Secular Stagnation And Housing Craziness

I’ll briefly discuss the idea that balance sheet recessions take a long time to recover from. Debt fuelled asset bubbles don’t always wind down in an orderly fashion. There are bumps along the road. In the New Zealand experience of the GFC, we entered a recession earlier than the rest of the world and now, find ourselves in the monetary tightening phase as some countries like Australia are starting to slow down.

I think that the balances sheet restructuring hasn’t gone far enough. There is still too much private sector debt in New Zealand and no one has adjusted their portfolio allocation behaviour. New Zealand obviously has way too much allocated to property as an asset class and the inability of many people to think clearly about this issue is a major risk, in fact I’d say it is a bigger risk than even officials have indicated in some works.

Whilst I’d agree that servicing ability is what matters for mortgages – I disagree with the idea that highly leveraged housing loans aren’t a key driver of higher house prices. Most first home buying couples are broke and some even need their parents to help with the deposit. That makes them high risk because with labour market insecurity, the fact that many relationships don’t last and external shock risks like another global trade slump, lending money to these people is really silly stuff.

If the loan term has to be extended to 30 years in order for a mortgage to be “affordable”, that’s nothing different to what sub-prime experts Countrywide and Washington Mutual did in the US. They’d come up with fancy interest rate reset or balloon repayment structures to make the monthly payment affordable. When interest rates rose, the music stopped for millions of US households locked into these sorts of contractual agreements some were even fraudulently induced into.

If you look at the contribution employment growth in Canterbury is making to employment growth nationally, then you can’t help but realise that we’re in another asset price fuelled mirage. The balance sheet restructuring necessary to ensure that capital shallow firms can get the financing they need simply hasn’t happened. The only “businesses” that have received funding are farms on the back of high commodity prices.

I don’t think this is going to be fun in the medium term. Constantly deferring the day of reckoning makes the inevitable reversal worse than it has to be. It’s even more worrying when you realise that NIMBY homeowners have enormous political power – the housing sector in New Zealand is basically “too big to fail” as evidenced by National’s announcement last week of more fuel on the fire for first home buyers.

Cornwall Park Leases

One of the things that Shamubeel Eaqub talks about in NZIER’s housing affordability paper is the importance of making renting in New Zealand a better substitute for owning.

The Cornwall Park situation is where 21 year rent reviews and the enormous increase in land values of the property owned by the trust has led to tenants getting massive increases in ground rent.

I don’t have much sympathy for people who entered into these sorts of property use arrangements and then, when the trust is exercising its rights, cry out to protect their “economic rent” of not paying the full cost of living in this area by attempting to stave off massive increases in ground rent.

I would have thought that a prudent property owner would have set aside some savings to offset the inevitable increase in ground rent over a 21 year period. What would a diversified portfolio have earned over that period of time with regular contributions?

The real question to ask is how many holidays and automobiles these people have taken during the inter-rent review period. I’d wager hardly any of these people have set money aside for future ground rent increases whilst they consumed the difference in cost elsewhere in their budgets.

I would argue that these sorts of arrangements are actually ideal for improving housing affordability. They are less valuable than freehold arrangements and come with more risk, but they shouldn’t be ignored as an option for improving the supply of housing.

Real Estate Agent John Key Tells Local Government They Suck (If Only)

Prominent real estate agent John Key said the central government has to manage its finances carefully. He didn’t point out that local government can’t manage its finances carefully. If only he’d told them local governments around the country suck.

Sensible government is being destroyed. By turning KiwiSaver into HouseSaver and undermining the independence of the Reserve Bank through soundbite sparring, John Key is putting the economic recovery at risk.

Our economy grew 2.4% last year and is on track for similar growth, he told attendees. We know DSGE models are dangerous territory. We have no idea what economic growth will be, despite Treasury projecting out public finances for decades.

He didn’t talk about how GDP rising because of the Christchurch rebuild isn’t really economic growth, but simply replacing what was already there before. The broken window fallacy is a key driver of the economic recovery plan.

