BNZ chief economist says continued strong house price rises in Auckland would likely see introduction of rules limiting mortgage sizes relative to earnings

By David Hargreaves

BNZ chief economist Tony Alexander sees a good chance of some kind of debt to income ratio (DTI) rules being introduced if house prices remain strong in Auckland.

The Treasury expressed enthusiasm for DTI rules in a paper prepared earlier this year but only recently released under the Official Information Act.

And in his Weekly Overview Alexander says that at the moment prudential regulators around the world are trying their best to prepare their economies for the next financial shock – "one of which seems to come along every 10 years or so".

This preparation takes the form of deepening regulation of financial institutions including higher capital requirements.

"Given the global liquidity bath does not look like ending for many years the risks are that the regulators move toward more measures aimed explicitly at stamping out the fires they see springing up as cashed up investors target assets – like housing for instance.

"Thus one should not lightly dismiss the NZ Treasury recommendation made in a paper sent to the Reserve Bank discussing the loan to value ratio rules where Treasury suggest debt to income rules," Alexander says.

"The RBNZ have made enough comments regarding problems they are encountering and working through in seeing if such rules could be introduced to make one conclude that their introduction is highly likely if strong house price rises in Auckland continue."

Alexander suggested that such measures might be along the lines of mortgage debt not being able to exceed "perhaps 4.5 times income for a household".

"The restriction may apply to a geographic area, perhaps exclude first home buyers. Though that latter exclusion may not achieve the improvement in financial stability the central bank would like as first home buyers generally purchase at quite high debt to income ratios."

Alexander says "the message" is that if interest rates can’t go up as economies grow because technology, excess capacity, and behavioural changes keep inflation well in check, "then other means need to be found" to keep liquidity growth under control and limit the risk of deep financial shocks which could cause depressions.

"The period of experimentation by central banks aimed at finding effective prudential tools suitable for the coming decades has only just started.

"Borrowing costs to you and I will stay low for decades. But credit availability is on the cusp of becoming far, far more difficult these next 10 years. How to cope with this as a borrower? Talk with your grandparents about how they got a mortgage before 1985," Alexander says. 

In the recently released paper Treasury says the rise in household debt in the 2000s was largely due to the rise in house prices and, to a lesser extent, changes in interest rates, "and the Treasury would agree with the RBNZ that this is a trend that requires further analysis".

"...The key aspect is that a rise in debt relative to income means an increase in the vulnerability of households in the event of a shock to income.

"There are a range of tools available for addressing this. LVR limits target one aspect of loan sustainability, that is, credit loss given default. Debt-to-income limits (DTIs) are an alternative macro-prudential tool that would offer an alternative or additional way of managing financial system vulnerability by targeting the likelihood of default.

"We appreciate that this is more difficult to implement in practice and that various technical issues meant that LVRs were chosen in 2013. We welcome the RBNZ’s work on DTI data since then, and look forward to the developments in this area," Treasury said.

Labour's Housing spokesperson Phil Twyford has put out a media release calling on the Government to "rule out" introducing DTIs.

“Such measures in England and Ireland have curbed skyrocketing house prices but they have come at a price – they’ve locked first home buyers further and further out of the market," he said.

“...With the median Auckland house price of $771,000 already nearly the equivalent of 10 times the median household income, few people will be able to buy into the market."

Twyford says the Government needs to embark on "a massive state-backed building programme to flood Auckland with affordable houses and crack down on foreign speculators".