LVR restrictions

The successive waves of LVR controls that the Reserve Bank Governor has imposed on banks’ housing lending in recent years are back in the headlines, with comments from both the Prime Minister and the Leader of the Opposition (here and here).

As readers know, I’m no defender of LVR restrictions.  The other day I summarised my position this way

I never favoured putting the successive waves of LVR restrictions on in the first place.  They are discrimatory –  across classes of borrowers, classes of borrowing, and classes of lending institutions –  they aren’t based on any robust analysis, as a tool to protect the financial system they are inferior to higher capital requirements, they penalise the marginal in favour of the established (or lucky), and generally undermine an efficient and well-functioning housing finance market, for little evident end.  Oh, and among types of housing lending, they deliberately carve-out an unrestricted space for the most risky class of housing lending –  that on new builds.

You’d never know, from listening to the Governor or reading the Bank’s material, that New Zealand banks – like those in most other floating exchange rate countries –  appear to have done quite a good job over the decades in providing housing finance and managing the associated credit risks.   We had a huge credit boom last decade, followed by a nasty recession, and our banks’ housing loan book –  and those in other similar countries –  came through just fine.

The Bank’s statutory mandate is to promote the soundness and efficiency of the financial system.  On soundness, successive (very demanding) stress tests suggest that there is no credible threat to soundness, while the efficiency of the system is compromised at almost every turn by these controls.

At a more micro level, this comment (from my post yesterday) about the Bank’s debt to income limit proposals is just as relevant to the actual LVR controls they’ve put on in successive waves.

Much of the case the Reserve Bank seeks to make for having the ability to use a debt to income limit rests on the assumption that banks don’t do risk management and credit assessment well and that, inevitably crude, central bank interventions will do better.  The Bank’s consultation paper makes little or no effort to engage on that point at all.  It provides no evidence, for example, that the Reserve Bank has looked carefully at banks’ loan origination and management standards, and identified specific –  empirically validated –  failings in those standards.  Neither has it attempted to demonstrate that over time it and its staff have an –  empirically validated –  superior ability to identify and manage risks appropriately.

For all that, in partial defence of the LVR controls right now, many of those who are calling for the controls to be lifted or eased seem to be giving all the credit (or blame) for the current pause in housing market activity to the LVR controls.   That seems unlikely.  Other factors that are probably relevant include rising interest rates, self-chosen tightening in banks’ credit standards, pressure from Australian regulators on the Australian banking groups’ housing lending, a marked slowdown in Chinese capital outflows, and perhaps some election uncertainty (Labour is proposing various tax changes affecting housing).  I don’t know how much of the current slowdown is explained by each factor, but then neither do those focusing on the LVR controls.   Neither does the Reserve Bank.

And the backdrop remains one in which house price problems haven’t been caused mostly by credit conditions, but by the toxic brew of continuing tight land use restrictions (and associated infrastructure issues) and continuing rapid population growth.     Those two factors haven’t changed, so neither has the medium-term outlook for house and land prices.  Political parties talk about improving affordability, but neither main party leader will openly commit to a goal of falling house prices, and neither main party’s policies will make much sustained difference to the population pressures.   A brave person might bet on  some combination of (a) a recovering Australian economy easing population pressure, and (b) talk of abolishing limits around Auckland actually translating into action and much more readily useable land.  It’s a possibility, but so is the alternative –  continued cyclical swings around a persistently uptrend in the price of an artificially scarce asset.

And thus, in a sense, the Reserve Bank has a tiger by the tail.  House prices are primarily a reflection of serious structural and regulatory failures, and the problem won’t just be fixed by cutting off access to credit for some, or even by just buying a few months breathing space until a few more houses are built (before even more people need even more houses).   This isn’t a “bubble”, it is a regulatorily-induced severely distorted market.

So I strongly agree with the Prime Minister that, having repeatedly sold the LVR controls as temporary, the Reserve Bank Governor really needs to lay down clear and explicit markers that would see the controls be wound back and, eventually, removed completely.     And yet how can the Governor do that in any sensible way?   After all, the underlying problem wasn’t credit standards, or even overall credit growth.  It appeared to be simply that the Governor thought that he should “do something” to try and have some influence on house prices, even though he (a) had no good model of house prices in the first place, and (b) his tool didn’t address causes at all, and bore no relationship to those causes –  it was simply a rather arbitrary symptom-suppression tool.  And the Reserve Bank knew that all along –  they never claimed LVR controls would do much to house prices for long.

Because the interventions weren’t well-designed, any easing or removal of the controls will inevitably be rather arbitrary, with a considerable element of luck around how the removal would go.   What sort of criteria might they lay out?

