UPDATE: There was also a release yesterday of some Reserve Bank papers on these issues.  The Reserve Bank papers are described as being released in response to OIA requests.  The Treasury papers were pro-actively released, but apparently in coordination with this Reserve Bank release.  I have not yet read the RB papers.

I got home late last night and missed the significance of Stuff’s story about the newly-released Treasury papers on the Reserve Bank’s proposed new LVR controls.

But reading the package of material that The Treasury released, it does not paint a particularly pretty picture.

First, it is interesting that Treasury has pro-actively released this material, about the proposed investor restriction that the Reserve Bank is currently consulting on.  It was not extracted from them reluctantly by a citizen’s Official Information Act request.  One assumes that they released the material with at least the acquiescence of the Minister of Finance.   I’m all for transparency, but this release suggests something quite uncomfortable about relationships between the Reserve Bank, Treasury, and the Minister –  something already hinted at in the Minister’s comments on a couple of occasions about the Bank’s handling of monetary policy.

I don’t agree with everything in the Treasury papers –  for example, invoking the results of a DSGE model as a basis for advice on the timing of a relaxation of LVR limits is not particularly persuasive.   But the bottom line seems to be that Treasury, the government’s chief economic policy advisers, are also not convinced that the case has been made for the proposed new investor controls.

For the moment, as they note, decision rights on these matters rest exclusively with the Governor, but if the Governor can’t make his consultative paper convincing to The Treasury  –  who are by no means as sceptical of the general case for active regulatory interventions in this area as I might be  –  it should be a little concerning to the rest of us.

Here is what Treasury had to say on the substance a month ago in their aide memoire to the Minister on the Bank’s consultative document:

Overall, we do not think that the consultation document makes a compelling case for the proposed use of these macroprudential settings, due to the concerns below. Nevertheless, the RBNZ does have the decision rights, and so our focus will be to work with the RBNZ to make improvements in some key areas. Our main focus will be to encourage:

• Clarification of the problem identification, evidence and channels. We accept that house price changes can have macroeconomic implications, but the RBNZ’s mandate is to promote financial stability. Therefore, the policy should be reframed to focus more clearly on reducing systemic risk, rather than on prices in a particular market.
• Additional evidence on the investor segment. The evidence presented is somewhat mixed on the extent that high-LVR investors underpin systemic fragility, as they are a relatively small part of the market and many may be able to alter their portfolio. Similarly, we will be asking the RBNZ to provide further information on the extent to which the increase in investor activity may have been encouraged by the original LVR policy.
• Discussion on the risks of relaxation of the speed limit outside of Auckland should credit growth and prices pick up again. Although we appreciate that the policy was designed to be temporary, and that the RBNZ prefer light touch regulation, there are a number of potential downsides. In this case, the policy rule is not clear, and the RBNZ policy settings are reactive to recent data. This may lead to an active management of policy settings, which may increase market uncertainty and reduce RBNZ credibility. This is particularly important around LVR limits – Treasury modelling using a DSGE framework suggests that the costs of taking the limits off early may be greater than leaving them in place for longer.
• Evidence from policy evaluation and additional cost benefit analysis of this policy to be published, including with respect to the other options available. The consultation paper contains little discussion on some of the possible unintended consequences, such as: increased risk of disintermediation or higher non-bank lending; the possibility of shifting demand towards cashed-up buyers; or risks that investors leverage up property outside of Auckland. We will also be asking the RBNZ for more detailed evaluation on the impact of the existing LVR policy, and of the unintended consequences compared with the impacts anticipated in the Regulatory Impact Statement.

The points expressed about process are also a bit disconcerting:

Process

A robust process of consultation is a characteristic of good regulatory practice and should occur within government at the options stage well before the policy is made public.

The late notice and lack of consultation complicates the ability of government agencies to coordinate, which could lead to government policy that conflicts or pays inadequate attention to government’s wider economic objectives.

We will raise these issues with RBNZ and propose process changes to address these concerns.

As I noted in my address last night, under the current Reserve Bank Act model the Governor comes close to being prosecutor, judge, and jury in his own case.  That is a dangerous feature.  Managing the risk makes it all the more important that the Bank goes out of its way to engage pro-actively with the Minister and with Treasury when it is proposing new regulatory measures.  Consultation matters for a whole variety of reasons, but Treasury’s views and questions can, among other things, offer one arms-length test of just how persuasive the Bank’s arguments are.

