Key misses the point on financial regulation

I know it’s politics but seriously – this is why the confusion between “affordability” and “financial stability” (guess what they are separate things) leads to ridiculous statements, this time from the PM.

“Yes I accept absolutely and endorse the view that the banks should be forced to use this (LVR limits) as a legitimate tool.

“I don’t think it should be a tool that is used to write high LVR ratios for a bunch of rich people, and lock out a whole lot of first-home buyers.”

“I’m not saying it’s going to be perfect or there won’t be some implications but for the most part we want those first-home buyers to get a chance to buy a home.”

“So you can’t tell me that the trading banks can’t work with the Reserve Bank and make sure that those people are better looked after.”

Let’s ignore the fact that “rich people” have equity, so can afford to actually put a deposit down, so aren’t going to be hit in the same way by LVR limits (all it does here is ensure these groups reduce leverage).  And let’s also ignore the fact that the riskiest speculators won’t get hit by this policy … as they won’t be able to get funding through banks in the first place.  Let’s also ignore the fact that banks are supposed to be competitive, and the RBNZ shouldn’t really be trying to “wheel and deal” them.

Ok then, given this LVR limits are still being looked at because of concerns about systemic risk in the banking system – first home buyers do indeed take larger loans, and will be at greater risk of defaulting, trying to “exclude” them is just entirely missing the point of the policy.  Yes LVR limits, or increasing the costs for high risk loans, are not a particularly good tools – but turning around and making them completely useless and not dealing with financial stability at all is ridiculous.

But you may say “Key is just concerned about affordability and wants the RBNZ to solve it”.  This is ‘disingenious’ at best.  It is the GOVERNMENTS job to work on equity and redistributionary type policy – not the frikken central bank.  If the government is concerned about affordability for first home buyers, then focus on government policies for this – don’t lean on the independent central bank.

COULD YOU PEOPLE STOP BLAMING THE RBNZ FOR EVERYTHING – IT DOESN’T MAKE ANY SENSE (yes I’m shouting – but in a slow loud manner, instead of an angry one.  Maybe this will get people to actually “think about why” they keep saying these things, I’m experimenting here).

Ya know if we are thinking about affordability then we can look at issues that increase the supply of housing, or income transfers (although a lot of this would be capitalised in house prices), as “solutions”.  Stop trying to blame the central bank for the fact that trade-offs exist and work with the trade-offs at hand.

  • Owen

    It is also dangerously naive as this sort of policy was one of the major contributors to the recent GFC.

    • Indeed – although I would say that this is more the focus on affordability, while restricting the central banks ability to deal with financial stability, was/is the issue, rather than one in of themselves.

      It is important to remember all these policies are related, but also keep strong institutional and operational separation (with communication and co-ordination between institutions). Many people may think this is strange – but it is so we can appropriately define, and discuss, the very nature of the intervention we are trying to achieve in the first place. Interesting stuff.

      • raf

        I don’t like LVRs at all. That’s surely a risk management issue for the lender. I’m, much happier about increased capital requirements, which limits aggregate lending. “Affordable housing” will come when banks return to lending on salary multiples (as they did prior to the great leveraging) and land and building costs come down relative to wages.

        As Owen notes, government intervention in the mortgage market in the US was nothing short of a disaster. It’s going to take many years for wages to catch up with house prices and barring a crash (which would implode the banks), there’s not much that can be done, other than keeping a lid on credit expansion and increasing the supply of housing (and being patient).

        • “”Affordable housing” will come when banks return to lending on salary
          multiples (as they did prior to the great leveraging) and land and
          building costs come down relative to wages.”

          So you are suggesting that increased credit availability has led people to bid up house prices in competition with each other? I can understand how this would lead to greater gross debt – but given it is a transfer between NZers, this doesn’t explain the lift in net debt. I’m not sure it really gives the whole story of house prices – especially given the way prices didn’t get “bid down” when credit availability plummeted in NZ.

          “As Owen notes, government intervention in the mortgage market in the US
          was nothing short of a disaster. It’s going to take many years for wages
          to catch up with house prices and barring a crash (which would implode
          the banks), there’s not much that can be done, other than keeping a lid
          on credit expansion and increasing the supply of housing (and being

          You are talking about NZ here? As in the US case prices did collapse – I’m pretty sure you are talking about NZ 🙂

          I’m not sure about explicitly targeting monetary quantities in this way. When their are unforecastable shifts in demand for investment, sure policies are costly. We are essentially punishing other borrowers for the fact people want to “overinvest” in housing … even though they also don’t seem to actually be overinvesting in terms of building.

