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House in an Auckland SuburbGareth Morgan

Reserve Bank solution misses the point

House in an Auckland Suburb

One is not enough. Over-investment in the property market is a direct result of the presence of so much investment demand for property

Remedy for New Zealand’s housing bubble needs to focus on curbing investors’ enthusiasm for property.

The Reserve Bank has announced it will lift the ratio of deposits to loans in order to take the heat out of the housing market.

There are a number of grounds for intervening in the housing market and the appropriate instrument to use depends on the reason for the intervention.

That there is an imbalance is evidenced by the very high house price to income and debt servicing to income ratios that still prevail in New Zealand compared with historical and international averages.

If it’s considered that a supply shortage is the problem, and that demand is normal or not unsustainably stimulated, then the appropriate policies need to be supply-focused, not targeted on altering demand.

Policies such as freeing up land, introducing more competition into the building supplies market, reducing the local body planning restrictions and compliance issues would all act on supply.

If, however, it’s demand that is considered unsustainable, the policy response required is quite different.

Further, what demand policies are appropriate depends on what it is about demand that is considered unsustainable.

My view is that demand is the problem.

This is probably also the Reserve Bank’s view, as its policy response targets demand. But that is where our agreement ends. The bank has a very different view from me on what it is about the demand that cannot or should not last.

According to its published comments, the bank is concerned about the risk to the banking sector posed by a large quantum of housing loans that might go sour should some sort of macroeconomic shock hit the economy.

This is consistent with its policy choice to make people have a higher deposit before they buy a house.

Of course they might borrow the deposit from elsewhere – which is what’s happened in the past with this type of approach – but presumably the Reserve Bank thinks it can isolate our banking system from such fringe lending this time.

Maybe. But in my view the risk of a collapse in the banking system isn’t why the bank should be intervening anyway.

The damage to the economy from this sector is occurring even with a banking system being unaffected, even with the banks being able to pass the various “stress tests” the Reserve Bank boffins subject their bank clients’ sheets to.

The issue is about the allocation of capital – capital that is required to generate income and jobs.

Over-investment in the property market is a direct result of the presence of so much investment demand for property. That bubble has been inflated since financial deregulation in the 1980s.

If I’m investing in multiple properties I’m not being forced to put my funds to work by investing in businesses that generate income and jobs.

And the reason I shun those is because the commercial banks make it infinitely easier for me to invest in property and let it lie idle. They regard property as more secure collateral than any other type.

Why? Because the Reserve Bank directs them to. The prudential ratio requirements dictate to the banks that they must give preference to mortgage lending over all other types of lending.

So yes, it is a supply issue – but not supply of property, but rather supply of finance. And whether that supply is so high as to put the banks’ balance sheets at risk is beside the point.

The damage is being done to the economy anyway as non-housing investment is shunned in favour of speculative demand for housing, demand that has nothing whatever to do with the demand for accommodation.

The problem with demand for property in New Zealand is one that has arisen as a legacy from a long history now of Reserve Bank prudential policy combining with selective tax policy to provide a toxic little no brainer for property investors.

Put bluntly, it is the easiest way in town for people to make money – all they need do is gear up and the tax-free gains are, over time, sumptuous. All Kiwis know this and it is the national pastime.

In other words the demand for housing has less and less to do with the demand for accommodation and more and more to do with the demand for a property as an investment proposition.

Tenanting the building is of second-order concern if the bulk of the contribution to your profit is the price appreciation. It’s almost like hoarding artworks or rare coins.

Certainly in Auckland over the past year – again – that has been the game to play. Now of course the Reserve Bank policy to lift deposits required will be successful in quelling demand – unless non-bank lending again fills the gap.

But the problem with that instrument is that it hurts most the people who cannot afford to enter the housing market, it affects far less those of us who have several houses as stores of value, that is, repositories for our accumulated savings.

We care less about leverage. We still care – but not as much as the hard-working young couple with two children trying to get a foothold in the market.

We’re on the bus, higher deposit rates will simply alter the arithmetic of our geared speculation, it doesn’t lock us out.

