Investor finance restrictions

The Reserve Bank is consulting on the Governor’s proposal to ban loans with an LVR in excess of 70 per cent for residential investment property businesses in Auckland.  I have written quite a bit on this proposal since it was first revealed when the FSR was published in mid-May, and was hesitant about spending more time on the issue (my kids would have preferred another board game or two). But I did decide to write something.

Submission to RBNZ investor finance restrictions July 2015

Submissions close on Monday.

Here are a few extracts from the introduction and conclusion of my (not overly long) submission.

As I have noted in various pieces of public commentary on this proposal, in such matters the Governor effectively acts as prosecutor, judge and jury in his own case.  As such it is difficult to have any confidence in the consultative process –  it is simply implausible that the  single person actively and publicly proposing such restrictions can take a properly dispassionate and impartial approach to assessing submissions on the proposal.    The proposed turnaround time, from the closing date for submissions to the release of the final policy position (“early August”), casts further doubt on the seriousness, and open-mindedness, with which the Bank (the Governor, as sole decision-maker) is approaching the consultative process on the substantive proposal (as distinct perhaps from the fine operational details).   Confidence in the process is further undermined by the fact that no cost-benefit analysis has been provided for the proposal.   We all know that cost-benefit analysis, in the right hands, can be generated to support any proposal, no matter how egregious, but proper cost-benefit analysis at least force the preparers to write down their assumptions, which enables them to be scrutinised, debated, and challenged.

My concerns about the substance of the proposal fall under five headings:

  • The failure to demonstrate that the soundness of the financial system is jeopardised (this includes the failure to substantively engage with the results of the Bank’s stress tests).
  • The failure of the consultative document to deal remotely adequately, with the Bank’s statutory obligation to use its powers to promote the efficiency of the financial system.
  • The failure to demonstrate that the statutory goals the Bank is required to use its power to pursue can only, or are best, pursued with such a direct restriction.
  • The lack of any sustained analysis (here or elsewhere in published Bank material) on the similarities and differences between New Zealand’s situation and the situations of those advanced countries that have experienced financial crises primarily related to their domestic housing markets.
  • The failure to engage with the uncertainty that the Bank (and all of us) inevitably face in making judgements around the housing market and associated financial risks, and the costs and consequences of being wrong.

The absence of any substantive discussion of the likely distributional consequences of such measures is also disconcerting.  Distributional consequences are not something the Reserve Bank has ever been good at analysing.  In many respects they were unimportant when the Bank’s prudential powers were being exercised largely through indirect instruments (in particular, capital requirements) but they are much more important when the Bank is considering deploying direct controls.  In particular, the combination of tight investor finance restrictions in Auckland and the continuing overall residential mortgage “speed limit” is likely to skew house purchases in Auckland to cashed-up buyers.  In effect, to the extent that the restrictions “work” they will provide cheap entry levels.  New Zealand first home buyers and prospective small business owners will be disadvantaged, in favour of (for example) non-resident foreign owners.    At very least, it should be incumbent on the Bank to spell out the likely nature of these distributional effects.


The restrictions proposed by the Reserve Bank do not pass the test of good policy.  The problem definition is inadequate, the supporting analysis is weak, and the alignment between the measures proposed and the statutory provisions that govern the use of the Bank’s regulatory powers is poor.

Reasonable people might differ on when policy tools should be deployed, but we should be able to disagree on the basis of much more extensive, robust, and well-documented background material than has been presented in this consultative document.   At present, the evidence that we do have suggests that the New Zealand banking system is strong and highly resilient, with no sign that there has been any serious or disconcerting deterioration in lending standards.  The Reserve Bank appears to be mistaking high house prices that result from real structural factors (land use restrictions and immigration policy), with those that results from a credit-led process.  The latter might argue for much tougher prudential controls, though probably still less distortionary indirect ones.     But there is simply no evidence at present of such a credit-led process.  Yes, house purchases need to be financed, but that appears to be a largely passive facilitative process, which poses no materially enlarged threat to the soundness of the financial system.

A brickbat and a bouquet for Treasury

A brickbat and a bouquet for Treasury this morning, following from the pro-active release yesterday (albeit with many deletions) of papers related to this year’s Budget.  Pro-active release is a welcome practice that should be more widely adopted.  Indeed, in some form it is a practice that should generally be made mandatory.