          I’d also note that if it is the above argument, of higher credit availability driving up gross borrowing, then prices will not fall – and yields will stay lower. It isn’t a “bubble” it is a structural change in the market.

          • raf

            Yes, I think houses have been bid up but for two reason. One is the increased availability of credit and bank’s willingness to lend on higher valuations, as long as the debt can be serviced. The other is the impact of overseas cash coming in (I was an example of this when I moved here from London in 2002), which brings new money into the market. it’s the overseas funding that is a big driver and once the market kicks off, it’s self-reinforcing, as banks lend on valuations and debt servicing ability. The reason prices didn’t get bid down was because they are sticky, in that people will not sell at a loss and as long as they can keep servicing the debt, there is no issue. Remember, they are not dealing with mark-to-market issues 🙂 The forced selling comes when they lose their jobs and have to sell…..that’s why the most important number is actually the unemployment one!

            Yes, I was talking about NZ. Structural change is possible i.e. lower yields. Just as we saw with EMU convergence, this is the result of the deflationary undertow, masquerading as a downward shift in inflation expectations.

            I think there is a common theme here. One is the impact of the current account deficit. The other is the way banks price risk. I’ve seen it first hand from my trading days (it always starts on the trading floors!). It’s all about funding and cash-flow. Asset values are just something to be packaged up and leveraged to the max. Unfortunately, we have moved so far from the underlying reality. That’s my main point.

            • “One is the increased availability of credit and bank’s willingness to
              lend on higher valuations, as long as the debt can be serviced”

              Yar, you loosen a credit constraint and gross debt rises and so do house prices – that is cool. But net debt doesn’t rise, as people are transferring houses between each other (no impact on CA deficit in this case either),

              Say that people borrow due to the lower credit constraint, this is cool. However, if they are borrowing to consume this suggests that this is welfare improving – as previously they wanted to smooth consumption and couldn’t. If they borrow to “build houses” then we end up with yields on property declining due to the credit constraint … and the cost of “housing services” and thereby affordability as a whole being lower than it would have been! In both cases, the lift in the CA deficit isn’t a bad thing either – just a sign of these shifts.

              This is indeed a different issue to a shortage – but it also implies that as long as there is no financial stability issues (so as long as they are dealt with by central bank regulation) then this is actually a positive thing rather than a negative thing …

  • I think the whole buying a house thing is weird. I’m happy to rent.
    I just don’t think the RBNZ is capable of implementing its LVR and counter-cyclical capital buffer rules without unintended consequences.
    I think there’ll be a new wave of second-tier lenders not subject to RBNZ prudential supervision to fill the gap in construction sector credit provision to solve the supply side problems. Cash only developers can’t the extra 20,000+ houses a year needed as NZ Initiative report suggested.
    High LVR loans aren’t the problem – the lack of credit provision to developers and builders is IMHO. How many builders have gone insolvent over the past few years, who are now not in a position to use their skills to rebuild Christchurch or fix supply side issues in Auckland?

    • Buying will matter more for you, Brennan, once you’re married and planning on kids. Residual control rights over the house are then more important (flexibility to make capital investments in insulation/heating, change paint schemes, etc). Otherwise, rental is great!

      • I’ve always thought a campervan would be good – flexibility residual control rights rolled into one!

        • That’s true, I’m young so different priorities at the moment.

          It is an interesting calculus when you have a family and high school comes round – how many families in the Grammar zone / Boy’s High zone trade higher rent for that benefit in lieu of buying a house?

    • Indeed. You raise two incredibly important points here that don’t get quite enough attention, namely:

      1) Do we have sufficient justification for countercyclical capital buffers – given we struggle to appropriately measure the cycle, and estimates of how it fits into the “financial stability” framework are not always clear or compelling.

      2) Are we clear on what we really mean by “affordability”.

      On the affordability note, things aren’t really clear if we are talking about a housing service:

      But if we suddenly value house prices independently of that (so we make a normative judgment regarding people valuation of characteristics that come from ownership) we may have an issue. That is quite a large leap as a starting point …

  • boristhefrog

    Well the 2nd tier lenders are out there… but they are typically bulk funded by foreign capital (think hedge and PE funds) and operate well below the radar… thing is these guys really know how to charge and make the antics of some of the now deceased finance companies look positively child like…

    How about a minimum 35% IRR on funds advanced will all funds advanced on day 1 compared to the monthly drawdown banks or ex finance companies would employ? In effect these funders take most, if not all the profit away from the developer – leaving the developer with no money… and no incentive to make the deal work…

    Coupled with an aggressive and hostile council (Hello Auckland Council, I’m looking at you…) and you can see why there are so few developers around…

    The tragedy of all this is now we are left, post the devastation of the GFC on finance companies, without a reasonably priced source of funding, which means fewer developers and fewer houses being built – and even with Auckland house prices rising at 13% per annum there seems to be no incentives (yet) that makes it viable….

