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AUG 13

RBNZ looks set to take a positive step

The risk of asset bubbles forming, and eventually bursting is a significant risk to our countries financial stability. This risk is not new: the U.S. housing market bubble and crash which fuelled the global financial crisis in 2008 and the bursting of the housing bubble in 2007 on both sides of the Irish Sea are some recent examples. When financial stability is in question, asset values tumble, debt both increases and becomes increasingly difficult to sustain and the real economy falters as we have seen in Spain, Greece and Cyprus in particular.

The Reserve Bank (RBNZ) look set to introduce Loan to Value Ratio (LVR) “Speed limits”, one of the macro prudential tools outlined in their memorandum of understanding earlier in the year. This would mean essentially limiting the number of loans banks can create over a set LVR.

These “speed limits” would be introduced with two aims:

  1. Dampen housing demand. Although some of the house price increases are due to a lack of supply, particularly in Auckland, this tool attempts to reduce demand by limiting the number of low deposit mortgages which are created.
  2. Reduce risk to financial stability. The low deposit or high LVR mortgages carry a higher risk of default when interest rates rise or the economy hits more difficult times. Limiting the number of these will lower the risk to overall financial stability. 

Although it is clear that this will make it more difficult for some first home buyers to enter the market until further savings are made, this is a much needed policy shift. Both Government and the opposition have called for exemption for first home buyers, but this is a purely political reaction. They should understand the need for these speed limits, and any exemption for first home buyers would serve to essentially defeat the purpose of the policy altogether; as first home buyers tend to be one of the house market drivers and make up a large portion of low deposit loans.

If macro prudential tools, such as these LVR limits are not introduced the RBNZ may be forced to move the OCR much earlier than expected, even in the face of low inflationary pressures. This would have a severe negative effect on manufacturers and exporters, causing an increase in the already significantly overvalued exchange rate and increasing the cost of borrowing.

There is more to asset markets than the availability of finance; supply, tax distortions that attract investors, all play a role. Despite much of the OECD already having a Capital Gains Tax in place, Government refuses to move in this policy area. Perhaps this is just too much of a political risk facing an election next year with many wedded to property speculation.

This tax distortion provides incentive for investment into land and property, rather than productive areas, where it could provide jobs, growth and fuel innovation, due to the tax free gain when selling property which has increased in value. The introduction of a Capital Gains Tax would also help to curb the property investment mind set of Kiwi’s. It is worth considering where the value comes from, for example in Flatbush, over 16 years a bit of land increased from $890,000 to over $112m – who paid for the increase? It is the same bit of land. The increase is paid by debt and transfers from the real economy, hence the two speed economy: strong growth in the non-traded sector and contraction in the traded sector. Is this sustainable? I think not.

While the introduction of LVR limits by the RBNZ will be a step in the right direction, there are other tools which should also be used along side this and the OCR. This could be achieved through changes to the Reserve Bank Act:

  • Targeting more than just price stability, including the exchange rate.
  • Limit lending on other asset classes, for example, farms.

These changes, alongside the introduction of a Capital Gains Tax would go a long way in addressing the challenges confronting our traded sector today and helping to provide a more supportive environment for manufacturing and exporting to grow, benefiting all New Zealanders. 

tags: rbnz, reserve bank of new zealand, housing, loan to value ratio, speed limits, capital gains tax
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