I Don’t Think The Banks Realise What They’ve Just Acknowledged

New borrowers negotiating home loan terms over roughly two years are likely to pay more than 1.5 percentage points more for their mortgages annually if they have a deposit of less than 20 per cent, including a higher headline interest rate and an increased low-equity margin of 0.75 per cent.

They’ve told us that if your deposit is less than 20% they need to tack on 150 basis points to cover the risk of low equity mortgages.

When you add it to comments by Reserve Bank Governor Graeme Wheeler, who said last week floating mortgage rates could go to 8% by the end of next year, you have a problem for low equity buyers who aren’t fixing their interest rate.

Why? Because 800+150=950 or 9.5% per annum floating rate for low equity borrowers. That will change the affordability equation for a non-trivial proportion of low equity mortgage holders.

I hope all of these buyers are adjusting their Excel spreadsheets regularly to keep track of these things. Do home buying types even use Excel to model their personal finances over time? Bueller? Bueller?

READ: John Cochrane On Financial Reform And Macroprudential Policy

Financial Reform in 12 Minutes:

The “macroprudential” idea that the Fed can spot “bubbles” forming, and can and will stabilize asset prices by artfully controlling interest rates, intervening in many markets, and controlling the details of financial flows, so that nobody loses any money in the first place, is a triumph of pipe dreaming. (An earlier panelist eloquently called it “profoundly misguided.”)

Go read the whole thing at The Grumpy Economist.

Is The Reserve Bank On A Mission To Lose Its Independence?

The role of a central bank is to implement monetary policy. The role of a central bank is not to act as an arbiter of what credit allocation decisions are good and what credit allocation decisions are bad.

Matt Nolan has a very good overview of the issues around the level of discretion the Reserve Bank is claiming mandate for with respect to macro-prudential policy.

I’d point out that on top of the level of discretion the Reserve Bank is engaging in, the Basel III framework which includes provision for unexpected losses, is just as discretionary and distortionary when it comes to capital allocation decisions in the economy.

The idea that a bunch of officials can forecast market tops better than private industry is hilarious. If they could they’d be hired by hedge funds in the US straight out of graduate school and would never set foot in a central bank because the opportunity cost in terms of wealth accumulation would be too high.

Even though I’m still just an economics student, I follow the literature and blogosphere closely. I know that since the global financial crisis, a lot of the stuff the Reserve Bank talks about in its bulletins has been dealt to by private actors.

How so? Banks are only going to give large mortgages to large earners in stable careers. If you run a business or are self-employed, you are subject to credit rationing because banks have been burned so often. Although Rob Hosking is correct in saying that LVR restrictions will save some people from themselves, the unintended consequences of discretionary policy are where the real welfare losses lie.

At the heart of the housing affordability issue is that in 2008 a lot of banks prematurely pulled the plug on residential development funding that was plugging the supply and demand deficit in Auckland and other places around the country.

New Zealand is a poor country – someone on wages is unlikely to be able to save up enough capital to take a risk on a speculative property development so banks need to match up developers with loans. It’s risky – but it’s a societal benefit because without this activity, there would be no downwards pressure on house prices.

In the most cynical of analyses, I think the RBNZ could be pre-empting the possibility of a Labour / Greens / NZ First coalition government ripping up the already expanded memorandum of understanding and throwing in a whole lot of additional policy objectives for the RBNZ to achieve.

Are they on a mission to lose their independence? It sure seems that way. I’m not convinced that there is enough discussion about the trade-offs involved in making arbitrary decisions on what sort of lending is good and what sort of lending is bad.

In terms of efficiency, risk should be managed by those closest to the coalface. I think there has been a bit too much hysteria over the finance sector and not enough examination of how substantial changes in how they do business in light of their regulatory changes makes the Reserve Bank’s new clothes an awkward fit.

6 Charts You Need To See From The Latest Reserve Bank Bulletin

The Reserve Bank Bulletin is always an interesting read. The June issue delivers with “The last financial cycle and the case for macroprudential intervention” by Chris Hunt.

I like Reserve Bank publications for the awesome charts they produce. In this piece they try and apply the policies they’re suggesting to the 2001 – 2008 boom.

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Look at the massive reduction in private sector credit growth to business – how much of that is due to finance company failures and risk aversion on the part of bankers? It also seems like agricultural credit growth ground to a halt as we saw over-extended farmers like the Crafars have their loans called in.

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OK – so if you are on a floating rate mortgage, that you can only afford when interest rates are low, what happens to your debt servicing ability when interest rates rise? Bueller? Bueller?

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Finance companies competed aggressively in the property development sector, lending on more marginal and riskier housing projects which ultimately sowed the seeds of failures within the sector from 2006.

OK. So with massive population growth and supply side restrictions on housing, who shall fund the supply-side response? What constitutes a “marginal and riskier housing project” when New Zealand is not building enough houses each year even to keep up with population growth and reduced family formation?

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There are some big questions that don’t appear here – how do we compensate society if our macro-prudential intervention chokes an economic recovery before it even gets started? Do we include the costs of subdivisions not built or higher rents paid for apartments when marginal apartment building projects can’t get approved because of higher capital requirements in the financial sector?

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There is a trade-off between lending and meeting Basel III requirements. There hasn’t been nearly enough discussion of how Basel III by itself could kill any credit financed recovery (household risk preferences won’t pay for it!).

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OK so here the author is highlighting the gap between actual capital ratio and what any counter-cyclical buffer would have been to put a dampener on credit growth starting late 2005 – if the RBNZ had possessed such powers.

  1. Where would financial institutions raise additional capital from if their regulating central bank has just taken action to force them to raise additional capital or substantially reduce their loan book?
  2. Where would non-bank deposit takers be in this situation? How can the Reserve Bank stay ahead of alternative credit providers?

If there is one thing we can be grateful for when it comes to the Reserve Bank, it’s that you can read their bulletins regularly and develop a pretty good idea of where monetary policy and prudential regulation are headed.

They are transparent – so when I see criticism of “shadowy central bankers” it’s clear that someone hasn’t spent time on the recently redesigned Reserve Bank website.

All of this stuff affects you and your finances – particularly if you have a mortgage – so there’s no excuse not to read through this stuff when it’s available for free.