So the Reserve Bank’s choice of policy instrument runs two risks:

•It won’t work because non-bank finance will fill the gap – this is particularly likely if capital inflows from abroad find the rates on offer in New Zealand luscious.

•It will hit hardest those not causing the problem in the property market anyway. The bubble is not driven by folk trying to get into the market, it’s driven by those of us with multiple properties, all retained because we know what a great return tax-free capital gains on property are.

What should the Reserve Bank do?

First, speak to the Government about the lack of wisdom in having a mandatory tax only on cash income, but a selective one on income earned from capital, be it capital gain or implicit income that having use of the capital confers.

The biggest taxpaying mugs in New Zealand continue to be those subject to PAYE. The Government has them under the taxman’s hammer.

But so long as you can increment your wealth via an appreciation in the value of your assets, for example, you are free of the burden of tax. That reality is unfair and terribly inefficient when it comes to generating income and employment for New Zealand.

The toxic twins of a comprehensive income tax on cash incomes only and a selective tax on effective income from capital (whether that accrues from capital gains or imputed rent of the asset), together with a central bank that directs banks to finance property above all other assets, will continue to hamper the achievement of better living standards for New Zealanders and underwrite an ongoing property market boom, all the while ensuring fewer and fewer New Zealanders will ever own their own accommodation.

Part two tomorrow: Home buyers versus speculators.

  • raf

    Good points. Also make sure you support P2P lending, when it finally gets clearance from the sleepyheads at the FMA. That will enable the connection of investors and business, improving returns for the former and lowering finance costs for the latter.

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  • rob

    Even the govt know a CGT is the first step. They just don’t have the cajones to do it- knowing it will annoy their constituency more, and if they wait, Labour will do it anyway, and can take the heat.

  • cosmopolite

    Adding another tier of rates payable to the IRD is feasible, albeit unpopular. This extra tier of rates could be confined to property that generates no income, although this will prove even more unpopular.

    I support the RBNZ putting a ceiling of 80% on the LVR for the purchase of one residence, and of 70% on all other property purchases. I don’t care if the deposit money is raised by nonbank borrowing, as long as the resulting loan is not secured by the property under purchase. Better yet, it should be unsecured, in order to discourage such loans from coming into being ;).

  • John Morrison

    Three queries Gareth please, One; Surely the “money” you put into “multiple houses” isn’t necessarily lying idle? Has it not just changed hands and is still in circulation?
    Two; I too believe that it is “demand” that drives up house prices, but isn’t increased supply the answer? (I agree totally that a Gov. should treat all investments as perfectly equal)
    And three; Isn’t introducing a CGT too late? If introduced now it will probably justgive those damned fool speculators huge tax credits instead of a much earned bath when the “bubble” bursts?

    • Gareth Morgan

      Hi John
      1. It’s not about “the money” but rather if I’m investing in houses when I could otherwise be investing in a business and creating profits and jobs the economy is worse off. If we’re all playing this game that’s a heap of investors deciding not to stimulate the economy.
      2. The excess demand is only there because of the RBNZ directive to the banks. Deny you the access to credit and you “demand” wouldn’t be there. So my point is the credit providers should not be favouring mortgage lending.If they did that demand and supply would soon be in balance.
      3. I do not advocate a CGT. I don’t know how many times I have said this. I advocate a wealth tax. You get taxed on your house every year no matter what its price does.

      • John Morrison

        1. That’s good
        2. And that’s good too.
        3 OMG That’s not good, it implies that I am taxed every year on the value of my business? Including the goodwill component?
        That also implies an annual stock take of consumables etc?
        Thanks for your reply.

  • Mike M

    Yes, it’s always frustrating to witness the hypocrisy of the RBNZ and finance minister attempts at jawboning down property bubbles when they are the root facilitators. Now, the banking industry and property owners/speculators are joined at the hip. Both have a significant interest in the game continuing.

  • Stu Luttrell

    We keep patching up the one thing that has created ALL of these issues, you can also add poverty, sickness & environmental destruction. That “one thing” that holds back the human race from truly advancing, has outlived its purpose, & has done so for the past 80 years, when non-man hours surpassed man hours production. No government, bank or economist is going to solve the issues that need to be solved, if they did, they wouldn’t have a job!