Risks to the financial system posed by an overheated housing market may be greater now than they were in the leadup to the global financial crisis, says Reserve Bank deputy governor Grant Spencer.
Spencer, in a speech yesterday to Business New Zealand, repeated the bank's message that it was considering loan to valuation ratios (LVRs) - which cover the amount of money that can be loaned relative to the value of the property - as a tool to try to cool what it sees as an overheated housing market.
Present conditions in the housing market were a "real threat" to future financial stability, he said.
"In the pre-GFC housing boom, with hindsight and with the macro-prudential framework we now have, we would most likely have applied macro-prudential instruments with the aim of reducing systemic risk.
"While limited housing supply is at the heart of the problem, strong demand supported by easy credit is underpinning the rapid escalation of house prices," he said, adding that demand for mortgages was close to pre-GFC peak levels.
"If this momentum persists, the housing market pressures could also become a threat to general price stability."
Spencer said LVR restriction was more difficult to implement relative to other macro-prudential instruments but the bank believed it to be the best tool, apart from interest rates, to moderate the strength in housing demand. He added that in the low-inflation environment, interest rate increases were not seen as an appropriate response. Although they would have benefits for financial stability, LVR restrictions would bring efficiency costs.
"In order to keep these to a minimum, we believe any restrictions should be set as speed limits, and have relatively few exemptions," he said.
In the bigger picture, potential efficiency costs involved in instigating LVRs would need to be compared against the "significant economic and financial damage" that could result from a housing boom that ended in a severe housing downturn.
Spencer quoted from a report which said New Zealand had the fifth highest house price overvaluation, relative to incomes, in the OECD.
The four potential macro-prudential instruments included in a memorandum of understanding between the Reserve Bank and the Minister of Finance, Bill English, worked in different ways to reduce financial system risk.
Of the four, the LVR instrument was the one with the best scope to dampen the strong demand for housing, as well as reducing the risk to bank balance sheets, Spencer said.
But Spencer said they were not a panacea.
"We know that LVR restrictions could introduce market distortions," he said.
"However, we need to assess inefficiencies against the potentially significant economic and financial damage that could result from a housing boom that ends in a severe housing downturn".
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, Spencer said.
David Tripe, director of Massey University's centre for banking studies, said conditions in the real estate market were such that some intervention in the home lending market was justified. "Whether this is the best way to do it is quite another matter," he said.