A submission to the Reserve Bank’s faux consultation

A bit under three weeks ago the Reserve Bank announced a proposal for a further, substantial, extension of its LVR controls on banks’ mortgage lending  It is formally a proposal, subject to a consultative process, but it is all done in such a mad rush that it is difficult for anyone to take the “consultation” process seriously.  Late last year, the Bank announced that it would be allowing substantial consultative periods, and on this occasion they have offered no argument or evidence for why it is so urgent that such a short time is allowed for consultation and the preparation of submissions.  Presumably it is just the impatience –  backed by very little analysis – of the Governor –  much the same impatience that means this is now the third attempt in three years to get LVR controls “right”.  What was worse was the instruction to banks to simply fall into line now.  We live in a country supposedly governed by the rule of law, not the whims of men.  And until the proper consultative process has been completed, and the Governor has had regard to all the submissions, what he is proposing (a) is not law, and (b) cannot be counted on as ever being so.  But just to write that is to explain why it is hard to take the consultative process seriously.

I have  written and lodged a submission.  It was a fairly rushed job, but I’m out of commission for the next couple of days and needed to get it in this evening.

Submission to RBNZ consultation on further extension of LVR limits Aug 2016

This is the heart of the conclusion of my submission

In substance, the proposal if adopted will further undermine the efficiency of the financial system, while doing little or nothing to reduce any threats to financial stability (risks which, on your own stress tests are already very low). Indeed, there is a risk that such direct controls could increase, albeit modestly, the risk of serious financial system stresses because it will reduce the volume of capital held against bank mortgage books.    Over time, the growing use of direct controls risks progressively undermining the willingness and ability of banks to do their credit risk assessments, and to compete with each other in doing so,  rewarding going along with the Bank’s assessment of risks, while gaming the rules at the margin wherever possible. 

Since the Bank offers us no reason to think that its own assessment of credit risks –  in the aggregate or at a more disaggregated level –  is superior to that of the market, and since our banks actually came through a much larger housing and credit boom largely unscathed, there is little basis for us to prefer the Bank’s judgement.  And it has offered nothing to suggest how much its planned intervention might affect the probability or severity of any crisis. 

Over-reliance on a very slender base of international evidence, and a failure to think hard about the distinctiveness of New Zealand (from, say, the Irish or US experience) or to make the attempt to gather and analyse New Zealand loss experiences should give citizens little reason to have any confidence in what the Bank is proposing,   Even if investor loans were to prove slightly riskier, all else equal, than owner-occupier loans, the scale of the differentiation in the rules for the two types of lending suggests the Bank is driven at least as much by tilting the playing field against investors and in favour of first-home buyers as by its statutory responsibilities to use its powers in the interests of financial system soundness and efficiency.  If so –  and I hope there is nothing to that suspicion –  it would have involved the Bank stepping well beyond its responsibilities (with little ability for citizens to hold it to account if it did so).

There isn’t much to like in the consultative document.  The empirical evidence they now rely on is two studies undertaken by a central bank (the Irish one) which had already decided to have a regulatory distinction between investor loans and owner-occupier loans.  One of those studies is claimed to examine the UK experience –  in fact, it looks as the loan books in the UK of the three (failed) Irish banks, not necessarily a representative sample of UK experience.  I’m open to the possibility that investor loans are slightly riskier than owner-occupier ones, but have simply not yet been presented with any compelling evidence.  And the Bank has still made no effort to look at the experience in New Zealand, where the post-2008 reductions in house prices in some regions were not dissimilar to the UK experience, where unemployment rates lingered high, and where in some cities nominal house prices stayed well below previous peaks for a prolonged period. Obviously, New Zealand data reflecting New Zealand banking practice, New Zealand law, and New Zealand cultural norms would be more persuasive than the experience of the Irish banks (and even those research papers have some real problems).

The proposed controls differentiate between investor loans and owner-occupier ones to a huge extent.  Implicit in these proposed new rules is the view that loans to an owner-occupier with an 80 per cent LVR are less risky – not just as risky –  as loans to investors with a 60 per cent LVR.   Nothing in the data they’ve presented warrants that sort of differentiation, and it looks like a bit of covert redistributive policy: regardless of the riskiness of the respective loans, make things harder for investors and help out the first home buyers (even though those young buyers might be getting in right near a peak).  That simply isn’t the Bank’s job.  It is charged with financial system soundness and efficiency: it pays lip service at best to the efficiency issues (and the way its controls will progressively undermine competitive credit allocation decisions) and its own stress tests say that the financial stability risks are slight.  And why should regulatory policy be prohibiting a young person in, say, Wanganui getting into the rental property market with an LVR above 60 per cent.  Direct controls lead to arbitrary boundaries, absurd outcomes, and/or ever-increasing regulatory complexity.  That was part of the reason why we deregulated markets, and relied more extensively on indirect instruments, in the 1980s. it remains a good model –  and served New Zealand well through the boom and bust of the last decade, when our banks came through largely unscathed.

