Let’s be blunt: Politicians and housing

I see that there is political  discussion about loan-to-value ratios.  Both National and Labour have repeatedly said the RBNZ needs to do more about financial stability using its tools like LVRs (National signed an agreement with the Bank, Labour said it would bring them in as a tool), the RBNZ turns around and introduces loan-to-value speed limits because of the mess the Auckland housing market is finding itself in, then both political parties suggest that they don’t want the RBNZ doing anything. [Note: This isn’t necessarily a defence of LVR’s – this is more about the principle 😉 I discuss this quickly at the bottom]

Did we need a clearer indication that politicians just want someone else to blame, rather than having to face trade-offs directly.  No we don’t, that is why I didn’t put a question mark there …

I’ll be blunt here – do any of the politicians talking have an understanding of the reasoning for the policy change?  Or do they understand and have decided to be disingenuous?  They seem like nice enough people, so I think they are just truly concerned about the impact on certain groups (a noble concern) – let us touch on the regulation issue briefly here to put government in context!

Wow, that is one of the least blunt “blunt” statements I could have written.

When we talk about an issue of “financial stability concerns” we are explicitly saying that individual banks will be taking on too much risk relative to what the “system as a whole” should be taking on.  As a result, there is some sort of negative externality from said lending.  Guess who the risky borrowers are (in terms of defaulting on a banks loan, especially following a aggregate decline in house prices), are they the property investors who either aren’t borrowing from the banks or already have significant equity … nope.  Are they the people selling their old property and buying a new one with significant equity … nope.  Are they the first home buyers, who are leveraging themselves up by putting down tiny deposits and crossing their fingers hoping house price keep going up … bingo!

Any regulation to deal this risk will have a significant impact on highly leveraged lending, which is what first-home buyers are – so the Reserve Bank can ignore their financial stability mandate, or they can respond to this.  If you “take out” the change in financing options for first home buyers then you are “taking out” the financial stability gains as well …

In this Rates Blog article that I mention here I say:

Some may say that a bubble right now makes house prices expensive right now, thereby reducing affordability right now. However, why do we care if someone cannot afford to buy a house at this very second – couldn’t they just wait till the bubble is over?

However the concern here is that, New Zealanders that go out to buy a house during this bubble end up facing all the risk and expected drop in house prices associated with the bubble.

Generally these people are young New Zealanders who intend to start a family, and as a society we feel a bit rough about the fact they are in that position.

So the idea here is that we believe there is a housing bubble, however when it “pops” is uncertain, and as a result a new house buyer is really taking on “risk” rather than facing a certain depreciation when they take on the choice to buy.  But my view was that:

Instead, we need to be honest about the transfer that may exist between current older homeowners and the young, and think about how the tax and transfer system can be made to deal with this. Admit the perceived unfair transfer that is taking place within society and deal with it directly.

This doesn’t sound anything like arbitrarily f’ing around with the RBNZ mandate and making it impossible to actually do the job they’ve been given in the Memorandum of Understanding on Macro-prudential policy.  At the moment political parties want to loosen financial conditions for home owners, and introduce all sorts of schemes that will get capitalised into house prices.  Instead, the politicians should be looking at it as a distributional issue – it isn’t about giving young households cheap large houses that only exist in fantasy, it is about being realistic about any intergenerational distribution issues that we believe exist due to the inherent “cause” of the current “bubble” or a broader “misalignment” – this has to be relative to what we think is “fair” around the distribution of lifetime resources.  We can’t just “pop” a bubble, but if we understand the causes we can deal with the distributional issues associated with it.  Looking at supply side constraints (which both parties are) makes sense – good to see that.

But what about the near term?  Worst case scenario, one-off tax all property, given money to group who is “hard done by” – if you aren’t willing to do that, you are faking your belief in a distribution issue 😉

Now if you want some policy solution here, I’d reiterate it needs to be based on perceived causes, which would involve figuring those out and making a view.  My personal view is completely different – I’m sick to death of people my age feeling comfortable taking on loans with deposits of 5-10% and then crying about the cost.  I’m sick of hearing people whine about the idea of having to rent, and acting as if the costs that come with renting (which are real) are worth blowing a whole bunch of your lifetime earnings on by massively overpaying for a house.

