Anybody unfortunate enough to pick up a copy of Wellington’s daily newspaper today was assaulted by a screeching headline ‘Pricking the housing bubble’. Accompanying this was an entire front page devoted to how Bill English’s 2013 Budget is some sort of “3-pointed” magic pin. Someone find me the smelling salts!
Housing is cannibalising the rest of the New Zealand economy, no disagreement there. In fact I’ve been going on about this for years. There are policies that can stop this stupidity, but Bill English’s bag of tricks isn’t up to the job. The key ingredient – tax neutrality for housing – is missing and what is there, with few exceptions, is mutton dressed up as lamb.
I’m not going to focus on the decision to support non-government, not-for-profits, supplying community housing. This is good in principle but where will the new funds and therefore significant growth in supply come from? Nor am I going to delve into the decision to allow the fast-tracking of resource consents for new subdivisions. What does this say about the quality of urban living for all residents and community-based democracy? But I am going to address the Reserve Bank’s new prudential tools.
I’ve repeatedly gone on record in the past saying that the Reserve Bank’s prudential policy was creating a housing monster – the policy rewarded banks for lending to housing as opposed to other sectors. The policy effectively meant housing loans were cheaper to supply for the banks than other loans because they had to keep relatively fewer financial assets to back them up. This approach was wrong, and the economy as a whole has paid the price. The housing market en masse is a big risk for the economy – simply because so much money is invested in it – and this ‘systemic’ risk should have been reflected in the costs the banks faced when they made housing loans. It wasn’t.
As an aside, it would be nice to think that bankers would be able to see and factor in these systemic risks at the time they make loans, leading them out of self-interest to pull back from lending that jeopardises the system and therefore their own bank. But in this respect it seems that bankers, despite with their fancy qualifications and fat salaries, are no different to any other business people or traders and are incapable of incorporating systemic risk into their business decisions.
One piece of positive feedback I have about the Reserve Bank’s new prudential rules is ‘Hurray, at last we face the possibility that the favourable prudential treatment of housing might be removed’. Another positive is that it seems likely automatic stabilisers in the system might be enhanced with banks being required to put aside more capital into reserves during good times (limiting their ability to make new loans then but gaining gunpowder for tough times) than they might otherwise have done. This goes someway to addressing the lemming tendencies of bankers. However that’s about where the good news ends.
There is a definite impression that the Reserve Bank will be using these tools to dip in and out of the lending markets, depending on how hot they view the housing market. In technical jargon, the RBNZ has the capacity to use these tools ‘counter-cyclically’, just as it does with the OCR which directly impacts on interest rates. How else to interpret the Reserve Bank’s own description of what it will be able to do:
“The Reserve Bank’s aim would be to apply the restrictions at times when…lending was judged to be posing a significant risk to financial system stability.
What nobody seems to be saying, and this is surely a puzzle, is that New Zealand has been down this track before and failed spectacularly. In the post-war period until 1984 the Reserve Bank used direct tools similar to those being proposed now. The RBNZ had tools that they could apply at will to alter the costs to banks of loans depending on the sector which received the loan, and the state of the business cycle. This facility is now being granted to the RBNZ. The RBNZ also had tools to influence growth in the different types of loans banks made (eg low equity loans) – snap again. As well, then the rules applied only to the banks, not other lenders (like solicitors) – again, this is the case today.
Of course, many things were different in the 1970s. For example, then the government could also force banks to lend to it by requiring them to buy its bonds, and there was no fiscal discipline. Bureaucrats picking winners and politicians forcing banks to fund government largesse was a big part of New Zealand becoming economically unsustainable in the 1970s and 1980s. Back to that future will be suicide.
But the one constant between then and now is that the RBNZ now has tools available to it to influence the allocation of bank loans depending on officials’ views about the business cycle. That’s really dangerous. It simply isn’t possible for officials to know accurately when in the cycle they should intervene. Getting it wrong with these sorts of weapons at their disposal has serious consequences. It’s bad enough with interest rate levers – and the RBNZ is careful to give long lead-ins to changes there – but prudential tools used for counter-cyclical purposes are a different fish altogether.
Another lesson, duly acknowledged by the RBNZ and behind some of the fine-tuning they are currently considering, is that leaving any lender out of the new regime gives that lender a competitive advantage (as solicitors’ mortgage trusts once had). You would no longer have a level playing field, and worse yet, the ones who would do well would be out of view of the regulators. This clearly increases risk in the system, it doesn’t reduce it. And don’t forget the added costs policies like this impose on the economy too – new bank compliance costs that will give a step jump in interest costs and higher tax-funded expenses for the RBNZ.
Finally, a key lesson from earlier regimes is that central bank prudential policy cannot do all the work. We know (as was true in the 1970s) if appropriate supporting policies are missing, relying on prudential policy will at best delay inevitable adjustments and invariably introduce imbalances elsewhere in the economy.
In the current case, investment in housing is eating into the structural strength of the New Zealand economy. This is because it has favourable tax status as well as favoured status with the RBNZ prudential guidelines. Making prudential policy a discretionary cyclical tool is really high risk and the housing tax break hasn’t been touched.
The signalled path ahead for grappling with the overheated housing market will be ugly to watch and ultimately unsuccessful.