Who will build the houses?

One of the Prime Minister’s campaign lines has been “who will build the houses?” if immigration numbers are cut back.   It is a curious line of argument, for a variety of reasons.

But it takes on a particular air of unreality when used –  as I heard in a debate last week –  to attack the Labour Party.    After all, Labour is campaigning on a policy that will (a) leave the current 45000 per annum residence approvals target unchanged, and (b) reduce students visa numbers quite substantially (resulting in a one-year reduction in the net PLT migration inflow).  On their own numbers, the changes they are proposing won’t make that much difference to the number of work visas issued, and where those numbers do change, the intention is to focus reductions at the lower-end of the skill spectrum.  (Their document is here, and my post on it is here.)   For what it is worth, Labour even proposes a Kiwibuild visa, designed to ensure that any reductions in work visa numbers don’t interrupt a flow of construction workers.

The student aspect aside (and even that isn’t part of the 100 day plan, although it isn’t that long until the new academic year starts), one might reasonably doubt whether Labour is serious at all about reducing ongoing immigration pressures.   Their policy, if implemented, won’t materially alter the net inflow over time. And I heard this morning an extended interview with Jacinda Ardern on Radio New Zealand in which she declared that she would have no problem at all with a net 70000 migration inflow per annum if only the houses were there, and actively endorsed some recent strongly pro-immigration comments made by Helen Clark.    Labour, like National, is still a “big New Zealand” party –  despite the economic damage that strategy has been doing over decades (remember how bad our productivity record has been) and will continue to do (ever more people and a heightened priority on improving water quality and meeting climate change targets is a recipe for severely undermining our productivity prospects.)

But this post isn’t about Labour’s proposals, but about (a) what has actually been happening over the last few years in the construction sector and related migrant inflows, and (b) more briefly, how the economy might adjust if there was to be a sustained material cut to target levels of non-citizen immigration.

In his weekly column in last Friday’s Herald, Brian Fallow touched on some of the first of those topics.  He went to the latest annual MBIE Migration Trends and Outlook publication (for the year to June 2016 –   MBIE could you please make data easily accessible on a more timely basis), looked at the data on who had been granted Essential Skills work visas in recent years, and concluded thus:

The conclusion has to be that the impact of net migration flows on the housing market and the construction industry is overwhelmingly on the demand, not the supply, side.

There has been a big increase in construction activity in New Zealand in the last few years.  Some of that is driven by the Christchurch repair and rebuild process, but increasingly the key influence has been the unexpectedly rapid growth in the population.  Each of those people needs a roof over their head.

And so employment in the construction sector has increased rapidly.    Here is the data from the HLFS, showing the percentage increase in people employed from calendar 2013 to calendar 2016 for each of the sectors employing more than 100000 people.

HLFS by sector

The construction sector has had by far the biggest increase in employment over the last three years.  Around 56000 more people were employed in construction in 2016 (on average) than in 2013 (the current total number of people employed in the sector is around 240000).

What contribution has non-citizen immigration (the bits our policy controls) made to this employment?

As Brian Fallow noted, on MBIE’s own numbers, this is how many Essential Skills visas were granted for construction trades and construction labouring roles in the year to June 2016.

And a startlingly low proportion – 7 per cent, or 2233 to be precise – were classified as construction trades workers like carpenters, plumbers, plasterers, tilers and painters. If you include scaffolders and builders’ labourers, the proportion rises to nearly 10 per cent.

And here are the corresponding figures for the previous couple of years.

Essential skills visas granted
2013/14 2014/15 2015/16
Construction trades workers 2090 2123 2233
Construction and mining labourers 399 546 831
Construction sub-total  2489  2669  

3064

 

Total 26502 28548 31766
Construction as % of total 9.4 9.3 9.6

Those might look like quite large numbers but:

  • at last report, construction jobs made up 9.3 per cent of all employment (and yet in this really rapidly growing sector only around that share of Essential Skills visas –  suggesting that immigration was hardly easing sector-specific pressures), and
  • as Brian Fallow also pointed out, most of these Essential Skills visas were being granted to people who were already in New Zealand (eg renewals).  Of 31766 Essential Skills visas granted in the year to 2016, only 8334 (or 26 per cent) were new workers (the proportions are similar in the earlier years).
  • people arriving and taking up first-time work visas need to be offset against people leaving.    In the three years I’m looking at here, MBIE tells us that the total stock of people here on essential skills visas increased by only 10062.   If the patterns were similar for construction jobs as for other roles, construction would account for about 1000 of that increase.

Of course, some people will have moved from work visas and obtained residence visas.  Based on the 2015/16 residence visa approvals numbers, that might have been around 450 people working in construction roles per annum.  Over three years, perhaps as much as 1500 people.