He was talking to a bunch of town clerks who’ve rebranded as “Chief Executives” and bumped their compensation packages to include comparison with NZX executives.

At no point was there any discussion of how town clerks are underperforming relative to NZX executives and how their supervisors – hapless councillors all round – are just as powerless as MPs.

There was an opportunity for John Key to point out how councils are spending way too much money on pet projects and over-inflated salaries for “make work” roles. But he didn’t bring it up because he already knows that the grey ones have the power.

“Better Local Government” is an oxymoron. All the reforms are for nothing if a town clerk can make $550,000 a year while spending more on wages than it earns in rates.

The RMA will be reformed, but not in a way that will change the billing opportunities for RMA consultants and lawyers. John Key didn’t discuss how some property developers have exited the market – a negative supply side shock – because of the RMA and decimation of lenders who had some gumption to lend.

The Productivity Symposium recently included a good presentation on construction productivity. Booking inspections is one of the biggest problems. It’s a bottleneck around the country, one of the real culprits for housing affordability.

Home buyers don’t want pre-fab anything and we’re a decade behind on trades training so most of the productivity improvements have to come from local and central government.

The need for special housing areas where the government agrees with a local council to make consents easier is an indication of how far gone local government is.

Simply inform councils that consent processing times have to drop lest they get a “Local Government Manager” installed like Environment Canterbury. They’ve had a decade to sort it out since the Local Government Act reforms.

It’s not like democracy in local government matters anyway – just look at how few people vote in Local Body elections! You made the best case against democracy in local government in your speech Prime Minister.

The “39,000 new homes over the next 3 years” target for Auckland house construction is pathetic. If you read the recent NZ Initiative report on housing affordability, you’d realise that hundreds of thousands of houses will need to be built over the next decade to make up for lower construction levels and population growth.

It is disappointing that in his discussion of the Reserve Bank having to raise interest rates, he seems to think the consequences of a rising Kiwi dollar and hurt exporters are bad. Is John Key really an NZ Inc evangelist when he had a career in the foreign exchange markets? Does he think “exporting stuff” is better than exporting services?

He also ignores the idea that demand for housing can come from better job opportunities, immigration and a completely different way that couples form households in 21st century New Zealand. A rapid price rise is a signal most of the time. Bubbles are rare, but bubble stories make more sense and get more reader attention.

He does support the independence of the Reserve Bank, but his Housing Minister is undermining the loan-to-value restrictions with potential changes to Kiwisaver first home subsidy rules and he’s having an effect on markets.

He dedicates more time in his speech to discussing the cycle trail. If there was ever an example of how local government can “get stuff done” on pet projects like that, whilst ignoring rising wage bills, rates and permission fees, the cycle trail is a sad reminder of what happens when you don’t take a blade to the permanent government every so often.

Local government sucks really bad at almost everything it does with respect to making it easier to build houses. Real estate agent John Key missed the opportunity to call them out at their “we’re so wonderful, pat me on the back please” conference.

 

Why John Key Will Take Graeme Wheeler’s Independence Away

An independent central bank is better than a government micro-managed central bank.

If you disagree, have a read of the interesting things National Prime Minister Robert Muldoon did with wage and price controls.

Furthermore, the global financial crisis shows what happens when central bankers fold under pressure from politicians and big banks to “do something” in the form of quantitative easing.

Yes, many central bankers desperately wanted to bail out the global financial system, but a good number warned that no good would come of it, and they’ve been proven correct.

A jobless recovery around the world made easier because artificially low interest rates make borrowing for capital investment easier and thus replacing labour with robots is simply a profit maximising strategy for corporations.

Last year I was writing about how the Labour-Greens-NZ First troika could prove disastrous for the independence of the Reserve Bank of New Zealand.

But I clearly forgot that John Key is an interventionist just as much as Helen Clark ever was. It’s just that he intervenes in different areas of policy.

The issue of housing affordability is on track to become an election issue. If young couples can’t buy houses they are less likely to have kids, which means the demographic ponzi scheme paying for unproductive oldies to stay alive collapses forthwith.

