Loan-to-Value Ratio and Housing Price Cycle: Empirical Evidence From Indonesia

Charvin Lim,Siwi Nugraheni

doi:10.23917/jep.v18i2.4846

Abstract

The subprime mortgage crisis in 2007-2009 which led to a global recession has highlighted the importance of regulating credit for housing market. The urgency arises not only to manage non-performing ratio, but further to manage price in the housing market which is a potent source of financial imbalance. Loan-to-value (LTV) regulation is imposed in order to dampen the housing price cycle, preventing the occurrence of bubble issue. This study tries to capture the influence of LTV implementation on housing price and assesses its effectiveness in the national scope. Error correction model is used to portray the short and long-term dynamics of housing cycle with regard to policy, macroeconomic, and financial variables. We concluded that LTV is an effective policy to dampen the price cycle in the long run, but not in the short run. In the short run, housing price is closely determined by the macroeconomic factors. Furthermore, we found that the implementation of LTV has made housing price to become more persistent, suggesting a change in the market expectation structure and the behavior of housing price cycle.

Highlights

The global financial crisis reminds us the urgency of financial stability, and, the importance of housing cycle in determining macroeconomic soundness
Housing has become an important element of most economies, especially those with vast growing and developed financial sector
The detrimental effect of housing price bubble, we study the factors influencing movement in housing price with Indonesia as the focus

Summary

Introduction

The global financial crisis reminds us the urgency of financial stability, and, the importance of housing cycle in determining macroeconomic soundness. Shwartz (2012) mentioned that the size, the scope, and the price nature of housing are the underlying reasons why issues on mortgage debt could systemically damage the financial system and the economy. With the nature of having immense value, it governs the largest proportion of wealth for most households – and a significant portion of assets for financial institutions. He highlighted that out of 19 OECD countries he observed, 9 of them have mortgage debt size that were larger than the equity market in the pre-crisis period.

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Results

Conclusion