Former Economics Editor of the NZ Herald

Brian Fallow: Courting of home buyers tawdry


Key better to help level property playing field than try to score points over Reserve Bank mortgage plans.

Graeme Wheeler intends letting banks decide on mortgage restriction exemptions and John Key should leave them to it. Photo / Mark Mtichell
Graeme Wheeler intends letting banks decide on mortgage restriction exemptions and John Key should leave them to it. Photo / Mark Mtichell

The public pressure Prime Minister John Key is putting on the Reserve Bank to devise some kind of carve-out for first home buyers from forthcoming restrictions on low-deposit mortgage lending is politics at its most tawdry.

If he was genuine in his concern about their being disadvantaged relative to property investors he could, instead, legislate to reduce the tax advantages the latter have over owner-occupiers in the market.

Although it has yet to make any final decisions, the bank has been increasingly clear that it intends to restrict high loan-to-value (LVR) lending in the mortgage market and to do so by way of a "speed limit".

That is restricting the proportion of new lending a bank can do above, say, 80 per cent of the value of a property.

It has also been very clear, most recently in a speech by deputy governor Grant Spencer on June 27, that it does not favour exempting this group or that among those borrowers potentially affected, leaving it instead to the banks to apportion the available credit among their clients as they see fit.

After all, that is the business banks are in.

The prime minister, however, continues to suggest that the regime could and should be designed to limit the impact on first home buyers. The latest version, reportedly, is to advocate exempting them if they seek to borrow less than $500,000.

Politically this probably looks like win-win spin.

If governor Graeme Wheeler resists this pressure, as he should, the prime minister can say. "Blame him, not me. I did my best for you. But it's his call."

If alternatively Wheeler caves in, the prime minister can claim the credit.

That credit would soon curdle, however, if down the track the housing market takes a dive.

Key would not be doing first-home buyers any favours by making it easier for them to get up to their nostrils in debt, only to be left with negative equity if the market corrects.

Auckland house prices have risen by just under 20 per cent over the past year, as measured by the Real Estate Institute's stratified housing index.

They would only need to return to the levels of a year ago - already stretched relative to incomes and rents - to almost wipe out 20 per cent equity.

Wheeler lived in the United States through the boom-bust housing cycle there which triggered the global financial crisis.

He has seen, up close, what it does to an economy much stronger than ours to have one mortgage in four under water - that is, where the debt exceeds the market value of the property.

Last month he said that about 30 per cent of new mortgage lending in New Zealand these days is to borrowers with deposits of less than 20 per cent, and that about 30 per cent of new lending is to first-home buyers.

He did not need to add that it is likely those two groups overlap. A lot.

Spencer said the Reserve Bank's preference was to keep the policy simple and effective by not having major exemptions and by minimising the possibilities for avoidance.

It is not alone in its belief that the housing market poses a growing risk to financial stability in New Zealand. "This view was also expressed by the International Monetary Fund and OECD in their recent reports on New Zealand and also by the three major rating agencies," Spencer said.

Indeed the IMF linked the fact that New Zealand has extremely high house prices, relative to incomes and rents, and high levels of household and foreign debt, to the fact that housing is the only tax-preferred saving option.

Sir Roger Douglas' changes to tax treatment of retirement savings by way of managed funds has left us with a regime which is unusually harsh by international standards.

By contrast the tax system rolls out the red carpet to investors in rental properties.

They are treated as having gone into business and therefore entitled to deduct any expenses, including interest, they incur in earning a taxable income, rent.

The banking system, however, simply sees them as borrowers seeking a loan on the security of residential property.

The result is that landlords can debt-finance to a far greater extent than most real businesses (the kind that employs people).

They can then engage a property manager so they don't have to deal with tenants, and sit back enjoying all the benefits of leverage in a rising market until they are ready to sell and collect their tax-free capital gain.

And when the Reserve Bank raises interest rates, the impact is up to half as large again on owner-occupiers, who cannot deduct their interest costs, as on landlords.

This is no level playing field. It is so far from level it requires crampons and an ice pick.

It helps explain why house price inflation is a bigger problem at the lower end of the market, where investors and first-home buyers are most likely to compete, especially in Auckland.

The Productivity Commission's report on housing affordability says that between 1995 and 2011 the gap between house prices in the lower quartile of the market in Auckland, compared with the rest of the country, increased by 260 per cent in real terms. For upper-quartile properties it was 150 per cent.

The remedy usually put forward to this distortion is a capital gains tax, exempting the family home.

Labour and the Greens advocate it. But it has not always been the property of the political left.

I recall then-governor Don Brash going to Parliament's finance and expenditure select committee back in the 1990s to argue for a capital gains tax on investment properties. The MPs shrank back in their seats as if he were trying to hand out plutonium lollipops.

But there is another way of attacking the problem that is perhaps less politically fraught.

It is to limit the ability of landlords to claim interest deductions.

This would not be a radical innovation.

We already have a thin capitalisation regime which limits the ability of foreign multinationals investing in New Zealand to minimise the tax they pay here by substituting shareholder debt for equity in order to maximise interest deductions. The safe harbour limit is 60 per cent, as in Australia, and the rules around it are being toughened up.

Part of the policy justification is that otherwise these companies would enjoy a tax advantage over their New Zealand competitors with normal balance sheets.

The Government has already shown, in Budget 2010 which eliminated the depreciation deduction for property investors, that it is not ideologically averse to moving in this area.

New Zealand simply cannot afford another period of virulent house price inflation like that of the 2000s. The risk is too great that this time it will end in the kind of bust of which the northern hemisphere has provided some gruesome examples.

The supply-side measures in the Auckland housing accord are all well and good but will take too long.

LVR restrictions will buy the Reserve Bank some time but it will inevitably have to raise interest rates.

Borrowers need to be clear that mortgage rates are not going to remain at 50-year lows indefinitely. Money market pricing has rates a full percentage point higher by the end of next year and the tightening will not stop there.

Tax changes, like limiting interest deductions, are needed too.

And the Government would be better employed pursuing that than playing politics over macro-prudential policy.

- NZ Herald

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Former Economics Editor of the NZ Herald

Brian Fallow is a former economics editor for the New Zealand Herald. A Southlander happily transplanted to Wellington, he has been a journalist since 1984 and has covered the economy and related areas of public policy for the Herald since 1995. Why the economy? Because it is where we all live and because the forces at work in it can really mess up people's lives if we are not careful.

Read more by Brian Fallow

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