Thursday, 14 September 2017

Another part of the house price story

Housing is understandably high on the political agenda at the moment. But amidst all the blame-seeking and potential policy responses, one of the big drivers of our high house prices seems to be largely ignored, in part because it doesn't give the pollies any room to point the finger at their opponents.

The reason it doesn't is because it's a circumstance almost completely out of our own hands: the cost of our longer-term fixed rate mortgages is very low by historical standards, and that's almost completely because of international trends. We essentially import world bond yields - as the RBNZ's economists documented here - plus a risk premium for being New Zealand, and the banks onlend to fixed rate borrowers at that rate plus a commercial margin.

Here's a chart of current benchmark (10 year) bond yields across a range of the developed economies, using data from the Financial Times.

Long term interest rates are unusually low mainly because four of the major central banks - in the US, the Eurozone, Japan and the UK - have been keeping them very low by buying bonds (sending their price up and hence their yield down), a policy often known as 'quantitative easing' or QE. It's been part of their plan to give post-GFC monetary policy more oomph: traditionally, central banks have only bothered with short-term interest rates, whereas QE also gives them a good deal of control over longer term ones as well. Low yields in the QE countries have had knock-on effects on yields in non-QE ones like Switzerland.

And 'unusually low' doesn't even begin to describe the outcome. There are now literally trillions of dollars' worth of bonds (some US$9 trillion according to the FT) trading on negative yields: you pay the borrower for the privilege of investing in its debt. You can see in the chart, for example, that the Swiss and Japanese governments can borrow money for as long as 10 years where the investors end up paying the government. Just this week the Austrian government raised five year debt at a 'cost' of -0.165% a year.

We know that our own central bank is keeping short-term rates low - "Monetary policy will remain accommodative for a considerable period" as the latest policy decision put it - and that has been one of the elements in the recent price boom. As floating rates linked to the RBNZ's policy dropped, and household incomes kept growing, there was a surge in mortgage serviceability, which has been one of the big moving parts in the consequent boom in prices. But you knew that.

What's been less emphasised if that even if the RBNZ hadn't cut short term rates to where it has, the rest of the world's central banks dealt us substantially lower longer-term fixed rate mortgages in any event. And that boost to the demand side of the market isn't going away anytime soon. In the US the Fed is getting close to easing back on the scale of its QE (still buying bonds, but not as many), and the Bank of England and the European Central Bank may start heading the same way later this year or (more likely) next, while Japan looks set to keep its current QE going into the indefinite future. Whatever unwinding of QE that eventually materialises is going to be a slow, careful, gradual, medium-term process. There could well be local five year fixed rate mortgages around the 6% mark for quite a while yet.

There's another element to this imported easy monetary policy. Around the world there's been what the investment professionals have been calling "the hunt for yield" or, in more purple moments, "the craze for yield". The traditional widows-and-orphans assets of money in the bank and government bonds have been yielding little or nothing (indeed, US$9 trillion worth of less than nothing). So even conservative investors have been forced either to swallow the unattractive terms on their usual fare - this week Austria sold €3.5 billion of bonds with a hundred year maturity on a preposterously low 2.1% yield - or instead to head into income-yielding assets like property that offer something better.

The local  investor is making the same calculation. Even at current high prices you can still get a 3.5% to 4.0% rental yield on an Auckland house, according to the (very useful) data compiled by It's not what a conservative investor would normally be looking for from an investment property, but it beats the bank deposit and government stock alternatives. In our own little way we've got the same hunt for yield: it's not as extreme as in some places  - as the graph shows, our bond yields haven't dropped to Japanese or Eurozone levels - but it's another part of the picture.

And if you think the link between loose overseas monetary policy and New Zealand house prices sounds like the abstract reasoning only an economist could come up with, then you haven't paid enough attention to the Irish house price boom and bust. Ireland, which had been growing like topsy, was gifted eurozone interest rates that were too low for its circumstances. House prices exploded.

Speaking of adding fuel to flames, why would you increase subsidies for first home buyers? As an elementary bit of sketching supply and demand curves on the back of a shopping receipt would show you, the only immediate effect of subsidising the demand for something in fixed supply is to raise its price by the full amount of the subsidy. And it's not only ineffective, it's regressive - a straight transfer from the taxpayer (including all the low earners who pay tax from dollar one) to the house owner. In the longer run, it fattens the margins from housing development, so it could encourage more supply (assuming the binding constraint isn't land-use planning or construction capacity, and it might be), but in the long run we have all joined the bleeding choir invisible, we have snuffed it, we are no more. As a short-term policy it's worse than useless.

But that's this election for you. I'd thought we'd got past the worst of elections as they used to be, but this all-party lollyscramble, with its side dishes of daftness and deceit, is pure 1970s.

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