    Good times….. 🙁

    • I’ll be honest with you here – the fact the the NBFI sector is still in such a state is damned concerning. The destruction of reputational capital for an entire sector like that is a supply shock – maybe not permanent but a long-lived supply shock. And “dealing with it” is hard.

      I’m not sure if trying to rebuild Canterbury, sorting leaky homes, and build up Auckland at the same time, with unclear sources of funding and limited capacity, is going to be the solution – the next few years are going to be … interesting

      • boristhefrog

        The NBFI sector was in effect regulated out of existence by the efforts of the Treasury and RB, along with a fairly big push from inside the Govt about the investor losses from all the collapses.

        So not entirely sure how a sector recovers from being (for all intents and purposes) shut down by Govt regulation.

        This in part reflects the reality that most property developers in NZ are small time ‘mom & pop’ operations – NZ lacks the corporate property developers present in other markets (UK/Canada/Aust/Sing/HK for example) who are largely stock exchange listed with proper governance.

        The sector has tended to attract extreme risk takers with a penchant for flamboyancy (Nigel McKenna / Jamie Peters) who (were) right at the bleeding edge.

        i think this is pretty strong evidence that the property development sector in NZ has a very low IRR on a risk adjusted basis (probably negative, although a negative IRR is a nonsense) – in short its just not profitable.

        And fundamentally thats the issue for the housing market.

        • So I guess the question is does this suggest that there is scope for entry, that there is regulatory failure, or that we lack scale.

          • Boristhefrog is right – the extreme risk takers got wiped out and smaller developers can’t afford to bet their entire asset base on a new subdivision.

            Also, I was listening to Bloomberg Radio this morning and in the US they talk about small businesses having from $1M to $10M a year in revenue!

            A lot of the development funding needed just isn’t big enough to satisfy some of the second tier lenders minimum deal size requirements. The banks also pulled the plug on some developers that would have finished projects and eased the supply side issues a bit in Auckland.

            That would suggest scale is a problem. The Manson family have thrown their hat in the ring to fill the gap in the market, but it’s not nearly sufficient IMHO. We can’t expect one wealthy family to bear the financing risk for desperately needed development finance!


            • boristhefrog

              The Manson family have made their $$ through construction rather than development and I expect they would only dip a toe in the water at best…

          • boristhefrog

            Matt… its more likely scale…. NZ doesn’t have any large scale projects (apart from the Chch rebuild) that would attract an offshore developer to set up in NZ and I expect once they do a review of the regulatory framework (RMA/council performance etc) they would stay well away…

            We all know what the regulatory failure is – its the RMA and the seemingly large anti-development bias of most councils (esp Akl Council)

            • I find the lack of densification in Auckland to be, interesting. This is an area that requires clarity and co-ordination, and the lack of densification implies some type of failure – rather than it being an indication that the preferences of Aucklander’s are very different. It is interesting stuff.

              • boristhefrog

                Well Auckland had had one round of densification in the form of in-fill and cross lease housing… but the next round is quite a step in terms of building size vs land area etc…

                My own view is that NZers and immigrants don’t want to live in hi-rise apartment stye buildings and that the idea of a detached house is what most people aspire to – there is always a % that will favour more density, but I don’t think that % has changed much over time.

                When we hear of so called first home buyers whining in the media about not being able to buy a house they are not in the market for an apartment – its a house that they are after with lawns and a garden and a place for the kids to play…

                That’s where the market generally…. so the debate about densification is more about what sort of lifestyle people want to have… after all, if you are going to live in an apartment building you might as well do it in a decent city where there are more benefits of living in a large city than in Auckland….

                • This is the kicker – people always say they want all these things. And hell the fact we don’t really build “entrant” homes anymore helps to illustrate the way this is impacting upon building patterns. However, if this is really the “social will” then they can have ridiculously expensive housing – sure.

                  If there is no co-ordination failure, and if it is all a representation of preferences, then there is no problem and the media should stop giving these people space to moan in 😉

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