Gareth Vaughan looks at why even the Third Coming of the RBNZ's high-LVR restrictions on home loans is merely fiddling around the fringes of the housing bubble

By Gareth Vaughan

The Third Coming of Reserve Bank restrictions on banks' high loan-to-value ratio (LVR) residential mortgage lending is predicted to shave up to 5% off house price inflation within a year.

This guesstimate, from the Reserve Bank itself, says the plan detailed yesterday to tighten credit availability, primarily to residential property investors, will dampen house price inflation by between 2% and 5% in the first year of implementation. This means the Reserve Bank expects a bigger impact than it did from either the high-LVR restrictions' first or second iterations.

The Reserve Bank predicted its initial crackdown from October 2013, that restricted new residential mortgage lending at LVRs of over 80% to no more than 10% of the dollar value of banks' new housing lending flows, would reduce house price inflation by 1% to 4% over the first year that policy was in place. 

Then last November when the Reserve Bank tweaked the LVR restrictions, to ensure borrowers would generally need a deposit of at least 30% for a bank loan secured against an Auckland rental property, it predicted the move would reduce Auckland house price growth by 2% to 4% over the first 12 months.

Whether the up to 5% dampening effect actually happens, or whether the up to 4% reductions for either round one or round two of the LVR restrictions occurred, is certainly debatable. But what's not debatable is the fact that house prices, in Auckland and more recently around New Zealand, have continued rising strongly despite the Reserve Bank's moves - so far - to restrict the flow of bank credit.

Real Estate Institute of New Zealand figures show that from September 2013, the eve of the initial LVR restrictions, to June this year, the Auckland median house price surged $251,000, or 44%, to $821,000. And the New Zealand national median house price jumped $100,000, or 25%, to $500,000.

'Billions of dollars of high-LVR lending hasn't happened'

In the consultation paper issued with its new LVR restriction proposals the Reserve Bank acknowledges that risks associated with the housing market have "increased for a much longer period than expected at the time that the LVR policy was introduced in 2013." It also argues that the LVR restrictions are improving financial system resilience by increasing households' equity buffers.

The Reserve Bank claims about $20 billion of lending at an LVR above 80% has not happened because of its initial high-LVR restrictions. And, it says, about $3 billion of investor lending at an LVR of above 70% has not happened due to last year's changes.

And the central bank, which says its LVR restrictions are about improving the stability of the financial system and reducing the impact on the financial system of any severe housing downturn, has previously pointed out the stock of high-LVR lending in banks' mortgage books fell to 13% of total loans in December 2015 from a peak of 21% in 2013.

"The policy appears to have reduced the risk of a [house price] correction, by curbing the rise in house prices and credit growth by approximately 5%," the Reserve Bank suggests. 

Action is required on many fronts

Nonetheless, yesterday's Reserve Bank statement quoted Governor Graeme Wheeler saying; "The drivers of the housing market strength are complex and action is required on many fronts that extend well beyond financial policy. Broad initiatives to reduce the underlying housing sector imbalances need to remain a top priority."

This comment could be interpreted as Wheeler returning Prime Minister John Key's "they should get on with it" comment directed at the Reserve Bank earlier this month, and then reiterated. Key's comment came just ahead of a speech by Reserve Bank Deputy Governor Grant Spencer is which Spencer effectively called for action from the Government to tackle runaway house price inflation.

Spencer pointed to three key areas well outside the Reserve Bank's remit, but where government moves could make a difference. These are housing supply, tax, and migration policy.

Of housing supply Spencer noted, "the key challenge in the long run is to expand housing supply to meet the growing demand." 

The latest Statistics NZ building consent figures show just 61% of the new homes Auckland needs monthly to keep up with demand were consented in May. And HSBC economists recently estimated Auckland has a shortage of about 30,000 homes, which is equivalent to about 6% of the region's total housing stock, and that the shortfall is increasing by about 7,000 homes a year, as record low interest rates and record levels of net inward migration fuel demand.

Tax and migration policy

Spencer also said it was important to explore policies that "will keep the demand for housing more in line with supply capacity." Two key areas here are tax and migration policy.

"On the tax front, the implementation of the bright line test for housing investors introduced in October last year has helped curb short-term speculative activity in the housing market. Consideration might be given to further reducing the tax advantage of investing in residential housing," he said, pointedly noting we have "a tax system that favours debt funded capital gains."

