The Dutch economy and financial markets are increasingly vulnerable to the housing sector.
T he Dutch housing bubble was the second biggest in continental Europe. Today, house prices are down 15% from their peak in 2008 and nearly 10% of Dutch homeowners are already underwater on their mortgages. The problem is that housing price deflation has not yet run its course. Moody’s estimates suggest that if house prices fall another 10%, about 30% of Dutch homeowners would have negative equity in their homes.
There is an obvious danger that a private debt crisis could erupt, causing substantial damage to public finances. Note that relative to the size of its economy, the Dutch banking sector is enormous, with assets reaching more than 400% of GDP. This ratio is substantially higher than it was in Spain when the housing bubble there was at its peak, indicating that a sharp rise in bad debt is all but inevitable should real-estate prices fall further.
Risks to the banking system are further heightened by the potential illiquidity of financial institutions’ balance sheets. Dutch banks are heavily leveraged and very dependent on the wholesale market, as their loan-to-deposit ratio stands at 132%, one of the highest in Europe. Should a housing meltdown provoke a banking crisis, the Dutch government will be forced to assume much of the bad debt in the banking sector.
The increasing vulnerability of the Netherlands’ economy and its financial markets suggests that Dutch bonds may be grossly overvalued. With rising banking sector risk and a continued decline in real estate prices, our Global Investment Strategy service recommends an underweight allocation to Dutch government bonds relative to German bonds as the spread is near recent lows and does not properly reflect potential risks.