I see that, due to concerns about systemic risk for the financial stemming from the housing market, the Reserve Bank of New Zealand has decided to increase capital requirements for high loan-value mortgages. Fine, I think this can be fit inside our concept about why you want to deal with these types of issues, as we’ve noted here.
But it is a balancing act, and there are some comments I’m inherently uncomfortable with. Namely the context of these two statements:
credit is now increasing faster than the rate of income growth (figure 2.1), after declining as a ratio to income over the past four years. …While credit is growing more slowly than in most of the decade before the financial crisis, that growth is stretching household debt-to-income ratios, which are already elevated (figure 2.2). Rising house prices, combined with a greater willingness on the part of banks to lend against low deposits, suggests that many new borrowers will be acquiring homes with higher debt levels relative to both income and assets. Low mortgage rates are helping to keep household debt burdens manageable in the short term, but the increase in underlying indebtedness leaves households vulnerable to a reduction in incomes or a rise in interest rates.
- We should compare credit growth to average expected income growth – not current income growth. You borrow in the basis of future income, so the comparison they laid down was a bit dodge. 4% credit growth is lower than this.
- New Zealand is rebuilding its (arguably) second biggest city. It will have to accumulate a higher level of debt (especially relative to current income) to do this. We are going to have higher current account deficits etc as a result – the idea is that this investment in a new city will create a rate of return that covers it. If we believe the rebuild leaves some areas streched this is still not a concern – it is just when those sectors in turn threaten to undermine the financial system. Given this, the increase in investment, activity, employment, and debt are all pretty slow – this type of counterfactual is an important element to keep in mind.
We DON’T care about financial stability because we are worried about asset prices, or bubbles. If people want to piss their money against the wall gambling on a bubble, no policy maker should try to help them. It is if their actions have an impact on the broader economy – if we think that financial markets are underpricing risk due to systemic risk issues for example – that we care. Bubbles and debt don’t magically stop people working and producing in of themselves, and we have to be careful that we interpret the data with the perceived externality in mind, rather than solely being focused a moral distaste for bubbles and debt … which is policy irrelevant.