Gareth Kiernan senses a 'whiff of megalomania emanating from Number 2 The Terrace', with 'an increasingly superior attitude' about its own understanding of the NZ economy

Gareth Kiernan senses a 'whiff of megalomania emanating from Number 2 The Terrace', with 'an increasingly superior attitude' about its own understanding of the NZ economy

By Gareth Kiernan

The Reserve Bank may talk about targeting financial stability, but its implicit policy goals of improving housing affordability and squeezing investors out of the property market smack of a dogmatic approach to setting policy that lies well outside the Bank’s mandate.

In a moment of clarity earlier this year, the Reserve Bank highlighted a number of structural issues that were contributing to the rampant Auckland housing market, and stated that monetary policy could not “be used currently to dampen housing demand, as CPI inflation is below the Reserve Bank’s target range.” 

In the speech by Deputy Governor Grant Spencer, the Bank talked about a number of factors feeding into Auckland’s housing boom, including impediments to development from the RMA and council zoning, migration, and the lack of a capital gains tax.

But the Bank has not let the presence of structural problems with Auckland’s housing market, all of which are outside its sphere of influence, stop it from furiously fiddling the controls.

The Bank’s hands may be tied in terms of the interest rate lever, but it has invented an increasing number of macroprudential buttons to let it try and micromanage the Auckland market.

Ostensibly, the Bank has marketed these tools as aiding its goal of improving financial stability, but how well-founded are its interventions?

The effects of the 2013 LVR restrictions

Firstly, let’s assess the effects of the initial loan-to-value restrictions introduced in late 2013. House sales in Auckland over the year to October 2014 fell by 12%, and house price inflation slowed from 15% to 9.2%pa.  But the effects weren’t only felt in Auckland – sales volumes around the rest of the country dropped by 8.7%. Looking at the data region by region, one of the most surprising aspects is that there was a positive correlation between sales growth in 2014 and the level of house prices before the LVRs were introduced.  In other words, sales activity in regions with lower house prices was, on average, more negatively affected by the LVR restrictions!

To be fair to the Reserve Bank, the original LVR restrictions were never explicitly about targeting the Auckland market specifically. But given that house prices and affordability ratios in Auckland imply that the city’s housing market poses the most financial stability risks due to a potential house price correction, it is reasonable to assume that the Bank was hoping for the biggest effects to be felt in Auckland.

Are LVRs the best tool?

In our view, it is questionable whether LVR restrictions are even the best way to deal with the financial stability risks posed by a housing market downturn. The Bank effectively limited the quantity of high-LVR lending that could take place, leaving the retail banks to decide who was “worthiest” of getting a mortgage with a deposit of less than 20%. But economic theory states that rationing via price, rather than via quantity, leads to a more optimal allocation of resources, because those people who are willing to pay the higher price (or, in this case, the higher mortgage rate) are the ones who expect to get the greatest benefit from the good or service they are purchasing. 

This utility-maximising outcome does not necessarily occur under quantity rationing, because the seller has no way of knowing which individuals will derive the greatest benefit from obtaining the product.  Think back to the first half of the 1980s, when there were strict limitations around the availability of credit. At that time, having a good relationship with your bank manager was probably just as important in determining your ability to get a mortgage as all the necessary financials such as your income, estimated ability to service the mortgage, etc.

If the Reserve Bank believed that high-LVR lending posed a greater risk to financial stability than other mortgage lending, it could easily have increased the capital adequacy requirements relating to this subset of mortgages for retail banks. Forcing the banks to keep more capital on hand to back their high-LVR lending would have effectively increased the relative cost of this type of lending for the banks, and pushed up the mortgage rates faced by buyers with low deposits.1

The problem posed by Auckland

It was clear to us throughout 2013 and 2014 that the LVR restrictions would not permanently slow the Auckland market’s momentum, due to the significant housing undersupply problem in the region, as well as some of the structural issues mentioned earlier that were identified by the Reserve Bank.