They’re not special though, and don’t deserve special treatment like the first home subsidy – a perversion of Kiwisaver as a retirement savings scheme if there ever was one.

But on the other side of that same coin they don’t deserve another slap down in the form of higher loan-to-value restrictions.

This is because banks are unlikely to grant such loans – which run the risk of negative equity if house prices fall – to low income households.

In the aftermath of Basel III and other risk management changes in the banking sector, loan quality matters a lot more than it did before 2008.

If the Reserve Bank does want to put a speed limit on housing, they are completely ignoring the supply and demand story around housing services.

In fact, they are basically saying that static efficiency (one price for housing! no price changes! a price rise is not a signal but an indication of a bubble!) beats dynamic efficiency.

What they’re also doing is missing the wood from the trees – the reason house prices are going up so quickly is because it’s not only hard to build a house, it’s almost impossible to obtain financing for property development.

And what they’re also doing is forgetting that a lot of house deposits come from parents and grandparents.

Young people in aggregate suck at choosing profitable careers and saving – economic outpatient care is probably the key driver of the Auckland housing market.

How does this work? Well, if two sets of parents chip in tens of thousands of dollars each to the pittance scraped up by Jack & Jill then suddenly a mortgage can be approved.

John Key will foil the Reserve Bank Governor Graeme Wheeler on this issue because he knows that despite an independent central bank being an inherently good thing, his 3rd term in government is simply more important.

 

Why There Is No Need To Worry About Chinese Home Buyers

When house prices rise and people can’t afford the new price level, someone must be blamed.

It is too easy to blame Chinese for higher house prices in Auckland because they are an easy target for Kiwis with anti-foreign bias.

It’s a short-sighted attitude – in most cases, foreign real estate transactions are a transfer of wealth to the recipient country.

If you don’t agree, I’d suggest you investigate how Japanese real estate purchases in the United States at the height of their 1980’s boom worked out in the long run.

Have you done that? Well, if you had, you’d know that pretty much every office building sold to Japanese buyers at “inflated prices” was bought back by a US investor at a substantial discount to what the Japanese buyer paid.

When we think about why Auckland house prices are high, we can use a simple supply and demand story.

The supply of Auckland housing is restricted by the metropolitan urban limit and a plethora of Auckland Council regulations and planning rules.

The supply of Auckland housing is restricted further by a lack of willingness on the part of banks to lend to property developers.

These two supply-side factors mean that fewer houses are built in Auckland and there is upwards pressure on house prices because supply can’t respond fast enough to what is happening on the demand side.

What is happening on the demand side? Well, Auckland is the place to be for higher wages. There is massive internal migration to Auckland from other parts of New Zealand.

This puts a lot of pressure on Auckland housing demand – before we add in that immigrants tend to move to Auckland first and stay in Auckland because that’s where the jobs are.

That means that there is a lot of demand side pressure on house prices – before we even take into account the effect of “speculative” or “investment property” demand for housing.

If we add in those demand side factors, it is quite straightforward to accept a 16% year on year rise in Auckland house prices, before even taking foreign buyers into account.

This means that blaming the Chinese, whether natural born Kiwis or immigrants, is really stupid.

As soon as supply side restrictions are eased, there will be downward pressure on house prices. The marginal “speculative” or “investment property” purchase could end up in a mortgagee sale.

There is no need to worry about Chinese home buyers, because they are a small part of the market, and if their “speculative”  buys don’t work out, the previous owner got a gift of wealth from China.

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.

Buying A House Is Weird

Economist Shamubeel Eaqub is right, renting is better than buying. It’s weird how obsessed New Zealanders are with real estate. Browsing the real estate section of TradeMe or Open2View must rival consumption of online pornography when you think about the volume of data transferred.

I’m just about to move to a cheaper room. It’s in Thorndon, close to university and further away from the bright lights of Courtenay Place with overpriced bars and nightclubs. I spend thousands of dollars a year on housing and I’m happy with how my side of the trade is working out. In the long-run I will be far better off than whoever owns the property I am renting a room in.

