Brian Fallow 's Opinion

The Economics Editor of the NZ Herald

Brian Fallow: Home buyers beware - rates are set to rise

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Loan restrictions buying time for Reserve Bank but intentions for monetary policy will become clearer next week

It's too soon to tell what effect the LVR regime is having on the housing market. Photo / File
It's too soon to tell what effect the LVR regime is having on the housing market. Photo / File

Ask an economist a straight question and you are liable to get one of two answers: "It depends" or "It's too soon to tell".

So it is if you ask how the Reserve Bank's restriction on high loan-to-value ratio (LVR) mortgage lending is working out, two months after it came into effect.

It depends on what you take the object of the exercise to be, they say, and the problem there is that the Reserve Bank has espoused multiple aims.

Foremost among them is financial stability, that is, to ensure banks' balance sheets are sufficiently robust to withstand the bursting of a property bubble and avoid any need for the kind of costly taxpayer bailouts we have seen in the United States, Britain, Ireland and elsewhere during the global financial crisis.

Governor Graeme Wheeler has also voiced concerns about the personal and wider economic impact of a sharp fall in house prices on highly indebted households, in the context of some future shock to employment and the incomes out of which mortgages have to be paid.

Even if people can still meet their mortgage payments, if that means cutting back on other things the broader effects on the economy would be grim.

And negative equity - owing more than your house is worth - can leave people trapped in a property or a job or even a marriage they would rather quit.

Like any insurance, if the calamity LVR restrictions are supposed to mitigate does not occur then people look grumpily at the cost. If the calamity does occur, it will look like a bargain.

Graeme Wheeler is worried about indebted households.  Photo / Mark Mitchell
Graeme Wheeler is worried about indebted households. Photo / Mark Mitchell

As well as limiting the damage of a property bubble bursting, the regime is supposed to reduce the likelihood of it happening by curbing growth in household debt and house prices.

The difficulty in assessing that is the counterfactual, that is, how much debt levels or house prices would have risen without this intervention. Clearly there are offsetting influences on the demand side of the housing market, notably a strong turnaround in net migration flows.

The bank has been coy about quantifying the impact it is looking for.

But if the concern is how stretched the ratio of house prices to incomes and household debt to incomes already are, one might speculate that it would like to see the rate of house price inflation and credit growth converge with growth in nominal incomes.

Statistics New Zealand's triennial household economic survey found that median household income rose 8.5 per cent over the three years to June 2013, or an average of 2.8 per cent a year. Median house prices rose 14.2 per cent nationwide over the same period or 4.7 per cent a year.

While growth in wages and salaries, the largest source of household income, is expected to pick up as the economic upswing tightens the labour market, no one is forecasting it to match the 10 per cent pace of house price inflation already on display in the Real Estate Institute's latest numbers.

The same survey of household finances found that over the three years average weekly mortgage payments hardly increased, up just 1 per cent, reflecting historically low and falling interests rates.

The risk is a fool's paradise effect.

Borrowers need to be aware that current market pricing, effectively endorsed by the Reserve Bank, implies a rise in interest rates of around 2 percentage points over the next two years.

And that would just take short-term rates back to neutral, that is, a level which neither stimulates nor restrains economic activity which it now puts at around 4.5 per cent. It is worth remembering that in the last cycle the bank pushed the official cash rate to 8.25 per cent, driving mortgage rates into double digits.

The less effective the LVR regime proves to be, the higher mortgage rates will go, all else being equal.

It seems that part of the attractiveness of the LVR regime to the Reserve Bank is as a means of buying time before it starts to raise interest rates and risk pushing an over-valued New Zealand dollar higher still. We will get a clearer view of its monetary policy intentions next week.

So what effect is the LVR regime having on credit growth and the housing market?

It's too soon to tell.

Some transactions will have been brought forward in anticipation of what were well-telegraphed policy changes, while others may be delayed while people wait for things to settle down.

What we can say - to use a phrase beloved of politicians - is that the share of new mortgage lending going to borrowers with high LVRs halved in October. However, most of the increase in high LVR lending was offset by a rise in lending to borrowers below the Reserve Bank's 80 per cent LVR threshold. Mortgage pre-approvals over the past three months have been down 7.2 per cent by number and down 2.5 per cent by value on the same three months last year.

But the stock of residential mortgage debt, which reflects repayments as well as new lending, rose 6 per cent in the year to October, the highest annual increase for five years.

As for prices, Barfoot and Thompson reported yesterday that the median house price in Auckland in November jumped 5.3 per cent from the month before to $621,400, while turnover was in line with November last year.

Real estate agents surveyed by the BNZ report a sharp drop in the number of first-home buyers in the market.

And builders have warned of a perverse effect on the supply of new housing.

The Registered Master Builders Federation says a survey of builders found a 27 per cent drop in inquiry levels.

"We put this difference down to vendors being unable to sell existing homes to commission new ones and buyers with more than 20 per cent deposits not progressing as they may be concerned about not being able to fund increased costs during construction," the federation's chief executive, Warwick Quinn, said.

This invites a couple of responses.

Maybe people looking to commission a new build should lower their sights, both for what they expect for their existing home - if we take that "unable to sell" comment seriously - and in terms of what they want to build.

The building consents data continue to show the average floor area of new residential dwellings is around 200sq m and the average cost (just the building, not the section) is over $300,000.

And if the problem is the risk of costs rising during construction to a level that might put the client over a 80 per cent LVR threshold, how about quoting a price that can be relied on?

The Reserve Bank is sceptical but says it will be watchful for signs of unintended consequences.

All in all, then, the picture from the data is foggy.

Meanwhile, the Bank for International Settlements (BIS), often described as the central banks' central bank, has published some research on the effectiveness of a range of policy tools, including restricting LVRs, in stabilising house prices and housing credit.

It is based on data from 57 countries over 30 years and it gives scant support for the Reserve Bank's approach.

"Of the two policies targeted at the demand side of the [credit] market, the evidence indicates that reductions in the maximum loan-to-value ratio do less to slow credit growth than lowering the maximum debt servicing to income ratio does," it concluded.

"This may be because during housing booms rising prices increase the amount that can be borrowed, partially or wholly offsetting any tightening of the loan to value ratio."

And none of the policies designed to affect either the supply of, or demand for, credit has a discernible impact on house prices, it says. "Only tax changes affecting the cost of buying a house, which bear directly on the user cost, have any measurable effect on prices."

It qualifies the conclusion by noting that it reflects average effect across 57 heterogenous economies, "A policy that is ineffective in one country may be highly effective in another."

Nevertheless the BIS's conclusion about the greater effectiveness of regulating debt servicing ratios chimes with what bankers and mortgage brokers say is the more relevant test of creditworthiness than LVRs.

The Reserve Bank's financial stability report last month forecast the debt servicing ratio (interest and principal) for a representative new entrant to the housing market will climb from around 34 per cent of income now to around 43 per cent in a couple of years.

- NZ Herald

Brian Fallow

The Economics Editor of the NZ Herald

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