The residential housing market in Iceland: Analysing the effects of the recent mortgage market restructuring

In June 2004 the government-backed Housing Financing Fund eased its loan regulations in an attempt to consolidate its position in the domestic credit market. This led to a strong response from the domestic commercial banks which actively entered the mortgage market for the ?rst time. These changes led to a substantial decline in long-term real mortgage rates, increased the access to credit, and allowed homeowners to withdraw equity from their homes without actual transactions. This paper sets up a simple model of housing demand and supply to analyse these e¤ects. The results suggest that the structural change has led to a substantial rise in housing demand, with house prices rising by just under 20% one year after the change. This triggered a similar rise in housing investment roughly two years after the reform. The model predicts that the e¤ects on house prices gradually die out as house prices return to the level that is consistent with normal pro?t margins in the construction sector. The housing stock, however, remains about 5% larger than in the baseline scenario. The e¤ects are even larger when taking account of the second-round e¤ects on the housing market through the e¤ects of increased wealth and easier access to credit on general consumption and overall demand in the economy.