After initially being cold on the idea of regionally targeted restrictions, the Reserve Bank has done an about-face this year and is trying to clamp down specifically on the Auckland market.  It would be disingenuous to suggest that the accelerating house price inflation we’ve seen to date in Northland, Waikato, and the Bay of Plenty has been a side-effect of the Reserve Bank’s policy – the data we have so far relates to the period before the Auckland-specific LVRs came into effect. But the spread of demand into Auckland’s neighbouring regions will only be exacerbated by a lower hurdle for lending on property in Pokeno rather than Pukekohe.

It would be foolish to turn a blind eye to the Auckland housing market and suggest that it doesn’t pose any financial stability risks.  In other words, it could be argued for the Reserve Bank that the ends justify the means – the side-effects of a regionally targeted policy are worth bearing if we can reduce the chance of a financial sector meltdown.  As for investors, the fact that they are more likely to default on their mortgage means they should be treated more cautiously and face tighter restrictions, right?

How evil are investors?

This point is where things really get messy.

Papers released by The Treasury under the Official Information Act in late October show that it is not convinced that property investors present any greater risk of default than owner-occupiers. The collapse in property markets internationally following the Global Financial Crisis seemed to include an exceedingly high proportion of investors defaulting on their mortgage payments. But when empirical research was undertaken, the analysis suggested that the higher default rate among investors was due to the stage of the cycle that they bought property.  Late in the housing boom of the mid-2000s, investors made up a higher-than-average proportion of property purchasers. 

So when the economy entered the downturn and property prices plunged, a higher-than-average proportion of those people who were unable or unwilling to continue servicing their mortgage were also investors. Their debt-servicing costs were higher, and they were also more likely to have been left in a negative-equity position.

Michael Reddell and Ian Harrison, both former employees of the Reserve Bank, have highlighted the Reserve Bank’s apparent willingness to misrepresent these overseas studies in its eagerness to control the housing market. Housing affordability and home-ownership rates have been politically sensitive topics for over a decade.  In New Zealand, home ownership is a distinctly preferable living arrangement to renting because of the tax advantage it enjoys due to a lack of any capital gains tax on people’s primary dwelling.  But high home-ownership rates are also seen by many as indicative of a well-functioning society. 

Home ownership is seen as being virtuous in and of itself, as opposed to the evils of renting – perhaps this attitude stems back to many New Zealanders’ British ancestry, where the land was owned and controlled by a wealthy few and society was heavily class-based as a result.  But the Reserve Bank appears to have bought into this line as well.  What other explanation can there be for the Bank’s misapplication of the research in its keenness to squeeze investors out of the Auckland property market?

Unelected megalomania

What is most concerning about the increasingly heavy-handed role that the Reserve Bank is taking on is that it does so from a place of unelected authority.  The independence of the Bank from political interference in its day-to-day operations is unquestionably important, in terms of both its monetary policy and financial stability mandates.  The Bank also unquestionably has more expertise in either of these areas than any politician is ever going to have, so being delegated these responsibilities makes sense.  But that being the case, the Bank has a duty of care to undertake those responsibilities as “correctly” as possible.  Seemingly misrepresenting the facts to pursue its own ideological aims is certainly not best practice.

In our view, the Reserve Bank has adopted an increasingly superior attitude about its own understanding of the New Zealand economy, monetary policy, and financial stability over recent years. The assertion that “we know better” has meant that the Bank has been reluctant to engage in much debate, and instead has been quick to dismiss those who disagree with its viewpoints. 

But economics is not an exact science – the most cynical observers would argue it’s not a science at all – and there is always significant scope for wrongly interpreting the way the world works and what the data is telling us.

By choosing to limit the amount of high-LVR lending to an arbitrary level of 10% of all mortgage lending, and by questionably singling out property investors as a source of heightened financial risk, the Reserve Bank has shown itself to be increasingly paternalistic in its pursuit of financial stability. It seems the Reserve Bank has a belief that it better comprehends the financial risks, either on a personal basis for individual borrowers, or on a systemic basis for banking institutions. 

In the wake of the GFC, almost everyone would argue that increased monitoring of banks and a greater availability and transparency of financial system information were desirable and necessary. But the increasing number of levers being pulled by the Reserve Bank to try and actively manage parts of the economy beyond its core focus of monetary settings and the financial system is concerning. When combined with the Bank’s superior assessment of its own abilities, the whiff of megalomania emanating from Number 2 The Terrace is inescapable.

