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Rich world's most indebted consumers caught in bubble mystery

[COPENHAGEN] Bubbles are generally impossible to see on the way in, and blindingly obvious in hindsight. But when an economy boasts the rich world's biggest household debt burden, the stakes couldn't be higher.

In Denmark, borrowers on average owe their banks about three times their disposable incomes (an OECD record). The country went through its most recent boom-bust cycle in 2006-2008, when home prices slumped more than 20 per cent from peak to trough, triggering Denmark's worst recession in a generation.

Now, prices in Copenhagen are higher than at the frothiest point of the previous boom. Nordea, the Nordic region's biggest bank, says there's reason to fear this might be the next bubble.

Danish household assets are still worth more than their debts. But "asset prices can fall and too high a debt, particularly if undertaken with variable loans, can be much more difficult to service if rates increase," Helge Pedersen, chief economist at Nordea's Copenhagen office, said in a phone interview.

"I am afraid that liquidity issues may show up," he said. "High gross debt financed by variable loans can lead to a liquidity issue and problems to service debt. And if asset prices fall, that's a bad cocktail."

So far, there's little sign the housing market is cooling down. Apartment prices are now 7.4 per cent above their 2006 peak, according to Statistics Denmark data. House prices are fast approaching their pre-crisis peak after jumping 2.3 per cent last quarter from the first three months of the year.

The development has followed Denmark's descent into the once unthinkable realm of negative rates. Its central bank, which defends the krone's peg to the euro, has acknowledged its policy rate probably won't go positive until 2018 at the earliest.

Danish short-term mortgage rates are negative, as are 10-year government bond yields.

Mr Pedersen says the combination of ultra-low rates and rising house prices provides fertile ground for speculative behavior to start sprouting.

"It's important to remember that Danish households are among the most indebted in the world," Mr Pedersen said in a note.

"And even though our assets are worth more than our debt, it's relevant to underscore the risks of further increases in debt." "It's notoriously difficult to predict a bubble," he said.

"But it's also a fact that most bubbles weren't predicted before they burst. That's why it's so important to sound the alarm now."

BLOOMBERG