  • a pause in house prices for a couple of years?  Well, perhaps, but as everyone knows no one is good at forecasting cyclical fluctuations in immigration.  Take off the LVR controls and, for unrelated reasons, house price pressures could still return very quickly,
  • housing credit growth down to, say, the rate of growth of nominal GDP for a couple of years.  But there isn’t much information in such a measure, as the stock of housing credit is mostly endogenous to house prices (high house prices require a higher stock of credit).

The latest set of restrictions seemed to be motivated as much by a distaste for investor buyers as by any sort of credit or systemic risk analysis, so it isn’t clear what indicators they could use to provide markers for winding back the investor-lending controls.  And since the Bank has never documented the specific concerns about banks’ lending standards that might have motivated the controls in the first place, it isn’t obvious that they could easily lay out markers in that area either.  Since the controls were never well-aligned with the underlying issues or risks, it seems likely that any easing won’t be able to be much better grounded –  almost inevitably it will be as much about “whim” and “taste” as anything robust.  Unless, that is, the incoming Governor simply decides they are the wrong tool for the job, and decides to (gradually) lift them as a matter of policy.   Doing so would put the responsibility for the house price debacle where it belongs: with politicians and bureaucrats who keep land artificially scarce, and at the same time keep driving up the population.

Some have also taken the Prime Minister’s comments as ruling out any chance of the Reserve Bank’s debt to income tool getting approval from the government.  I didn’t read it that way at all.

But he [English] explicitly ruled out giving the bank the added tool of DTIs, which it had requested earlier in the year.

“We don’t see the need for the further tools, Those are being examined. If there was a need for it then we’re open to it, but we don’t see the need at the moment. We won’t be looking at it before the election.”

As even the Governor isn’t seeking to use a DTI limit at present (only add it to the approved tool kit), and as submissions on the Bank’s proposal haven’t yet closed, of course the government won’t be looking at it before the election (little more than a month away).  It will take at least that long for the Reserve Bank to review submissions and go through its own internal processes.  In fact, at his press conference last week Graeme Wheeler was explicitly asked about the DTI proposal, and responded that it would be a matter for his (acting) successor and the new Minister of Finance to look at after the election.    Perhaps the Prime Minister isn’t keen, but his actual comments yesterday were much less clear cut on the DTI proposal than they might have looked.

In many ways, the thing that interested me most in yesterday’s comments was the way both the Prime Minister and the Leader of the Opposition seemed to treat decisions on direct interventions like LVR or DTI controls as naturally a matter for the Reserve Bank to decide.

The Prime Minister’s stance was described by as

However, he again reiterated that relaxing LVR restrictions was a matter for the Reserve Bank. “I’m not here to tell them what to do.” English said government was not going to make the decision for them and that he did not want to give the public the impression that politicians could decide to remove them. “The Reserve Bank decides that.”

The Leader of Opposition similarly

“But we’ve not proposed removing their ability to set those…use those tools,” Ardern said. “We’re not taking away their discretion and independence.”

Both of them accurately describe the law as it stands.  The Reserve Bank –  well, the Governor personally –  has the power to impose such controls.    But there isn’t any particularly good reason why the Reserve Bank Act should be written that way.

The case for central bank independence mostly relates to monetary policy.  In monetary policy, there is a pretty clearly specified objective set by the politicians, for which (at least in principle) the Governor can be held to account.  In our legislation, the Governor can only use indirect instruments (eg the OCR) to influence things –  he has not direct regulatory powers that he is able to use.

Banking regulation and supervision are quite different matters.  I think there is a clear-cut argument for keeping politicians out of banking supervision as it relates to any individual bank –  we don’t want politicians favouring one bank over another, and we want whatever rules are in place applied without fear and favour.  In the same way, we don’t want politicians making decisions that person x gets a welfare benefit and person y doesn’t.  But the rules of the welfare system itself are rightly a matter for Parliamant and for ministers.

There isn’t compelling reason why things should be different for banking controls (and, in fact, things aren’t different for non-bank controls, where the Governor does not have the same freedom).  As my former colleague Kirdan Lees pointed out on Morning Report this morning, when it comes to financial stability and efficiency, there are no well-articulated specific statutory goals the Reserve Bank Governor is charged with pursuing.  That gives the holder of that office a huge amount of policy discretion –  a lot more so than is typical for public sector agencies and their chief executives – and very little effective accountability.    So when Ms Ardern says that she doesn’t propose to take away the Bank’s discretion or independence, the appropriate response really should be “why not?”.

