By Bernard Hickey
Reserve Bank Deputy Governor Grant Spencer gave an excellent speech this week explaining why the bank is seriously considering regulating to limit the growth of low deposit mortgages.
It was the bank's strongest indication yet it will intervene to cool an over-heated housing market.
Anyone thinking of borrowing more than 80% of the value of a property in the next couple of months should read the speech and know that window could be closed by the end of the year.
Banks are already closing the window.
They are imposing 'low equity premiums' on interest rates for mortgages with loan to value ratios of more than 90%.
Brokers have told me the 'loosest' banks in the market, ANZ and ASB, have significantly tightened their lending criteria in recent weeks to make it harder and more expensive for first home buyers and investors to borrow more than 90%.
The central bank has been crawling all over the boards and senior management of these banks for months, pressuring them to tighten up again after a burst of competition from the beginning of last year unleashed a surge of lending growth and turbo-charged the supply-constrained Auckland and Christchurch housing markets.
The Reserve Bank is of course right to force a re-tightening, but it may not be enough.
Even the bank acknowledges its proposed 'speed limits' on high loan to value ratio (LVR) lending is no panacea.
But, unfortunately, Spencer ruled out using the bank's 'blunt instrument' of a hike in the Official Cash Rate increase to whack the housing market.
This is where the Reserve Bank risks making the same mistake it has acknowledged making before the Global Financial Crisis and that inflation-targeting central banks all around the developed world made.
They kept interest rates too low for too long because the consumer price inflation measures they were targeting told them there was no inflation problem. That meant they ignored the creation of asset bubbles that could and did burst to devastating effect inside the American and European financial systems.
This is where a peculiar type of schizophrenia has taken hold.
Many central banks have split themselves into two separate parts: one that regulates banks to keep them safe, and one to run monetary policy to control inflation.
They have separate tools and believe the oil of prudential policy shouldn't mix with the water of monetary policy.
The Reserve Bank is still clinging to this schizophrenic dogma that allowed housing bubbles to inflate and burst all around the world.
It's time now for the bank to prioritise financial stability over its inflation target.
As has been shown in America and Europe, the financial carnage from a burst housing bubble is much more damaging in the long term to an economy than a temporary deviation from an inflation target.
The bank should use an OCR hike now to stop this housing boom in its tracks.
It may push inflation below the bank's 1-3% target band in the short run.
But it will help avoid a much more damaging deviation into deflation in the long run if an even bigger housing bubble bursts inside New Zealand's highly concentrated and still foreign-funded banking system.
This article was first published in the Herald on Sunday. It is used here with permission.