First home buyer help – lets repeat others’ mistakes

National has announced policy to support first home buyers to take on more debt. It will have an entirely predictable outcome: higher house prices and higher debt.

The only good thing about this policy is that it is relatively small: $64m over four years. That’s $16m per year and assuming 90% gearing, $160m of house sales. That’s just under 0.5% of $36b of housing turnover in the year to July 2013.

To National’s credit they couch it in terms of a short term response and in the backdrop of other work to look at housing and land supply. But it is still a bad policy that inflames demand for housing even further, before they have tangible impact on increasing supply.

First home ownership subsidy/support policies have been tried in USA, Australia and UK. This led to a high amount of borrowing by those who could not afford it. It was also at the heart of the sub-prime crisis in the USA and the subsequent GFC.

Following is a comment from UK after the 2013 first home buyer policy was announced (from FT):

Andrew Bridgen, senior economist for Fathom Consulting, a forecasting firm run by former Bank of England economists. Bridgen said: “Help to Buy is a reckless scheme that uses public money to incentivise the banks to lend precisely to those individuals who should not be offered credit. Had we been asked to design a policy that would guarantee maximum damage to the UK’s long-term growth prospects and its fragile credit rating, this would be it.”

Pretty much the same situation here. The predictable outcome is that demand will increase without increasing supply. This will increase house prices.

The borrowing will be done by those who are on low incomes and they will commit a large portion of their incomes to debt repayment. If economic circumstances change (say redundancy) or family circumstances (say an illness or an additional child) could force them to financial difficulty.

This policy also flies in the face of what the RBNZ is trying to do with macroprudential tools – which the government turned into legislation recently. The macroprudential tools are meant to reduce the amount of risk in the financial system by not lending out too much to high risk people (low income, low job security, etc) and high risk debt (low deposit, over-priced asset, etc).

The underlying issues are around debt and supply.

Households are borrowing again and a large chunk of it is in low deposit borrowing (take a look at the bank GDSs). Why do we have such a favoured status for housing, where it can have gearing of well over 80%, but few businesses, including those with commercial property portfolios, cannot? Maybe we should have a grown up conversation about banking regulation.

Planning rules require some work too. Archaic and ossified planning regulations mean that there are many barriers to the supply of housing where it is needed (including bizarre lot size requirements in suburbs even when they are in transport nodes).

The housing debate and ‘solutions’ are about the next election. It will have the entirely predictable outcome of higher prices and more debt.

  • jp

    On a positive note, we must have cracked all other problems in NZ, such as the tail of poor education outcomes, if this is the best use of taxpayers’ money.

    • Shamubeel Eaqub

      Agree. We could not have spent $64m in our education system with any benefit at all…

  • JC

    Agree with your comments, The Telegraph is currently reporting on the predictable rise in London property prices.

    One thing to the good about the Nats policy.. to use it you must have saved for a 10% deposit.

    JC

    • Shamubeel Eaqub

      It does, but it still means we are getting those with low incomes to take on a 90% LVR mortgage when house prices are trading at more than 20x PE (price to rents). Not sure that would be a good investment decision…

    • http://www.tvhe.co.nz/ jamesz

      The UK situation is about to get even better in January when the mortgage guarantee is extended to all first-time buyer, rather than just new builds! It’s times like this that I wish I owned a house.

  • http://gropingtobethlehem.wordpress.com/ Bill

    Amazing how useful supply-demand analysis can be. Now if only we could convince policy-makers with it.

    I will take issue with one statement, though. The contribution of mandated lending for sub-prime borrowers to the GFC has been extensively researched, and I tend to agree with the view that the contribution was small to non-existent. See: http://www.americanprogress.org/issues/housing/report/2011/02/08/9126/faulty-conclusions-based-on-shoddy-foundations/

    Sub-prime borrowing did contribute, but much of that lending was private firms chasing higher returns. It led to systemic damage through securitisation based on faulty models and outright fraud.

    • Seamus Hogan

      Bill, you are right that the role of the government-encouraged lending to poorer home buyers is a pretty small part of the overall story of the GFC, which has many parents, but can you not make a strong case that government enthusiasm for sub-prime lending had a role to play in the failures of regulatory oversight?

      • http://gropingtobethlehem.wordpress.com/ Bill

        As you say, many parents. So yes, it would be interesting to go back to the documents of, say, 2000-2005 and see what they say about achieving the goal of home-ownership. That’s how Greenspan couched it, after all — I forget the exact words but something about financial inventions making lending available to more people.

        But, if we are going to link goals and lack of oversight, we should also examine the goals of the regulators. The revolving door between Washington and Wall Street creates an incentive for regulators to be light-handed.

        Also, the AIG collapse was at least as much about being too clever by half as sub-prime lending. AIG sold derivatives then sold insurance on the derivatives, compounding their exposure to falling values. The causal chain from sub-prime failures to GFC includes those kinds of activities.

    • Shamubeel Eaqub

      Hi Bill, yes the sub-prime issue was more at the genesis of the issue, that was magnified by fraud, lack of regulatory oversight and many other factors. But the housing bust and foreclosures were exacerbated to a large extent by high levels of debt to low income households at the peak of the cycle.

  • Seamus Hogan

    Great post Shamubeel. I see you are listed by your name not as “The Hand” of the king. Does this mean you have joined the TVHE team as a regular blogger?

    • Shamubeel Eaqub

      Hi Seamus, the idea is to be a regular contributor. Although I cannot promise to be nearly as prolific as Matt!

      • http://tvhe.co.nz/ Matt Nolan

        Feel free to keep writing quality posts including clear explanations and figures – while I quote posts and make sarcastic comment :)

  • http://thewatercoooler.wordpress.com/ RC

    Welcome Shamubeel, the man with the coolest name in economics, along with Seamus.

    Your contributions are much appreciated and I look forward to more interesting posts.

    • Shamubeel Eaqub

      RC. Thanks – you forgot to mention also the hardest last name to pronounce ;). I had the worst mangling of my last name at a speaking event in Taranaki this morning….

      • http://thewatercoooler.wordpress.com/ RC

        Must admit I’ve probably butchered your surname a few times but I’m getting better at it.

        Do you think kiwis have an unhealthy sense of housing entitlement? Isn’t housing affordability a myth? Houses are selling are they not?

        • Shamubeel Eaqub

          RC, we have an unhealthy obsession with housing, but its not much different from many other Anglo-Saxon economies like Australia, USA, UK, Canada.

          Housing affordability is a funny thing. Because its not well defined. I think most people define it as the ability to buy a house with a mortgage when you are a young couple/family. But I could be wrong. It certainly doesnt mean access to shelter. Stats NZ report shows rents are broadly stable as a share of income over time. http://www.stats.govt.nz/browse_for_stats/people_and_communities/housing/Rental-affordability-1998-2012.aspx

          In politics this probably means that they want:
          1) house prices to rise for those who own houses and
          2) house prices to fall for those who dont own houses.

          So far objective 1 has won out. But if the balance shifts, the RBNZ will have to look hard at the financial stability stuff…

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