Monday, 26 August 2013

Some perspectives on the Reserve Bank's high LVR controls

The Reserve Bank's plan to put limits on how much of their new lending banks can do on a high Loan-to-Value-Ratio (LVR) basis has been widely discussed in the New Zealand blogosphere and the mainstream media, and I don't think I need to add too much more to the coverage. If you missed RBNZ Governor Wheeler's speech when he announced the plans, here's the Bank's press release, which also has a link to the speech itself. Governor Wheeler used some OECD calculations on house prices to show that New Zealand houses are unusually overvalued at the moment (shown below).


If this looks familiar, it's because you may have seen the same data in my earlier post on the OECD's numbers, where I had concluded that "when you see us like this, well out on the left-hand edge of the developed world with unusually expensive house prices, you begin to have rather more sympathy for moves to curtail high loan-to-value-ratio lending".

That's still my view, though I have some sympathy for first-time buyers who are likely to be the group most hit by these new controls, and I also wonder why, if the problem is principally people buying very pricey homes in Auckland (mainly) with a low deposit, why the controls couldn't have been more targetted at the red-hot market rather than at everyone. But on balance the LVR controls probably take a bit of financial risk out of the banking system, and that's welcome. It also gets the Bank out of the tight spot where its normal way of dealing with an exuberant housing market (higher interest rates) would have worsened its other problem, namely a very high Kiwi dollar. If you like graphs, I've discussed the Bank's housing/currency dilemma here.

Once you start introducing direct controls on bank lending, it's easy to wade in deeper. But I'd be very wary, though, of direct lending controls that went any further than this. As Governor Wheeler said, "Rising house prices in Auckland and Christchurch are mainly a result of supply shortages, although demand-side pressures are also a factor due to pent up demand, the lowest mortgage rates in 50 years, and aggressive competition among banks for new borrowers, including borrowers with low deposits". "Mainly" is the key word here, in my view, and I'd have used something a bit more emphatic: while supply and demand are the two blades of a scissor, and it can get semantic trying to disentangle their contributions, I'd have said that the desperately low level of supply is easily the most important moving part here.

As the Governor noted, "Auckland’s Council suggests that Auckland’s current housing shortage is 20,000 - 30,000 houses with 13,000 houses needing to be built each year to meet future demand.
Christchurch’s shortfall is around 10,000 houses.  Strikingly, for a city with geographical boundaries equivalent in size to Greater London, and a population of 1.5 million (a sixth of Greater London), Auckland has only produced an average of 4300 new houses annually over the past three years". Even if, through the 'Auckland Accord' between Auckland Council and the national government, housing supply expands, it will be a long time indeed before building even matches annual new demand, let alone erodes the existing shortage.

There's also, frankly, not a lot of evidence of a general blowout in the volume of lending. In the year to June, lending to the resident private sector is up by only 3.9%, not a lot in the context of an economy in quite a strong cyclical upswing. Lending on housing is up by a bit more (5.1%), but that's not a lot, either, when house prices in Auckland are up by about 16% and in Christchurch by about 10% (I'm using the Governor's estimates here). And if you look at the growth in households' non-housing borrowing, which is where you might find evidence of a general splurge by households, it's up by only 1.9% over the past year. Modest growth in the high-level credit aggregates can, of course, hide some lower-level problems (eg if all of that modest credit growth was to shonky borrowers on poor security), and some 30% of the banks' new lending is (apparently) at high LVRs. So, as I said, there's a case for a small touch of the brakes - but not much more.

I'm also not too sure that the household sector as a whole is in a dangerously indebted position. The Governor did say that "Household debt, at 145 percent of household income, is also high and, despite dipping during the recession, the percentage is rising again", and that also caught others' attention - Bernard Hickey, in his column 'Brave move to dodge bust' in the Herald, said Wheeler's speech showed that "our household debt is now higher relative to our GDP than the US, Australia and Greece" (I couldn't find the reference in the speech, myself, though Wheeler certainly made the 145% point).

In a way, though, that is like saying, Bill Gates has maxxed out on his credit card. So what, in the context of the rest of his financial position? New Zealand households' debt to income ratio may have crept up a bit, but New Zealand households' assets to income ratio has climbed even faster.
In March this year, households had $194 billion of financial liabilities (the vast bulk of it, $180.8 billion, being housing borrowings). But they had $245.9 billion of financial assets: their net position (financial assets, less financial liabilities) was in the black, to the tune of $51.9 billion. What's more, that surplus of assets over liabilities is up by $15.7 billion over the past year.

Households also have massive amounts of home equity ($477.4 billion at the end of 2012). That is flattered by the current level of house prices, but it's still a sizeable buffer.

There will, of course, be some low-equity borrowers within those aggregate healthy home equity figures, and there will also be some borrowers who can make a go of loan repayments at current low interest rates (current average floating mortgage interest rate, 5.87%) who will struggle at higher interest rates. While I can see the case for a small tweak to what banks can do, I still don't see an overly fragile, overly extended household sector in these numbers, nor do I see runaway growth in banks' lending.

One thing that did somewhat appal me, though, when I went back to look up that 'Auckland Accord' on freeing up more land for housing in Auckland, were the truly dire statistics on how long it has been taking to get planning approval for new housing - in the proposed new Special Housing Areas (I'm quoting from the government's May announcement of the Accord), "New greenfield developments of more than 50 dwellings will be able to be approved in six months as compared to the current average of three years and brownfield developments in three months as compared to the current average of one year" [my emphasis added]. You can point fingers at the banks, if you like, or at households and their love affair with property, but if you want to find the real culprit behind Auckland's housing shortage, look no further than your friendly local council staff.

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