“My house my castle.” This is a phrase
uttered by countless New Zealanders from all walks of life, across different
ethnicities, both genders and over a wide range of ages. Put simply, we like
buying, selling and developing real estate. Talking about house prices, rental
yields and leverage can sustain conversations well into the evenings at summer
barbeques. There exists the persistent herd mentality that house prices will
continue to rise – such beliefs can have disastrous economic consequences, as
evidenced by the Great Depression. The fair value of an asset is the cumulative
value of its expected future cash flows, which may be derived from future
re-sale or from leasing, discounted back to today’s dollars at a rate of
interest at which the capital tied up in the asset could be employed in an
alternative use, for example by investing in government securities. Assets
cannot sustainably maintain deviations from their fair values, though as Keynes
famously noted, “The market can stay irrational longer than you can stay
solvent.” Devout believers of laissez-faire would argue that there is nothing
inherently harmful about housing bubbles and subsequent price corrections,
on the basis that the market is merely reacting to the mutual forces of supply
and demand. Few, if any, economists these days are completely anarchist: even
Friedman acknowledges the role of government in upholding property rights and
basic functioning of law and justice.
For most Western economies such as in New
Zealand, it has been deemed appropriate to separate fiscal objectives from
monetary and macro-prudential objectives, where the latter is the
responsibility of the central bank. In particular, the Reserve Bank of New Zealand
(RBNZ) is concerned with maintaining a healthy average level of inflation on
the order of 1%-3% p.a., as measured by the Consumers Price Index (CPI). The
CPI band does not take into account house price inflation, which for new
home-buyers is very much a part of the cost of living. The RBNZ argues that
house price inflation is largely attributable to two factors: housing shortages
and easy credit, where loan-to-value ratios (LVRs) above 80% account for 30% of
new lending. Of late, the monetary authorities have become concerned that this
level may be threatened by upward pressure due to beliefs that Auckland housing
is significantly overvalued, and due to the risk that house construction in
Christchurch could otherwise be financed through high LVR loans. As such, they introduced a policy restricting LVRs greater than 80%
on residential property to make up no more than 10% of the portfolio of each
and every bank in the country.
The policy has been met with quite strong
opposition, mostly from prospective first-home buyers and from the construction
industry. While the former group is listed by the RBNZ as one of the reasons
why the policy was introduced in the first place, it is the latter that is of
more concern. Public opinion suggests dampening rising demand has come at the
price of slowing supply. Research from consulting company, Branz, showed 5000
new houses could be jeopardised by applying LVRs to new house construction. RBNZ
deputy governor Grant Spencer made a statement earlier this month claiming that
while high LVR construction lending is only around 1% of total residential
lending, it finances around 12% of residential building activity, which means
that low deposit lending will fall outside the 10% speed limit if it is
financing new construction. This fact contributed to the RBNZ’s decision to introduce an
exemption clause allowing higher LVRs for new housing construction to generate
new supply to ease inflationary pressure in the housing market.
The
exemption clause may enable continued development in Christchurch relative to the
no-exemption situation. One may have similar expectations for the overheated
Auckland housing market. Further, by relaxing the constraints on construction
supply, the clause may help support and even boost employment in the
construction industry as New Zealand construction workers may now have reduced incentives to migrate overseas in search of more attractive and abundant
opportunities; likewise, foreign construction workers may be encouraged to migrate here.
One issue with the initial policy is that it has led
to some banks charging higher interest rates on low-deposit loans, effectively
imposing price discrimination on would-be first home buyers. This issue, in conjunction with the
exemption clause, lends weight to the argument that these prospective
home-owners would have increased incentives to obtain finance to construct new
residential property, as opposed to saving for the
required deposit on a mortgage under the new LVR restriction.
The RBNZ cannot fix each and every problem within an economy. For political
objectives, such as access to housing for those unable to afford it, to be
achieved as well, government must take a long-term view and construct and
implement appropriate fiscal policies that do not conflict with those of the
central bank. What the RBNZ did not take into account in forming its initial
LVR policy is the significant effect that wealthy investors, both domestic and
foreign, are exerting on house prices – this responsibility may lie
more in the hands of central government.
