LVRs are coming: Let’s think about the causes underlying this

I see the RBNZ has come out with the details of the LVR restrictions (loan-to-value limits on mortgages) they may well put in place soon.  That is cool.  I’m also a big fan of the “question and answer” style discussion of people’s submissions here.  Brennan McDonald summarises the details here.

However, in the release about this, there were several quotes about LVRs that I had to admit I had issues interpreting.  Either these quotes miscommunicate the justification the Bank is using for such policies, I have completely misinterpreted the quotes, or they communicate it perfectly and I fundamentally disagree with the association they are using.  These ones are not about housing affordability, they seem to strike at something more fundamental.

As a result, I thought I should have a chat about the quotes in question – and why I think our understanding of them, and the causal mechanisms involved, is central to thinking about policy.

The quotes are:

“LVR restrictions on residential mortgage lending can help to dampen excessive house price growth in periods when credit growth is boosting housing demand beyond housing supply,” Mr Spencer said.  “In so doing, they can reduce the risk of a rapid correction in house prices and the economic and financial instability that would ensue.

“In situations where house prices are overvalued, the further that house prices rise, the more likely it is that a disruptive downward correction will occur.  Such a correction would be very damaging if combined with a significant deterioration in economic or financial conditions.”

Read more

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. This will drastically increase the cost of the homes, which are as of now being sold. I recently took the assistance of a company to sell my house fast Arizona and not only did the house get sold remarkably soon, but the money was transferred to my bank account without any delay. So this policy which has just got introduced could make things for potential home buyers a little difficult.

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. Read more

Growing consensus on capital requirements

Sounds like the Massey University panel on banking regulation was good times – with Don Brash, David Tripe, and Bevan Graham all largely in agreement.

For what it matters I also agree with a lot of what they said 😛

On a side note Brennan McDonald linked to a Radio NZ piece on LVR restrictions which he recommends.  I haven’t heard it – but I wouldn’t be suprised if it goes down the same road as the panel.

So what seem to be the main points from the panel (from the article – I was not at the panel presentation): Read more

Some links on bubbles and monetary policy

Robert Shiller has writtem extensively about bubbles.  Via Stephen Kirchner I saw the following:

Because bubbles are essentially social-psychological phenomena, they are, by their very nature, difficult to control. Regulatory action since the financial crisis might diminish bubbles in the future. But public fear of bubbles may also enhance psychological contagion, fueling even more self-fulfilling prophecies.

One problem with the word bubble is that it creates a mental picture of an expanding soap bubble, which is destined to pop suddenly and irrevocably. But speculative bubbles are not so easily ended; indeed, they may deflate somewhat, as the story changes, and then reflate.

Trying to understand the mechanism, and the such, is indeed important for policy.

This also feeds into the discussion about keeping financial and monetary policy separate (via Scott Sumner):

If you look closely, the parallels to the Fed’s dramatic QE policies and current financial stability concerns are uncanny. In both stories, the recession was identified as the result of speculative excess. In response to the crash, both times the Federal Reserve embarked on a program of monetary easing. However, in both instances excess reserves failed to budge, and this was interpreted as a sign that banks just didn’t want to lend — the Fed was pushing on a string. Finally, as excess reserves persisted, the threat of “speculative purposes” was used to bully the Fed into tightening. The key difference between now and then is that we have a Fed that recognizes its role in supporting the real recovery. Those in 1936 were not as lucky.

Why did the Fed go on such a destructive path in the 1930’s? Rotemberg identifies the tightness of policy as a consequence of something called the “real bills doctrine”. Under the real bills doctrine, the Fed saw its role as providing credit so that there was enough, and no more, credit to invest in “productive uses”. Since the Great Depression was preceded by a speculative stock bubble, then Fed officials put a premium on making sure credit was put to “productive uses”; The real bills doctrine was the result. According to this doctrine, monetary policy should tighten in recessions when demand for credit falls so as to make sure what credit remains is put towards productive uses. Conversely, monetary policy should ease in booms because firms are looking to find credit to fund their projects. In other words, the real bills doctrine prescribed a procyclical monetary policy.

This goes to show that we need to avoid framing effects when thinking about monetary policy. Because the Great Depression was the result of an equity bubble, then the economists of the day were so concerned about bubbles that they pursued destructive monetary policy. It is just as important to not make the same mistake today. As the real bills doctrine shows, using the tools of financial economics to solve monetary problems can be very destructive.

I would note that the GD likely wasn’t caused by an equity bubble – it was believed to have been caused by an equity bubble.  The fallacy of composition was alive and well in the interpretation of macroeconomics!

The Open Bank Resolution

Today we have a panel discussion going on at NZAE 2013 on the Open Bank Resolution policy.

I am on the panel as the third speaker – the goal is that I’ll summarise the arguments of the previous two speakers:  Ian Woolford (RBNZ) will be speaking about why the OBR is a good move, while David Tripe (Massey University) will be listing his concerns.

The slides of my presentation can be found here.  I wasn’t sure what the other speakers would cover, so I have 14 slides for a 15 minute presentation – during the actual presentation I will skip sections that aren’t necessary.  As they say, better safe than sorry.

I do not have the knowledge of the other two speakers, and look forward to learning a bit from them.  The purpose of my presentation is to “get us towards questions” by outlining a general view of how to view the OBR policy, and by asking a few questions.  If you are not at NZAE, feel free to thrown some questions in the comments and I’ll tell you if I learnt the answer at the conference 🙂

My notes Notes for OBR presentation

The dangers of “financial stability”

In an otherwise clear, insightful, and useful speech regarding the use of macroprudential tools – and why – the Reserve Bank states the following

While the Reserve Bank’s mandate is to promote financial stability, not social equity, there are clear implications here for housing affordability. As house prices and debt levels trend increasingly upwards, so too housing becomes less affordable, particularly for first home buyers. While macro-prudential policy measures might make credit less accessible for a period, they should help to make house prices more affordable in the longer term. Such measures should also reduce the risk of a sharp housing downturn and the loss of equity that would result, particularly for highly indebted home owners.

And from the summary:

“While macro-prudential policy measures might make credit less accessible for a period, they should help to make house prices more affordable in the longer term,” Mr Spencer said.

Sigh.  Is it necessary to go down this road, does it have anything to do with RBNZ policy?  Do people even know what they mean by “affordability”?  If our concern was due to a bubble, does mentioning affordability confuse or help with understanding Bank policy?  Does their comment make any sense (note, I don’t think it really does)?

Why bother defending the Bank from politicians who act like the RBNZ is responsible for everything (here, here) if the Bank is keen to make arbitrary ill-defined statments that seem to imply just that?

Is financial stability not actually about financial stability – but a catch phrase used to justify moral judgments regarding “rebalancing” and “deleveraging“.  This is one of the dangers of focusing on financial stability in such an ill defined way, and one of the reasons why Scott Sumner has pointed out why care must be taken (extra comment here).

This speech was otherwise a good set of clear statments that discussed RBNZ policy.  Why try to pretend it does other things?  It is statements like this one about affordability that makes people believe the central bank can dance upon the head of a pin and make happinesses and manufactured products rain down from the sky.