The Reserve Bank did what it was supposed to do on Wednesday and told borrowers and banks and businesses to brace for financial stress that would "test resilience." It talked about dark clouds on the economic horizon and "risks skewed to the downside" in its half yearly stock-take of how our financial system is coping with spiking interest rates.
An alien arriving from another planet might think most home owners were deep under water with negative equity, drowning in high debt and were on the verge of being kicked out of their homes after the fastest spike in mortgage rates in living memory. Actually, nothing could be further from the truth. New Zealand's households, businesses and banks are all in rude health, with default rates at infinitesimally low levels and capital buffers stocked to the gunnels.
You wouldn't know it by reading today's headlines. "Dark clouds over NZ's economy," warned Newshub. "Rising interest rates will test financial resilience," wrote 1News, cribbing from the Reserve Bank's own news release on its November half-yearly Financial Stability Report titled: "Global financial stress will test resilience." The NZ Herald heralded: "Negative equity warning for home buyers," while Stuff focused on a "growing number of households struggling financially" because of higher mortgage payments that were about to get much worse.
Yikes. Dark clouds. Negative equity. Financial stress. Struggling households. Things must be really bad. On top of the risk of nuclear armageddon, an unprecedented and ongoing global pandemic, and Taylor Swift having all 10 of the top 10 most popular songs all at once this week. Whatever next? A wave of mortgagee sales and young homeowners being turfed out onto the streets in a vortex of forced sales, triggering scads of mortgagee sales, bank losses and ghost developments?
Yeah...nah
Actually, we should all just step back from the edge of the headlines and take a few deep breaths. We all need to take a class in financial stability and macroeconomic policy yoga. 'Namaste', Governor, rather than 'brace for it.'
Almost all of us will be absolutely fine, and even those who bought homes last year and are beginning to hyperventilate at the prospect of a 7%-plus mortgage should just take a chill pill, as the kids probably never said. Those with relatively high debts who paid prices that have now slumped 10% to 20% in the pixels of the valuation websites they check daily were only able to borrow after passing their banks' seemingly ludicrously high test rates at the time of over 7%. They were put through the wringer last March or April with the assumption that they were able to handle a seven point something mortgage rate. It seemed a pain in the proverbial at the time, but now it feels like prudent bankers operating prudently for the good of themselves, their shareholders, their customers and the economy. Anyone still in work won't be kicked out. It is only the dead and the divorced who need to worry, and they have other things to worry about.
The calculations showing they face paying more than 50% of their disposable incomes also assume their incomes have not changed. Most in this position will have seen double-digit disposable revenue growth since they took out their mortgages. It will hurt and the local purveyor of flat whites may not make so much money, but the world is not going to end.
The same prayers of thanks should be said for the high loan-to-value ratio (LVR) rules reintroduced in early 2021, and then tightened in late 2021. All but a few buyers were forced to hold at least 20% equity before buying, with the investors having to hold at least 40%, and often a lot more.
That means the share of buyers who are likely to get into negative equity once house prices have fallen the 20% forecast from peak to trough by the Reserve Bank is actually very low. What might have seemed to be a giant exercise in pointless party-pooping at the time, now feels like the grown-ups were in charge after all.
No one liked the LVRs when they were introduced in 2013. The banks, the brokers, the buyers, the sellers, the voters and the politicians all hated the LVRs, bitching and moaning all the way down the Terrace and across the road to the Beehive. Previous Reserve Bank Governor Graeme Wheeler even lost his job (well, didn't get a second term) because he introduced LVRs and then tightened them in the face of a fair amount of bitching and moaning from across the road. The ninth floor was livid before the 2014 election.
Take a closer look at the actual risk
A closer look at the actual levels of negative equity, mortgage servicing stress and mortgagee sales in New Zealand's housing market, banking system and corporate balance sheets shows the nation in a rude state of health and easily able to handle a 7% mortgage rate, let alone a higher unemployment rate.
This week's FSR came out with a fresh stress test of our banking system showing even a 47% fall in house prices with a 9.3% unemployment rate and a cyber-attack couldn't bring down our banks. They were even profitable in all but one of the four years of the stress test timeline and their capital reserves remained more than twice the minimum levels.
Reserve Bank Deputy Governor Christian Hawkesby was also careful to point out in the news conference that it was his job to put his serious hat on and warn against home buyers getting too indebted or bankers becoming too loose. But, he said, we shouldn't lose sight of the strength of the base we have.
"Just a reminder," Hawkesby said after another question about how borrowers could possibly cope with higher unemployment, "this is our Financial Stability Report, so this is the one where we put the gloomy hat on, deliberately."
"We benefit from a financial stability perspective from the strong, strong starting point that we have," Hawkesby said when asked about the financial stability risks from a slowing economy.
"We have very high levels of employment. We have high levels of income, job security. And so all of those things benefit financial stability in the near term. We are conscious that in a rising interest rate environment that will slow the economy down, or that will result in a weaker labor market," he said.
"What our research and our stress tests are showing is that the financial system is resilient not only to our central view of a cooling labor market, but for a scenario where unemployment was much higher than anticipated."
'Praise be to the LVRs'
The central bank's Manager of Financial Systems Analysis, Chris McDonald, was also clear about the strength in our system.
"When you look across the household sector, households are in a good position. And that's because the house prices have increased over the past couple of years prior to the peak that we saw in the last year," he pointed out.
"And so the equity that they have has increased, so they have that buffer for potential price declines. In addition, we had the LVR settings that were in place since 2013. And that, again, is credited with increased buffers for households," McDonald said, pointing out however that a few might be strained.
"Now, while in aggregate households are in a strong position, they're always going to be pockets of risk, And so we've put some numbers in the report that shows that right now, even with the 11% decline, only 2% of households are in negative equity. And partly that's just because house prices have only really fallen back to the level that they're at in May last year. So they're still high relative to where they weren't pre pandemic," he said.
'Keep talking to your banker and they should keep talking to you'
Governor Adrian Orr also pointed out banks were in a strong position to help customers that they (by definition) they had already put their trust in.
"My advice to people is to talk with their financial advisors and stay close to the bank. House prices falling don't create a financial crisis in and of themselves, it just means that you're living in the home," Orr said.
"The servicing of mortgages is where you need to stay very close to the banks. If they have lent wisely, then you are the wise person they have lent to, and they should be able to work with you through through good times and bad," he said.
"So stick close to your banks and banks stick close to your customers, would be my suggestion. We are in a strong position to weather this international challenge."
Hawkesby emphasised that mortgage servicing, rather than equity, was the key, and that delinquency rates were extraordinarily low.
"The really important part of servicing mortgages is your income and your participation in the labour market. So that's why having a strong economy and this strong starting point puts us in a good position," Hawkesby said. Participation in the labour market means having a job in reserve banker language.
"So that's a really key feature of your ability to service your mortgage, regardless of where the level of your house price is. And it's why when we think about financial stability and the types of stresses that we worry about, it is the ones where unemployment is high for a prolonged period."
But even then, a 9.3% unemployment rate and a 47% fall in prices aren't enough to take down the banking system. Not even close.
Adrian Orr quietly pointed out in this discussion that his much-criticised push before Covid to force banks to hold capital was now paying dividends in financial resilience terms.
"The resilience of the financial sector is is strong and open to an enormous amount of buffering. Is it infallible? No. So there's always that balance between levels of capital and efficiency versus security and precaution. And New Zealand sits at the more conservative end of that, because of the capital work we've been doing," Orr said.
Pointedly.
And correctly.
We should all just take a deep breath, put our palms together and breath out through our noses.
Namaste, Governors.
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