First the brickbat.  Very late in the Budget process, as the government continued to flail around with an apparent sense that “something must be done” about the housing market, but a reluctance to expend political capital to actually address the underlying issues (land use restrictions and the active policy-driven programme of inward non-citizen immigration), Treasury was asked for some advice on several tax options.  None involved serious or thoroughgoing reform of the overall tax system  (eg land tax, taxing imputed rents, shifting the basis of local authority rates back to land values, inflation-indexing the tax system (which reduces the value of interest deductibility), or even less desirable measures such as a comprehensive capital gains tax, or ring-fencing the ability to offset losses on rental properties).  Instead, they were patches, or worse.  Treasury compounded the problem by throwing in its own proposal –  an Auckland Investor Levy.

By this point, Treasury was probably under quite unreasonable pressure.  As they bluntly note in their 24 April Treasury Report, “because of the very short timeframe, this is a longer and less considered report than we would normally provide”.  That is not a good basis for making policy.  But public servants must respond to the demands of their Ministers.

The Auckland Investor Levy –  a 1 per cent annual levy on the value of residential rental property –  appears not to have been the Minister’s idea, but a proposal of officials.  Perhaps they saw it as something less bad than other possibilities canvassed in the paper (such as an interest levy).    But this is not just an idea that Treasury is reluctantly providing pros and cons on.  They recommend to the Minister to “consider progressing” such a tax.  Much of the discussion of the proposed Auckland Investor Levy has been withheld in the document that is released, but the summary table at the back of the paper makes it clear that Treasury is pretty sympathetic to this option.

And yet:

  • There is no analysis in the paper to explain why Treasury believes that investors, as opposed to (say) owner-occupiers are a  particular “problem” in the housing market.
  • There is no discussion of how the “tax advantages” of housing are distributed among owner-occupiers and investors.  Previous analysis has suggested that unleveraged owner occupiers are at the greatest advantage.
  • There is no apparent attempt to reconcile this proposal with the more general point that there appear to be too few houses (or at least too little effective land supply) not too many.
  • There is no analysis in the paper to justify why such a wealth tax should be so partial.  Why impose a levy on investor residential properties, and not on owner-occupier ones?  Why houses and not commercial buildings?  Why rental houses and not farms or equities?
  • Treasury proposes hypothecating the revenue from this (supposedly temporary) levy to the Auckland Council, and yet there is no discussion (released) of the difficulty of lifting the levy in future (and thus depriving the Council of a major revenue line).
  • There is no discussion of the efficiency costs (or the equity) of having one tax system for Auckland, and one for the rest of the country.

In a rushed paper, I’m not suggesting that Treasury could have fully adequately dealt with each of these issues, but it is pretty inexcusable that these issues are not even mentioned.

And the bouquet.  Media reports indicate that Treasury proposed ending public funding of Kiiwrail and either markedly reducing the size of the operation, or closing the company altogether.  Given the amount of money that has already been sunk into Kiwirail, in one sense it would be a shame if it were to come to that.  But sunk costs are sunk costs, and unfortunately it does not appear that the analysis underpinning the earlier injections was particularly robust.  I don’t suppose Treasury expected that Ministers would agree to their proposal, but it is good that it was made.

It is particularly encouraging that the recommendation was presumably endorsed by the Secretary to the Treasury.  I spent a couple of years on secondment to the Treasury, which overlapped with the early days in Treasury of Gabs Makhlouf, fresh from the UK.    A major discussion was held one day to try to gravitate towards an agreed “narrative” on the reasons for New Zealand’s disappointing long-term economic performance.  Gabs’s contribution was to observe that New Zealand’s problem was that it had underinvested in rail.  Britain developed railways and exported the technology around the world, and New Zealand never really took advantage of it.    Fortunately, it did not seem to be a widely held view.  I guess Gabs has learned.  A while ago I asked for a copy of an “economic narrative” document Treasury did in 2013.  If and when it arrives, it will be interesting to see how the Makhlouf Treasury now accounts for New Zealand’s disappointing longer-term performance.