We need expert advisers in these areas, and we need expert people implementing the controls and ensuring that different banks are treated equitably, but policy is (or should be) a matter for politicians.  It is why we have elections.  We get to choose, and toss out, those who make the rules.  It is how the system is supposed to work –  just not, apparently, when it comes to the housing finance market.

I’ve welcomed the broad direction of the Labour Party’s proposal to shift to a committee-based decisionmaking model for monetary policy.   But, as I noted at the time of the release, their proposals were too timid, involved too much deference to the Governor (whoever he or she may be), and simply didn’t even address this financial stability and regulatory aspects of the Bank’s powers.      There is a useful place for experts but –  especially where the goals are vague, and the associated controls bear heavily on ordinary citizens –  it should be in advising and implementing, not in making policy.   Decisions to impose, or lift, LVR controls or DTI controls should –  if we must have them at all – be made by politicians whom we’ve elected, not by a single official who faces almost no effective accountability.



24 thoughts on “LVR restrictions

  1. Very informative thoughts, thanks, Michael. When you say,

    “The latest set of restrictions seemed to be motivated as much by a distaste for investor buyers as by any sort of credit or systemic risk analysis”

    I wonder if cooling non-owner occupier appetite for housing assets was the aim, would DTI be a more effective/targeted tool than LVR? i.e., thus deterring new entrants to loss-making residential property investment?


    • The DTI idea is terribly badly designed for investor properties (for reasons covered in Ian Harrison’s paper I linked to yesterday). Broadly speaking the DTI tries to look at residual income after allowing for servicing costs and essential living expenses. That may work ok for owner-occupiers (altho there are problems there too) but it is very ill-suited to what is essentially a business operation – add another rental property and the owner’s living expenses don’t rise at all. If they want to kept pressure on investment finance – for “political” reasons more than from any analysis assessing risk – they’d be better to stick with the current LVR controls. Of course, the longer any of these controls are left on the more the risk that borrowers will move to unregulated lenders. I think many people (including me) are surprised it hasn’t already happened to a greater extent, but it is surely only a matter of time (it is exactly what happened in the pre 84 regulated period).


      • Thanks. Yes, if I recall correctly – our first home in 1979 had three different mortgages on it – post office, bank and solicitor.


    • I don’t have time to go back to Werner’s papers today, but a couple of months ago a friend asked for my advice on one of Werner’s papers (I think one called A Lost Century of Economics). My response was as below – worded more starkly than I’d have put it on the blog, but it was between friends and former colleagues:

      I finally had a chance to read the Werner paper.  I guess my take on it was fairly similar to your own. I thought it was a very nice collection of quotes, illustrating the different ways in which people have told the stories about money and credit creation (all the while never once noting that things are a bit different depending on whether a country has a fixed exchange rate –  in which there are genuine net additions to the money supply from central bank fx business –  or a floating one).  

      But it got worse as it went on.The stuff around development finance seemed close to incoherent, and I think it was because the author doesn’t distinguish between pressure on real resources (savings and investment, in national accounts terms) and money/credit.  This is a common problem I’ve found in commenting on other stuff [ name deleted] has sent me.     In a development context, one can print all the local currency money/credit one likes, but it doesn’t change savings/investment balances at all.

      On the “central bank conspiracy” side, I agree it is mostly nonsense, altho where there is probably something to it is that central banks have such a huge command of research resources (incl funding for external research, hosting conferences etc) that what central banks do and don’t want researched probably influences what is actually researched more than it really should.

      On the money/credit creation stuff, I guess my overall view was that all three ways of telling the story were part of the overall story, and thus when the author says that the BOE article ran all three, I didn’t have a problem with that.  I think my biggest problem with the whole thing is the failure to integrate money with macro.  Thus the technical description of which accounts are debited and credited is fine, but not very enlightening.  Actual credit arises because someone wants to borrow for a purpose, and in the course of that borrowing (and purposeful) transaction, they typically take actions which simultaneously make someone else want to hold more deposits.     Given that rapid credit growth here often goes hand in hand with a widening current account deficit, those “more deposits” may not be held by NZers, they may be an increase in banks’ funding from non-residents.

      Finally, the author doesn’t seem to recognise that his point about a difference between banks and non-banks is totally specific to UK regulatory provisions.  In NZ, non-banks can lend and take deposits in just the same way banks can, and there is no difference of economic substance between the two classes of institution.


  2. I liked Donald Ellis’s comment about the Reserve Bank and Macro-Prudential tools. It went something like this.

    Graeme Wheeler went charging out with a cry of ‘follow me’ as he attacked the housing crisis, only to get that sinking feeling that actually no one was behind him….

    So while Graeme was putting down covering fire, expecting the government to come in and attack the real causes….. the government went off declaring the whole battle as….. nothing to worry about….no crisis here…. it is a sign of success…..

