Reserve Bank doing the right thing in limiting banks' high loan to value ratio lending to cool property market.

You might think, for all the fuss about them, that the Reserve Bank's new loan restrictions are being introduced to punish hipster house hunters for ironic facial hair and forcing middle-aged people to wear uncomfortably skinny jeans.

But it turns out the Reserve Bank has other reasons for limiting the amount of high loan to value ratio (LVR) lending that the banks can do.

If you've heard him speak, you'll know that Reserve Bank Governor Graeme Wheeler makes an extremely good case for the new policy.

Although sad-faced young couples, who have missed out on their dream home because they need a bigger deposit, make a better-looking one and have been getting all the attention lately.


Personally, I was sceptical about the LVR policy precisely because it does put the squeeze on first-home buyers and makes it harder for them to get into the property market in the short term.

But I've been convinced that the reasons for introducing the policy are valid. I am still sceptical about the extent to which LVRs will actually work to change the market.

If the gap between supply and demand is wide enough, no amount of regulatory policy can hold back the market - just look at China where far heavier bank lending restrictions are doing little to cool the urban housing boom.

On balance, though, the Reserve Bank is doing the right thing in giving these measures a try. If they take the edge off the demand then they'll be a step in the right direction.

There are at least four good reasons for introducing LVRs.

The first is that they protect first-home buyers from being trapped into high levels of debt that they might not be able to service if interest rates rise dramatically in the next few years - which they are expected to do.

Given the projected interest rate rises of two full percentage points over the next two years, we are likely to see bank rates rise above 8 per cent and it seems entirely reasonable to imagine retail mortgage rates going above 10 per cent within the next five years. That's where they were in 2007 and in the 1980s they went much further.

Interest rates are currently at historically unprecedented lows and that is a dangerous place to be taking on a low equity mortgage.

Worse still, if were to see the kind of house price crash that happened in the US five years ago, then it is these people with the highest debt levels who will be most likely to hit negative equity.

In other words, they could be left owing more to the bank than the house is worth. In these conditions those with high debt levels lost their homes along with their deposits and all the rest of the money they had put into their homes.

So yes, it is a bummer if you've missed the chance to buy a house this year because of the LVRs.

But, if you can't afford a 20 per cent deposit on a house, then perhaps you can't really afford the house. And if that's not fair then it is not fair because of the fact that house prices are too high.

Which is a second good reason for LVRs. If they dampen demand they could potentially lower house prices. In Auckland and Christchurch they almost certainly won't, but they could help slow growth and that could buy some time for house hunters to keep saving for a deposit.

A third upside to LVRs is that if they work they will reduce the need for the Reserve Bank to raise interest rates as fast as it might have. That's good for all mortgage holders, especially new home owners with high debt levels.

Finally there is the official reason the Reserve Bank is introducing these restrictions. The bank has a statutory duty to ensure the stability of the New Zealand financial system for the good of the country. That means it has some control over how banks are allowed to behave.

The Reserve Bank is simply not comfortable with the banks holding a high level of low equity loans in the wake of the worst financial crisis the world has seen since the Great Depression. Debt was to blame for the crisis in 2008.

So to those who say the bank is being overly cautious, one can only ask: "Dude, what planet have you been on for the past five years?"

The Reserve Bank Governor doesn't put it quite like that. He uses a lot of facts and figures to make a similar point.

Wheeler was working in the US during the global financial crisis and saw firsthand what the meltdown did to the most vulnerable home owners. They lost their homes.

If you think the near total collapse of the global financial system in 2008 has been resolved and that we should allow ourselves to be lured back into a new era of loose credit, high-risk investment and property-led growth, then you are a plonker.

The reality is that there are still enormous structural problems with the global economy and the local economy that need to be resolved or we will repeat the cycle. Most of them involve dealing with debt.

House price bubbles are breaking out all over the world in response to the low-interest-rate environment that was needed to keep the system afloat after the crisis.

Just how we get back to normal settings without stifling the greenshoots of recovery is a hugely challenging issue.

What we do know is that GDP growth, house price inflation and even wage growth that is not backed by actual improvements in productivity is nothing but another bubble.

And another bubble would be bad for all of us. In fact it would be worse than bad. Given the lessons we should so clearly have learned from such a recent crisis, falling prey to another bubble would be an outright embarrassment.