Housing market booms followed by busts have been associated with financial instability and significant costs to the economy in many countries over the years, reflecting the importance of the housing sector. Still, the degree to which such house price boom-bust episodes have led to more widespread financial instability differs between countries, in part because of important differences in countries’ housing finance systems, including the role of government.

This chapter analyzes housing finance systems in a number of representative advanced and emerging economies in order to identify factors that enhance the stability of housing finance systems and financial stability more generally. In particular, it examines aspects of housing finance systems in some advanced economies that contributed to financial instability in the recent crisis. The chapter draws in large part on empirical analyses that confirm that rapid mortgage credit growth and strong house price increases go hand in hand. The analyses also account for the impact of a number of housing finance characteristics on mortgage credit and house prices. In particular, they suggest that government participation in housing finance exacerbated house price swings and amplified mortgage credit growth during the run-up to the recent crisis, particularly in advanced economies.

Countries with more government involvement also experienced deeper house price declines. Moreover, higher loan-tovalue ratios are significantly associated with higher house price and credit growth over time for advanced economies, in line with other studies. This effect disappears when emerging economies are included in the sample over the most recent period, possibly due to less formal loan limits in these countries, where lending to a large extent still takes place in unregulated sectors. Based on an evaluation of evidence presented in the chapter, including the empirical analyses, three broad areas of best practices for stable housing finance systems emerge: (1) enhanced risk management, underwriting standards, and supervision; (2) more careful calibration of government participation; and (3) improved alignment of incentives of participants using capital market funding. When discussing these best practices, the chapter also notes additional aspects that need to be considered by policymakers in emerging market countries as they set up their housing finance systems