If banks’ lending behaviour is found to have contributed to New Zealand’s housing quagmire, then banks must be held to account and share the pain when the bubble inevitably bursts, writes the University of Auckland’s Michael Rehm
New Zealand’s housing markets are in a quagmire. Kiwis suffer from the least affordable housing in the English speaking world.
The Labour-led Government is not proud of this and is aggressively crafting policies to re-instill affordability while simultaneously trying to promote home ownership. Successive governments, including the present one, have homed in on housing supply as the euphoric solution to the country’s housing woes. This supply-focused strategy is very popular worldwide and is politically convenient as it spurs job and economic growth.
Unfortunately, housing markets, in New Zealand and across the globe, are systemically broken in a way that expansion of new housing supply alone cannot fix. In New Zealand when supply-side solutions, namely the government’s flagship KiwiBuild, did not yield results, policymakers brainstormed for alternatives. The latest supply solution is the rushed Housing Supply Amendment Act, passed urgently under the long shadow of Covid.
The base assumption at the beginning of Covid was the pandemic would bring on intense downward pressure on house prices. To counter this, the existing demand-side policy measures such as strict loan-to-value restrictions were lifted and interest rates were slashed. Housing was deemed too big to fail. In effect, the Government and Reserve Bank offered market participants a crystal clear signal that they would not allow house prices to decline, despite the chronic, severe disconnect between prices and fundamentals such as rents and incomes.
As this market signal sunk in, the collapse of interest rates pushed real returns on alternative investments such as bank term deposits into negative territory. The net result was a flood of direct investment into housing. Residential investors in particular went on a home buying binge. While all forecasts assumed a collapse in house prices, the opposite occurred and prices exploded.
During this same time, new housing supply was breaking records each month and the borders were largely closed. Economics 101 did not offer a valid explanation for the antithesis that was unfolding. The Government knew it had to act and in March it effectively declared war on residential landlords by barring investors from claiming mortgage interest costs. The Government has also indicated a preference that the Reserve Bank wield its monetary policy tools to subdue demand from investors while sparing first time home buyers. In July the Minister of Finance added debt-to-income (DTI) limits to the RBNZ’s toolkit.
DTIs are now undergoing a second round of public consultations. It seems likely that if a DTI restriction were to be invoked it would lie at a level of six times borrowers’ incomes. Of course under such a policy setting, exemptions aside, roughly half of investors and one-quarter of prospective first home buyers could not purchase. Therefore it is unsurprising that politicians and the RBNZ are coy to implement a debt-to-income tool. Although the mechanism can re-establish the link between homeowners’ incomes and house prices in the long run, in the short run a DTI restriction is a nuclear bomb capable of vapourising house prices.
The Government is hoping to perform delicate surgery on the market and cut out investors, which they see as a cancer killing first home buyers’ chances of getting onto the property ladder. However, if the Reserve Bank applies a DTI, the result would amount to a poisoned chalice for first-time buyers as they will surely assume massive mortgages and be the first to fall into negative equity when house prices inevitably revert to levels supported by fundamentals.
Although landlord greed seems to be the primary target of the new housing policies, there is an even larger, greedier actor behind the housing markets: banks. Without the eagerness of banks to lend increasing amounts of debt onto the shoulders of owner-occupiers and residential investors, the current obscene prices would not be possible. Arguably, loosely regulated bank lending is the central reason behind the gulf between house prices and household incomes in New Zealand and around the world.
It is critically important to appreciate that when banks expand their lending they create new money in the process. Banks are not simply an intermediary between depositors and borrowers. The creation of new money is an immensely profitable enterprise, polar opposite to running a rental property ‘business’ which is primarily a gamble on future capital gains.
According to the Deloitte Top 200 Index, ANZ bank generated $1.8 billion in after-tax profit in 2020. With 9000 employees, that is just over $200,000 in annual profit (after operating costs and tax) per head. Much of this profit leaves New Zealand to be paid out in Australian dollars as dividends to bank shareholders.
New Zealand banking is unique within the OECD. According to the IMF, Australian subsidiaries account for 86 percent of New Zealand banking sector’s assets. The next highest foreign ownership is Mexico with 41 percent controlled by Spanish banks. New Zealand is in a league of its own.
The New Zealand Government has supported policies to dampen residential investors’ speculative demand but it seems reluctant to tackle the housing market head on in fear of hindering first home buyers or bursting the house price bubble. Given the Covid antithesis, which saw house prices unexpectedly skyrocket, the role of banks in inflating the bubble warrants investigation. If banks’ lending behaviour is found to have contributed to New Zealand’s housing quagmire then banks must be held to account and share the pain when the bubble inevitably bursts.