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.

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.

Reserve Bank Responds To Submissions On LVR Speed Limits

Today the Reserve Bank released their response to submissions on the LVR speed limit “macroprudential tool” they intend to implement to curb what they see as risky lending.

If you want to know the full story read the long document over at the RBNZ.

Key Points:

  • There were only 20 submissions, mainly from banks. Interestingly, small banks with an average of $100M / month in residential mortgage lending over a rolling 3 month won’t face speed limit
  • The RBNZ will restrict the proportion of high LVR lending as opposed to high LVR lending itself – presumably in recognition of the reality that many high LVR mortgages will be to very high earning couples
  • There will be a transition period because some banks think they’d breach the rules even if they stopped all high LVR mortgage approvals tomorrow
  • There will be an anti-avoidance rule so banks can’t get around the speed limit – the detail can be found in section 7 of the updated BS19 document (Framework for restrictions on high-LVR residential mortgage lending)
  • It will take time for banks to process their backlog of pre-approvals if the speed limit is applied and time for them to forecast high LVR loan flow to stay under the limit
  •  Disintermediation risk is acknowledged – people topping up deposits with credit cards or using multiple second tier loans to resemble a traditional residential mortgage – banks could be hit by anti-avoidance provisions if they try to get around restrictions

There is a lot of stuff that still needs to be worked out by the Reserve Bank and the banking sector. If we think about what the Reserve Bank is trying to achieve – dampening what it sees as risky lending in the housing sector – and then we think about what the government is trying to achieve – every special snowflake moaner being able to afford a house – I have to wonder why, in the light of how Basel III has already impacted the lending that actually matters to growing the economy i.e. commercial and agricultural lending – why they don’t save the expense and complications of this scheme with something simpler?

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.