The Reserve Bank, faced with soaring Auckland house prices and low inflation, is getting creative. They are looking at making it harder for investors to borrow the money needed to buy rental properties. So at least the RB accepts the problem is a demand one, unlike Bill English who remains deluded thinking that all we have to do is build more houses all over the Bombay hills.
But this RB response will do little to halt what’s distorting our property market: The toxic duo New Zealand has sponsored for years via a Reserve Bank that insists that lending to housing is less risky than any other type of loan a bank can make, combined with the loophole in the taxation regime that enables home owners to dodge their fair share of tax. These two structural distortions amplify the pressure from the population growth of Auckland on house prices, into a raging brush fire of house price inflation. Until they are dealt to, we are whistling in the wind.
John Key highlights the dilemma
The Prime Minister can clearly see the dilemma facing the Reserve Bank; inflation is below the 1-3% target zone, and heading south (at least in the short term). Meanwhile, Auckland house prices continue to rise at a rate that threatens our entire financial system.
If the Reserve Bank drops interest rates to boost inflation, the Auckland housing market will go stratospheric. If it raises interest rates to dampen the flames in Auckland, the rest of the country will suffer, and potentially topple the whole country into deflation. If you are wondering why falling prices is a bad thing – would you bother buying anything if you knew it would be cheaper tomorrow? No, nobody would, so the economy would freeze in its tracks.
But refuses to help out
John Key understands financial markets, but isn’t interested in making any of the changes that would really make a difference. We have been criticising for years the Reserve Bank’s instruction to banks that they must favour lending on housing over lending against other types of assets. The Reserve Bank argues that the default risk for mortgages is lower, but has no comprehension of, or respect for the impact such a policy rule is having on behavior. It’s self-fulfilling, borrowers gear up where they can get the cheapest money and eventually that leverage leads to a speculative bubble. We have seen this play out in recent years overseas, and it’s just a matter of time before it bites here.
In fact, the music has played longer here because we have a second factor conspiring to inflate the bubble. Housing investment is also a one-way bet, thanks to the loopholes in the tax regime. This is much bigger than the lack of a capital gains tax – we fail to tax any of the non-cash benefits a homeowner gets from their property. With the deck stacked in this way, it’s been a total no-brainer that investors have leveraged every ounce of equity they have to buy more houses.
So the Reserve Bank has to get creative
Recall the Reserve Bank’s last move was to create loan-to-value restrictions, which created political fallout over the impact on first homebuyers – the very people who they shouldn’t be punishing. That made it inevitable that their next target would be property investors. And they have international evidence on their side that suggests that these investors are far more likely to walk away from their mortgage when the going gets tough.
The Reserve Bank’s latest idea to address the symptoms of the house price crisis is to target investors. The proportion of the housing stock in Auckland owned by investors – up to 40% – is now being identified as a threat to the stability of our financial system. By contrast, the RB argues that people who own their own house are far more likely to keep paying the mortgage, even when it doesn’t make sense for them to do so.
Will it work?
The devil is in the administrative detail for the Reserve Bank here. Any policy which targets one type of borrower over another creates an incentive to change how that borrower appears in the eyes of the law. The market will no doubt get creative with finding ways around it – we might soon see partners or even children of wealthy families buying their own house. Trusts and companies could also be helpful in shrouding investors from the watchful eyes of the banks.
If they conquer those demons, the Reserve Bank still has to worry about all the other places that investors can borrow from. We have already seen first homebuyers turn to their parents in the face of loan to value restrictions. Could this push more investor borrowing into the hand of finance companies?
There is also a big question mark over whether this will capture foreign buyers, who may not be dependent on our banks to make their purchase. This might put increased pressure on calls for a register of foreign buyers (which itself could be possible to get around).
Is this good news for first homebuyers?
Taking some of the investors out of the market will theoretically leave more room for first homebuyers. But this is unlikely to send investors to the wall and spark a housing fire sale, so will do little for historically high house prices. All we expect to see is a slowing in the speed with which they rise.
Do we really want to see the next generation of house buyers leverage themselves to the eyeballs to get their first house? A far more durable solution would be to treat housing like we do other assets, both in the eyes of banking policy and in our tax regime. House prices would soon fall to affordable levels and end our obsession with this unproductive national investment pastime. Who knows – we might even start investing in things that make money.