Brian Fallow: Reserve Bank paves the way for more intervention

About 30% of new residential mortgage lending goes to investors, almost all of which falls outside the restrictions on high-LVR lending. Photo / File

Residential property investors look to be in the Reserve Bank's sights if it should opt later this year for another LVR-style intervention in the property market.

What it announced on Thursday is not that. But it paves the way.

In its role as guardian of financial stability and supervisor of the banking system it is consulting the banks on how best to define residential property investors, ahead of what will be an enduring change to the capital adequacy rules intended to make banks more resilient to a possible housing market correction.

That is different from a temporary intervention - "macro-prudential" in the jargon - which restricts lending to some set of borrowers in order to reduce demand in the housing market, like the curbs on high loan-to-value ratio (LVR) loans introduced in late 2013.

However, the case for that sort of macro-prudential move is growing and the bank's consultation paper includes this cautionary passage: "It is partly to facilitate the introduction of a macro-prudential property investor policy, should that become necessary, that the Reserve Bank now proposes to establish a separate asset class for residential property investment loans."

It is a bit like a farmer saying, "I haven't decided to send the full-mouth ewes to the works, but I'm cutting them out from the rest of the flock in case I do."

About 30 per cent of new residential mortgage lending goes to investors, almost all of which falls outside the restrictions on high-LVR lending.

Requiring the banks to hold more capital against loans to residential landlords is expected to have a modest marginal impact on house prices and rents.

The great majority of banks' lending is funded by money they borrow rather than their own equity. Marginally increasing the latter, especially at a time when the world is awash with cheap money (witness falling fixed-term mortgage rates) is not going to make much difference to their funding costs.

It would, in any case, be up to the banks to decide how to trade off some pressure on margins against market share. And to the extent that some banks already classify loans to landlords separately from owner-occupier loans, the Reserve Bank's plans only codify existing practice.

In the Auckland market with annual house price inflation running at 13 per cent on Quotable Value's data or 15 per cent on the Real Estate Institute's, real mortgage rates are seriously negative. House price increases cover the mortgage rate more than twice over and are, moreover, untaxed.

A regulatory change that might increase landlords' interest rates by 25 basis points at the outside is not going to make much difference to the prices they are prepared to pay for properties.

Governor Graeme Wheeler warned last month that the more stretched house prices become relative to incomes, the greater the risk of a sharp correction.

That is more than a statement of the obvious. Wheeler was living in the United States when its housing market crashed and he has seen close up what it does to an economy when one mortgage in four is under water.

In the medium term the solution to Auckland's runaway housing market is more supply. So far the supply-side response falls well short of what is needed.

In the short term that means eyes must swivel to the demand side.

Waiting for gravity, in the form of ever rising unaffordability, to prevail is very risky. It could take the form of a crash.

Curtailing demand through the price of credit, that is by raising interest rates, is the last thing the rest of the economy needs.

That leaves the option of curbing volumes through restrictions on lending.

LVR-style restrictions on investors are not the only option, ANZ's economists point out.

A debt-to-income limit, such as the Bank of England has adopted, is another possibility as is limiting interest-only loans.

Any macro-prudential intervention is bound to have negative spillover effects elsewhere in the country. But the collateral damage from interest rate hikes would be much worse.