A key feature missing from the consultative document is any recognition that to the extent that the controls reduce high LVR lending, they will also reduce the amount of capital banks need to hold against their mortgage books. The Bank argues that the proposals will reduce the risk of financial crisis, but they show no sign of having thought much about the implications of the reduction in required capital.  If the capital requirements for high LVR loans were too low in the first place, that might be one thing. But our risk weights on housing loans are among the highest anywhere, and the Bank went through a consultative process not that long ago to increase those risk weights on high LVR lending.  And as part of what the controls will do is push a pile of lending to just below the respective ceilings –  there will be a lot of 59.9 per cent investor loans , even though a 59.9 per cent loan is little less risky than, say, a 60.1 per cent loan.  Capital requirements are likely to fall further as a result, even if the underlying risks haven’t changed much.   It would be unfortunate if measures ostensibly designed to reduce financial system risk actually modestly increased those risks, by reducing the capital buffers banks have to hold.

I don’t suppose submissions will make any difference to the Bank, but time (not much time, if they plan to have the restrictions in effect from 1 September) will tell.

Readers will recall that a couple of weeks ago the ANZ’s local head, David Hisco, called for the controls to be much more constraining than what the Bank is proposing. As I noted, there was nothing to stop ANZ restraining its lending accordingly.  But I do hope the ANZ will now pro-actively release its submission to the consultation so that we can see if Hisco’s submission on regulatory policy aligned at all with the rhetoric in his newspaper article.

I have lodged an Official Information Act request for all the submissions the Bank receives.  If past practice prevails they will eventually release those of entities other than banks, while claiming that the Reserve Bank Act prohibits the release of the bank submissions. I discussed this curious interpretation of section 105 of the Act the other day.  It cries out for a short amendment to the Reserve Bank Act to make it clear that all submissions on new regulatory proposals of this sort are covered by the Official Information Act.  That, of course, would be just a start on the sort of extensive reforms of the governance of the Reserve Bank that are needed.



Perhaps 20 more terms in office will be enough?

The ever-ebullient Minister of Economic Development (and a great deal else beside) Steven Joyce was interviewed on TVNZ’s Q&A programme yesterday, defending the government’s economic record.  Despite the efforts of the interviewer to pin him down –  including on the rising degree of unease even among some of those one might think of as “elites” about immigration policy –  Joyce put up a pretty forceful defence, often citing the Prime Minister’s mantra that if New Zealand has challenges they are ‘quality problems” or “side-effects of success”.  If one didn’t have access to the facts, it might even have sounded persuasive.

I was tempted to devote a lengthy post to the Minister’s claims, but I have other stuff I really have to finish today.  So apart from noting in passing New Zealand’s continuing lousy productivity performance (see the chart in this post), I wanted to focus on just two of the areas the Minister covered.

The first was around the skills of immigrants.  In June the OECD released the results of a fascinating multi-country study of the skills level of workers.  It suggested that the skill levels of New Zealand workers –  over several dimensions – were pretty high.  I wrote about it at the time, and summarized the high-level findings this way

Looking across the three measures, by my reckoning only Finland, Japan, and perhaps Sweden do better than New Zealand.    Perhaps there is something very wrong with the way the survey is done, and it is badly mis-measuring things, but those aren’t usually the OECD’s vices.  For the time being, I think we can take it as reasonably solid data.

As I also noted, the survey also looked at the skill levels of non-native born workers.  In almost every country, including New Zealand, the skill levels of immigrants were below that of natives.  Of course, in every country there will be many very able immigrants, but these are averages across the full samples of native born workers and immigrants.  As I pointed out, if your country (New Zealand) already had among the very highest skill levels in the world, and immigrants had less good skills, it didn’t lend much support to the idea that we needed lots and lots of immigration to lift the productivity of New Zealand workers, and make up for deficient skill levels at home.

But none of that stopped Steven Joyce introducing this same report in support of the government’s immigration policy.  How did he manage that?  Well, he correctly pointed out that New Zealand’s immigration policy is more skills-focused than those of most countries.  Unlike most countries, we have almost complete control over who we let in –  there isn’t a material illegal immigration problem –  and unlike, say, the United States (where legal immigration is mostly family-focused) we have an explicit economic/skills focus.  We may not do it well –  my argument –  but we are less bad, on that score, than most.

One might reasonably expect literacy skills of immigrant workers to lag behind those of natives –  after all, for many/most English isn’t their native language.  But the OECD survey also reports results for “problem solving proficiency in a technology-rich environment” (Figure 3.15 of the OECD report).  There are 28 countries/regions in the OECD study, but there is only data on the skill levels of immigrant workers for 17 of them (many of the other simply don’t have much immigration).

