It is great at amplifying equity gains in a rising market, and the housing market has certainly been that lately.
But it is just as potent at destroying equity when asset prices fall.
Say you buy a house with 20 per cent of your own money and 80 per cent of a bank's. If a year later its price has risen 20 per cent your equity has doubled. But if instead it has fallen 20 per cent you are on the brink of negative equity.
And for first-home buyers, when CoreLogic estimates these days it takes an average 10-and-a-half years to save a deposit, that would be disspiriting.
People are too liable to believe it is some sort of immutable law that New Zealand house prices do not fall.
That certainly has been the case for a long time.
It will continue to be the case, too — right up to the point when it ceases to be the case.
The Reserve Bank warns that the risks of a housing market correction are growing.
The fundamental gap, years in the making, between the demand for, and supply of, housing is narrowing.
Residential construction is going strong, as strong as labour and materials shortages allow. And with the border closed population growth has plunged to less than a third of its rate in the five years pre-Covid. Even when border restrictions are relaxed, in a world in which the coronavirus is endemic net migration gains are unlikely to return to pre-Covid levels.
"We consider this undersupply [of housing] to already be reflected in current house prices," the bank says. "As a result further strong house building will put downward pressure on house prices, even given the historic undersupply."
Then there is the combined impact on investor demand of changes to the tax laws and loan-to-value ratio (LVR) restrictions. This has seen investors' share of new mortgage lending fall from 21 per cent at the start of the year to 17 per cent in August.
The third, and perhaps most significant, downward influence on house prices is the Reserve Bank's own intention to raise interest rates. It estimates a neutral level for the official cash rate — one which is neither stimulatory nor contractionary for the economy overall — is around 2 per cent. That is 1.75 percentage points higher than now.
Anticipating tightening monetary policy here and abroad mortgage rates have already begun rising from historic lows.
For would-be first-home buyers, who would need to get up to their necks in debt to get on to the property ladder, the prospect of rising interest bills joins a daunting list of obstacles.
In the June quarter just past, first-home buyers accounted for 19 per cent of new residential mortgage lending.
Some 38 per cent of that lending was at an LVR of 80 per cent or more.
And half of it was at a debt-to-income multiple of five times or higher, including nearly a quarter at a DTI above six. By historical standards those ratios are high.
So is the ratio of median house prices to median disposable incomes. "Even if house prices stay at their current levels, and incomes grow as they have historically, it would take eight years for house prices to return to the same level relative to incomes as in early 2020," the Reserve Bank said in its August monetary policy statement.
Reserve Bank of New Zealand governor Adrian Orr. Photo / Mark Mitchell
Rampant house price inflation has underpinned a dramatic increase in household wealth.
Statistics New Zealand estimates that in the year to March 2021 households' combined net worth increased by $400 billion or 21.5 per cent, the lion's share of which (54 per cent) was an increase in housing equity in both owner-occupied and investment properties.
The wealth effect — people's willingness to consume a few cents in the dollar of that increase in net worth — has been an important underpinning of demand in a challenging year for the economy.
But the flipside is a sense among the young that the traditional Kiwi dream of homeownership is a prospect so distant as to be imperceptible.
The latest blow is the Reserve Bank's decision last week to halve to 10 per cent the LVR "speed limit" or maximum permitted share of new mortgage loans banks can make at LVRs of more than 80 per cent.
Over the past five months first-home buyers accounted for an average 77 per cent of such lending.
But over the same five months lending at LVRs over 80 per cent to all borrowers accounted for only 9.2 per cent of new lending, so it was already within the new speed limit. That raises questions about why the consultation process was so perfunctory and rushed.
The Reserve Bank said its analysis indicated most mortgage borrowers would be resilient to a decline in house prices of up to 20 per cent.
Given the pace of house price inflation — CoreLogic's nationwide house price index rose 27 per cent in the year to August — recent movers and investors have benefited from the equity gains on their previous properties, the bank said, "whereas recent first-home buyers have come into the housing market with less purchasing power and have generally needed to borrow at higher LVRs and hence are more vulnerable to price falls."
It estimates that 22 per cent of recent first-home buyers — those who have borrowed in the past year — would be in negative equity following a 20 per cent house price decline from June 2021's level.
Among the submissions the bank received critical of its plan was one from Geof Mortlock, who worked at the Reserve Bank for 24 years and another five at the Australian financial regulator APRA.
The proposed LVR policy would not make much difference to house price inflation, Mortlock said; it's a point the Reserve Bank concedes.
"If one strips away the (false) argument of financial stability as the justification for the increased restriction on LVR lending, one is left with the impression that the real reason the RBNZ has embarked on this path [is] for some kind of 'welfare' purpose — ie to protect highly leveraged households from a fall in house prices. That is not part of the RBNZ's statutory mandate."