Many moons ago I felt empathy about escalating housing costs until I actually looked at the HES figures about housing costs – now I don’t, and I’ve come to see this as an example of people wanting something for nothing.  I do agree that Auckland is a special case, and the amount of uncertainty about what is going to happen up there is tough … but we can hardly say that is unrelated to policy right 😉 [Note:  The next day Treasury released a paper on affordability, time to adjust my priors again?  Don’t know, have to read it 🙂 ]

So I say hells yea, lets increase bank capital requirement related to housing loans – if that is where the systemic risk issue is seen to be, and that’s appropriate regulation, do it.  The distributional stuff is the governments issue – and if you are another whining Gen Y person who feels hard done by, jump on Twitter and say something dumb about how much better it was in the 1950s or some rubbish.  Preferably tag @TVHE in it so I can bathe in my generations inherent whining about everything – hey it has consumption value 🙂

Note:  I’m not saying it is Gen Y specific – it is mid-20s to late-30s specific (so I guess I’m including Gen X – which indeed I am), people rally to causes that increase their own bargaining position, it just makes sense.  All your other generations were just as bad – and I’m not trying to defend you from anything at all 😉

Note 2:  In case someone reads this and starts blahing about vested interests, I don’t own any property, and I’m not completely heartless – I likely just calculate social welfare differently to you.  That might sound heartless, but its more just nerdy.

Note 3:  My preference would be for RBNZ policy to ensure the banks are holding sufficient capital/equity for their housing loans – rather than trying to ping a single factor related to the risk of individual borrowers.  The point is the specific risk associated with a house price correction to the financial system, not to change the relative pricing of risk between the types of loans – this is why I noted I wasn’t defending LVR’s in of themselves, and part of the reason the Bank is using LVR instead of anything else is because it is a known quantity, while other policy tools don’t come with the institutional knowledge that banks and the RBNZ requires to do things quickly and effectively.

Update:  Eric comments here.  One thing I’d note is that the fact that equity holders are the first ones to be wiped out doesn’t necessarily get rid of the perceived issue of systemic risk – where the view is that banks aren’t taking into account the risk to other banks of them increasing their exposure to housing assets.  Sounds like a pecuniary externality I know, which is part of the reason why I’m more willing to describe it than to fully defend it.  I’d prefer to view it in a more general insurance framework with reference to LOLR and deposit insurance functions in the way I believe Eric is.  Eric discusses more here.

  • Clarification if needed: OBR doesn’t eliminate the risk that banks might try socialising risks, but it does help reduce the risk. Heads banks win, tails the banks’ shareholders are entirely burned along with their unsecured creditors… unless I’m missing something obvious, that seems a sharp enough way of focusing incentives.

    Or think of it this way. If I take too many risks and smash my car into a bus, killing both me and a pile of the passengers, current rules don’t require my estate to compensate the affected external parties. But I’m still dead if I do that. So if you change the rules so that my estate is liable, my behaviour at the margin really doesn’t change much: I have a strong enough existing reason to avoid taking those risks; the external component is inframarginal to my decision. That’s how I think about OBR. The shareholders losing all their equity and the holders of unsecured debt losing their assets ought to be sufficient incentive to induce appropriate effort.

    The best counterargument would be if the shareholders and bondholders really don’t monitor and if they run a completely screwed up internal compensation regime that let the effective decision makers run the heads I win big, tails I get a golden parachute strategy.

    • Even with the OBR, as long as there is an implicit bailout for depositors this acts as an implicit subsidy in the banking system. The government will bailout the large banks in the face of a systemic event – that immediately puts us in a second best world unless they can find a way to credibly tie their own hands 😉

      I just want our regulation to be consistent. As I said in the post I’m not fully supporting LVR’s, more trying to give a description of the rationale and pointing out the inconsistency we are seeing from politicians atm.

      Also note, the OBR is there to ensure that households and firms have liquidity and that the bank is wound down in an orderly manner – this is the focus of it. Atributing other outcomes to it opens a much larger can of worms, which involves trying to interpret tacit government action – however, we can’t ignore those if we go down that road.

      • I liked the bus crash analogy sufficiently to expand it into a post. If the thing works the way I think it does, then remaining risk externalities are pretty likely inframarginal.

        • Hmm you might have to expand upon that point for me.

          As long as there are expectations of a bailout, depositors treat their lending as less risky than it actually is. Even with full information, and a situation where bankruptcy wipes out shareholder value in the firm, this leads to excessive risk taking and a wedge between the risk premium demanded by depositors and the risk taken on by banks.

          I can see how an inframarginal externality argument could also be made – but that is separate again to this argument right?

