Regulatory Responses to Property Cycles

After each major cyclical downturn, the cry tends to go up that this must never be allowed to happen again. Lessons must be learnt from past failures, and measures must be put in place to ensure that there is no repetition. As usually the property market is identified as a major contributor to unsustainable booms and the inevitable slumps that result, it is often one of the focuses of new regulation, which is primarily achieved through influencing the amount of lending on property made by the financial sector. The chapter traces the main property cycles and the national and international regulatory responses that market slumps and crashes provoked. In particular, the crash of 1974 resulted in important changes to the ways that secondary bank lending on property was regulated and to the creation of valuation standards. Policies of financial liberalisation and deregulation with light touch regulation pursued after 1980 appeared initially to function effectively, but the financial crisis of 2008 called into question this approach and has resulted in tighter regulation of banks and lending to the property sector. The problem regulators face is that property sector has the ability to absorb funds at times when deposits are growing rapidly, and financial institutions are forced to chase creditworthy borrowers or face downward pressure on yields. Yet financial institutions have less knowledge about the property market and individual projects than borrowers. Borrowers are able to default on loans with relatively little recourse available to financial institutions, so this asymmetrical information puts them at risk of losses. The chapter examines how effective regulatory responses to property cycles have been and whether and to what the extent property cycles are driven by forces that make them almost impossible to regulate. Central to this is the question of whether the infinite capacity for innovation in the financial sector, globalisation and international financial arbitrage and the ability of financiers to create institutions that are able to evade regulation mean that regulators are constantly having to play catch-up. Regulators therefore may approach the next cycle perfectly equipped with the policies to tackle the previous one but having to confront financial innovations that challenge their abilities to respond.