In his weekly column in today’s Herald, Brian Fallow outlines and reviews some of the criticisms I have made of the Reserve Bank’s proposed Auckland investor property finance controls. The accompanying cartoon (only part of which is online) shows pygmies attacking the giant Wheeler, secure in his moated castle.
Fallow’s piece is a very fair presentation of some of the arguments I have made, particularly in my LEANZ address last week (and he also notes the Treasury’s evident disquiet about the proposed controls). I’m not going to repeat old material here, but will just highlight a couple of the points that arose in subsequent discussion.
Brian noted that Grant Spencer, the Bank’s Deputy Governor, has often argued that even though the stock of debt is not currently growing rapidly, there are a lot of new loans occurring and hence the risks are rising. My response to that point is that, in normal times, there will always be lots of new loans, and lots of repayments going on. It is great that the Bank is now collecting more detailed flow data that enables us to better see that breakdown. But because we have no historical time series, we don’t have any good basis for interpreting it, and knowing what it might mean about risk. In particular, as I noted, we don’t know what the pattern of new loans vs repayments was in the credit and housing boom of 2003 to 2007 when, for example, housing turnover was much higher (and from which episode, as a reminder, banks emerged unscathed). That drives me back to the international empirical literature on crises, which suggests that big increases in the stock of debt (relative to GDP) over short periods of time has been one of the best indicators of building crisis risks. Of course, historical empirical work is also limited by data availability, but at this stage with no material increase in debt to GDP ratios, and no sign of any material deterioration in lending standards, there doesn’t seem a basis for great concern about financial stability in New Zealand.
I have also suggested that the Bank should be doing more careful comparative research and analysis on the similarities and differences between New Zealand’s situation and those of countries that have had nasty housing busts (US, Spain ,and Ireland) and those that did not (UK, Canada, and Australia for example). Brian posed the reasonable question as to whether people won’t just focus on the superficial similarities and differences, cherry-picking points of similarity or difference that suit their own argument. That is a risk, but in a sense that is the point of doing research and analysis (for which the Bank has far more resources than any else in New Zealand), and making it available. It enables informed debate to occur, and each piece of data or analysis is open to scrutiny and challenge. The contest of ideas and evidence is a big part of how we learn.
Fallow concludes his article thus:
A financial crisis is a low probability but high-cost event, as the Treasury says. If you focus on the low probability, like Reddell, the conclusion is that the bank should pull its head in. If you focus on the high potential cost, like Wheeler, you would want to do whatever you can to slow the growth in house prices and buy time to get more built and for the net inflow of migrants to return to more normal levels.
Maybe, but actually I suspect that misrepresents both Graeme and me. Graeme Wheeler probably thinks the probability of something nasty happening in the New Zealand financial system in the next few years is higher than I do. And I’m not just focused on the low probability of serious financial stresses. That is the importance of stress tests. They aren’t probability-based. Instead, they take an extreme scenario (in the Bank’s stress tests, a tough but appropriate extreme scenario) and examines what happens to banks if the scenario happens. On the evidence the Bank has presented so far, the soundness of the financial system is not jeopardised in such an extreme scenario. Whatever Graeme Wheeler’s personal inclinations or feelings, a threat of that sort is the only statutory basis on which the Reserve Bank should be acting.
What the government does is, of course, another matter. I reckon it should be doing more about liberalising land use restrictions and, since large scale change in these restrictions seems unlikely, should probably reduce the very high target level of non-citizen immigration.