Opinion: If Graeme Wheeler is as worried as the FSR suggests, he should push much harder on Loan to Value Ratio limits. His current 'hands off' approach is dangerous

By Bernard Hickey

Graeme Wheeler told us for the first time today what he thought of using Loan to Value Ratios (LVRs) to cool down a housing market without having to hike the Official Cash Rate.

He's not that keen on using such 'unconventional' tools, despite other very conventional banks such as the Bank of Israel, the Hong Kong Monetary Authority, the Monetary Authority of Singapore and Canada's Banking Regulator all choosing to use or extend the use of LVR limits this year to control bubbly housing markets.

Wheeler told us that even if he had these LVR limits he wouldn't use them at the moment. Watch the video above for the section of his first press conference where I ask him about LVRs.

In one comment he effectively undercut the warnings from the Reserve Bank's own Financial Stability Report aimed at cooling down increasingly loose housing lending by banks that is helping to fuel house price growth of 5-10% in Christchurch and Auckland.

The warnings were substantial and repeated. In the overview the phrase 'excessive credit growth' is used twice in two paragraphs.

Here's a sample: "Excessive credit growth could worsen housing market imbalances given that house prices appear over-valued on a number of measures."

And this: "The Reserve Bank is also developing a broader macro-prudential policy toolkit to help achieve this objective. At present, credit growth is still reasonably subdued, but the Reserve Bank remains alert to developments that might warrant macro-prudential intervention."

Wheeler was referring to a memorandum of understanding the Reserve Bank is formulating with the government over which so-called macro-prudential tools it should use and how.

But in the next sentence he suggested he wasn't that keen to use them, referring to how they tended to advantage first home buyers at the expense of existing property owners and residential property investors.

Wheeler is sticking with the tone he set in his first speech, which is that his job under the Reserve Bank Act is to target inflation of around 2% with the Official Cash Rate and that any macro-prudential tools are useful mostly to keep the banking system safe, rather than to help boost the power of interest rate policy. Wheeler also reiterated he is reluctant to intervene in the currency and use Quantitative Easing.

More Brash than Bollard

In short, Wheeler showed himself to be more orthodox in his thinking than the previous governor and more committed to pure inflation targeting -- more Brash than Bollard. He is clearly uncomfortable with the idea of using such 'unorthodox' tools as LVR limits.

That is a pity because all sorts of economic data is signalling the Reserve Bank needs to act to bolster the power of monetary policy and avoid another damaging asset bubble.

Wheeler himself pointed to figures in the report showing house prices still around 4.5 times median incomes, well above the 3 times seen in the 1990s and just below the highs of over 5 seen at the peak of the boom in 2008.

The report pointed to a significant easing of lending standards in home lending in recent months.

"Discussions with banks suggest that high loan to value ratio loans are now beginning to form a significantly larger share of new mortgage lending than has been the case for most of the period since the financial crisis," it said.

By warning about the risks and pointing to the evidence, the Reserve Bank is then undercutting its own message by saying it's reluctant to do anything about the risks.

And they are large risks.

House prices are surging in Auckland to record highs with volumes reported by Barfoot & Thompson up almost 50% in October from a year ago.  This is sucking in capital, keeping the New Zealand dollar high and preventing the rebalancing of the economy. It risks repeating the housing and consumption boom that unbalanced the economy from 2002 to 2008.

It presents the risk that the Reserve Bank may have to hold back from cutting the Official Cash Rate to avoid further pumping up the Auckland housing market, or that the Reserve Bank is forced to hike the OCR to slow the market down. Either would damage the real economy.

LVR limits allow the bank to slow (or speed up) the housing market by using the tool rather than the OCR.

This is a tool used earlier this week by the Bank of Israel to cut its official rate without worrying it would further heat up an already hot housing market. Israel is limiting first home buyers to an LVR of 75%, existing home buyers to 70% and property investors to 50%. Canada has reduced its maximum loan to value ratio to 80% from 85%.