I completely disagree with the idea that renting is less secure than owning your own home. David Whitburn’s comments that a landlord can just kick you out are completely off the mark for a lawyer. The Residential Tenancies Act and Tenancy Tribunal provide a reasonable level of protection for residential tenants.

When you enter into a rental agreement, you go in with your eyes open. In exchange for lower levels of security and the landlord covering the cost of insurance, rates and mortgage repayments you get a substantial discount on the cost of housing. If you complain about the terms of the deal, shop around for a better one.

A unique feature of the New Zealand rental market is that many landlords are reasonable people. If you have a young family and need access to schools there is no harm in asking for an extra month or two’s notice if the landlord is going to sell up. It’s called “not being a dick” and when housing affordability is a major issue landlords need to be responsive to longer lead times for residential tenants departing.

You don’t need to buy a house before you have a family. If your partner won’t settle down with you before you’ve bought a house, you might want to read about the Relationship Property Act. Multiply the cost of your mortgage over the expected life of your relationship by 0.5 and ask yourself if you’d like to write a cheque to your partner for that amount of money. If not, it might be time to end the relationship.

If you decide to have children and buy a house, you’re not giving them security at all. This sadistic rationalisation must be linked to the poverty of experience many Kiwis have growing up. If Mummy and Daddy didn’t spend $1,100 a fortnight paying off the mortgage on a dingy villa that costs an extra $20,000 in maintenance to keep from falling apart they’d be much happier.

They’d have more money to spend on expensive groceries, overseas trips, luxury goods, private school fees, charitable donations and fine dining. Instead of working on behalf of Australian bankers we’d be working on behalf of our friends, family and neighbours. There would be no need to ship billions of dollars a year in interest payments overseas when it could stay here and create jobs if we merely stopped participating in groupthink.

Parents could even afford for one partner to stay at home with the kids. They wouldn’t need to work a dreary office job that barely covers day care, the cost of work clothes and commuting. This is because tens of thousands of dollars a year wouldn’t need to be earned in the first place because there isn’t a massive mortgage payment to be made. Imagine how much happier children would be if Mum or Dad didn’t abandon them every day to go to work. I’m sure glad my Mum took time out of the workforce with my younger brother and I. Parents with young children are funnily enough a group with the most to gain from renting before a primary school needs to be found.

I can see myself buying a house one day, eventually, potentially, if house prices decrease significantly to around 3 times the median income. But after my experience with debt so far I sure as hell wouldn’t want a rapacious bank involved with where I sleep and retreat from the world. I’ll buy a house when I can pay cash and have as much again left over. With the median house price in Wellington central $472,000 that means I’d want at least $944,000 in liquid assets before buying a house.

If more people thought like me New Zealand would be far better off. You’re bailing out baby boomers who failed to save for retirement when you pay too much for a house. When they all die, the market will be flooded with houses because their impoverished children can’t afford the upkeep or to develop large sections in high demand areas.

If you want to calculate the difference between buying and renting for your own specific situation, the New York Times has a fantastic interactive tool. You’ll need to think clearly about the assumptions being made, but will get a good idea of the size of the tradeoffs you make when you buy a house.

Buying a house is weird because for 99% of people you are betting the farm on the possibility of an out-sized capital gain while exposing yourself to the risk of losing everything. You’ll spend twice what you paid for the house in interest, fees, maintenance, insurance, remodelling, furniture, landscaping and the opportunity cost of all the money you spent on all of the above which would amount to such an enormous sum that you could rent forever on the interest and dividends.

Buying a house is weird. But I’m glad that lots of New Zealanders don’t think so. Renting is a discount on the cost of housing. Landlords are basically subsidising my cost of living. I’m not throwing money away because you have to live somewhere. I hope the difference between the cost of renting and the cost of buying continues. I can prove with maths I’ll be better off, but I’m not concerned about convincing people who buy into the house owning cult.