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.

Better Explanations Are A Waste Of Time

NZIER economist Shamubeel Eaqub interacts with the public at large over at, discussing house prices in Auckland amongst other things.

The comments devolve into anti-economist derp, without any discussion of the actual topic at hand. The benefits of interaction with the general voting public are significantly over-estimated.

Comment sections on almost every website are terrifying. It’s amazing how illogical most participants are, and of course you have to be on the look out for someone invoking Godwin’s Law.

Social media and commenting on blogs has set back the progress of thought a generation. Too many stupid people are sharing their opinions and influencing others who won’t spend the time reviewing the literature, reading long books on the issue written by experts or even acknowledging that maybe, just maybe, someone has a more informed opinion than they do and should be at least considered before they explode in an outburst of derp.

This isn’t an endorsement of technology driven wonk-led policy formation. It’s more of a call to take a minute to think before participating in a discussion. Most issues are way more complex than they seem – and the intuitive, easy answers run the risk of being completely opposed to reality and how the world actually works.

Census Data And Tyler Cowen’s Average Is Over

The second major release of 2013 census information happened last week. The 2013 regional census summary tables with household income information were updated, and a very rich set of data is able to be discussed.

Household income data is important in any discussion around inequality because we can use it to look at how the New Zealand population is moving to not only where the jobs are, but where they can afford to live the lifestyle they want.

A common refrain is that housing is too expensive in central Auckland, Wellington and Christchurch. With respect to median household incomes in these areas, that’s quite true. But since the 2006 census the median household income in Auckland has grown from $63,400 to $76,500; in Wellington City from $74,200 to $91,100 and in Christchurch from $48,200 to $65,300.

Percentage increases of 20%, 22% and 35% respectively lead to an obvious question that has to be asked – if Auckland has had the lower growth in median household income, why has it had the highest growth in median house prices?

But wait, the Auckland region is an aggregation of all of the different areas of Auckland. We have to look at local board areas to get a better idea. Taking higher income areas – Devonport/Takapuna where median income has grown from $68,800 to $85,800 (24%) and the Orakei local board area where median income has grown from $88,700 to $107,900 (22%) – there’s a big story inside relative income gains between different suburbs linking to relative changes in house prices.

How do I link this back to what Tyler Cowen was discussing in Average Is Over? Well, in order to live in central cities where higher salaries are on offer, the entry price point will rise relative to other areas over time as the economy moves closer towards higher levels of capital utilisation in service industry business processes.

More people will have to sell out of expensive central city areas and buy in cheaper areas in order to survive after retirement or any change in their ability to earn labour market income.

During this process, capital losses in suburbs that aren’t close to “good schools” and job opportunities are a distinct possibility. Perhaps many people who think they’ve gotten “bargains” will find that higher interest rates and capital losses in the medium term are not as pleasant as being able to say that they’re on the “property ladder”.

One thing that the income inequality crowd haven’t wrapped their heads around is that as Auckland becomes larger and more integrated into Asia Pacific conglomerates corporate structures, significantly higher income inequality is essentially a given. Hardly anyone is making the connection between technology driven job polarisation and the risks to non-superlative suburbs in terms of capital loss.

Why Inequality Is On The Agenda

In brief response to Paul Walker’s post “But why does inequality matter?” :

  • Inequality is on the agenda because the media are writing about it
  • The media are writing about it because envy is as old as the hills and journalists earn rubbish wages so anyone on a higher income is a fair target for them
  • Most journalists’ eyes glaze over when they see numbers so clear discussion is not possible
  • So despite a lot of evidence to suggest that maybe income and wealth inequality in New Zealand isn’t as bad as it’s made out to be, that conclusion doesn’t get page views so emotive language rules how the discussion is framed

Interesting examinations of relative shares of national income accruing to capital and labour respectively are unlikely to be examined in depth. This review by Branko Milanovic – The return of “patrimonial capitalism”: review of Thomas Piketty’s century “Capital in the 21st Century” – is very interesting.

I’m surprised that all of the people wanting to discuss inequality haven’t made the obvious conclusion of changing capital/labour income shares – you must do everything possible in your power starting with living below your means to accumulate capital or get into a position to earn very high levels of labour market income.

Any other policy proposals outside of your own individual actions are hilariously naive. Take for example the impossibility of solving housing affordability in New Zealand – if housing earns a return in the form of rent you would otherwise pay (Piketty includes housing as wealth) – then increasing the supply of housing lowers the wealth of property owners.

Obviously, with so many New Zealand households having no other wealth outside of their home equity, it is political suicide to introduce policy that does anything more than make some marginal increases of the housing supply possible. Recall that even the housing accord in Auckland will fast track a mere fraction of the additional housing units required to absorb the enormous increase in Auckland’s population both past and projected.

I’m not concerned about income inequality or wealth inequality. I am concerned about the shallowness of the discussion and complete suppression of any discussion around what capital actually provides to society in the form of enabling enormous advances in living standards and enjoyment of life. Simple minds will always be attracted to simple “problems” with simple “solutions” that absolve them of any responsibility.