The new Governor is letting his entrenched orthodoxy blind him to a pragmatic solution.

His determination to say 'Look Ma, no hands!' could run the New Zealand economy off the road.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment or click on the "Register" link below a comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current Comment policy is here.

24 Comments

We must all clearly remember "Mr All talk and no action" words today.
 
The day will come when the Banks again implode when the housing market again crash due to excessive leverage and speculation. Then we must remember to remind Mr All Talk and No Action that he must not use Taxpayer's money again to bail out the Banks because they are "systematic" and "essential" to the working of the economy.
 
He has warned us, now we must warn him !!!

Yes, go buy a house with it.

Well Spencer, how do you think that went...?
Oh , um quite good overall Sir, but that Hickey's a bit of a nuisance with the questions about our toolbox ..
Yes, he is rather, still  do you think they see the new broom yet, so to speak..?
Ah,well I think it will take a little time for them to see the subtlety in the doingness of nothing  Sir, but I'm sure given time.....
 Spencer have Maxine cancel the doughnuts and replace them with , oh Macroons or those vanilla custard thingys.... oh and decaf only..! I'll show them who's what.
Yes Sir......, oh and Sir you might want to wear some mittens or those educational puppets on your hands if your going to remain that animated.
 
Line of the interview...We are talking to those institutions to gain a better understanding of their strategy.....
Deary me , Wheedler their strategy is for you to have no idea what their strategy is until you need bail them out ....nincompoop..!
 BTW ...Bernard...Look ma no Hands..! loved it....the irony is Wheedler is all hands when bullcraping his way through the snorefest.

Yet more evidence (if anymore was needed) that the RBNZ and its head have been captured by the high street banks. I am not sure whether we ever actually had an independent central bank, but we sure as hell do not have one now.

Hmm. Not the most inspiring. "House prices have only gone up 10% or so in Auckland in the last 12 months, so that's all right then." How much do they have to go up before they get concerned? 100%? Then they might get around to doing something when it is far too late.
 
Bernard, I thought the Core funding Ratio might be a better tool to ask about. For one thing it is their idea (and a most excellent one at that) and for another it works. Whereas LVRs are subject to gaming at best. Why is 75% for one year considered sufficient?.  Why not 100% Core Funding Ratio for 5 years? If they just keep putting the CFR up then surely that will control credit growth and hence systemic risk.

Hugh...I agree with you, National should have taken action after the 2008 election...I'm quite supportive of the reform they are proposing (although more action on the demand side is required)...but it's all several years too late...the only thing saving National is that the opposition are worse, they don't seem to be offering constructive solutions for housing affordability.

What a load of nonsense suggesting that LVR s should controlled.
The only people that will be hurt will be the first home buyers who usually have the smallest deposits or equity at their disposal.
Those with more wealth will sail right through any restrictions.
Muldoon tried that during his rule and spawned all sorts of distortions and the rise of shonky lenders and rip-off merchants.
One of the answers could be to encourage long term renting as is common overseas along the lines of commercial leases.
Forget it. Controls never work.

Correct... while they still allow foreign cash to flow into NZ residential property, it won't solve anything.... however, when done in conjunction with foreign ownership restrictions, it could have just the right effect on the property market.

Completely agree Big Daddy,  First time buyers will be absolutely stuffed, they will be the ones paying rent as well as saving for a mortgage.  I know I've been there.  I have just bought a small cottage with 90% LVR,  saving another 10% would leave me in a far worse financial position as I would have to pay an extra 2 years rent on top of the extra savings. Money that now I will be plowing into my mortgage.
Property Investors and the wealthy would still have sufficient capital to breeze right though the limits

Hugh
I agree with you as you know on the need for supply side solutions but I disagree that LVR controls are not a valid approach.
Supply side measures alone will never be as effective in a small country like NZ compared to Aus or for that matter the USA. Even if controls are loosened the country will still struggle with its lack of size, capacity and economies of scale. Nothing will ever be done that can get over this scale issue, short of importing lots of foreign workers and paying them peanuts. 
I believe NZ needs both supply and demand side solutions, and with regard to the latter LVR controls are much needed. 
My understanding is that Texas has such controls. Please correct me if I am wrong.
Matt in Auckland 

I found a link that explains Germany's attitude to debt, which in German is schuld and also means guilt.
 
http://blogs.reuters.com/anatole-kaletsky/2012/09/13/why-the-current-europhoria-will-likely-fade/
 
It is probably good cultural protection from excessive borrowing bubbles. But it didn't stop Germay from excessive lending to debt junkies, in the Europes periphery.
 
