Our central bank's starting to resemble an eccentric scientist, with macro-prudential tools its chemistry set. The worry is that too many ingredients will get mixed together with unpredictable results, says David Hargreaves

By David Hargreaves

There was something very familiar in the way the Reserve Bank Governor and Deputy Governor started talking up the merits of debt-to-income ratios at the press conference following release of the six-monthly Financial Stability Report.

It bore an uncanny resemblance to the RBNZ's actions in 2013 leading up to the introduction of 'speed limits' for the banks on the amount of money they could advance for high loan to value mortgages.

In May that year the RBNZ signed off on its new macro-prudential toolkit  in agreement with Finance Minister Bill English, which was contained in that year's Budget announcement. LVRs were included in that toolkit, but the RBNZ had appeared tepid on the idea of using them.

That changed quite quickly - certainly in terms of public comments anyway. In late May 2013 Governor Graeme Wheeler was suddenly extolling the virtues of LVRs in a speech in which he said that "...loan-to-value restrictions may help to reduce the actual supply of mortgage lending".

The official impost of a speed limit was announced by Wheeler on August 20, 2013, so a little under three months after the first clear utterances that suggested such a policy was on the cards.

So, we fast-forward to last week's FSR press conference and the 'we like debt-to-income ratios' coming from Wheeler and his deputy Grant Spencer.

Significance under-played

I think because those comments came out in the press conference rather than the FSR document itself, that the country's economists have horribly under-played the significance of them as a pointer to what will happen.

It's of interest to note that the release of the FSR document was the first such RBNZ document release done without a 'lock-up' for media and analysts beforehand. The RBNZ cancelled this longstanding - and I might say extremely useful practice -  following the leaking of information by MediaWorks from an earlier such lock-up.

I wonder if in this instance the RBNZ was concerned about how news of moves to debt-to-income ratios would be filtered into the marketplace if such news was contained in a document unceremoniously dumped on said marketplace at 9am in the morning and with market participants not having the chance of a sneak peek first. So, it could be that it was a definite strategy to issue a bland, vanilla FSR document - and then push the boat out further with the public utterances at the press conference.

ANZ economists seemed to be reasonably well onboard in their Market Focus this week with what I believe is the 'true picture' from that FSR, but others have not quite followed suit yet. And it wouldn't surprise me if we didn't see a follow-up public speech by one of the top people at the RBNZ within a week or two to more strongly back up what was said at that press conference.

The pattern repeats

The pattern is almost identical to what happened in 2013. We've had the RBNZ being coy previously about debt-to-income ratios - as it was once about LVRs - only to now turn around and give clear indications that these ratios are very much on the table.

It took three months from the first public utterances on LVRs to the announcement of them. It might be similar this time - though there is the complication that at this stage debt-to-to-income ratios are not yet in the macro-prudential toolkit, so would have to be signed off by the Government first.

I don't think it will be the problem with the Government that some are making out. I don't for a moment think the Government was thrilled about the impost of LVRs either, but it went along with it.

In actual fact, the Government can nicely step aside, shrug its shoulders and say that the RBNZ as an independent body has the right to do what it thinks best. In essence, the Government can at least attempt to wash its hands of the introduction of debt-to-income ratios and try to avoid being blamed. In some respects that's better for the Government than it itself introducing a policy on the housing market that is not popular.

The upshot is I still think that debt-to-income ratios may well at least be announced by about October - even if they are not ready for introduction till next year.

A proliferation

I think the ratios are in principle a good idea. But I am concerned that we appear to be seeing a proliferation of these macro-prudential policies. And it does rather start to cast the RBNZ into the role of the eccentric scientist playing with a chemistry set to get the right solution. As many young children have found out, playing with a chemistry set can have unintended consequences.

We've already got the LVR speed limit, then we added the Auckland investor restrictions, and a differential speed limit between Auckland and the rest of the country. Now, are we going to leave all that as it is and just add on the debt-to-income ratios as well? It all starts to look a bit ad hoc to me. And the problem with introducing a number of measures is that they all might have slightly different effects and impacts, which could act against each other. That unintended consequences thing.

I think there's validity in the argument, for example that the LVR speed limits have in their own way incentivised investors to get more involved in the house market because of the way in which they have disincentivised first home buyers. So, then you take action against the investor problem...that you've helped to worsen. And what problem does the investor action then create? Do you see what I mean?

So, I say go ahead with debt-to-income ratios, but what about a rethink of LVRs?

The RBNZ has fairly warmly congratulated itself on the success of LVRs. Personally I think the central bank has crucially played-down the very big role that the ill-starred interest rate hikes from the RBNZ in 2014 actually played in dampening the house market then. If the LVRs had been left to do the job on their own I don't think you would have seen quite such a dampening effect.

Macro-stew

But one thing is clear, the banks, who were charging headlong into high LVR lending before 2013 have been pulled back. According to the RBNZ, across the banks now, high LVR lending accounts for only 13% of bank mortgage exposures versus 21% in 2013. What that means is that the banks are more insulated now against a precipitous house price fall than they were previously. And that's a good thing.

Does anybody remember though, that the LVRs were supposed to be temporary? The RBNZ doesn't mention that any more.

I hope that the whole LVR policy is thoroughly reviewed over the next few months - at the same time as the debt-to-income ratios policy is finalised.

If it's at all possible, I say let's see the lifting of that LVRs policy, in conjunction with application of the debt-to-income policy. And then let's think about making banks hold more capital against their mortgages.

We need this to be kept simple, otherwise the country risks getting immersed in macro-stew.