People will be missing the point if they measure the effectiveness of the RBNZ's Auckland property investor moves simply by how much house prices go up or down

By David Hargreaves

As the dust starts to settle on announcement of the Reserve Bank's new restrictions on property investment, which specifically target Auckland's runaway housing market, the focus can soon be expected to shift to what the errant Auckland house prices do in response.

The RBNZ has to some extent set expectations in this regard by saying the new measures might trim 2-4% off Auckland's house price inflation.

So, from about now (notwithstanding that the moves aren't officially due to take effect till October 1) the likes of the bank economists will be crunching the numbers to see if that sort of impact (or indeed more) is achieved.

But In the midst of all this, it would be easy to lose sight of what our central bank is actually aiming to achieve.

There are two main reasons why the RBNZ can be concerned about rising house prices. One is a 'monetary policy' reason - that the rising house prices might fuel inflation (though remember house prices themselves aren't included in the Consumer Price Index). The second is a 'financial stability' issue - that the rising house prices might be accompanied by big increases in debt levels that would pose a threat to the financial system in the event of a sudden, sharp, correction in house prices.

No inflation worries

At the moment there are absolutely no worries about inflation in the near term and in fact the bigger short term risk is we may push toward deflation. 

But, of course, the RBNZ is very worried about the risks to financial stability. And that's why it is doing what it is doing.

It is worth repeating that. The RBNZ is reining in property investors in Auckland because it is worried about risks to the financial system. It is not per se concerned about how much the average young couple has to stump up with to get the keys to their own house.

So, the RBNZ in coming months and years will be measuring the success or otherwise of this policy by whether the moves have decreased the risks to our financial system, not whether more beaming young couples are standing on doorsteps waving.

There's the old joke about if you owe the bank $10,000 and can't pay you've got a problem, but if you owe the bank $10 million and can't pay the bank has got a problem.

Our prudent banks

Banks are always incredibly cautious and prudent until subsequent events (a big fall in asset values for example) prove that they haven't actually been cautious and prudent at all. That's when the fun starts.

These new RBNZ moves are saving the banks from themselves, forcing them to put a ceiling on the proportional size of loans to investors. This will irritate the hell out of them (the banks), because they are always cautious and prudent and therefore don't need telling how to run their business, while madly scrambling after customers to meet targets to keep increasing the size of their loan portfolios.

It's worth looking at the impact of the new measures if we were (hey, and let's hope these measures will help to avoid it) to witness Aucklandgeddon and a devastating fall in house price values.

To take a very basic example, if a mum and dad property investor team paid $1 million (very possible, let's face it) for an Auckland property and borrowed a bog standard 80% of value ($800,000), they would then have $200,000 equity. Therefore they could stand a 20% fall in Auckland house prices before losing their equity.

More to the point, the couple's bank could stand a 20% fall in Auckland house prices before IT starts to lose money...

Reined in

Under the new rules our mum and dad will only be able to borrow $700,000 and they will undoubtedly carp about that. But, the good news is they (and the bank) would actually be able to stand a 30% fall in Auckland house prices before going underground. So, in one fell swoop the buffer for such investors and their banks has actually been increased by some 50%.

The significant thing about all this is that if there was to be a big downturn in the Auckland market, it is the investment properties that would be sold first. If we were to see a whole lot of houses previously valued at a $1 million all selling for $700,000 then under the current situation the banks could easily be losing $100,000 a time - which would mount up for them pretty quickly. Financial disorder would be in the offing.

An Aucklandgeddon scenario wouldn't be great for owner-occupiers either - but of course these are the people who would probably sit tight, assuming they can hold on to jobs. After all, if you don't sell then a massive fall in the valuation of your house is merely a book-keeping exercise (albeit an alarming one). When I was in England in the mid-1990s I actually knew some owner-occupiers who were still in negative equity following the downturn that kicked in around 1989. They were a bit depressed about it, but they still had a roof over their heads, and I should imagine by about 2000 they were probably feeling fairly perky about life.

So, the true measure of these RBNZ moves will be whether the banking sector becomes sufficiently de-risked that it can bear a downturn in the housing market. And you have to say, these moves have the potential to considerably insulate our banks against the risks.

Going up

I think it is eminently possible, nay probable, that Auckland prices will keep going up strongly in the near term.

The RBNZ's estimate that as many as 20% of purchases in New Zealand are from cash buyers (with perhaps half of these overseas investors) was most illuminating. The RBNZ did not give Auckland-specific figures, though you could speculate that the percentage of both cash buyers and overseas investors may well be higher in Auckland than the rest of the country.*

But even if you talk about around a fifth of the potential Auckland house buyers being impervious to any credit-driven controls, then you have to say that fifth can keep driving prices up. But the point about that is those buyers will be taking all the risk themselves. If they lose money it's not really anything for the RBNZ to worry about.

So, remember, the RBNZ is not some fairy godmother watching over Auckland house prices to get a better deal for the first home buyers.

If as a country we are sufficiently concerned about that issue then its up to the Government to do something about that (little pink pigs flying around, anybody?).

The RBNZ is doing its best to ensure we don't end up as some broken-bottomed shell of an economy sinking into the Pacific. And that's its job.

*This paragraph was subsequently altered to clarify that the RBNZ estimates referred to the whole of the country, and not just Auckland.