Macro-Prudential Decision Framework

From the latest Reserve Bank Bulletin. There are many subjective assessments of the factual situation at hand in this diagram. I think 2013 marked the beginning of the end for inflation targeting in New Zealand. Even if Labour/Greens don’t win the election, the median voter first home buyer now thinks of the Reserve Bank as the government agency that stopped them from buying their first home with LVR restrictions.

The precious snowflakes of my generation don’t like being told no, and will now be ripe for the picking as the election looms – promises of affordable housing would have nothing on any major party campaigning on “forcing the Reserve Bank to consider ordinary Kiwis” or other nebulous feel good nonsense.

Despite the success of inflation targeting and the low levels of inflation we see now, I’m worried that we’ll look back to this year and mark it as the start of a new chapter in independent monetary policy that ends up looking like a complete rollback to the 1970’s.

Does Labour Really Need To Be Imported For Housing?

The framing of where frictions lie in any market are an interesting insight into the minds of people far from the coalface.

RBNZ Deputy Governor Grant Spencer has let a real zinger slip out in a speech to the Property Council when he says:

“A more responsive supply side is key and will require: a responsive and innovative building sector; an adequate supply of labour, some of which will need to be imported; and a responsive planning and consenting process. The accord between Government and the Auckland Council is a positive step in this direction.

This is simply not necessary. The construction sector might have strong confidence at present, but there is an enormous amount of skilled labour pottering around on small projects and deciding not to move to Christchurch or Auckland because the wages on offer aren’t high enough or the cost of shifting is too high.

A sensible policy solution would be making it easier for under-employed construction sector workers already living in New Zealand to make the move to cities where there is higher demand for their skills. This would involve addressing longstanding issues around contractor-subcontractor relationships, health and safety regulations, trade licensing and how the self-employed are treated poorly by central and local government.

A lot of policy wonks have no comprehension of how hard it is to find reliable workers in the construction sector. For people selling their labour, it amazes me that their “costs of production” can’t be taken into account but any firm will use “higher costs” as a standard reason for raising their price.

The wages on offer in Christchurch and Auckland are not enough to entice under-employed workers from other regions unless they have no overheads – single guys are pretty much the target market.

Through importing workers from overseas to do this sort of work, you’re actually imposing costs on taxpayers. Why? Because the skilled construction worker who *needs* $30 an hour to keep his family fed and sheltered won’t have the cash to make the move to Christchurch or Auckland.

This means that over time, the already terrifying level of hysteresis in the construction sector with many skilled tradespeople deciding not to get licensed because they’re sick of all the fees they have to pay and a lot of less skilled construction workers who have been doing intermittent projects in the provinces, will result in long term unemployed people who cost tens of thousands a year in welfare spending.

Immigration is a good thing – but using it as a “quick fix” for an industry that has been completely gutted by council cardigan wearers, central government busybodies and imported “expertise” (British project managers not used to NZ conditions were top spruikers of leaky building related product) is sadistic in the extreme.

A better solution would be this: if you have experience in construction and move to Auckland or Christchurch and gain employment in construction, you’ll receive $2,000 in cash to help with moving and an $20,000 tax credit over 2 financial years.

Familiarity with NZ standards and practices is far more important than rushing something. Has everyone forgotten what one of the key drivers with leaky homes and buildings was? Smashing out projects fast because everyone involved in the project was making no money and wanted to get in and get out.

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 The Reserve Bank Should Hire The Mentalist

Over the weekend I’ve decided that the Reserve Bank should hire The Mentalist.

They are currently not taking into account the unique psychological problems that home buyers are burdened with.

In fact, their plans to implement LVR restrictions highlight a clear misunderstanding of how inelastic demand for “houses” is here.

The central assumption of my mental model is that the median home buying couple will do anything to get a house.

They will beg, borrow and steal in order to “get on the housing ladder” or some other reason that highlights their inability to think like an economist.

Real estate agents know how emotional home buyers can be. They even refurnish open homes to include children’s toys in nurseries to tug the heart strings and enhance the idea that “this is where we can build a family”.

What we know from the addiction literature is that addicts are quite price-insensitive.

I posit that the majority of New Zealand house buyers are housing addicts.

Therefore, raising the price of houses through making it harder to borrow with a low deposit will have 3 effects on the market for “houses”:

  1. Borrowing from finance companies will rise to top-up deposits.
  2. Parents and grandparents will give their kids way more money than necessary.
  3. Nothing will change the supply (it’s restricted) and demand (it’s growing) story in Auckland so restrictions could actually increase house prices even more than before the policy is implemented.

The Reserve Bank, if it really wanted to do something around making people jump through more hoops in order to obtain mortgage financing for an asset that shifts household consumption onto a whole other level of assorted expenses (rates, insurance, maintenance, kitchen remodelling etc) should hire The Mentalist.

The Mentalist would be tasked with building a clear psychological profile of “house” addicts and figuring out trigger words that could be used to reframe the stupidity of buying a house with a 5% deposit.

Through conducting focus groups and surveys that highlight the similarities between drug addicts and couples desperate to get on the housing ladder “no matter what”, bank risk management and credit control teams will receive a signal that they’re dealing with a very special type of client.

Sadly, The Mentalist is currently doing advertisements for ANZ. And that’s why the public sector regulators will always lose out to the private sector. They pay their experts more.

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.