    Donald said that Graeme when he realised he was isolated, a man alone in a battlefield,with the wrong weapons and that he could not effect a decisive victory, he should have retreated back…. but like so many pig headed people (Donald thinks this is a characteristic of public officials) he doubled down on his attacks…..


    • I think that is part of it, but the other part was this determination not to see NZ experience a US type crisis without ever having done the careful considered analysis looking at similarities and differences, and who had and hadn’t had crises in 2008/09.

      When the first lot of controls were put on I think it is safe to say that almost none of staff supported them – and there was never a substantive discussion at the relevant policy committee about the merits and demerits, pros and cons of such an initiative. It was all the Governor. Perfectly lawful of course, but not really very wise, or an example of good leadership and stewardship.


    • The 40% equity restrictions on the LVR came about from John Key rather than from Wheeler himself. That’s my issue with the use of the tools. There was no research by the RBNZ and there was nothing on when the tool once used would be lifted. There is no benchmark established.


  3. I am amazed at the amount of intellectual endeavour and volume of column centimetres devoted to solving a problem of a government decreed level of $1½ million as the investment level for investment visas, and that’s what the princelings and bolt-holers and foxes did – they began paying $1½ million for properties with a CV of $750,000 – there were examples of that. Crazy stuff. Crazy times set in. The local investor public realised what was happening and 2 years later jumped on the band-wagon and joined the party. And they found willing banks eager to lend. A belated application of LVR’s only applied to locals who required local funding from the willing banks. It wasn’t enough. Prices didn’t respond. LVR’s increased to 40%. A little less froth was seen. Then the CCCP began fox-hunts. Prices slowed a little. Then the CCCP enforced money transfers to $10,000 pa for non-property purposes. Obviously dirty money had been finding its way into Auckland property. The RBNZ is responsible for controlling that. Have you ever seen any actions undertaken over that. I haven’t seen any. Although have seen some in Australia.

    Remind me – what was the problem again – one set of participants seem to have been sorted out but not by any NZ action and now the lobbyists and urgers who were silent on the way up are frothing at the mouth now that the frantic-money crowd at the coliseum have gone home and prices are easing.


  4. A thought: are risk weights and minimum capital requirements also an impediment to an efficient financial system? Just wondering if it is possible to do away with most regulatory controls and let bankers, borrowers, debt/equity investors, and deposit holders decide whether bank assets and associated capital structures properly reflect risks assumed? (Credible) resolution with no bail out doesn’t seem impossible…..?


    • They do tend to have that risk, but detract less from an efficient market than direct restrictions that limit directly the ability of banks to lend to particular borrowers. It is always, in principle, a cost-benefit analysis. Some would argue that the min risk weights and min capital requirements are trying to mimic what the market would deliver were the no-bail-out stance credible. As it isn’t, some capital regulation is needed to limit the moral hazard, and thus limit the Crown’s fiscal risk.

      I think everyone would agree that capital buffers are sufficient to safeguard the banking system, and thus dominate LVR/DTI controls on that score. LVRs etc come into play when authorities want to do something more – eg directly lean against house prices, or skew the playing field to favour, say, FHBs over investor buyers.


      • …..understood; get’s the mind ticking over – keep thinking the banks are mainly privately held and under pressure to grow profits which they do predominately by increasing assets: trouble is, as they all increase lending volumes the marginal credit risk must surely get higher; squaring that with their collective influence on (the public desire for) financial stability seems inevitability tricky


      • Which is, I argue, where the cross-country track record becomes relevant. Do banks have a track record of lending on vanilla housing portfolios in ways that lead to serious trouble for them and the financial system? I’d assert that historically the answer is “no”. Things seem to be different on, say, commercial property development loans – perhaps the difference is that it is quite rare to get a systematic overhang of houses, and in the commercial property development space the potential borrowers have big dreams, big egos, limited liability, and it is quite easy for whole new developments to lie idle for years.


      • I am unsure why economists belief capital buffers would play any part in safeguarding the banking system. Capital only forms part of working capital in the initial injection of funds.

        Cr Capital
        Dr Cash

        It is how that cash is utilised that determines the stability risk. Inevitably that cash would be lent to borrowers in order to earn a margin. Capital is not free. Shareholders have an expectation of dividends to be paid out each year and more new capital dilutes the shareholding percentage and potentially lowers the share price. The higher the capital buffers increases the cost of lending.