Here is the proportion of foreign-born workers with what the OECD calls relatively high level skills in this (problem-solving) area.

skills technology

New Zealand scores well here.  Our (really large scale) immigration programme seems to have done better in attracting people with these sorts of skills (and keeping out others) than most other countries have.

But remember that our overall workforce –  mostly native-born –  also has among the very highest level of skills of any of these countries. On this particular measure, we were top equal with Sweden.

So here is the gap between the skill level of natives and the skill levels of immigrants (again, on this problem solving proficiency measure).

skills gap

New Zealand doesn’t do too badly –  although Israel and Ireland stand out as clearly better –  but in every single one of these countries the skill levels of the average immigrant worker are less than those of the average native worker.  And this in an area –  the use of technology –  where the Minister often likes to stress the importance of immigration.  We don’t have the problems of Sweden or the Netherlands, but these OECD data –  which the Minister himself quoted in support of his policy –  just do not support the claim that our immigration programmes have been boosting overall skill levels in New Zealand.  If anything, those programmes have been a net drag.  As I’ve repeated many times, I’m not suggesting immigration never could boost skill levels –  or that there are not many highly-skilled individual immigrants (as there are many highly skilled natives) –  but our skills-focused programme, on the scale the government continues to stick to, just isn’t achieving that goal.  Perhaps with annual target of 10000 to 15000 non-citizen migrants (per capita, the same sort of rate as the US has) we might do so.

The interviewer also attempted to push the Minister onto the back foot over the government’s target for the share of exports in GDP.  The goal, announced several years ago, was to lift exports as a share of GDP from around 30 per cent to around 40 per cent by 2025.  I thought the formal target was daft and dangerous, even while sympathizing with the intuition that motivated it – small countries get and stay successful by selling lots of stuff, competitively, in the rest of the world.

As the Minister fairly noted, the base level of exports got revised in one of SNZ’s long-term national accounts revisions.  But that does not change the fact that exports as a share of GDP have been going nowhere.  It is all very well to blame low dairy prices –  as Mr Joyce sought to –  but on other occasions he’d be telling us just how well tourism and export education sectors were doing right now.

Here is chart of exports to GDP, going back to the start of the quarterly national accounts data in 1987. This time, I’ve also shown the average export share for each of the last three governments.

exports to gdp by govt

Plenty of things cause fluctuations in the series, and not many of them are under the direct control of governments.  Nonetheless, the average export share of GDP is materially lower under this government than it was under the previous government, and the latest observations are below even that average. Since the start of 2009, exports have averaged 27.7 per cent of GDP.  Under the previous National government –  one that first took office more than 25 years ago, that average was 27.5 per cent.  The government’s goal was to lift the export share by 10 full percentage points, and there is now only nine years left until the target date.  On performance to date –  and policy to date – we might be waiting several more centuries to achieve that sort of goal.

It is time Mr Joyce and his colleagues faced the fact that they are simply failing on this count.  A rather different approach is needed –  one which permits/facilitates a sustainably lower real exchange rate, orienting the economy more strongly towards investment in the tradables sector, and enabling more able firms to grow (and locate here doing so) by successfully selling to the rest of the world.  As I’ve noted before, per capita output in that vital outward-oriented part of the economy hasn’t increased at all for 15 years now.  It seems unlikely that that sort of reorientation will occur, all else equal, while we continue to bring in, as a matter of policy, so many not-overly-highly-skilled non-citizen migrants each year.

And finally, the interviewer introduced my name to the discussion as one of those skeptical of some of the government’s claims.  Mr Joyce suggested that I was among those who had predicted a large balance of payments blowout, thus apparently undermining the credibility of my arguments.  Of course, economists are pretty hopeless forecasters, so when an economist offers a prediction about the future one should (a) always take it with a considerable pinch of salt, and (b) wonder if the economist recognizes his/her own unwarranted over-confidence.  But in this particular case, I didn’t even recognize the forecast.  Since I’ve spent the last four years –  both inside and outside the Reserve Bank –  arguing against interest rate increases and for interest rate cuts, it would be surprising if I had been worrying about the current account deficit blowing out.  Demand has been consistently weaker than it should have been –  inflation has been below target, and unemployment has lingered above the NAIRU.  Whatever I’ve warned about, I’m pretty sure it hasn’t been the current account of the balance of payments.

(UPDATE: And, as a reader notes, as banks’ dairy losses mount there will be an almost one-for-one temporary reduction in (mostly foreign-owned) banks’ profits, and thus in the current account deficit.   That won’t be a sign  of economic success either.)