Peter Lyons: Applause for Reserve Bank's LVR move

Reserve Bank Governor Graeme Wheeler. Photo / Mark Mitchell

Opinion

The criticisms levelled at the Reserve Bank over its introduction of loan to value restrictions for mortgages suggest a frightening ignorance about our vulnerabilities exposed by the global financial crisis. The move had been well signalled and the primary goal is to ensure the stability of our financial system. We should be more concerned that the banks fail to perceive any concerns themselves.

It is worth summarising the key features of the GFC to emphasise our vulnerability to future financial shocks. The GFC was the outcome of a combination of circumstances rather than the actions of a few greedy bankers. The emergence of major new players in the global economy such as China , Russia and India has unleashed a huge pool of cheap labour and manufactured output on the world economy.

These countries are seeking to export their way to prosperity. Many have been running massive trade surpluses. They have recycled these surpluses back to developed countries in the form of easy credit. Meanwhile, most Western economies deregulated their banking sectors in keeping with their belief in free markets. These deregulated banks eagerly acted as conduits for the huge pool of credit available on world markets. Until 2007, banks in New Zealand made full use of easy overseas credit to flood our mortgage market creating massive housing inflation.

The Reserve Bank even sent a delegation to Japan to discourage it from lending to us. In the United States the pool of decent borrowers quickly dried up so the sub prime mortgage market was born. This eventually viciously exposed the frailties of the international money merry-go-round.

The other key feature that has impacted on many developed economies has been the growth in income inequalities. The real incomes of middle and lower income earners have largely stagnated. But this stagnation has been disguised by easier access to credit in the form of credit cards and consumer and mortgage finance. Previous generations found it much harder to access credit. People have been encouraged to live beyond their means.

The GFC exposed these fault lines in the world economy. Most developed nations avoided a complete financial meltdown by resorting to aggressive monetary policies. This included reducing interest rates to record lows or quantitative easing.

This is like putting a surgical dressing on a wound that fails to heal. Unfortunately the looser monetary policy in New Zealand has contributed to a resurgence in housing inflation in certain regions. The Reserve Bank is faced with the stark choice of raising interest rates or using a more surgical approach such as LVR's.

The gaping wound is the fact that most developed economies are still living beyond their means. They are financing their lifestyles by borrowing from developing countries with trade surpluses. Shopkeepers cannot keep financing their customers indefinitely.

The key lessons we should have learned are that we are a tiny country in the global economy. Our housing market experienced a credit induced bubble before the GFC but never really corrected. The huge private debt levels remain. This means we are very vulnerable to external shocks. These could include a rapid drop in our exchange rate or a major export scare. A more likely scenario is a rise in domestic interest rates.

A further issue is that banks do not always get it right. Their primary concern is their bottom line rather than the stability of the financial system. Individual bankers are motivated by bonuses, commissions and market share. Any who express misgivings about the combined effects of their lending practices on an economy would likely need to seek alternative employment. This is why the Reserve Bank has acted by introducing LVRs to reduce reckless lending in a dysfunctional global economy full of potential shocks.

Our cost of living is likely to continue to rise. Consumers in developing economies are competing directly for basic commodities such as meat, dairy products and petrol. Like other developed nations our inflation rate has been subdued by the influx of cheap manufactured goods from developing nations.

This has caused major job losses in local firms unable to compete, depressing wage growth and inflation pressures. Unfortunately you can't eat a smartphone or sleep under a Samsung tablet. We need to recognise our vulnerability in the global economy. The Reserve Bank should be applauded for trying to bring us to our senses. Our politicians seem less willing to do so.

Peter Lyons teaches economics at St Peters College in Epsom and has written several Economics texts.