The Reserve Bank’s latest Financial Stability Report is due out on Wednesday. Perhaps we will see some further articulation of the Governor’s strange vision of the Bank as a tree god, but I guess the main interest will be in what, if anything, the Governor does with the loan to value controls rushed into place, and then frequently amended, by his predecessor a few years ago. It is as well to recall that although legislation is going through Parliament at present that will, at least on paper, modestly weaken the Governor’s personal power over monetary policy, in respect of banking regulation his statutory powers remain untrammelled, and unchannelled. There are few legal constraints on what he – an unelected official whose appointment was controlled by unelected and unaccountable academics and company directors – can do.
Market economists are, understandably enough, focused on the narrow question of whether there will be any changes to the rules announced this week. You can read a summary of their views here. I remain less interested in that (forecasting) issue than in the cases for and against having such controls in the first place. They are a new thing: we never had some legal restrictions in the bad old days of a heavily regulated financial system prior to 1984. But, like weeds or wilding pines, once regulatory controls get in place people come to treat them as normal, the only debate tends to occur around the edges, and it takes huge effort to do something serious about fixing the problem. Years ago, when the LVR restrictions were first introduced, we were assured they would be temporary (I was still inside the Bank at the time, and as far as I could see senior people genuinely believed it) but now the very idea that willing lenders and willing borrowers should be free to contract on mutually agreeable terms seems to be becoming lost.
The Herald’s economics columnist Brian Fallow used his column last Friday to argue to “Keep the brakes on houses”. I can’t see the column on line, but the gist of his article is that house prices are high and household debt is high and that unless that combination changes the Reserve Bank shouldn’t think of lifting the LVR controls. It doesn’t matter that stress tests repeatedly show that banks can cope with big falls in house prices and even big rises in the unemployment rate. It doesn’t matter that our banks came through the last serious recession – when household debt to GDP was about as high as it is now – unscathed. It doesn’t matter that high house and land prices are mostly a phenomenon of the artificial scarcity created by land use restrictions (with high construction costs into the mix). It doesn’t even seem to matter than there is no evidence that the LVR controls have made banks safer (banks with fewer individual risky loans also need to hold less capital) or the economy more stable. It doesn’t seem to matter that the LVR controls have acted to favour established (cashed-up) buyers over new entrants to the housing market. No, even though there is no threat to financial stability, and everyone recognises that LVR limits impede the efficient functioning of financial markets (and those are the only two criteria the law allows the Bank to act under), the call is simply to leave the controls in place.
It was a bit like people in earlier decades who opposed removing import licenses or exchange controls because of the “foreign exchange constraint” (imports might increase if we took the controls off): papering over symptoms rather than tackling causes is rarely a sensible approach to policy. Sadly, this government, like its predecessor, seems to be doing almost nothing to fix the underlying problem (and when I heard the UDA announcement over the weekend cited as something that had “worked well” in the UK and Australia one was reminded a new of just how obscene house prices in the UK and Australia remain). But if the government isn’t doing anything serious, they will no doubt be grateful for the cover the Reserve Bank provides, claiming that somehow it is “doing its bit”, when it has no responsibility (there is “our bit”) for the fundamental problem.
But, of course, with no evidence whatever, the Governor is convinced that he knows best, the banks and markets are too “short-sighted” and so no doubt the controls will remain. If the Governor is really so convinced he should at least really go to the effort of persuading the Minister of Finance to agree to extend the restrictions to other non-bank lenders. The LVR controls only apply to banks because they are the only lenders the Reserve Bank Governor himself can order round in this way – restrictions on other non-bank deposit-takers require the agreement of the Minister of Finance. We have been fortunate in the last few years that there has been less disintermediation of mortgage business to non-bank lenders than most (including Reserve Bank staff doing the evaluation) had expected. But if we learned anything from the decades of heavy controls prior to 1984, over time risk-taking will gravitate to institutions where it can occur. Putting in place a competitively-neutral regulatory framework (treating banks and non-banks similarly) was a huge step forward in the 1980s, and it is unfortunate that the Reserve Bank now treats the same risks differently depending on whether an institution wears a “bank” or “non-bank” label.
At the press conference a few weeks ago for the Monetary Policy Statement, the Governor and his deputy (once a fairly market-oriented economist) indicated that in the forthcoming Financial Stability Review the Bank was planning to outline a more disciplined framework or road-map for assessing when, and whether, adjustments should be made to the LVR controls. In principle, that sounds sensible and welcome. In principle, it should involve the Bank setting out some markers against which they can be held to account when the next decisions/reviews come round. Whether it is so in practice only time will tell, but I was disconcerted when I heard them talking of this new framework as something similar to what they have for OCR decisions.
While we have a Reserve Bank there have to be regular monetary policy decisions. That isn’t so for LVR restrictions, and it would be unfortunate if the initiative the Bank has foreshadowed was also about entrenching LVR controls as a permanent feature of New Zealand’s financial system. Capital and liquidity requirements, backed by regular and robust stress tests, should remain the heart of our banking regulatory framework, rather than having bureaucrats reach into private businesses – well-run over decades – and tell them who they can and can’t lend to, or who they can and can’t employ. But bureaucrats have incentives to build up their bureau and are typically reluctant to give up powers they’ve once got their hands on. They are just human, and in their shoes you and I might face similar temptations. We need banking regulation and supervision – mostly, in my view, because politicians will bail out large banks in crises and everyone knowing that efforts need to be made to limit the risks – but its appropriate place is distinctly limited, accountable, and kept in fully in check. Instead, those paid to hold the Bank to account – ministers, the Board, FEC – mostly just accommodate the regulators, at times even egging them on.
On a totally different matter, for anyone interested in a some snippets of New Zealand economic history, you might want to try the latest Newsroom/Radio New Zealand Two Cents’ Worth podcast, which was built around the odd coincidence that – if you look at the data a bit loosely and from the right angle – for several decades in a row, years ending in 8 had also seen a New Zealand recession. I did an interview with Bernard Hickey for the podcast, in which he had me run quickly through aspects of the New Zealand economy in each “8” year since 1918. As I noted to Bernard, there is now a rather large hole in the market for a up-to-date economic history of New Zealand (the last full one appeared in about 1985 and much has been done, much has happened, since then). Brian Easton’s long-awaited history of New Zealand from an economics perspective – his framing – is still awaited.