Opinion: The Reserve Bank is right to be worried that this housing boom might provide a bigger threat to financial stability than the last one

How seriously were we supposed to take it when Reserve Bank Deputy Governor Grant Spencer warned last week that the risks to financial stability from the latest housing market upturn "may well be greater" than they were in the last boom before the global financial crisis in 2008?

After all, central banks are supposed to worry, aren't they? It's their job.

Besides, surely the deputy governor is not trying to tell us that the current housing upturn - still in its infancy - is anything like as risky yet as the rushing boom of the mid-2000s that saw nationwide annualised house price rises of well over 20%, while household borrowing was growing at annualised rates of as much as 16.5% and month-on-month by as much as 1.5%?

The day after Spencer's speech the RBNZ released its monthly "sector credit" figures, which show how much households, businesses and the agricultural sector, are borrowing. Sure enough, in line with the RBNZ's concerns, these figures are showing a marked uptick.

The total amount borrowed by households (mostly on houses but also through consumer credit) rose by a seasonally adjusted 0.5%, the same as for the previous two months but much higher than the average 0.2% rises we were seeing a year ago. Likewise the 12-month gain in borrowing was 5%, which was the highest 12-monthly figure since October 2008.

But of course the latest gains are nothing like those 1.5% and 16.5% figures seen in the mid-2000s, so why worry?

Well, in his speech Spencer also said this: "In our view the strength of housing and credit demand is not fully reflected in the aggregate credit data. Total outstanding mortgage credit growth is increasing but still at lower rates – of around 5% to 6% per annum – than in the previous boom.

"However these growth rates are net of debt repayments which have been significantly higher in the years since the GFC. New mortgage approvals and loans have been growing at a faster rate and are now comparable with the pre-GFC peak levels. The value of house sales is now also near the 2006-07 peak levels.

"If house prices and debt were rising from depressed levels, then these trends would not be of real concern. However the current house price and debt trends are on top of already high base levels – both by historical and international standards."

He then made reference to New Zealand having the fifth highest house price overvaluation, relative to incomes, in the OECD.

If we crunch a little further into the household finances, RBNZ figures show that in the March quarter (the latest available figures) Kiwi households had total financial assets (not including house values) of NZ$245.9 billion. Against this they had total borrowings of NZ$194 billion, leaving a net financial wealth of NZ$51.9 billion.

You have to go back to 2000 to find a bigger net financial wealth figure. In March 2009 the post-GFC-ravaged Kiwi households had a net financial wealth of just NZ$11.6 billion.

Good as it gets?

So, the recovery since then has been admirable. But you wonder if the latest figures will be as good as it gets.

For the year to the end of March the RBNZ calculated that Kiwi households had a total disposable income of NZ$133.2 billion. This figure has grown relatively slowly, first reaching NZ$100 billion at the end of 2006.

A key figure to look at is how both assets and liabilities relate to that disposable income in percentage terms.

As a percentage of household total disposable income the total household assets figure has moved since the start of the 2000s in a fairly tight range between 165% and 185% (the latter figure actually achieved in March this year).

The proportion of debt to disposable income has been much more volatile. Back in 2000 total debt represented less than 100% of disposable income. But having moved through the 100% figure later in 2000, the percentage then raced as high as 153% by September 2009, before slowly easing back to 142% by June 2012. However, since then the figure has been rising again, reaching 146% by March this year.

Because of the recent rise in financial assets of households the proportion of net financial assets to disposable income has been rising, up to 39%, from a low point of just 10% in early 2009.

Little reduction in debt

So, New Zealand's households have definitely gained on the assets side but, worryingly, there has been little real reduction in debt ratios.

To go back to 2000 again, just before the start of the last housing boom, in June 2000, household financial assets as a percentage of disposable income represented 172%, while debt to disposable income was 99% leaving net financial assets making up 73% of disposable income - close to double the percentage we have now.

What those figures in basic terms tell you is there is much less "wiggle room" in the household finances than there was in the run-up to the last housing boom.

In mid-2000 average floating mortgage rates were around 8.7%, by mid-2003 they were down to 7.2%, but by July 2006 they were running at 9.5% and then peaked at around 10.7% in mid-2008.

At the moment of course, the RBNZ gives the average floating rate as around 5.8%. The current low rates are the main reason that some reduction in overall household debt ratios has occurred.

What happens later?

But consider, Kiwis have managed to blow out the ratio of debt to disposable income from 142% to 146% at a time of historically low interest rates. What happens when the rates, as sure as night follows day, start rising again?

If you go back all the way to 1991, according to RBNZ figures the household debt servicing costs as a proportion of disposable income averaged between 6% and just under 10% all the way up to mid-2004, when 10% was breached and the figure then moved up as high as 14.4% by mid-2008.

The figure has since gradually dropped back to 8.9% by March this year. However, that still puts the figure at a fairly high level based on figures prevailing before the big run-up in the mid-2000s, remembering again that our interest rates are currently at unsustainably low levels.

Soaring Kiwi

Another statistic worth throwing into the mix is that the Kiwi dollar relative to our major trading partners was, as of last month, some 43.5% higher in value than it was in 2000. This is a very big reason why inflation has been so benign. In 2000 inflation was 3% - now it's 0.9%. The unemployment rate in 2000 was 6% - now it's 6.2%.

Put this all together and what have you got?

The figures tell us that in the run-up to the last housing boom Kiwis had relatively low levels of debt, they were coping with the effects of a dollar that was at quite low levels, inflation was relatively high and mortgage rates (at about 8.7%) were at levels from which proportionately they didn't actually get that much worse (10.7%). In other words the situation at the start of the 2000s was that the key economic indicators didn't have a lot of "downside risk".

But you wouldn't say that now.

The dollar has recently been at historically high levels. Interest rates are at historically low levels. Inflation is as low as it gets. And yet, our household debt levels are still high.

It could get ugly

If the rapidly inflating house bubble encourages people - particularly first time buyers - to really stretch themselves, then when things turn for the worse - particularly through higher interest rates - it could get very ugly. When all is said and done, anybody finding it tough to meet mortgage payments now is going to be in real trouble once the interest rate tide turns.

The worrying thing is that a lot of people seem to be pushing aside the prospect of higher interest rates. The rate rises will come, don't doubt that. That's already inevitable given the way house prices are going up. Add in the possibility of further falls in the value of the dollar (this will be very dependent on what happens in the US and with their quantitative easing) and that will drive retail prices, giving further impetus to the need for rate rises to curb inflation.

As we know, the Reserve Bank's eyeing up putting "speed limits" on the amounts banks can lend on low-deposit (20% and less) mortgages. But as we also know the Government's fighting the central bank on this, intent on getting first-time buyers exempt. The latest suggestion from the direction of the Government is not applying the new rules on properties under NZ$500,000.

Watered down

My best bet would be that any limits on high loan-to-valuation lending are now going to be so watered-down as to have no impact.

It really is looking to me like the best chance the RBNZ has of taking some air out of the housing bubble now - and preventing tears later - is to hike the official interest rates rate now.

But since I think there's zero probability of that happening (given that it would also be extremely unpopular with the Government), it is going to be a case of wait-and-see.

Yes, the RBNZ is right to be worried. But it looks like any real action is not going to come till its already too late.

Last time the housing bubble burst the damage was remarkably limited. Next time we might not be as lucky.