  5. Sorry but I need to be reminded on what the problems really are and that LVRs and /or DTIs are only fiddling around the fact that we have:
    1. Too many landlords and not enough owner occupiers and
    2. Prices are too high – certainly in Auckland.
    Overseas they have sales taxes, foreign buyer restrictions and nil/low occupancy penalties which we fail to try and the RBNZ has no options to use.
    As one affected by the FIF tax regime, I would plead for an income tax based on 6% notional income including on land already zoned.


      • Rates penalises owner occupiers (not tax deductible) v. investors
        FIF (equivalent) makes low yields less attractive than now which would help lower market prices and hence FTBs


      • House prices are driven upwards by emotional home owner occupiers and not by logical business investors.


      • Owners occupiers use those services provided by Council so why would rates penalise owner occupiers? In the same manner tenants use services and therefore landlords have to pay the same rates. Why would you penalise landlords with double taxation in the course of carrying out a business activity?


  6. There are many factors that have contributed to high housing prices. However it is my opinion that on top of the economic fundamentals are elements of a bubble. Yes LTV ratios would seem like a blunt tool, but it would seem to be irresponsible not to take away the punch bowl when the party is getting out of control. Also I’m unconvinced that banks in NZ or elsewhere are particularly good at risk management.

    How can one prove to sceptical economists that there is actually a bubble. And if there is a bubble what would the best tool be to tackle it ?


    • I guess I am a “sceptical economist”, and as such tend to want to look at all other plausible explanations before falling back on a “bubble” story. At a big picture level, I don’t see much about NZ (and Akld) house prices that can’t be relatively simply explained by structural factors – land use restrictions and population pressures. Of course, there isn’t a good empirical quantification of the former factor, but the restrictions are no secret and nor are the huge gaps between land prices for developable land and land councils bar people from building on. I’m not suggesting there are no speculative participants in the market – clearly there are, and probably always will be – but for many the opportunities for “speculation” are made possible by the land restrictions/population pressures toxic brew (not “toxic boom” as i see one media outlet suggested i was saying).

      Of course, central banker love the punchbowl line – and I’ve used it plenty of times myself – but its validity does rest on a valid diagnosis of the problem. It makes sense to take the punchbowl away if excess alcohol consumption is the problem, but if the party is getting rowdy for other reasons – some more people arrived eg – , removing the punchbowl may well be a welfare-detracting solution (since ill-targeted).

      It is always worth remembering how modest the RB’s own claims were for the impact on LVR controls on house prices. If LVRs could really hold prices 25% lower than otherwise semi-permanently it might be much easier to make the case for them, but the actual claim is something like a 10th of that effect, for a year or two.


    • Whenever someone talks about bubble, the Tulips analogy story comes up. I have never worked out how a limited supply model with land and height restrictions in combination with record net migration(of students and foreign workers) equate to a overproduction and therefore an unlimited oversupply Tulips model.


  7. Michael: “…the stock of housing credit is mostly endogenous to house prices (high house prices require a higher stock of credit)…”

    Brilliant concisely stated principle.

    There is hardly a more damaging misconception that high house prices are the result of credit availability rather than distortions in the supply side of land for housing.

    The corollary to this, ironically, and little-known to western pundits, is to be found in many developing countries:

    1) no mortgage credit at all available to most people
    2) a large proportion of the population in illegal slums
    3) house price (unit) median multiple in the formal housing market generally between 10 and 15
    4) a significant proportion of housing unit purchases done with cash – savings and family assistance (of necessity built up over a long time)
    5) global advisory experts calling for development of “mortgage finance” institutions to give all the poor unhoused people a chance of getting into the formal housing market!

    The way the western world got through this impasse 100 years ago, was automobile based sprawl and competitive land supply enabled by government agencies of integrity (outright corruption is as much of a problem in developing countries, as ignorant policy). The informal slums that are normal under conditions of historically entrenched monopolistic land supply, are actually a default form of “median multiple 3” housing, which is the real need. Interestingly Bertaud notes that the increasing use of motor scooters by the poor, is leading to this default “affordable housing” – (illegal slums) becoming more spacious and better-appointed, at greater distances from the city.


    • Indeed, people forget that 80% of property sales is by people that already own a property. It does not matter what price you pay for a property because you have a property to sell in the same market. When someone in New York pays $40 million for an apartment and looks at a property in NZ, any NZ property is going to look cheap. No one wants to pay too far beyond “market price” but when a property ticks all the boxes, emotion takes market price up a little notch. 10 little notches per annum over 10 years usually equates to doubling of the market price every 10 years. Rent or disposable income has very little to do with market price for houses.

      That is why it does not take many overseas buyers to move the market along. Even if you do not have foreign buyers, Tourists and international students have been dropping $15 billion every 12 months into the local communities and that has to go somewhere and inevitably it ends up in a property.


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