[1] High-LVR borrowers did end up facing higher mortgage rates from October 2013 as well, but it is unlikely that this lift in mortgage rates was the primary or binding constraint on high-LVR lending.

Gareth Kiernan is Chief Forecaster at Infometrics.  This article originally appeared in Infometrics’ newsletter and has been republished here with permission.

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Gareth, you're in the wrong place if you are trying to convince readers landlords are not the devil. Let the diatribe begin.

RBNZ has been more willing in recent times to try new things because just adjusting interest rates is ineffective. The changes they've made have allowed collection of a lot of information that we otherwise wouldn't have.

For example we know that a large volume of foreign money was involved with most of it originating in China. Now that the flow is restricted we can see that despite the RBNZ regulations the foreign flow of cash had a very large influence.

The 30% equity limit is now sending Auckland property investors into other regions of NZ so it's not all speculation.

The one thing RBNZ won't change is the main driving behind house price increases and that's the risk weighting of mortgages relative to other types of loans that banks make. The current weighting makes mortgages at 4.25%+ more profitable than any other service simply because the bank can hold less capital. The banks are more vulnerable to a house price crash than any other event.

If you look at the subprime crash dodgy credit ratings, and reassessment of the rating of the dodgy financial instruments made the crash really bad. The same mechanism could occur if there are dodgy property valuers here in New Zealand. Why is there no focus on the very real risks? Why has nothing been learnt?

this commentary only convinces me that the RBNZ completely misses the point. A fundamental fact of human psychology is that people will always seek a path of least resistance. If they are trying to get rich, in NZ property investment has been an ideal vehicle - easy to avoid taxes, plenty needing homes, high demand and best of all minimal regulation and controls. The economic theory is based on ideals not reality. The regulation that the RBNZ is talking about is just fiddling on the edges (waiting for Rome to burn?) so as not to cause too many howls of unfairness. Regulation is what is needed and a good place to start will be to cap rents, which will quickly produce a number of economic benefits;
1. reduce demand for houses as investors returns will be limited to capital gains
2. 1 will cause an immediate reduction in house prices, making them more affordable for ordinary Kiwis
3 Put more money back in the hands of every one in through the reduced rents, and mortgages
4 3 will help to address poverty, particularly in the major centres thus helping to address other head line issues such as child poverty
5 the Government will save a lot of money as the amount needed for accommodation supplements will be significantly reduced
6 the extra money save from rents and mortgages will be available for other spending or saving and thus support the other economic money-go-rounds that are the normal economic activity

The critics will be any one invested in the current mess who will stand to lose, especially the banks, but are firmly in the minority, as almost everyone else will have a benefit. I also believe that the Government should legislate to require any property owner in NZ should at least be a resident here. I don't care what the TPPA requires - this is our country, therefore Kiwis come first!

Yes, I was in a small business in the mid-eighties when Muldoon (a socialist prime minister in National drag) brought in a universal rent freeze. My landlord, a rapacious Londoner on the make, told me I was 'getting away with murder' as I was due a rent review. He had recently bought the (commercial) building and was about to do a quick-flick for a capital gain after a rent increase and a lick of paint. After that I was forever favourably disposed towards Muldoon.

Infometrics, Ridell and Harrison are all beating the drum and laying the platform for institutional change at the Reserve Bank.

Be careful what you wish for.

Beating the drum?

Reddell-CroakingCassandra's constant bitter tirade is more like the crusade of a man seeking revenge for some perceived slight during his time of employment at the RBNZ

RBNZ is between a rock and a hard place...
Nothing to do with Meglomania..
With very low inflation.... the pressure to lower interest rates is intense.
The GFC has shown that it actually pays to watch the amount of Credit that gets created. ( I think I recall Bollard saying that )
The GFC has also shown that the Most dangerous place to have a bubble form is in Real Estate.. (A Real Estate crash leads to economic downturns. )

My own view is that The Reserve Bank may be able to influence where newly created credit first enters an economy..... BUT... after that it can flow wherever it likes.....
In NZ it seems to flow into Real Estate.

For me ... this shows that we really do need to revisit the underlying principles of the whole Inflation Targeting policy framework...

