I’ve now read the Reserve Bank’s consultation document on the latest iteration of their ever-extending, but highly unpredictable, LVR restrictions, and also the issue of the Bulletin they released yesterday Financial stability risks from housing market cycles. Neither document seemed remotely convincing: just a series of the same old material, now twice-over lightly, that mostly doesn’t stand up to much scrutiny. It was particularly striking that in the Governor’s mad rush to put yet more controls on banks and yet more potential borrowers, he never stops to reflect on any lessons from the fact that this is the third iteration (the Third Coming, as Gareth Vaughan puts it) of these controls in less than three years. Does this not raise any questions in the Governor’s mind – or those holding him to account – about the Bank’s ability to set these sorts of controls effectively and provide a stable climate for private businesses and households?
But I’ve been tied up with other stuff today, and even on the Governor’s rushed timetable there are still a few days left to think harder about the Bank’s analysis. (It is noteworthy that, despite the Bank’s commitment only a few months ago to longer consultative period, there is no attempt in the consultative documents to make a case for why action is so urgent that the new – welcome – standard is just tossed out the window. Various critics suggest the Governor has bowed to political pressure, but I don’t believe that is the explanation).
So today I wanted to focus mostly, and quite briefly, on this table from the Bank’s consultative document. As the Bank itself puts it, this table summarises the discussion “through the lens of a cost-benefit analysis”.
It looks like no cost-benefit analysis I’ve ever seen. I could commend to the Governor and his staff The Treasury’s guide to undertaking cost-benefit analysis. Agencies simply cannot get away with calling a short list of possible costs and benefits, painted with the broadest possible brush and with not a number in sight, a cost-benefit “analysis”. How could anyone look at a table like this and conclude with any confidence that what the Governor is proposing is in the national interest? Perhaps he is right, but this table simply doesn’t show it.
Everyone knows there is a great deal of uncertainty about many of the possible costs and benefits, but one of the key arguments for disciplined numerical cost-benefit analysis is that it forces agencies to write down numbers, make the case for those numbers, and illustrate the sensitivity of the resulting bottom line to a reasonable range of alternative assumptions. Everyone knows bureaucrats and ministers game the system to help produce the outcomes they want, but the discipline of writing down the numbers is part of enabling others to scrutinize what is being proposed. As a reminder, this is a consultative document – a proposal for scrutiny and external comment – and the Governor is legally required to have regard to submissions that are made. The law isn’t supposed to allow the Governor to simply rule by decree.
It is also striking that nowhere in the document, or anywhere in the cost-benefit so-called “analysis” is there any sense of the distributional implications of the proposed policy. Who gains and who loses is often as important as the aggregate assessment of national costs and benefits? It isn’t clear that the Bank has given that any thought whatever. That shouldn’t be good enough: Treasury, the Board, and relevant parliamentary select committees should be questioning the Bank about the inadequacy of what it has rushed out yesterday.
What should be doubly disconcerting is that the Bank also shows no sign of having thought, in a disciplined way, about the distinction between private and social costs and benefits. For example, take the very first “benefit”. Loan losses are not a loss for the country as a whole, they are simply a redistribution of wealth among people within the economy. Banks might be glad to have lower loan losses at some future date, but then banks – private businesses accountable to their shareholders – are able to adjust their lending practices themselves. Indeed recent evidence – banks reining in, or cutting altogether, lending to offshore borrowers – illustrates that they do just that. What is that gives the Governor confidence that he is better able to make those judgements than the private businesses he is regulating? We simply aren’t told – even though this is his third attempt to get it right.
And why is a temporary reduction in house price inflation – the second “benefit” – a national gain. Again, it redistributes gains/losses among players in the economy – providing slightly cheaper entry levels in the near-term for those not directly affected by the controls, at the expense of those who are directly affected. How do we value this alleged “gain”, especially if the fundamental distortions in the housing market – yet more regulations – aren’t changed.
I could go on. There is, for example, no attempt to justify the proposition that it matters less if potential landlords are squeezed out of the market than if potential owner-occupiers are squeezed out. And from a financial system efficiency perspective one could reasonably argue that an upsurge of non-bank lenders would actually be a net gain, given that the controls are being put on at all. But in any case, there is not a single number in sight.
These are highly intrusive controls, being imposed in a sweeping manner, and there simply isn’t much to underpin them. Perhaps it won’t matter much to the Bank. After all, the Prime Minister, the Labour Party Finance spokesperson, and even the former leader of the ACT Party seem to be in favour. But citizens deserve much better quality policy formulation than what we have here.
I noted yesterday that it wasn’t clear quite why, even if one granted the need for some controls, we needed to effectively prohibit purchases of rental properties in places like Wanganui and Gisborne with LVRs above 60 per cent. I half-hoped the consultative document might shed some light, but no. Simply nothing.
As a reminder, real house prices in New Zealand as a whole are almost unchanged from the levels in 1987 – and since those in Auckland are so much higher, those in the rest of the country as a whole must be lower.
We didn’t have a domestic financial crisis after 2007. And I’m quite sure that anyone borrowing in those cities to the right of the chart, and anyone lending to them, is very conscious that house prices can go down as well as up. The case for this regulatory imposition just isn’t made.
As ever, if the Bank is determined to rush ahead and do something more (perhaps on the maxim that “something must be done by someone, and the Bank is ‘someone'”), the much less distortionary, and less knowledge-intensive, approach would be to increase capital requirements, either more generally or specifically on housing lending. Doing so would provide bigger buffers, at minimal cost to banks and borrowers (since the financing structure shouldn’t materially affect the overall cost of capital). The Governor talks complacently about longer-term reviews of capital requirements, but higher capital requirements could be imposed now. I doubt there is a good economic case for doing so, but it is much less bad case than what we’ve been presented with in this latest consultative document.