Opinion: The Reserve Bank's apparent enthusiasm for curbs on low deposit mortgage lending risks creating new problems

By David Hargreaves

Trying to interpret a Reserve Bank Governor's speech can almost be described as a peculiar kind of art form.

The important parts of such speeches are not what is said, but what is not said, or at least might be being said without being said. The observer of the speech needs to spot moments at which a clause within that speech might prompt the raising of a single eyebrow from the governor. Aha! There's the point! Or has he just got an itchy nose?

Governor Graeme Wheeler's speech last week was on the face of it an earnest, if rather dry, dissertation on some of the issues currently facing the RBNZ.

And yet, pulling myself back from the actual words for the moment, I was suddenly confronted with the image of the governor as a small boy who's just been given a train set for Christmas but has been told he must first sit at the table and endure dry roast turkey dinner with granny and ghastly great auntie Doreen for two hours before being allowed to play with it.

Yep, the governor has some new toys and reading carefully between the lines and straining for signs of quivering eyebrows, you get the firm impression he's just itching to play with them.

It seems therefore that much sooner rather than later New Zealand is in for what may or may not become known as "a dose of the old macros".

As we know the RBNZ has been moving with about as much speed as it can muster toward creation of four new "macro-prudential tools", which can be used alongside its traditional monetary policy tool - the rather blunt instrument that is the Official Cash Rate. Interest.co.nz has covered the development of the macro-prudential tools extensively, as can be seen here. Probably the best explanation of what the various tools entail is contained in this piece by Gareth Vaughan.

The particular tool that is worth getting your head around is the one that places limits on high loan to valuation lending. At the moment the banks are estimated to have about 30% of their lending book in loans where the amount advanced is 80% or more of the value of the property - or taken another way, when the buyers have a deposit of only 20% or less.

As might be gathered from my comments so far, there's nothing explicitly stated in last week's speech that says: "I've got the tools and I'm gonna use them!" But I include a couple of passages that I think indicate the most likely current path of thinking on what might happen:

Macro-prudential instruments directed at the financial sector risks arising from the housing sector have been deployed in several countries (eg., Canada, Israel, Korea, Norway, and Sweden), with weight often put on restrictions around the level of high LVR lending.

While there are important design issues to address in devising such measures, the empirical evidence to date suggests that during episodes of quickly rising real estate prices, LVR limits can help reduce the incidence of credit booms and decrease the probability of financial distress and sub-par growth following the boom.

One should be cautious in predicting the size of the impact of such measures when house prices are increasing rapidly, but we believe that macro-prudential instruments could have played a useful role in building up capital buffers and reducing credit demand and asset price pressures in the housing price boom of 2003-2007.

And then this bit:

This is where macro-prudential policies can play a useful role. Capital and liquidity overlays can help build up buffers in the banking system while adding to the cost of bank funding. And loan-to-value restrictions may help to reduce the actual supply of mortgage lending.

It certainly seems fair to presume, as economists of some of the larger banks already have, that taken as read, this means the RBNZ favours putting limits on high LVR lending. The assumption is that this will take the form of a "speed limit", IE the big banks will be given a maximum proportion of their books that can be loaned out on 80%-plus mortgages.

Just for example, if we take the current ratio of total high LVR lending among the banks of about 30% and then say the banks from now on, applying to new loans, can't have more than 25% of their books in high LVR lending, this would theoretically dampen demand and take pressure off rising houses.

It would seem clear enough that the RBNZ is keen to stop the rise again of the speculator, the ballsy investor who comes along and starts buying houses like they are going out of fashion with 90% mortgages in the belief that prices will keep going up. Get sufficient people like that in the market and, of course, prices will keep going up for some time. Big bubble. Pop. Ouch. We've been here before.

So, if such behaviour can be avoided by LVR limits, all well and good. But nothing in life is simple.

If you go back not many months, the utterances coming from the RBNZ appeared not to favour LVR limits. And the apparent sudden enthusiasm for them now is a bit worrying. What exactly changed the RBNZ's mind?

Unintended consequences

It's all right having the tools, but how well thought out have the consequences been? Is enthusiasm to "try out" these macro-prudential tools blinkering the RBNZ to what might be unintended consequences?

Let us try to imagine what could happen.

For a start, one of the anecdotal causes of the hot market, particularly in Auckland, is overseas investors coming here with suitcases stuffed with cash and buying up large. There is no hard evidence as to just how widespread such activity really is. To my knowledge there is no meaningful data available.

But obviously, cash-rich buyers, whether they be immigrants, overseas-based buyers, or Kiwis returning home with proceeds from sale of an offshore home will not be in the least bit disadvantaged by a high LVR limit policy. On the contrary, it should be a help. It will take some buyers out of the market. So, possibly we might see even more overseas-based buyers.

Ask yourself then, who is going to be affected? Well, it will be the first-time buyers won't it?

Young kiwi couples looking for their first nest and already having a struggle, could see the uphill gradient become even more severe under this policy.

A little lunacy

I had actually completely forgotten about it, but in thinking about writing this piece I was suddenly reminded of the experience of myself and my then fiance buying a first home in Wellington in the early 1990s. It was a struggle. In the end we borrowed 87% from the Countrywide Bank (long-since disappeared into the National Bank, which is not so long-since disappeared into the ANZ). Our deposit, such as it was, was made up 25% of money I borrowed from the journalist's credit union - but obviously didn't tell the bank about - 5% from the sale of a horse (don't even ask) and 70% from a very dishevelled savings programme.

It was absolute lunacy now I look back on it. But there you go. The frivolity of youth.

The one good thing we had going for us was that we might have been savings and asset-poor but we were strong on cash flow, both earning much higher than the average wage. And that meant we could keep the wolf from the door every month and meet the commitments. We were on the "housing ladder".

I've got no reason to believe the 20-and-30-somethings of today are any different. They will do what it takes to get a house. And that's what worries me.

According to Real Estate Institute sales figures for April, the median house price in Auckland was NZ$555,000. So, even if our first-home buyers are able to get in somewhere below the median price, say at NZ$400,000, they might need a deposit of NZ$80,000 under the new LVR limits policy. That sounds like a lot to save.

The worry is that the final composition of that NZ$80,000 for many couples might actually be NZ$40,000 of savings, NZ$20,000 advanced on the never-never from the in-laws, and NZ$20,000 borrowed from some second-tier lender at possibly exorbitant interest rates that the primary lender - the bank - will not be told about.

Recipe for disaster

It is a recipe for disaster, potentially.

So, yes, the LVR limits might help to insulate the banks against a housing bubble and some steam might be taken out of the housing market (though depending on the number of foreign investors and other people simply finding the money anyway this might be minimal). But the big risk is that those already feeling excluded from the housing market will feel more so. Do we really want that?

It seems to me that too much is being left to the Reserve Bank. Controlling the housing market should not be the RBNZ's job.

The Government can say it is trying to move on house prices by its development of a housing accord with the Auckland Council. Trouble is, nobody believes the targeted 39,000 in three years are going to be magically produced by the private sector - unless the Government offers some real incentives.

And likewise the Government has shown no inclination to act on curbing what I see as the biggest future threat to the New Zealand housing market, unlimited foreign capital coming in and driving up house prices.

So, really we've got a Government not doing its job and a central bank trying to do a job it really shouldn't be doing. I see problems ahead.