The RBNZ ends up arm wrestling with itself.... ie.. Very low inflation Very low interest Rates ( which as a policy tool is meant to influence the demand for credit ) and on the other hand trying put out "Bubble Fires" , resulting from the excessive credit growth, with Macro Prudential tools to try to counter the instability that results from the excessive credit..
.... a little bit crazy..

I've also learnt that command style economic management does not really work... Has too many distortionary unintended consequences....
( reminds me of the saying that Generals are always fighting the last war )

but what to use instead? also inflation is actually not a bad metric to gauge the health of the overall economy with.

"Generals are always fighting the last war" yes and that is peak oil effects and hence why inflation targetting has to be used to support the weakest flank and not an overall state.

it is almost a forgone conclusion we will have a correction in house prices in NZ, how big and how long nobody knows. who will default if anyone, will be neg geared mom and pop investors who will be front of the cue.
the RB should have brought in loan to income ratios for the whole country with higher ratios for number 2 , 3 , 4 etc etc houses
also the governments this and the last one should have levelled the playing field between investors and FHB. either take away interest deductible ability or allow both groups to apply it.
last they should of closed the ability of a non citizen to purchase a existing house.
eventually we will get there but we will feel the pain first and whether its only a stubbed toe or we lose a leg who knows.
As for leaving financial stability decisions to any government you have got to be kidding they are full of vested interests and can only see as far as what do I need to do to get elected in three years time

What you smell is desperation IMHO....shortly to become, "I need a change of underwear"

Good to see another person calling out the RBNZ and the pompous nonsense that goes on there.

Wheeler and co spent most of the last RBNZ briefing telling us how difficult their job was!

If I recall my Greek correctly, after Hubris comes Nemesis. Or is it souvlaki?

Sharetrader you are spot on.
Loan to income ratio's is exactly what is needed in addition to the LVR. Also a ban on foreign buyers or at least a stamp duty of say 15-20% on non resident purchases which would have helped pay for some of the infrastructure needed in the country. Letting the property market get out of control will only lead to pain in the future. That pain is likely to be tax payers supplementing rents (up 9% this year) as from what I understand nearly half of rentals receive some government subsidy. RBNZ needs to do more not less. As for governments, a 3 year term is too short and should be changed to 4 years so more can be achieved.

On another note how can the NZ PM get 100k more than his German and British counterparts and only 130k less than the President of USA. Forget about the pay rises and focus on the actual pay level. whats teh average NZ wage 45k. Gets paid 10 times the average seems extremely high. Before someone says he donates it all that is irrelevant as the next leader will get the same pay.

When combined with the Bank’s superior assessment of its own abilities, the whiff of megalomania emanating from Number 2 The Terrace is inescapable.

What is there not to like about the general level of observed RBNZ incompetence?

They and their global colleagues pose no threat other than their subservience to totally inappropriate models of inflation and the economy alike.

Examples abound.

Domestically, read more.

Global, read more and more.

If it wasn't a case of politicians using them as a crutch to lay blame for poor economic performance we would have rid ourselves of central bankers long ago.

If it wasn't a case of politicians using them as a crutch to lay blame for poor economic performance we would have rid ourselves of central bankers long ago.


Yet before we had central bankers we has a lot more economic crises. The interesting thing for me is the CBs seem to be staffed with right wingers and fresh water school types, yet that same brigade outside wants to get rid of them.


Care to document your claims?- the US Federal Reserve has been in existence since 1913.

Defending the rights and freedoms of the banker classes since 1913 under their motto

Bankers uber alles - lending to the worldwide masses.

The RBNZ and every other bureaucracy should not be able to own property, shares or any other income producing assets....when regulators have to generate income to pay dividends to the Government etc then their regulatory roles and income producing roles cause an unhealthy friction and this leads to bad decisions such as those delivered by the RBNZ!

It doesn't take a brain surgeon to work it out that non-elected officials cannot both regulate and return a dividend etc to the government.......yet this is what the current model of independence requires! Private business gets frustrated and some end up forming partnerships with the bureaucracies and all this leads to more damn problems like over-pricing......people need to think about what happens when the RBNZ owns e.g. property and shares!!

What property and shares does RBNZ own?