Contractual Savings for Housing

Problems of developing specialized financial services for housing are acute in transition socialist economies (TSE). Some constraints derive from the incomplete and imperfect privatization of the real estate sector. Others reflect the fragmented and undeveloped financial system. This paper examines a financial instrument, contractual savings for housing (CSH), that is often advocated as a major solution, but usually without consideration of its impact on the emergence of a competitive housing finance system and on overall financial development. Interest in CSH is high in Central and Eastern European countries. Legislation has already been passed in some of them (Czech Republic and Slovakia) and is under serious discussion in others (such as Poland). A CSH instrument is a dedicated loan-linked form of saving. It links a phase of contractual savings remunerated below market to the promise of a housing loan at a rate also fixed below market at the time of contract signature. The contract can contain a variety of incentives and options. CSH are advocated on the basis of their positive historical record in continental Europe. They were originally designed decades ago to generate long-term funds to be specifically channeled into the housing sector at a time when longterm finance was not available and reconstruction was a national priority. In environments where savings were very low, CSH encouraged household savings with the help of government incentives. They have also been implemented in developing countries as well, often with very mixed results because financial conditions for their success were either not fully understood, or not met. The issue is not whether such specialized instruments can work successfully. They clearly can. The issue is whether CSH syvtems remain advisable today to latecomer countries that want to develop competitive and flexible rmancial systems capable of integrating successfully with the global rmancial markets. It will take four to five years for a new CSH system to begin to have an impact. Would time, scarce financial skills and capital be more productively used at developing alternative solutions to the problems CSH were solving in decades past? This evaluation focuses on two very large and influential CSH systems: the "closed" German Bauspar system and the "open" French epargne-logement. In a "closed" CSH system access to the housing loan is a based on queuing; it can be made only if funds are available within the specialist institution. In an "open" system, the saver can legally call its loan at contract maturity, irrespective of prevailing liquidity conditions in the CSH system. The analysis examines these two types of CSH from the three very distinct perspectives of households, financial institutions, and financial authorities responsible for the development of the entire financial sector. * From a household perspective, CSH contracts facilitate the accumulation of equity, and offer the prospect of a low-interest loan. They establish a saving discipline and provide a concrete goal that many households find important. However, in inflationary TSEs the guaranty of a loan will not be not enough to achieve housing ownership. CSH contracts are designed to operate in low inflation and stable real interest rates environments. Inflation levels above 15% sharply erode the attractiveness of a CSH from a relative cost or affordability perspective: a widening financing gap develops between the CSH financing available and the rapidly rising cost of a housing unit. Conceptually, CSH instruments can be designed to operate in inflationary environments but such a result is achieved at the price of very limited usefulness to households. Even under low inflation, CSH instruments are designed to built up initial equity and to provide a second mortgage loan, leaving the provision of a primary loan unmet. The paper shows that even moderate inflation quickly leads to very low loan-to-value ratios for CSH loans. The widening gap must be financed with expensive -or non-existent -market rate mortgage loans. * Financial institutions face severe information asymmetries in transition economies where there are no retail financial markets, nor any form of credit bureaus, and income reporting is problematic. CSH are very effective for screening, monitoring and establishing the reputation of steady savers as future borrowers, and CSH contracts are good at lowering credit risks. Their screening efficacy is high. For instance, in France, delinquency and default rates for CSH loans are 10 times lower than for other