A few more points struck me about the Reserve Bank’s latest FSR.  This longer post is about housing, and later in the day I’ll touch on another couple of issues.

There seems to have been a knee-jerk reaction, including in newspaper editorials this morning, that we should be grateful to the Reserve Bank that “something is being done” by someone, anyone.  That is a terrible way to make policy.  If a child is drowning no one cares who jumps in to rescue the child so long as someone does.  But if a child has a serious illness the last thing we want is random enthusiasts (let alone powerful government agencies with the coercive force of law behind them) jumping in with their own patent remedies.  The Auckland housing situation (a social and political scandal, as I’ve said before) calls for careful diagnosis, informed by experience and insights from the rest of the country, and remedies that deal effectively with the underlying issues and causes.

Banning banks from lending a cent over 70 per cent of the assessed value of a property to “investors” in “Auckland” is a solution in search of a real problem.  What makes the Governor so sure that 10 per cent of Auckland mortgage lending can safely be made in loans over 80 per cent of the value of the property if the buyer is an owner-occupier (or, apparently, some classes of bach owner), but that not one cent can be safely advanced to “investors” for more than 70 per cent of the value of the property? On the evidence of the FSR, there is nothing solid to provide that confidence, but perhaps there will be more in the forthcoming “consultation” document?

Controls are begetting controls, but controls also beget disintermediation.  One of the arguments in 2013 for the “speed limit” approach to LVR restrictions (as opposed to a blanket ban) was that it would limit the extent of disintermediation (mortgage lending business moving from banks to other lenders).  But now the Governor himself is resorting to a blanket ban, in respect of people running small businesses, who typically have a greater degree of financial sophistication (including regular dealings with advisers such as lawyers and accountants) than most first home buyers.  Another reason why the Bank wasn’t too fearful of disintermediation was the belief – which I think was real at the time, but in fact was just another misplaced hunch – that the controls would be short-lived.  That has also gone out the window now, with controls layered on controls (lending restrictions on banks still exist in the rest of the country, where house prices rose 2 per cent in the last year).

Non-bank lenders (especially non deposit-takers, over whom the Reserve Bank has no regulatory control) will probably be busy this morning planning how to gear up their businesses.  I wonder what assurance can the Reserve Bank offer that if fringe lenders gear up to provide loans to investment property purchasers (and have portfolios much less diversified than a typical bank’s) that both the efficiency and the soundness of the financial system as a whole will not end up impaired?  Perhaps again the answer will be in the “consultation” document?

For decades, bank supervision – dedicated to promoting the soundness and efficiency of the financial system, as Parliament required – went on behind the scenes.  Ordinary borrowers didn’t need to pay any attention to what the regulator was up to, and nor should they have to.   The Reserve Bank focused on ensuring that adequate buffers were in place in case something very nasty happened.  And they did that without directly impinging on any individual borrowers’ plans.   Risks to banks arise from whole portfolios of loans, not from individual loans to SMEs (which is what investment property purchasers, or refinancers, are).  The Reserve Bank set the minimum capital requirements based on whole portfolios of loans, and recognising systemic risks, and then private borrowers and lenders – surely better equipped for the job than any official – decided whether or not a particular loan made sense.     In the last couple of years there has been a sea change, and not for the better.

High Auckland house and land prices are almost entirely a reflection of poor quality policy: unnecessary central and local government rules that impede the ability of supply to respond adequately in the face of policy-fuelled rapid population growth[1].  It has almost nothing to do with credit policies of banks.  In again interfering with the credit policies of those private businesses, the Reserve Bank will be rather arbitrarily redistributing some gains and losses, while imposing some deadweight costs on the whole economy as the efficiency of the financial system is eroded (and probably that of the housing and holiday home markets as well).  The Bank’s actions will probably dampen Auckland prices a little, for a short time.  Some people will buy a little more cheaply than they might otherwise have expected, and others will miss out.   But where is “dampening house prices” as an objective in the Reserve Bank Act?

And all the while there is still no evidence of a systemic threat to the New Zealand financial system.    Yes, house prices might fall substantially at some point, but the Governor has no better insight than anyone else on when, if ever, the balance of regulatory land use restrictions and policy-fuelled population growth will change.  More importantly, his existing capital requirements have been shown, by the stress tests, to be able to cope if house prices do fall sharply.  Administering prudential policy to promote the soundness of the financial system is his job –  and he looks to have done it – not trying to protect some house buyers over others, or fussing over whether people might eventually lose money on a purchase, all with no better information about the risks than anyone else has.

In this morning’s Dominion-Post the Governor is again reported as invoking the spectre of the US post 2006 “bust”.  But if that really is the parallel he is worried about, he has shown no evidence, and produced no sustained narrative, to illustrate why he believes that is a serious threat here.   Is there, for example, any evidence of a sustained deterioration in lending standards here – as there was, induced by policymakers, in the US?   It is a little hard to believe when credit growth is so modest, and the evidence of his own stress tests argues against it.   But if he has a case, let’s hear it.  I upset the Governor deeply a couple of years ago when I suggested that New Zealand deserved better than one of the rushed documents being prepared in advance of the first LVR restrictions.  I’d repeat the suggestion now, but I’d reframe it:  the law requires him to do better.  Yesterday’s document just did not provide the material to allow us to assess the Governor’s policies, proposed, present, and past.  That reads like a breach of the law.  It might be something for the Bank’s Board to ponder when they discuss this FSR at their next meeting.

Actions like those of the Reserve Bank, going well beyond their statutory mandate, are threatening and damaging in more ways than one.  At a micro level, it disrupts the business and life plans of many people, adding to costs, and unnecessarily and arbitrarily skewing the playing field in favour of some classes of participants over others.  But it goes deeper.  Next month we mark the 800^th anniversary of Magna Carta, which recognises that the government and its agents are often a threat to our liberties and need restraining.   The ability of private firms and individuals to go about their business should be restricted only when there is clear evidence of harm.  And when government does intervene, citizens are required to obey the law, not just the wishes of bureaucrats, having to cow before ominous threats that they are “expected to observe the spirit of the restrictions” not yet in place (which seems to be drifting rather too close to something like the Fitzgerald v Muldoon case).  Perhaps some good might eventually come from the latest episode if it finally prompts some interest (beyond the Green Party and The Treasury) in reopening important questions about the governance of the Reserve Bank –  just how much power, and how many functions, we should vest in a single unelected official.

[1] Low interest rates probably play a part.   Equilibrium land prices are typically higher when real interest rates are low, but without supply and land use regulatory restrictions the pure land component of a typical suburban house + land package would be pretty small.    Unimproved rural land (the factor in genuinely fixed supply) trades at less than $50000 per hectare.