The Euro debt crisis at one level can be understood as a fight over who will pay for the bad debt from that excessive lending/borrowing. The private sector lenders in Germany, France etc. The private sector borrowers in Ireland, Spain, Portugal etc. Or the Governments and tax payers in the periphery or centre.
 
The German attitude to debt means that they do not think it should be them.

On the mortgage financing LVR front, it will prove to be unworkable, as we found out during the Muldoon era, when prople simply worked around it.
Personally Hugh, I still have a little more faith in the ability of the NZ legal system to enforce regulation, if the NZ government decides to have regulation which is effective (vis a vis an LVR), I think they can. This especially applies to a system of laws, the monetary and banking system, if the government wants to change how that works they can, and they can enforce the laws they make. Unsurprisingly this would make all mortgage contracts which don't comply with LVR regulations illegal contracts.
Reading your comments Hugh, I sometimes wonder if your problem with these kinds of responses is that they might actually be effective, hence aleviating the 'need' for the developer focused response to the housing market. Maybe its unfair, but that's what your non constructive response to Matt implies to me. Why don't you aleviate my concern, by coming up with a more constructive response to Matt's comment, rather than the ridiculus claim that the government is unable to enforce its own laws. At minimum you should fully justify your argument, that if the government does write LVR regulations, a) there will be large scale black market mortgage contract lending, and b) that the government will have no real choice but to retroactively validate these mortgage contracts in response.
In fact since we don't see a) wide spread counterfeit lending of NZ dollers, and b) the government is not forced to validate any counterfeit money which does enter circulation, I don't think your argument has any validity anyway, this is a very marginal occurance. Obviously Matt was suggesting a widely enforced LVR should be introduced, why don't you address that concept, rather than assuming that a marginally effective LVR was being implied.
I should also point out that your statements about the S&L crisis imply that the Houston market has not been tested by a proper housing bubble (because they are still on the path to recovery from S&L, and its still front and centre in lenders and mortgagees minds). If your supposed developer focused response is only effective if and when the housing market is not condusive to a bubble, what kind of preventative measure is that to a bubble? Answer none, or at minimum its never been tested so we don't have any evidence it is effective. Of course this limitation, of policies you have been advocating for some time, has been obvious to all the intelligent commenters on this site, myself included. We could perhaps suggest that Houston has a 'voluntary' LVR and that is why it has had fewer problems with the recent US housing market correction. That still says that NZ should have a non-voluntary LVR then doesn't it.
 

I think its also worth pointing out the role of high property taxes play in Texas. I have a mate who lived in Houston for quite sometime, although his house was only worth about 150K, he was paying something like 5K per year in property taxes. These high land taxes must act as an incentive to develop property, as opposed to sitting on it and speculating. And if you are an investor and want to sell, its going to potentally hurt you quite  alot to leave a property on the market for too long, hence greater incentive to flick it quicker, at potentially a lower price
Its incorrect to say that Houston's housing affordability is purely the result of a more liberal planning regieme, although that's clearly an important factor
Nz should be lowering income tax and introducing land taxes 

But if high property / land taxes have helped keep house prices down then people have much greater chance of saving well for their retirement, therefore meaning they should "cope" with higher property taxes when they are retired. Well that is the theory at least!
Hugh I think you will find that Philbest like me also supports some form of land taxes, its undoubedly been part of the Texas success 

Bernard, this is similar to #5 in Wednesday's top 10.
LVR's reduce bank lending so If banks can't find alternative lending outlets then the money created by banks drops and so the overall money supply falls which can lead to a recession. If that happens then we will need stimulus etc, etc.