          • If the shareholders discipline bank risk-taking because they bear the greater burden in case of adverse event, then the depositors don’t much need to.

            • That isn’t sufficient though – there will be a bias towards debt (depositor) funding for loans instead of equity funding due to the fact it is implicitly subsidised. As long as the subsidy exists, there is a role for the central bank to impose capital requirements for banks – or to charge a levy that represents the implied “insurance premium”.

              I’ll be honest that I’m less clear on the broader systemic risk arguments, and the idea of cyclical tools – I’m not particularly convinced by them at present.

              I can accept broad based policies that work as a form of insurance given uncertainty if that is what society wants. Cyclical tools start to feel like micromanagement – I’ll reiterate it, I’m not actually completely behind LVR’s, I was mainly aiming to give the policy context 😉

              And this context involved the implicit social insurance line, given an assumption that the RBNZ has a certain adaptive expectations involved view of the way households and firms respond to asset prices … as that is the only real context I can try to understand many of these actions.

              • Agree with all that, just not sure that the implicit subsidy is large enough to merit a policy response.

                • That is a fair point – I’m pretty cautious myself. I usually convince myself that the clever wonk at the RBNZ have looked into it deeply enough to justify what is going on, and then as a result I update my priors on issues given that belief 😀

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  • boristhefrog

    Its all about Auckland and Canterbury house prices – parse the REINZ data and you’ll see that all the other regions in NZ are just noise…

    Now look at the listings data… you’ll see there that listings in Auckland are actually trending down (!)… so prices are up 20%, there is plenty of demand in Auckland and listings are falling??

    There is ‘something’ going on the Auckland hosing market and rising prices are the result – why aren’t owners responding to market signals in greater numbers? Could it be that house prices in Auckland aren’t yet high enough to encourage more sellers?

    Not sure that I believe the talk about the rental data either – but that is quite hard to interpret…..

    Any thoughts on owners reluctance to sell into a rising market??

    • Agree with your description 100% – over the national data nearly 50% of regions have real house prices mroe than 20% below their 2007 peaks.

      The falling listings, and “relatively” restrained amount of activity (it is still above its decade-long average), imply that high prices are needed to “get people to sell”. To me, this is a sure sign of uncertainty about regulation and value – even uncertainty though, not just uncertainty with massive downside which would actually lead to sales.

      People holding is consistent with the Westpac story of the expectation of rising prices in the future – given that holding one house “closes out” your natural short position on housing.

      The rental data is VERY hard to interpret – as we don’t have quality adjustment. I suspect quality adjusted rents will tell a very different story. In NZAE12 there was a paper that suggested that when you quality adjust rents, the fundamental value of housing was actually higher – if this is indeed the case, it also suggest there IS more of an affordability issue than I have allowed for. Overall, these are complicated issues 🙂

  • Jotham Whitler

    Politicians always want to blames someone else. This has been it and the people are sick of this. Those who are in power take advantage of those below them. When will we ever learn?

    • While their is an element of truth to this – I’m not sure politicians are doing it on purpose. In the NZ context, I’ve generally found a lot of these guys from all sides to be genuinely good people – however, they are trying to fight a war without maybe having all sides represented in their implicit understanding of the issue. The best thing to do is talk about it – without resorting to fighting.

      • FYI, if a comment has a random URL in it, it is usually spam Matt:)

        • I know – and I think I’ve said in prior threads before that if the spam comment is good enough, I will keep it and answer it 🙂

  • Blair

    Great post Matt. I’d also add that any handouts to first home buyers will quickly show up in the price of the type of houses that first home buyers like to buy.

    Bank capital is hard to measure (http://www.interfluidity.com/v2/716.html) and if you think sell side bank analysts and fund managers have a deep understanding of this stuff you probably haven’t talked to many bank analysts.

    • “I’d also add that any handouts to first home buyers will quickly show up
      in the price of the type of houses that first home buyers like to buy.”

      This is very true – I touched on it in a cursory way with this:

      “At the moment political parties want to loosen financial conditions for
      home owners, and introduce all sorts of schemes that will get
      capitalised into house prices.”

      But it is a point that needs more air.

      “Bank capital is hard to measure”

      This is fact. I suspect that is why there is a growing push for clearer, flat, minimum equity requirements for bank funding … the whole “bankers new clothes” shalarky.

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  • raf

    Always useful to look at the causes 🙂

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