The economic growth in the United States could be stronger. In economics, however, all things are relative. And Americans can feel relatively good about the state of their economy as Europe is mired in another recession.
Yes, GDP was better than expected in the eurozone in the third quarter. It only contracted 0.1 percent since Q2 where -0.2 percent was expected. Overall, it is a relatively mild contraction.
That did nothing to help the stock market, however. The EURO STOXX Index dropped 2.1 percent to close at 2,427 points. The euro was roughly unchanged at $1.2743
Netherlands Underperforms
As expected, Germany still did all right. The continent’s biggest economy was growing tepidly at 0.2 percent. France surprised on the upside, growing at 0.2 percent, as economists originally expected a contraction.
The problem in Europe is that as soon as one country improves, another country stumbles. In this case, the Netherlands’s economic growth was much worse than anticipated. The Dutch GDP contracted 1.1 percent over the quarter, whereas a contraction of only 0.5 percent was expected.
Upon taking a closer look, this is worrying. The Netherlands has always been considered part of the so-called core of solvent European nations. The country makes a large contribution to the different bailout mechanisms the European Union puts in place. Along with Germany, Luxembourg, Finland, and Austria, it has a AAA credit rating.
So what is the problem? The statistical report by Eurostat suggests a sharp fall in private consumption is to blame for the underperformance. The Dutch are thrifty people, but why have they slam their wallet shut all of a sudden?
Dutch Have Highly Leveraged Housing Market
To find the answer, one has to look at the Dutch housing market. Housing is relatively scarce in the Netherlands, due to its constrained geography. Almost 17 million people live in an area the size of New Hampshire and Vermont. Adding to the strain, a lot of the land cannot be used for building, because large areas are occupied by water.
This scarcity prompted banks to adopt very lax lending rules for mortgages. A large population of potential buyers and a finite supply of housing made it a low risk business.
They did not quite lend to unemployed people similar to during the heyday of the U.S. subprime lending boom, but they did lend against zero money down. In fact, since Dutch houses are so old, homebuyers usually financed 120 percent of the selling price in order to fund necessary renovations, with no equity necessary. This means if one’s house costs $100,000, the bank will lend $120,000, while the prospective homeowner does not need to pay upfront.
For good measure, the Dutch government also made the interest expense on mortgage loans tax-deductible. The result? It is much cheaper to buy than to rent in the Netherlands. Given this explosive mix of tax incentives and lax lending policy, one ends up with nothing short of a housing bubble.
Good Times Usually End Sooner or Later
In periods of reckless lending, the practice usually goes on unnoticed while everybody is happy as long as some key conditions are satisfied. This was the case until recently, but we have seen a reverse in some of the metrics, likely prompting the slowdown in the Dutch economy.
The borrower needs to have a job to fund the interest and repayment schedule. Until recently, the Dutch job market was always one of the best in Europe, but not anymore. Unemployment is now the highest since 2005, rising steadily since the middle of last year. The rate in October was 6.8 percent, up from 6.6 percent in September. While the absolute rate is still relatively low, it is the neagtive trend that worries most.
Banks also need to be well capitalized to be able to make new loans. Some of the Dutch banks have been nationalized and are facing tougher requirements for lending. The biggest private bank ING Group N.V. (Duthch: ING Groep N.V.) already has the biggest mortgage book and is the feeling strain on its capital.
This is not surprising, as the banking sector supports the most leveraged consumers in Europe. Dutch private households come only second to Denmark with total private debt just shy of 150 percent of GDP as of 2011.
When banks are tightening lending standards and employment is falling, fewer loans can be made to buy new houses. This leads to falling prices. And this is precisely what is happening at this moment, quietly but steadily. Housing prices are now at the level of 2004. They have been declining more than 8 percent year over year for the last three months.
The combination of declining prices and the lack of new loan origination reduces money spent on houses and renovation. As a result, the entire economy feels the pinch. Added to this, when homeowners see house prices fall and unemployment rates rise, they reduce consumption to prepare for worse times.
The Dutch enjoyed a few decades of rising house prices. Now, the trend seems to have turned and it’s dragging the economy with it. The situation can improve only if banks’ balance sheets are repaired and employment ticks up again. For this, the rest of Europe and the world needs to start growing again.
The Week Ahead
This week, we are likely to see some bickering again of European Union officials, when they meet Nov. 22 to pass the EU budget. The EU budget is relatively small, at around $165 billion in 2011. Its significance has fallen due to the trillions of dollars in bailouts making the headlines.
Nonetheless, negotiations are likely to be tough and will put a further strain on already fragile diplomatic relationships.
After backward-looking GDP data, purchasing-manager indices for the eurozone will shed some light into how the economy is doing now and in the near future.
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