Not sure LVRs would actually contract credit. More likely to just slow its growth.
cheers
Bernard

Yes, if we bring in LVR's now it will slow the growth in money from this point on. The level the LVR is set at, and the impact on other areas of the economy, will ultimately determine the effect on the money supply.

I disagree, introduction of effective LVRs would probably result in a decent sized credit contraction. As I see it this is because there are many players in the property market who remain there, leveraged, because of an anticipated return through house price appreciation. In fact I think a lot of soon to be retired folks are in this category (So I think its a very natural retirement saving phenomenon, as much as a foreign investment driven or speculative one).
If there are no longer house prices appreciations to be seen, they are likely to de-leverage where possible, which would result in a definite contraction in credit. Of course this is because why would you take the risk (of leverage) with no reward to be seen.
In fact this is likely to be very similar to the effects of the financial crisis, and the initial bursting of the housing bubble, on the general economy.
Now I think that's necessary, because there is going to be a housing market correction at some point anyway, but this indicates that the government should be encouraging the economy through this at the same time. Then its important to keep a lid on it, so that future pain is avoided.
 

Bernard, the sooner everyone realises that we live in a debt based economy the more we will all understand what is really happening
 
A debt based economy requires growth and that growth starts with a growth in debt. We see that now with the global economy, no one can afford to borrow so there is no growth so we are in recession.
Growth starts with debt which increases the money supply to fuel the growth. As most of the debt comes from the property market so that is what fuels most of the growth. Kill the property market and you kill growth, kill growth and you kill the economy. That is NOT going to happen in your lifetime so better get used to it.
 
The ONLY solution is to stop banks creating the money supply and have an independant, elected authority, independant of the government, responsible for the money supply. Until that happens the same ole, same ole, problems will persist.

Agree Mike. Joseph Huber and James Robertson have come up with the most comprehensive solution I have read.
http://www.jamesrobertson.com/book/creatingnewmoney.pdf
 
Though if things spiral down far enough a Steve Keen style debt jubilee will be required to transition.
 

No talk at all of the current account deficit; or employment, or productivity. Not their problem, apparently. Only inflation, and that banks in the end don't fail. Nothing else.
Pretty disappointing, as Bill English doesn't think the current account is his problem either.

Don't worry Stephen, the "free" market will offer up a solution - extend and pretend or bankruptcy

Who asked the question at 6:40?
BAZINGA, Mr Hickey!
Does that guy have a website? Would love to read a view that is less 'rabid bear' sometimes..
Also Wheeler didn't rule out LVR's. To me he highlighted a situation at the end where he may use it. There is more than one way to interpret that interview and often people hear what they want to hear.

A regulatory ceiling on LVRs is viable if all lending secured by a given piece of property is channeled through one bank. LVR ceilings may or may not nip house price bubbles in the bud. But I am confident that such ceilings will reduce the damage to lenders during property market downturns. Anything that reduces the systemic risk of the banking system is to the good.
I submit that house prices did not rise much in the 1950s and 60s for two reasons: minimal restrictions on subdividing and building, and LVRs capped at 75% (NZ) and 80% (USA).
LVR ceilings are rightly perceived as making life more difficult for first time home buyers. But is making it easier for first time home buyers to borrow more than they can afford doing them a kindness?? At any rate, helping one's adult children accumulate the deposit on their first bought house will have to become part of the Kiwi way of life. It already is part of the continental European way of life.
Some of you above have mentioned American rates (there called "property taxes"). Beware of comparing apples and oranges. American rates pay for police and fire service, and a substantial part of the operating cost of public schools. That is why rates on a USA house valued at US$150K can be as high as US$5K p.a. Given that not one cent of my ChCh rates pay for police, fire and schools, my rates account strikes me as rather high. Those rates do pay for recreational amenities beyond what I am accustomed to.