Or as NZ Herald columnist Brian Fallow recently put it; "The message from the tax system is clear: if you want to provide for your old age, don't save money. Instead, borrow and engage in highly geared plays in the housing market."

On the the controversial issue of foreigners buying New Zealand houses, Spencer suggested the introduction of a requirement for a New Zealand IRD number had probably restrained housing demand for a period late last year and early this year.

And on migration Spencer said; "We cannot ignore that the 160,000 net inflow of permanent and long-term migrants over the last three years has generated an unprecedented increase in the population and a significant boost to housing demand. Given the strong influence of departing and returning New Zealanders in the total numbers, it will never be possible to fine-tune the overall level of migration or smooth out the migration cycle. However, there may be merit in reviewing whether migration policy is securing the number and composition of skills intended. While any adjustments would operate at the margin, they could over time help to moderate the housing market imbalance."

Key, however, was quick to respond, ruling out changing his government's immigration policy to help tackle housing problems.

The housing affordability challenge

In the latest iteration of its high LVR restrictions, the Reserve Bank is proposing that, from September 1, no more than 5% of bank lending to residential property investors across New Zealand would be permitted with an LVR of greater than 60% (i.e. a deposit of less than 40%), and no more than 10% of lending to owner-occupiers across New Zealand would be permitted with an LVR of greater than 80% (i.e. a deposit of less than 20%).

Based on the current LVR distribution, the Reserve Bank says its proposed nationwide investor speed limit would potentially impact 70% of investor lending, split roughly evenly between Auckland investors, primarily at an LVR of 60% to 70%, and non-Auckland investors primarily at an LVR of 70% to 80%.

We can debate whether the Reserve Bank has, in high-LVR restrictions, chosen the right tool to tackle the housing bubble. Certainly many would-be first home buyers, finding themselves requiring bigger and bigger deposits, haven't been thrilled. But the Reserve Bank is doing something.

And the Reserve Bank is now lining up two potential additional tools. Also within the scope of its so-called macro-prudential tools, it is looking at both potential limits to high debt-to-income ratio lending, and the possibility of making banks hold more capital against housing loans (a counter-cyclical capital buffer or capital overlay). (I've previously argued for higher bank housing capital requirements here).

The other step the Reserve Bank could make to try and take heat out of the housing market is, of course, to increase the Official Cash Rate that's currently at 2.25%. But with annual inflation having now been below the 1% to 3% band targeted by the Reserve Bank for seven consecutive quarters, that's off the table.

Against this backdrop the ratio of Auckland house prices to average income has reached 9 or 10, and the house price-to-income ratio outside Auckland has got back to its pre-Global Financial Crisis peak of 5.3. Internationally a multiple of no more than 3 is generally regarded as a good marker for housing affordability. 

Former Reserve Bank Governor and ex-National Party leader Don Brash recently suggested Auckland house prices need to fall 60% to achieve affordability, given waiting for income growth to catch up with flat prices would take 50 years to restore house price to income multiples to around 3.

Meanwhile, investor lending has risen to 36% from 28% of overall mortgage lending over the past 18 months, and to 46% in Auckland. The Reserve Bank says about 30% of mortgage lending is now done at a ratio exceeding 6 times the borrower's income. Although record low interest rates are supporting loan serviceability for now, if interest rates and/or unemployment rise significantly, this picture could change dramatically.

Where the buck stops

The key point is that the time for Reserve Bank-style fiddling around the fringes is well and truly over. If we're to rein in Auckland's housing bubble and genuinely tackle housing affordability issues, the Government, not the Reserve Bank, needs to take the lead. Big decisions need to be made. Local government also has a role, notably around consenting and land allocation and pricing. Thus Auckland Council's impending Unitary Plan offers a key test on the local government front.

But ultimately central government can override both local government and the Reserve Bank. This, along with the various levers his government could pull, means the Prime Minister's office on the ninth floor of the Beehive is where the buck stops.The question is whether the government is merely governing for existing property owners or the greater good.

*The tables and chart below come from the Reserve Bank's consultation paper on its planned changes to restrictions on high-LVR residential mortgage lending. It wants the changes to take effect from September 1, and has called for submissions by August 10, which is less than a month away. Bank lobby group the New Zealand Bankers' Association said yesterday it was too soon to comment on the Reserve Bank's new high-LVR proposals.

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