Reflexivity, House Prices And Mortgage Lending

I’m currently reading another George Soros book “The New Paradigm For Financial Markets“. Reviewing his discussion of the 1980’s international lending crisis he notes:

In cases of debt leveraging the misconception consists in a failure to recognize a reflexive, two-way connection between the creditworthiness of the borrowers and the willingness of the creditors to lend: Usually there is a collateral involved,
and the most common form of collateral is real estate. Bubbles arise when banks treat the value of the real estate as if it were independent of the banks’ willingness to lend against it.

With respect to the New Zealand housing market we can analyse the creditworthiness of the borrowers.

We can also bear witness to the willingness of banks to lend on housing.

Total household financial assets are $224 billion and  total household financial liabilities are $188 billion – housing loans are $175 billion of this.

Household net wealth is $655 billion dollars of which some $455 billion is net equity in housing.

Mere supply and demand factors cannot lead to such ridiculously insane, out of touch with reality house prices and percentage of household wealth tied up in housing – a non-productive asset.

The key driver of this is the fact that banks don’t believe that house prices will fall or they wouldn’t be comfortable lending so much money on housing.

More than half of their credit exposure is to housing. Lending to the real economy – businesses and even agriculture – is a fraction of mortgage lending.

Any decrease in the collateral value of housing will turn all of the banks insolvent.

Alternatively, they’ll have to raise enormous amounts of capital to maintain the capital requirements they’re meant to have under Basel III requirements.