Remedy for New Zealand’s housing bubble needs to focus on curbing investors’ enthusiasm for property.

The Reserve Bank has announced it will lift the ratio of deposits to loans in order to take the heat out of the housing market.

There are a number of grounds for intervening in the housing market and the appropriate instrument to use depends on the reason for the intervention.

That there is an imbalance is evidenced by the very high house price to income and debt servicing to income ratios that still prevail in New Zealand compared with historical and international averages.

If it’s considered that a supply shortage is the problem, and that demand is normal or not unsustainably stimulated, then the appropriate policies need to be supply-focused, not targeted on altering demand.

Policies such as freeing up land, introducing more competition into the building supplies market, reducing the local body planning restrictions and compliance issues would all act on supply.

If, however, it’s demand that is considered unsustainable, the policy response required is quite different.

Further, what demand policies are appropriate depends on what it is about demand that is considered unsustainable.

My view is that demand is the problem.

This is probably also the Reserve Bank’s view, as its policy response targets demand. But that is where our agreement ends. The bank has a very different view from me on what it is about the demand that cannot or should not last.

According to its published comments, the bank is concerned about the risk to the banking sector posed by a large quantum of housing loans that might go sour should some sort of macroeconomic shock hit the economy.

This is consistent with its policy choice to make people have a higher deposit before they buy a house.

Of course they might borrow the deposit from elsewhere – which is what’s happened in the past with this type of approach – but presumably the Reserve Bank thinks it can isolate our banking system from such fringe lending this time.

Maybe. But in my view the risk of a collapse in the banking system isn’t why the bank should be intervening anyway.

The damage to the economy from this sector is occurring even with a banking system being unaffected, even with the banks being able to pass the various “stress tests” the Reserve Bank boffins subject their bank clients’ sheets to.

The issue is about the allocation of capital – capital that is required to generate income and jobs.

Over-investment in the property market is a direct result of the presence of so much investment demand for property. That bubble has been inflated since financial deregulation in the 1980s.

If I’m investing in multiple properties I’m not being forced to put my funds to work by investing in businesses that generate income and jobs.

And the reason I shun those is because the commercial banks make it infinitely easier for me to invest in property and let it lie idle. They regard property as more secure collateral than any other type.

Why? Because the Reserve Bank directs them to. The prudential ratio requirements dictate to the banks that they must give preference to mortgage lending over all other types of lending.

So yes, it is a supply issue – but not supply of property, but rather supply of finance. And whether that supply is so high as to put the banks’ balance sheets at risk is beside the point.

The damage is being done to the economy anyway as non-housing investment is shunned in favour of speculative demand for housing, demand that has nothing whatever to do with the demand for accommodation.

The problem with demand for property in New Zealand is one that has arisen as a legacy from a long history now of Reserve Bank prudential policy combining with selective tax policy to provide a toxic little no brainer for property investors.

Put bluntly, it is the easiest way in town for people to make money – all they need do is gear up and the tax-free gains are, over time, sumptuous. All Kiwis know this and it is the national pastime.

In other words the demand for housing has less and less to do with the demand for accommodation and more and more to do with the demand for a property as an investment proposition.

Tenanting the building is of second-order concern if the bulk of the contribution to your profit is the price appreciation. It’s almost like hoarding artworks or rare coins.

Certainly in Auckland over the past year – again – that has been the game to play. Now of course the Reserve Bank policy to lift deposits required will be successful in quelling demand – unless non-bank lending again fills the gap.

But the problem with that instrument is that it hurts most the people who cannot afford to enter the housing market, it affects far less those of us who have several houses as stores of value, that is, repositories for our accumulated savings.

We care less about leverage. We still care – but not as much as the hard-working young couple with two children trying to get a foothold in the market.

We’re on the bus, higher deposit rates will simply alter the arithmetic of our geared speculation, it doesn’t lock us out.

So the Reserve Bank’s choice of policy instrument runs two risks:

•It won’t work because non-bank finance will fill the gap – this is particularly likely if capital inflows from abroad find the rates on offer in New Zealand luscious.

•It will hit hardest those not causing the problem in the property market anyway. The bubble is not driven by folk trying to get into the market, it’s driven by those of us with multiple properties, all retained because we know what a great return tax-free capital gains on property are.

What should the Reserve Bank do?

First, speak to the Government about the lack of wisdom in having a mandatory tax only on cash income, but a selective one on income earned from capital, be it capital gain or implicit income that having use of the capital confers.

The biggest taxpaying mugs in New Zealand continue to be those subject to PAYE. The Government has them under the taxman’s hammer.

But so long as you can increment your wealth via an appreciation in the value of your assets, for example, you are free of the burden of tax. That reality is unfair and terribly inefficient when it comes to generating income and employment for New Zealand.

The toxic twins of a comprehensive income tax on cash incomes only and a selective tax on effective income from capital (whether that accrues from capital gains or imputed rent of the asset), together with a central bank that directs banks to finance property above all other assets, will continue to hamper the achievement of better living standards for New Zealanders and underwrite an ongoing property market boom, all the while ensuring fewer and fewer New Zealanders will ever own their own accommodation.

Part two tomorrow: Home buyers versus speculators.