Very Serious Endorsement Of Loan-To-Value Restrictions By Peter Orszag

Perhaps the Federal Reserve has something to learn from the central bank of New Zealand about how to manage a mortgage market. Unlike the Fed, which has been sharply criticized for having failed to keep the U.S. housing bubble from expanding, the Reserve Bank of New Zealand is sounding the alarm over rising housing prices and imposing limits on mortgages.

Source: Bloomberg View Column by Peter Orszag

Peter Orszag is a Very Serious Person. He was Obama’s first Director of OMB and worked in the Clinton White House too. He is also a well regarded economist.

He is now  Vice Chairman of Global Banking at Citigroup – a move that reflects his association with the Robert Rubin wing of the Democratic Party that moves freely between Washington DC and Wall Street.

The fundamental reason housing is getting so much more expensive in New Zealand is on the supply side. Earthquakes in 2010 and 2011 damaged much of the housing stock in Christchurch. In Auckland, land-use regulations — including a zoning restriction called the Metropolitan Urban Limit — constrain new construction. Bill English, New Zealand’s finance minister, rightly believes that these supply problems must be addressed for the housing market to stabilize.

Even so, the Reserve Bank of New Zealand deserves credit. As I learned from conversations in Wellington last week, the mortgage limits are controversial. But they seem likely to help head off a crisis or contain the damage should one occur. Think of how much better off the U.S. economy might have been if the Fed had tried that.

There are a lot of judgment calls being made in assessments like these. What if the supply side issues are not resolved – as in, the low levels of housing construction at present perpetuate for another decade ?

The New Zealand Initiative’s Free To Build report provides some interesting policy suggestions including Community Development Districts loosely modelled on Municipal Utility Districts in Texas.

But I’m leaning towards the conclusion that all of these discussions are just that. Most New Zealanders cannot afford any reduction in house prices / having capital losses imposed through markedly higher levels of construction because they can’t even spell portfolio diversification let alone adhere to it when it comes to exposure to “pwoppity”.

Diminishing Marginal Returns To LVR Restrictions

This paper from the RBNZ on the potential impact of LVR restrictions is interesting.

The net effect of this is that credit growth is expected to be about $3.2 billion lower over the first year that LVR restrictions are in place. This would lower annual housing credit growth by 1.7 percentage points in the first year. The longer LVR restrictions are in place, the more likely it is that borrowers would be able to find alternative sources of funding and alternative buyers would enter the market. As a result, we expect that LVR restrictions would have a diminishing effect on credit growth after the first year.

While I think that loan to value restrictions are basically saving young dreamers from negative equity and restricted options in the labour market (can’t move for higher wages if you’re stuck with a mortgage), the Reserve Bank is putting its independence at risk.

Nothing is more sacred in New Zealand than the home ownership cow. It’s even more sacred than dairy cows themselves, and that’s saying something considering the handouts dairy farmers get to help their capital gains farming.

Thus, as the election comes closer, I would not be surprised if there was a bipartisan consensus on a raft of further exemptions for “struggling young first home buyers” without any consideration of how stupid the obsession with home ownership is.

It’s almost as if politicians didn’t learn anything from the Global Financial Crisis, the sub-prime mortgage market and what happens when you start giving exemptions and subsidies and special treatment to facilitate a policy outcome that has fuzzy outcomes attached.

There Needs To Be More Discussion On Basel III Instead Of House Prices

Housing is topical. Housing is easy for a journalist with a BA in Media Studies to understand. Housing articles drive traffic for online ad impressions and listing revenue. But are high LVR restrictions really the answer to perceived problems with house prices?

Basel III capital and liquidity requirements are not topical, but when it comes to financial stability they are pretty much the global tool that is so much better than market specific intervention despite the fact that imposing higher loss reserves on certain types of lending can have supply side impacts because a lot of growth can only occur because there are capital costs that have to be financed by a bank.

The Reserve Bank response to submissions I wrote about yesterday is an example of why market specific (house prices are in a b*****! we must act now!) interventions with a good goal like improving financial stability and lowering systemic risk through avoiding a lot of mortgage writedowns if house prices ever fall and high LVR borrowers have negative equity, are not necessarily a good idea.

This sort of regulation is “good” in the sense that the RBNZ really cares about financial stability now it has some fancy new macro-prudential kung fu to implement. It isn’t good in that there is barely any discussion of basic supply and demand factors affecting house prices, particularly in Auckland.

But anyway the focus on housing is really crazy in light of how massive Basel III capital and liquidity requirements are in terms of changes to bank lending processes and risk management processes.

It’s like worrying about rules for adding a conservatory to your house when the global building authority has issued a mandate saying “you have to use office tower strength reinforced concrete with earthquake shock absorbers for your residential foundations”.

My dream is that one day more people will be as passionate about supply side effects flowing through from higher capital and liquidity requirements before even thinking about the enhanced (negative) supply side effects high LVR restrictions could have.

Remember all of those finance companies? They were providing the risk capital that built most of the apartment buildings and subdivisions to get to a point where New Zealand still doesn’t have enough apartments and houses on decent sections.

Now, banks can’t lend like some of their more aggressive property lending teams did pre-2008 and the second tier finance sector has restricted itself to “sure thing” deals. The other alternative is hedge funds looking for extremely high rates of return for short term loans that won’t ever be capitalised.

Why oh why can’t we have a better media? This stuff isn’t hard to get your head around. It’s just a basic supply and demand story. Supply of housing is restricted both by lower credit availability and by council and environment court red tape. Add in a demand curve shift to the right from immigration and this could have been an ECON101 essay question.