A more pro-active release policy from the Bank would also be welcome.  Perhaps, for example, the Reserve Bank could consider posting all submissions on the current consultative document on the Reserve Bank website, as and when they are received.  These proposals need all the scrutiny and debate they can get.

Last night I spoke to the Wellington branch of LEANZ on “Housing, financial stresses, and the regulatory role of the Reserve Bank”. They had a good turnout and some stimulating discussion ensued.

The text of my address is here

Housing, financial stresses, and the regulatory role of the Reserve Bank LEANZ seminar 25 June 2015

The presentation was organised in three parts:
• Making the case that high house (and land) prices in Auckland are largely a predictable outcome of the interaction of supply restrictions and high target levels of non-citizen immigration. With, say, 1980s levels of non-citizen immigration, New Zealand’s population would be flat or falling slightly. Much of that ground will be familiar to regular readers of this blog.   It matters because what has raised house prices in New Zealand is very different from what raised them in the crisis countries. In the United States, government policy initiatives systematically drove lending standards downwards in the decade prior to the crash, and in Ireland and Spain, imposing a German interest rate on economies that probably needed something more like a New Zealand interest rate systematically distorted credit conditions across whole economies. New Zealand – and other countries with floating exchange rates and private sector housing finance markets – had no such problems.  Credit was needed to support higher house prices in other advanced economy, but it was not the driving force behind the boom.

If I am right that the New Zealand house price issues result from the interaction of our planning regime and our immigration policy, then these are structural policy choices that systematically overprice houses, largely independently of the banking and financial system.  They are not ephemeral pressures –  here today and gone tomorrow.  They have been building for decades.  I hope they are reversed one day, but there is no market pressures that will compel them to (any more than there are market pressures that compel the reversal of planning restrictions in Sydney, London, or San Francisco).  These distortions are not making credit available too easily and too cheaply right across the economy  (which is the single big difference between NZ or Australia, and say the Irish, US or Spanish situations).  They are simply making houses less affordable.   The Reserve Bank has no better information than you, I, or the young buyers in Auckland do, on whether and when those policy distortions will ever be reversed.   And even if the policy distortions were corrected, it is pretty clear that real excess capacity (too many houses, too many commercial buildings) is a much bigger threat than simply an adjustment in the price of banking collateral.   No one thinks Auckland has too many houses, or too much developed land.

• The core of the paper was the proposition that the Reserve Bank’s actual and proposed LVR restrictions appear both unwarranted by, and inconsistent with, the Reserve Bank’s statutory mandate to promote the soundness and efficiency of the system. In subsequent discussion, a very senior lawyer went so far as to suggest that the Bank might even be acting ultra vires. My arguments around the LVR policies had a number of dimensions including:
o The almost total absence of any sustained comparative analysis of the international experience of the last decades, including the issue of why some countries (Spain, Ireland, and the United States) had very nasty financial crises and housing busts, and others (New Zealand, Australia, the UK, and Canada) did not.
o The lack of any engagement with New Zealand’s own experience in the last decade. Risks appeared much greater in 2007 than they are now, and yet the banking system came through a severe recession, and sluggish recovery, unscathed.
o The lack of willingness to engage openly with the results of the one piece of sustained work the Bank has done, the 2014 stress tests, which suggested that the New Zealand banking system, on the current composition of their asset portfolios, could relatively easily withstand even a very severe shock.
o The failure to address the efficiency dimension of the Bank’s statutory responsibility. Both the actual and proposed LVR controls will impair the efficiency of the financial system.
o The failure to identify and address the distributional implications of the controls.
o The failure to grapple with the limitations of the Bank’s (and everyone else’s) knowledge. There might be an arguable case for controls if we could be sure a crash was coming 12 months hence, but in fact the Bank has no better information than you or I do as to when, or if, there will be a substantial fall in nominal house prices.

• Discussion of the regulatory powers of the Bank, and its governance. As I put it in the conclusion:

These concerns bring into focus the weaknesses that have become increasingly apparent in the Reserve Bank Act. That Act was a considerable step forward in 1989, at a time when only a modest and limited role was envisaged for the Reserve Bank. But it is now 2015, and the legislation is not consistent with the sorts of discretionary policy activities the Bank is now undertaking, with modern expectations for governance in the New Zealand public sector, or with how these things are done in other similar countries. Doing some serious work on changing the single decision-maker model would be an excellent place to start, but it is only a start. A much more extensive rethink and rewrite of the Act, and the Bank’s powers, is needed to put in place a much more conventional model of governance and accountability, especially in these regulatory areas.