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Bundesbank needs to get creative with frothy housing market

The housing market has become a hot topic at German dinner parties. City dwellers boast about a profit of 30 per cent made in two years, moan about a shortage of good builders and fret about perceived inflation threats. After a decade of stagnation, property prices in the seven largest cities increased by 9.1 per cent in 2011. The Berlin market, in particular, cannot be explained by fundamentals any longer.

This is starting to look like a bubble in the making – and the Bundesbank is getting nervous. While the central bank stressed that it neither sees an actual bubble nor an imminent threat to the financial system for the moment, it also made clear that it wanted to avoid the mistakes of the Fed or the Bank of England, which stood idle for far too long.

However, the Bundesbank would find it harder than its peers to fight irrational exuberance pre-emptively. As only one of 17 euro zone central banks, it cannot act on interest rates.

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Hence, one of the most orthodox central banks might be among the first to play with the shiny new tools of macro-prudential regulation. The Bundesbank may have to tamper directly with the lending decisions of individual banks. German regulators could ask reckless lenders to ramp up liquidity or equity buffers. Capping "excessive" risk positions of specific banks is also on the cards. These are uncharted waters for central bankers. And for the time being, the legal foundations for that macro-prudential approach are just being implemented.

Moreover, as long as the new tools are just being used domestically, they will not be sufficient. Anecdotal evidence shows that many buyers in the German property market hail from other euro zone countries. There isn't much that Frankfurt can do about this.

If property prices get seriously out of hand, the Bundesbank will need the help of its euro zone counterparts. This should be a strong argument to expedite the creation of the banking union. The irony is that German policy makers are doing the opposite. Time for a rethink.

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