The Truth Behind Israel’s Housing Price Surge

A Bank of Israel report cited the banking system as potentially problematic for the Israeli economy because of its exposure to the real estate industry. The combination of banks’ high level of exposure to the related construction, real estate, and mortgage industries and the considerable share of housing costs per household creates risk to the financial system due to the possibility of internal or external shock. Such shock can trigger sharp and rapid increases in interest rates or a recession, which would negatively affect borrowers, which in turn would trigger a sharp and rapid turnaround in the housing market. This scenario could negatively impact the banks’ capital ratios and profitability.

The recent real estate spike is ostensibly the result of higher demand linked to the strengthening economy, foreign speculation, and the decline in housing starts. The economy has seen strong and steady growth the last several years; foreigner speculation of Israeli property has dramatically increased; and the decline of housing starts reflects the waning immigration of former Soviet Union expats. In fact, despite recent population growth, statistics show significantly more housing starts in 1996 than 2014. Those factors created a strong housing market and high prices. The higher prices lead to more borrowing, which boosted bank profitability while exposing banks to real estate industry risk. That said, there may be another politically-driven economic factor at play.

The shift from socialist-Zionism to today’s Zionism is dramatic. With roots in Nathan Birnbaum’s Kadima movement at the University of Vienna in 1889, Zionism went hand-in-hand with socialism. That socialist-Zionist ideology was subsequently manifested into the kibbutz movement, which enjoyed both special social and economic status in Israel. The religious-Zionist Mafdal was initially a religious, socialist party, remaining that way until the early 1990s. During the Warsaw Ghetto uprising of 1943, Mordechai Anelowitz’s socialist-Zionist ZOB would not join forces with Pawel Frankel’s centrist-Zionist ZZW (known as Revisionist-Zionists) to fight the evil Nazis due to their political differences regarding socialist Zionism. Yet on March 17^th the Israeli electorate heads to the polls to vote for a new government, with leading prime ministerial candidates being Yitzchok Herzog, a corporate lawyer, and Binyamin Netanyahu, a former venture capitalist. Clearly the electorate rejects socialism. And ironically, Herzog is the capitalist candidate from the labor faction of the Machane Hatzioni party. Capitalist-Zionism has dramatically replaced socialist-Zionism.

A socialist economy requires laborers, which have become fewer in Israel. As the kibbutz model changed and more and more of the younger generation embraced capitalism, the labor force void was filled by Palestinian laborers. Construction companies that had employed Israelis started employing Palestinians, which were suddenly cheaper. The same occurred in other blue collar industries. Suddenly, scores of Palestinians were streaming into Israel for work.

At the same time, Palestinian society was becoming more and more radicalized. That radicalization became extremism, wherein suicide bombers, who seemingly entered Jewish areas for work, killing innocents by detonated themselves. This terror compelled Israel to setup checkpoints at various crossings and eventually to build a security wall. The separation and partial removal of Palestinian labor threatened to damage economic activity.

To deal with this dilemma, Israel shed its socialist-Zionist roots in favor of an internationally-based, capitalistic economy focused on exporting technology. To that end, Israel devalued its currency, resulting in a technology export boom. This move decreased demand for Palestinian labor, thereby keeping Palestinians out of Israel proper and Jewish-controlled areas.

Moreover, removing Palestinian laborers from Israel’s workforce helped Israel score international points. Critics pointed to Israel’s security fence and use of checkpoints as a way to demoralize Palestinians, who were “just” looking for work. This pressure compelled Israel to relax standards at checkpoints, which compromised security due to the influx of suicide bombers. Now however, through the combination of the tech boom and governmental restrictions on housing starts, far fewer Palestinians enter Israel daily for work, thereby muting Israel’s critics on the issues of the security fence and checkpoints.

As a consequence, real estate and housing-related consumer borrowing increased as prices soared in response to the government-suppressed housing supply. Banks and other lenders capitalized on the increased business, resulting in more exposure to real estate and its related industries. For this reason the Bank of Israel is concerned about possible shock that would harm the banking system and the economy as a whole.

It seems that Israel’s security and political concerns influenced the government’s decision to embrace capitalism. While the founding Zionists are rolling over in their graves now that Israel rejected socialism, the political and security concerns on the ground have in part compelled Israel to embrace capitalism. And, by accomplishing the political and security objective subliminally, the critics voices have been somewhat muted. The downside is the higher housing prices and possible systemic risk to banks. Though problematic and potentially economically dangerous, the economic gain achieved through the technology sector and the better security situation made rejecting socialism an easy decision.