the economy in the medium to long term. One really doubts whether there is indeed an increase in demand for residential property, that is fuelling a shortage, which in turn would be fuelling the increase in prices.
If there were indeed a shortage of residential property, then one would not have the significant amount of empty properties that we have today. Moreover, it could be an issue that would be fairly easy to resolve - increase supply and prices would be edged slowly downwards. What we seem to have today is an oversupply of property and an increase in prices that is well above the inflation rate; an occurrence that is bound to confound economists. The increase in prices is not due to a shortage but is due to other reasons, and this is why it is speculative in nature.
To provide the wider perspective, one should note that housing represents 7.57 per cent of the expenditure on the basket of goods and services measured by the retail price index. However, this percentage represents only an average for Maltese households. Those that have taken up a loan to purchase a house would be spending, at least, as much as 25 per cent of their gross salary on interest payments and loan repayments. It is also worth noting that the increase in prices for this term was of the magnitude of 4.95 per cent between November 2005 and November 2006. The increase between November 2004 and November 2005 was of 4.28 per cent.
One also needs to assess what has happened in the area of house loans over the last 10 years. Up to around the beginning of the 1990s, all house loans were channelled through a financial institution (Lohombus Corporation) that had the involvement of both of Malta's largest major banks, Bank of Valletta and the predecessor of HSBC, Mid-Med Bank. With Bank of Valletta moving out of this institution and the development of APS Bank, we suddenly had competition in the house loans market. APS Bank took a very aggressive stance, reducing charges and offering attractive rates. Interest rates started moving downwards and the term of the loan was extended beyond what at that time was a traditional period of 25 years. Thus monthly payments should have been getting lower. Unfortunately what happened then was that the benefits of lower interest rates and a longer term for the loan translated themselves into higher house prices.
This situation persists today, and one would be right to be fearful of the consequences, if interest rates were to be increased significantly. Families would be saddled with interest payments that could stretch their finances beyond the limits, while holding on to an asset that costs more than what it was really worth.
Countries like the United Kingdom have been through such an experience before, and it was certainly a nasty one. We need to appreciate that the easier and cheaper access to finance has definitely pushed up house prices unnecessarily, with the result that the benefit was not reaped by the Maltese consumer but by the property speculators who expect returns in excess of 100 per cent over a 12-month period.
To compound this, a number of Maltese repatriated funds that they had deposited in foreign banks over a number of years. This was all liquid cash that had been hidden away. Some of this cash was invested in bonds, equity and collective investment schemes, while another chunk was deposited in local banks; but a great deal of it was invested in property. This obviously fuelled the increase in property prices beyond what the economic situation of the country and demand for housing would have justified. This in turn caused prices to go up even further, which house buyers now have to pay.
The competition in the house mortgage market and the repatriation of funds indicate that the issue of property prices is not a development of the last couple of years but a development that has spanned at least a decade. However, initially there was an increased underlying demand as occupational mobility and incomes increased significantly at the end of the 1980s and throughout the 1990s. Thus it was not seen to be a problem then. It is only now that it appears that house prices have stopped making any sense.
One also needs to assess the impact of such high prices on the rest of the economy. There should be no doubt in anyone's mind that consumers have had to curtail demand for other goods and services to be able to afford the mortgage. This has obviously impacted negatively on the commercial sector of the economy. In addition one also needs to consider that families and individuals have been able to allocate less funds for their pensions, this exacerbating a problem that we know already exists. Is there a way out? The sterling work of the Housing Authority is alleviating the burden which families with lower incomes are having to face. This work needs to be strengthened and more resources should be allocated.
Another measure that needs to be taken is to fix interest rates on house loans. Denmark is considered to have one of the best run mortgage markets and one of the reasons for this is that mortgages have fixed interest rates. This helps to avoid the speculative activities that variable interest rates would tend to bring about.
A third measure is that banks should avoid the temptation to allow consumers to leverage higher loans to finance their personal consumption on the basis of an increase in the value of their residential property.
Fourth, the tax authorities need to act more strongly to combat tax evasion in this sector, as this is a sector where the informal economy usually thrives. This would reduce the lure of property as a way of making a quick buck.
There could be the temptation to ignore the problem and let the market settle the matter. I do not believe that we should take this stance. In my opinion, we have in this situation, a case of market failure. The high prices for residential property are not the result of an underlying demand, and as long as this remains so, action is required not to allow speculators to make a killing. The economy needs it as this would release funds for other activities. One can argue the case from a social perspective as the Diocesan Commission for Justice and Peace has done; if one argues the case from the economic perspective one gets to the same conclusion.