Opinion: Is it politically tenable for the RBNZ to use its tool to crack down on low equity loans?

By Gareth Vaughan

With politicians from both sides of the House lining up in opposition to possible Reserve Bank applied restrictions on banks' low equity loans, is it tenable for the Reserve Bank to now use its new policy tool anytime soon?

Prime Minister John Key's opposition to restrictions on high loan-to-value (LVR) residential mortgage lending has been well documented.

We know Key wants an exemption for first home buyers and the Reserve Bank doesn't want to grant one.  

And we know last year Key had this to say;

Any consumer can effectively go around that [LVR controls]. All historical attempts to stop that haven’t been very successful.

You can certainly protect the banks’ balance sheets from over-exposure to the property market, but the capacity of someone to go to their friend or lawyer or some other institution to get that other piece of equity that they don’t have, is always real.

This week Key's rivals have also jumped to the defence of the first home buyer.

We've had Labour housing spokesman Phil Twyford say if his party was leading the Government it would give first home buyers an interim exemption from the "speed limit" on high LVR lending while it built 100,000 homes over 10 years and imposed a capital gains tax on second homes and rental properties.

And Russel Norman, co-leader of Labour's would-be coalition partner the Greens, said even though LVR restrictions are a good idea, they should be targeted at property investors and speculators, not at families trying to buy a home. 

The type of Reserve Bank we're supposed to have

The deal between the Reserve Bank and the Government opening the way for the possible use of LVR restrictions calls for consultation with Finance Minister Bill English and Treasury from the point where the Reserve Bank is actively considering macro-prudential intervention.

The Reserve Bank's also required to inform them prior to making any decision on actual deployment of a macro-prudential tool.

A second term for Reserve Bank Governor Graeme Wheeler, should he seek one, also requires government sign off.

So against this political backdrop, what's an independent Reserve Bank Governor to do?

If he really believes it's the right thing to do, stick to his guns and foist temporary limits on banks' high LVR lending.

 I for one will applaud Wheeler if he does. Because doing so, in the face of brickbats from the politicians, will show an independent Reserve Bank in action rather than one beaten down by politicians chasing votes and banks lobbying against regulatory intervention. And that is the type of Reserve Bank we're supposed to have.

And nor should Wheeler give first home buyers an exemption. They are key users of low equity loans and exempting them would make a mockery of the policy.

Temporary

My use of the word "temporary" two paragraphs up is important. Some of the more hysterical coverage and discussion on the LVR restriction tool, which the Reserve Bank is still finalising, seems to forget that - if implemented - it's only proposed as a temporary move. First home buyers wouldn't be "shut out" of the housing market permanently. 

And even with the LVR restrictions in place, banks have scope to use their high LVR loan quota solely for first home buyers, not property investors, something the Cooperative Bank's CEO Bruce McLachlan has pointed out.

"If we use our example (from a Reserve Bank paper suggesting in any three month period banks are limited to no more than 12% of their mortgage lending being above 80% and no more than 5% above 90%), it's still allowing for 12% of any bank's flow in any three month period to be in low deposit mortgages. It's then very much in the hands of the banks, - how would they choose to use the limit they have? They could choose to use that only for first home buyers."

"I don't think we can say automatically that this is going to disproportionately impact first home buyers," McLachlan said.

Banks reining in high LVR lending

Remember also that the potential use of LVR restrictions on home loans is one of four so-called macro-prudential tools the Reserve Bank has recently taken on. English and Wheeler announced a memorandum of understanding in May clearing the way for the Reserve Bank to use these tools, if it chooses to, on a temporary basis. The idea is that use of one or more of the tools would help dampen excessive growth in credit and asset prices and strengthen the financial system.

The Reserve Bank says any temporary use of LVR restrictions would take the form of "speed limits" limiting the share of new high LVR lending that banks may do, rather than banning such lending altogether. Banks would get a notice period as short as two weeks.

June quarter figures aren't yet available, but key indications suggest banks have reined in their high LVR lending as the Reserve Bank has ratcheted up its rhetoric. This notably occurred in a June 27 speech from Deputy Governor Grant Spencer. He said the Reserve Bank was "seriously considering" the use of macro-prudential tools to help moderate house price inflation pressures. And that the LVR tool "is the one with the best scope to dampen the current strong demand for housing, as well as reducing the risk to bank balance sheets."

LVR restrictions is also the one of the four tools - see detail on all four here - the banks themselves least want to see used. Why? Because its probably the biggest threat to their  profitability. And the banks argue, LVR restrictions would be "complex and costly" to implement.

Will they work?

If they are implemented, will the LVR "speed limits" work? They wouldn't have any impact on people buying up local houses with money brought in from overseas. But they would reduce overall bank supply of credit to the housing market and therefore surely have a cooling effect, to some extent, on the market.

But the Reserve Bank itself has outlined potential problems with the LVR tool. These include; adversely affecting efficiency, favouring wealthy home buyers/investors over first home buyers, arbitrage through non-mortgage (unsecured) top-up loans, and a risk of "leakage" to the unregulated sector and foreign banks should there be an increase in new lending by the non-banking sector.

It says restrictions on high LVR lending would need to be "vigorously" enforced and monitored in order to reduce avoidance. It says complying with any restrictions will be a condition of bank registration, or licencing, and that banks would be expected to comply with the spirit as well as the letter of the policy.

A runaway train

From Wheeler's perspective there's no question there's a boil that needs lancing with the Auckland housing market taking on the appearance of a runaway train. Earlier this year the Reserve Bank said about 30% of banks' new mortgage lending was coming through high LVR loans, up from about 23% in October 2011.

As Brian Fallow pointed out in an excellent NZ Herald article earlier this week; "Auckland house prices have risen by just under 20% over the past year, as measured by the Real Estate Institute's stratified housing index. They would only need to return to the levels of a year ago - already stretched relative to incomes and rents - to almost wipe out 20% equity."

This as ANZ economists suggest unemployment could rise from the current 6.2% back up towards 7%.

The major credit rating agencies are certainly watching with both Standard & Poor's and Fitch raising concerns about New Zealand "asset (read housing)  bubbles", and Moody's also raising concerns, bringing into question New Zealand's sovereign credit ratings.

With Wheeler apparently reluctant to raise the Official Cash Rate from its record low of 2.5% just yet with the Kiwi dollar already strong and official inflation below 1%, LVR restrictions, and their fellow macro-prudential tools, are the only way he can really attempt to rein in Auckland house prices.

But with political opposition from both sides of the fence, might Wheeler just decide he's picking too big a fight and look for a way out?

If he does, the banks reducing the percentage of new home loan lending being done at high LVRs significantly, might offer him the face saving way out. It appears as if the banks are heading down this path.

Wheeler can then say the Reserve Bank's rhetoric has forced bank's to cool their lending practices for now. But, the LVR restrictions tool is ready to go, with as little as two weeks notice, if required in the future.

And perhaps this has been the Governor's plan all along.

This article was first published in our email for paid subscribers. See here for more details and to subscribe.