Though singing the same popular and parsimonious refrain as his predecessor, Steven Joyce’s big announcement on cutting debt blithely ignored the country’s real debt problem, which lies conveniently off the Government’s books.

Announced, predictably enough, to the Wellington Chamber of Commerce last week, Joyce’s budget preview revealed the government’s net debt target would fall from its current goal of 20 percent of GDP by 2020 to between 10 and 15 percent by 2025.

It’s a high stakes game for a newly minted finance minister keen to make his mark on the portfolio in election year. Not only has National staked its reputation on being a prudent fiscal manager — a claim that will be tested on September 23, but Joyce occupies a precarious position in cabinet, holding a sought-after portfolio that might become a valuable bargaining chip in any post election coalition deal.

His argument for reducing the country’s debt-to-GDP ratio seems sane enough — if inexpertly argued.

“We are a geologically young country, and we are also a small country in an often turbulent world, so there are plenty of bumps ahead in the road ahead of us, whether they are natural disasters or from international events,” Joyce said.

In spite of his confusing phrasing — most countries are ‘geologically’ more or less the same age (that age being millions of years old) — Joyce’s dog whistle will have caught the ear of the electorate. This veiled threat isn’t about finance, it’s about tectonics. The finance minister is telling his public that if it is to weather another geological shock like the Christchurch earthquake, it will need to keep its debt at sustainable levels.

The problem with Joyce’s announcement is that he’s not looking at the right debt, a point made by ACT, whose leader and only MP, David Seymour said of the announcement:

“When private debt is more than four times’ worse [than public debt], the emphasis needs to be on returning Government surpluses to households and businesses.”

Private debt has ballooned under this Government, fuelled by rising house prices and slow wage and productivity growth.

National’s disregard for the ticking time bomb at the heart of its ‘rockstar economy’ is reminiscent of another crisis in a similarly lauded boom. In 2008, over the space of a few short months, Ireland found its model ‘Celtic Tiger’ economy brutally refashioned into one of the PIIGS, (Portugal, Italy, Ireland, Greece and Spain), pariah economies and poster children of fiscal indiscipline.

Ireland, with a population of roughly 4 million had enjoyed years of intoxicating GDP growth, reaching nearly 11 percent at the turn of the millennium, before stabilising around 5-6 percent the following decade. And unlike its spendthrift continental neighbours like Greece, Italy, and Spain, which fuelled economic booms with the fiscal dopamine of public debt, the Irish government held back. It ran near consecutive surpluses from 1997 to 2007, reducing its debt to GDP ratio close to the Joycean (Stephen, that is) sweet spot of 23.9 percent.

Then, of course, came the crisis. It emerged Irish banks had not exercised the same level of fiscal restraint as their government. Like banks around the world, those in Ireland discovered they had a disturbing number of bad mortgages on their books.

As Ireland’s GDP soared to stratospheric heights, the country’s homeowners enjoyed a massive property bubble. By 2005, the Economist ranked Ireland’s property market as among the world’s most overvalued (a distinction the magazine bestowed on New Zealand earlier this year), yet prices still went up, fuelled by indulgent lending.

Irish banks saw the total stock of mortgage loans blow up from €16 billion in the first quarter of 2003 to a peak of €106 billion by the third quarter of 2008, about 60 percent of Ireland’s GDP for that year.

As, one by one, private banks began to falter, the Irish government issued a guarantee of the debt on their books — an urgent measure designed to preserve the system’s liquidity and the solvency of the banks. This guarantee became a €64 billion bailout, which combined with falling tax revenue as a result of the contracting European economy, saw net government debt skyrocket to 119.5 percent of GDP in 2012, from just 23.9 percent in 2007.

Ireland’s mounting debt became too much to handle. In 2010, it conceded the banking crisis was too large for it to handle alone. It applied to the IMF and EU for an urgent loan to prop up the banking sector and its own government spending. An urgent €85 billion bail out was granted within a week. Ireland entered an era of punishing austerity, and ceded control over certain budgetary decisions to its creditors. Its national debt remains high at 78.6 percent of GDP.

If any moral can be drawn from this Gaelic parable it is that despite a government’s discipline, bad private debt can quickly become public debt in the midst of a financial crisis. This is a problem that should give Joyce pause for thought, had he not had many months to contemplate it already. The Economist is not the only authority to point the finger at New Zealand’s housing market, the IMF and even the Reserve Bank of Australia have also expressed misgivings.

In March, after one of its regular visits to New Zealand, an IMF mission concluded while the immediate outlook for the New Zealand economy was good, housing affordability and the stress this placed on the banking system was a problem. If there was a significant global shock, they warned, the high levels of household debt held by New Zealanders (an astronomical 168 percent of disposable income) risked destabilising the economy should a global shock lead to conditions that made it difficult for New Zealanders to repay their mortgages.

Just a month after the IMF report was delivered, the Reserve Bank of Australia, in one of its regular reports on the stability of the Australian financial system, decided it was competent to cast its own aspersions on New Zealand’s private debt problem, because Australian banks, which hold most New Zealand private debt through subsidiaries, were severely exposed and potentially threaten Australia’s financial system.

The Australian report drew out some interesting specifics. It alleges nearly a third of new loans have a high debt to income (DTI) ratio. Worse, unlike Australia, the investor share of all new loans is high (40 percent in mid-2016). This presents a further risk as these investors are likely to sell quickly in a downturn, compounding its effects.

Like the IMF, the Australian report endorses the New Zealand Reserve Bank’s desire for a DTI tool that would supplement the existing loan to value tool to bring this bad debt under control. This was perhaps a thinly veiled message to Stephen Joyce, who in February made it clear he would not be instituting the policy.

The insistence on a DTI tool is revealing. The onerous mortgages of people whose incomes place them at risk has the potential to destabilise our banking system, the way it did Ireland’s.

Joyce’s dismissive response, that he has advised households to consider how much debt they take on, is an obvious attempt to divert attention from the fact that housing is the chink in the armour of National’s lauded economic credibility.

Most homeowners are simply borrowing more heavily to do what New Zealanders have always done — take out a mortgage to invest the bulk of their savings in a solid, bricks and mortar asset. To say, in an election year, that this was no longer possible and to legislate to make it even more difficult would be to concede the country’s stellar GDP growth hides several grim economic statistics: dismal GDP per capita growth, dismal productivity growth, and dismal income growth compared with the cost of living.

Joyce will have to face up to criticism that poor income growth and rampant house price inflation under this Government’s watch will have placed home ownership out of the reach of most New Zealanders. To adequately respond to this crisis, the Government will need to confront its own economic record — an impossible task in an election year, but if swept under the rug an Ireland-style crisis could wreak far greater damage on National’s economic reputation. 

Leave a comment