By Associate Professor David Tripe
The Reserve Bank is currently consulting on tools that may help it deal with the overheated Auckland property market. While there’s been much hand wringing over housing prices, is intervention by the Reserve Bank really the answer?
Fears of a property boom, followed by an eventual bust, have stimulated interest in a range of actions that aim to keep the whole financial system stable, not just individual institutions.
This broader approach has been favoured by governments ever since the global financial crisis and is called macro-prudential policy. For the Reserve Bank it means regulating bank lending to create greater financial stability and the tools, such as restricting loan-to-value ratios, also have the ability to dampen down the housing market.
So, are we really at the stage where intervention is necessary? I’m not all convinced that this is the case. The most recent Quotable Value figures, to the end of last year, show a year-on-year nationwide increase of only 6.5 per cent. The average year-on-year increase since 1980 has been 10.8 per cent, and there should not be any cause for concern while rates of increase are lower than that.
It is only Auckland and Christchurch house prices that are identified as being of concern - and the underlying cause is obvious. Both are experiencing housing shortages - Auckland due to a shortfall in construction (relative to its growing population) between 2007-2012, and Christchurch due to the 2010 and 2011 earthquakes.
Given this, are increasing prices an unexpected or inappropriate outcome? Government policies to stimulate construction in these two regions would be a much more direct way of slowing price increases in those regions. And the last thing we need is a widespread fall in house prices throughout the rest of the country. That would have negative effects on bank lending and economic growth more generally.
All this is not to say that macro-prudential policies don’t have a role to play in the future if house prices continue to increase rapidly. Defining the criteria for their implementation would be a sensible idea - much like the Policy Targets Agreement that sets the Reserve Bank’s inflation parameters.
Macro-prudential tools come in the form of bank regulations, and if banks know the criteria for implementing them in advance they will hopefully adjust their behaviour accordingly.
It’s also important to consider the unintended consequences of policies. If loan-to-value ratios were restricted, for example, I’d expect borrowers to seek supplementary funding from sources other than New Zealand registered banks. In general, this would mean higher-risk institutions, which is hardly going to increase financial stability. It would also hit first home-buyers the hardest.
Other macro-prudential policies being considered by the Reserve Bank are: the counter-cyclical capital buffer, which requires banks to hold more capital during credit booms; sectoral capital requirements, which requires banks to increase capital in response to sector-specific risks; and increasing the core funding ratio.
These changes are likely to require a delay between the announcement of the policy and the policy coming into effect, limiting their effectiveness in slowing rapidly rising house prices. And as the new rules would only apply to registered banks, there is always the possibility they would encourage housing lending to move to other higher-risk institutions.
Whichever way you look at it, macro-prudential policies are not a simple solution to the housing bubble. There are always unintended consequences and the Reserve Bank needs to proceed with caution.
I believe the least disruptive course of action would be to adopt increased capital requirements through the countercyclical buffer, along with clear criteria for when the additional capital could be released. But even that is not a quick fix to the problem.
Associate Professor David Tripe is the director of Massey University’s Centre for Financial Services and Markets.