Stories about household debt and house prices are everywhere at present.  For anyone interested, Radio NZ’s Sunday morning show yesterday had a 20 minute (pre-recorded) discussion with Chris Green, of First NZ Capital, and me on some of the issues. I think we agreed on more than we disagreed, both emphasizing that large falls in real house prices have happened before and will, no doubt, happen again.  And the domestic economy is currently less robust than either Treasury or the Reserve Bank would have us believe.

The Radio NZ interviewer was, it seemed, keen to run with a narrative of mass collective irresponsibility, but as I’ve noted here before there is no sign that higher house prices are leading to a huge surge in consumption (any more than has happened with previous house price booms), and good reason to think that many people are very uneasy about the size of the debts they are having to assume to get into a first house.  I could have added that house sales per capita, and mortgage approvals per capita are not particularly high by historical standards.  Scandalous as the house price situation is, if there is a mania –  contagious exuberant optimism –  it must be very localized.

Tomorrow, I want to focus again on the Reserve Bank’s stress tests and how we should think about those results.  But before getting into that, it is worth briefly repeating a few other relevant points.

First, there is the constantly repeated claim, especially from some commentators on the left, that the system of banking regulation incentivizes banks to lend on housing security, skewing their whole portfolios towards housing lending, beyond the natural levels justified by the underlying riskiness of different classes of loans.     That is simply false.    The essence of the argument is that in calculating capital requirements, loans secured on housing generally carry a lower “risk weight” than most other forms of bank credit.   They do, and that is because such loans are generally less risky.  Compare a loan secured on an existing house in an established suburb, supported by the wage or salary income of the occupants, with a loan to a property developer for a new project on the fringe of a fast-growing town and you start to get a sense of the difference in risk.   If anything, the initial risk-weighted capital regime (Basle I) probably overstated the riskiness of a typical housing loan and understated the riskiness of many corporate loans (and sovereign exposures for that matter).  In the shift to Basle II, many countries appear to allow banks to reduce risk weights for housing exposures too far.  New Zealand (the Reserve Bank) was much more cautious (even than, say, APRA in Australia).  As I’ve noted previously, the IMF has accepted that New Zealand’s housing risk weights are among the highest used anywhere –  other countries have been coming towards us.   There are reasonable arguments as to whether risk weights can ever be assigned in a fully satisfactory way –  hence the support in many circles for simple leverage ratios, as a buttress to the capital regime –  but there is no reason to think that all types of credit exposures should be treated identically.  Bankers wouldn’t –  with their own shareholders’ money at stake.

Second, there have been plenty of systemic banking crises around the world over the decades.  But as the Norwegian central bank, the Norges Bank, pointed out in a nice survey a few years back, which has been cited by our own Reserve Bank,

Normally, banking losses during crises appear to be driven by losses on commercial loans. Loans for building and construction projects and (particularly) commercial property loans have historically been vulnerable. Losses on household loans appear to be a less significant factor,

This was true, for example, in the Scandinavian crises of the early 1990s –  savage recessions in which (in Finland) house prices fell by 50 per cent and banking systems around the region got into severe difficulties –  and in Ireland in the most recent recession.  And each of those crises occurred in fixed exchange rate countries, in which the authorities had (in effect) abandoned the ability to use monetary policy to buffer severe adverse events.

Are there exceptions?  Well, the US in the most recent crisis certainly looks like one on the face of it.  Housing loans were at the epicenter of the crisis, and the US has a floating exchange rate.  But as I’ve pointed out previously, drawing on excellent book Hidden in Plain Sight, much of what went on in the United States was the direct result of the heavy direct government involvement in the US housing finance market, and the legislative and regulatory pressure placed on private and quasi-government lenders to lower their lending standards on housing exposures. Government-directed credit is often a recipe for some pretty bad outcomes.  Advanced countries where the government did not have a substantial role in the allocation of credit (especially housing credit) and where domestic monetary policy was set to domestic economic conditions –  rather than, say, pegged to German conditions –  did not have banking systems which experienced large losses on their domestic loan books, and especially not their domestic housing loan books.  I’m not aware of any exceptions in recent decades.   I looked at the post=2007 crises here.

Individuals who have taken out large amounts of debt just before housing (or other asset) markets turn can find themselves in a very difficult financial position.  If the borrower has a good income, it might just be an overhang of debt that limits mobility.  In principle, banks can foreclose on mortgages with negative equity, but they very rarely do so as long as the loan is being serviced.  And nasty housing market shakeouts often take place in the context of severe recessions –  in part because building activity is one of the most cyclical aspects of the economy and building activity tends to dry up when house prices fall sharply.  But the case just has not been convincingly made that the New Zealand economy and financial system are seriously exposed as a result of current house prices per se, or of the current level of household debt.  As a reminder (a) that level of debt (relative to disposable income or GDP) is little changed over the last eight years, after a sharp increase in the previous fifteen years, and (b) that level of debt did not cause evident problems when New Zealand last experienced a pretty serious recession in 2008/09.   And relative to the situation on the eve of the 2008/09, New Zealand households now have a much higher level of financial assets (again relative to income or GDP) than they had then.     The risks now may be more localized and concentrated in Auckland than they were in 2007, but there is little to suggest that they pose more of an independent threat to the whole economy or the financial system.  On all published metrics –  whether or capital or liquidity – the banking system is in better health today than it was in 2007 –  and the same goes for the Australian parent banks.  When you dig into the details of the Reserve Bank’s FSR, that is what the data say, but it isn’t what you hear from the Governor.

