LVRs: First Home Buyer Killers

Gareth MorganEconomics

Graeme Wheeler LVR

The current Reserve Bank Governor should be congratulated on ending two decades of inertia, but the fundamental policy flaws with respect to the property market remain

We can expect the LVR (loan to value ratio limits) intervention to impact the housing market. We can also expect first home buyers to be in the firing line of this policy. How ironic, given that the whole issue with the housing market is that it’s locking out many first home buyers.

The LVR cure is like shooting the patient in the leg and expecting that once they recover, they’ll be better able to keep up in the property race.

Long ago our property market ceased being about providing New Zealanders with adequate accommodation and instead became an investors’ El Dorado where money can be made free of tax, riches multiplied by resorting to debt, and some of us can get rich while others have to pay more and more for a roof over their heads.

[quote align=”right” color=”#999999″]LVRs hurt most the people we should be helping, these first home buyers who have to borrow more and more the longer we perpetuate the tax and financial distortions which widen the gap between the value of accommodation and the price of a house[/quote] With the banks instructed by the Reserve Bank to lend on mortgage in preference to all other forms of lending, the flood of cheap money into the property market has unhinged house prices from the demand for accommodation. Demand is driven foremost by the ease of access to mortgage monies. Flood the market with housing finance and house prices soar, irrespective of New Zealanders’ need for accommodation.

This long-seated advantage of property as an investment has led to an endemic distortion in our capital markets, starving the business sector of funds instead the banks focussed on fuelling a multi-decade property speculation. It is the national pastime, far more popular than rugby.

This rot has been supervised by a succession of Reserve Bank governors who have lacked the fortitude to address the core problem, instead wringing their hands periodically in public about the excesses of the housing market and trying to jawbone the market down. That approach has been an unmitigated disaster, as is indicated for instance by the ratio of house prices to household income in New Zealand, which stubbornly remains one of the highest in the world, as well as way beyond historical norms here.

Finally the Reserve Bank has acted, ending two decades of inertia. On that, the current Governor should be congratulated. But that approach is one that will temporarily take the froth off the market but lead to borrowers accessing the non-bank and backstreet sectors for their finance. The fundamental policy flaws with respect to the property market remain – they are the toxic duo of a tax loophole and the favourable risk weighting the Reserve Bank accords mortgages issued by banks.

Australia suffers from the same disease, as last week’s published finding from the Grattan Institute attests. That report has found sharp falls in home ownership as a result and a massive stoking of the wealth divide between owners and tenants.

The Reserve Bank can’t fix the tax distortion; it and The Treasury have written screeds on that in the past and pleaded with politicians to find some courage to do it. To no avail, the Nats have no truck with closing the tax loopholes that we owners of capital thrive on, and Labour and the Green’s capital gains taxes specifically exempt the family home, therein making their proposals impotent.

Just to remind you about the tax break – if I put $500,000 in the bank I pay tax on the income, if I buy a house instead then the income equivalent I enjoy is free rent. But I don’t pay tax on that benefit, so it’s a tax-efficient way to enjoy a roof over my head. Some mugs leave their money in the bank and pay rent from the after-tax income it earns, they are tax victims. Far better to invest in the house and enjoy the tax dodge totally.

But the Reserve Bank can correct the lending distortion and it’s disappointing that it’s chosen not to. The problem is that it still sees the problem in the property market as cyclical rather than structural, hence the LVR instrument – one that like a dial, can be turned up or down depending upon where it’s thought we are in this property cycle. Suitable as a cyclical tool apart but the problem in our market isn’t cyclical, it’s structural so tweaking a dial isn’t appropriate. In fact LVRs hurt most the people we should be helping, these first home buyers who have to borrow more and more the longer we perpetuate the tax and financial distortions which widen the gap between the value of accommodation and the price of a house.

The appropriate response by the Reserve Bank should be to remove the risk-weighting favouritism it requires banks to give to mortgages. There’s an old adage in economics, that if you determine that something is an immutable truth (like for instance, mortgages are always a low risk form of lending) the market will act on that policy rule in a way that disproves your assumption.

This is precisely what’s happened as a result of decades of Reserve Banks providing favourable risk-weighting to mortgages. We all know it’s the easiest money in town, so we take advantage of that borrowing on mortgage, buying property, sending the price up. The demand for property has very little to do with the demand for accommodation. In short it can be whatever the Reserve Bank enables through the risk-weighting favouritism mortgages are given. This is why those who think the problem is supply are well off the reality.

Thanks to the collective action of the crowd, whose demand for property is validated by this easy money, the asset price can only go one way.  Sure there are booms and busts along the way, but the long term trend that results from structural policies that favour this asset class, is for prices to rise in real terms.

If the Reserve Bank was to give away its risk-weighting favouritism to mortgages then the commercial banks would be left to determine who they should and who they should not lend to. They will after all have less overall to lend on mortgage. It may be low deposit borrowers they cut off, it may not be – the collateral behind a loan is not the only consideration when assessing risk. And in particular if the banks understand that the gravy train of more and more lending available on mortgage is being slowed down, then they will act prudently to trim their mortgage book to the best quality credits they can. And the best quality is not the same as the least leveraged – which is what the LVR forces them to target.

Even if the Reserve Bank gets it right, ditches the LVR and adopts a neutral stance on the risk-weighting of mortgages, the property market will still be distorted by the tax break – and one wouldn’t expect conventional politicians to muster any courage to deal to that until we as society demand it. But we would have got rid of one of the market distortions – over-generous financing. And we would have done it in a way that doesn’t cripple first home buyers in the process.

LVRs: First Home Buyer Killers was last modified: December 15th, 2015 by Gareth Morgan
About the Author

Gareth Morgan

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Gareth Morgan is a New Zealand economist and commentator on public policy who in previous lives has been in business as an economic consultant, funds manager, and professional company director. He is also a motorcycle adventurer and philanthropist. Gareth and his wife Joanne have a charitable foundation, the Morgan Foundation, which has three main stands of philanthropic endeavour – public interest research, conservation and social investment.