I’ve been concerned for some time that the Governor has an inappropriate focus on the US experience.  He lived in the United States for more than a decade, including during the 2008/09 crisis, and although his role at the World Bank was focused on emerging markets, he got to participate in some of the international meetings that were epiphenomena around the crisis –  ie lots of headlines, but of little actual relevance to dealing with the various national crises.  Inevitably, that sort of experience influences a person’s perspectives.   But the Governor has never given us any reason to believe that the New Zealand situation now is remotely comparable to the US situation in the run-up to the financial crisis.

Despite all the research resource at its disposal, the Reserve Bank has never published any analysis or research looking at the countries which did, and did not, have domestic financial crises (and especially ones sourced in the housing mortgage books).    What marked out the US and Ireland, for example, from New Zealand, Australia, Canada, the United Kingdom, Norway or Sweden?  Each had very high house prices going into the global recession of 2008/09, each had had very rapid credit growth, most were seriously affected by the recession itself, and yet some had serious domestic loan losses and domestic financial crises, and most didn’t.    Almost certainly, the difference was not simply that the US and Ireland were selected for crises by some celestial random number generator, which indifferently spared the other countries and their banking systems.    As he rushes from one ill-considered distortionary intervention to another, overlapping one control upon another, exempting some borrowers and some institutions but not others, and impairing the efficiency of the financial system, surely the Governor owes us at least this modicum of explanation and analysis?  And that is even before we start asking questions about why the Governor (and his staff) should be thought better able to decide on the appropriate allocation of credit than private institutions whose managers have built careers on making lending decisions, and whose shareholders have considerable amounts of their own money at stake.  Last I looked, the Reserve Bank –  and the Governor –  has nothing at stake in the matter, and they have demonstrated no track record of expertise in making credit allocation decisions. In that respect, of course, they are little different than their peers in other countries. The level of hubris on the one hand, and lack of deep thinking, research and analysis on the other, is quite breathtaking.

And yet our politicians let them get away with it.  They leave so much power vested in a single unelected individual –  selected by another pool of unelected individuals  – whose term is rapidly running out, and who won’t be around to be accountable for the consequences of his intervention.   Then again, perhaps he will.  A typically well-sourced Wellington political newsletter last week claimed that the Governor is well-regarded in the Beehive and might well be reappointed.  It seems unlikely –  and I’d be surprised if our scrutiny-averse Governor even sought another term – but the line must have come from someone, presumably someone reasonably senior.

But, on a quite different topic, now I’m going to stick up for the Reserve Bank.  Bashing government agency spending on all sorts of things makes good headlines.  Bad policies deserve lots of critical scrutiny, and bad polices typically cost taxpayers a lot of money, whether directly or indirectly.  But frankly I was unpersuaded by the Taxpayers’ Union’s latest effort, highlighted in the Sunday Star-Times yesterday, around government agencies’ spending on Sky subscriptions.  Among core government agencies, the Reserve Bank was one of the larger spenders, with a total outlay of around $12000 in the last year.  The Taxpayers’ Union specifically called attention to the Bank.

But why?   The Reserve Bank has a variety of functions, some of which (notably the financial markets crisis management functions) which might warrant a Sky subscription even for professional purposes.  But even if the rest of them are scattered around lunch and breakout rooms in the rest of the building, so what?  Any organization seeks to create a climate that encourages high levels of staff engagement, and the recruitment and retention of good staff.  Some people are just motivated by cash salary –  always the overwhelming bulk of costs for central government policy and operational agencies –  but many are motivated by a richer complex of considerations, including on-site staff facilities –  which might include the quality of the cafeteria, fruit bowls, coffee machines, the Christmas Party, Friday night drinks, medical benefit schemes, access to newspapers, or even access to Sky.  In the private corporate sector there is a range of different approaches –  some no doubt work best for some types of workers, and some for others.  Sometimes these things are actually cheap at the price –  there is more motivational benefit than there is cost to the organization, which suggests everyone is better off.   Access to Sky was never one of the things the Bank offered that particularly appealed to me –  then again, the bonds built over a morning coffee, or gathered round a TV late on a rare afternoon when New Zealand was on edge of winning a cricket test in Australia, were probably good for the Bank, and for staff attitudes to the Bank.

I’m all for serious scrutiny of government agencies.  But focus on the big picture. Look at the quality of the policy advice and research being offered up. Look at the overall costs of organisations and functions, including overall average remuneration levels –  and perhaps even focus on the details when it comes to what senior managers spend on themselves.   But leave managers some flexibility to  attract, manage, and reward good staff  –  within those overall constraints –  in ways that don’t leave them constantly fearing “will this be a Stuff headline”.    We’ll all be a little less well off –  citizens who need a good quality public sector, with a limited number of able staff –  if we don’t.