In other words, in a construction sector where total employment has increased by 56000 in three years, perhaps only 2500 (or less than 5 per cent) of that increase will have been met by the immigration of non-citizens.

So in that sense the answer to the Prime Minister’s question is easy.  Who will build the houses if immigration is cut back?  The same people who always overwhelmingly have, people who were already here.

But perhaps more importantly, if immigration were to be sharply cut back, the number of people needing accommodation would fall.  At one extreme, if the population is growing by 100000 per annum (as it has in the last couple of years), that suggests a “need” for around another 35000 houses each year (on top of the small number that would need replacing each year with a static population).  With net non-citizen migration at present in excess of 70000, the non-citizen immigrant flows alone create a “need” for perhaps 23000 additional houses each year.     Even if we go back to Brian Fallow’s original numbers of gross approvals of Essentials Skills visas, 3000 construction workers cannot build 23000 houses a year.   So the way immigration policy is actually being conducted it is exacerbating pressure on the construction industry, not relieving it.  That additional pressure is substantial.

(It needn’t be that way of course.  In the short-term immigration will almost always in increase economywide demand more than it increases supply.  But composition of the immigrants afffects where the pressures are most felt.  At the extreme, if all the migrants were builders (and related occupations), they’d probably just about keep up with the additional demand for housing (building, in effect, to house themselves).  Then the demand pressures would show up more severely in other sectors.    But when there is a big increase in the population, and hence in construction activity, immigration policy certainly isn’t relieving construction sector constraints when only around 10 per cent work visas are going to construction workers, when almost a quarter of the new jobs are in construction.)

So what would happen if, say, the 45000 residence approvals target was cut to, say, the 10000 to 15000 per annum I’ve been advocating (still, in per capita terms, around the rate of permanent approvals in the United States), and issuance of work visas was also tightened up, so that the stock of people on temporary work visas was no longer growing?

Overall, growth in domestic demand would weaken, and with it the pressure on domestic resources.  The notion that the short-run demand effects of immigration outweigh the supply effects shouldn’t really be controversial.  It has been that way in New Zealand for many decades.  But, given the huge scale of the pressures that new people put on the construction sector (not just houses, but roads, schools, offices, shops etc), and the fact that immigration policy as actually run has not seen us bring in many construction workers (10 per cent of the visas, when 25 per cent of the new jobs have been in construction), such a policy change would greatly ease resource pressures in the construction sector specifically.  In some other sectors it is quite conceivable that resource pressures could increase (one could think of export-oriented sectors such as tourism or dairying) if such an immigration policy change was made.  But on the construction side of things –  one of the most politically and economically pressing areas of our economy – the gains (the relief of pressure) would be substantial and almost immediate.  Not only would construction sector resource pressure ease, but land prices could also be expected to fall back to some extent (due to a reduction in expected future demand).

More generally, across the economy one would expect to see  interest rates falling (both market interest rates and the OCR) and with them the real exchange rate.    A lower real exchange rate would help secure the overdue resource-switching towards the tradable sectors. It would also provide the additional margin that would enable employers in those sectors to bid up wages to the extent required to attract existing residents to take up jobs in those sectors.    Plenty of people would be freed up from the construction sector –  a country with a modestly growing population wouldn’t have 10 per cent of total employment in construction –  and they’d be looking for jobs elsewhere.  Most of them would be long-term residents or citizens –  something we know with a high degree of confidence because the government’s own data tell us not many visas have been issued in recent years to people in construction, whether skilled workers or labourers.

But I guess the Labour Party can’t really use these arguments to push back against the Prime Minister because they aren’t actually planning a material and sustained reduction in non-citizen immigration at all.  That’s a shame.

(And if you wonder why all this discussion has used visa numbers up to June 2016, that is because MBIE only release more recent numbers in massive (600000 line) unwieldly spreadsheets.  It is possible that patterns in the last year have been a little different, but it seems unlikely –  given the similarity in each of the previous three years.  But debate would be better-informed, and more timely, if MBIE would make  timely data available in more readily accessible formats, as happens for almost all other important economic data released by Statistics New Zealand, the Reserve Bank or whoever.)

 

 

Housing failure set to continue

I’ve long been sceptical that any government is likely to fix the housing market problems any decade soon.   Some of that was specific New Zealand points: National seemed to be doing almost nothing, Labour had done almost nothing when it was in government, and Labour seemed likely to rely on the anti-development Greens if and when it formed another government.    But most of the scepticism was – and is –  rather more overarching: no one has been able to show me a case study anywhere in the world where intense land use restrictions had once badly messed up a housing market, and where those controls had then been successfully unwound and housing made affordable again.   In principle, there was no reason why New Zealand should not have been first.  But the ages of pathbreaking New Zealand reforms  –  whether the 1890s or the 1980s –  seem well behind us at present.

It wasn’t a weekend that led my to revise my opinion.    In yesterday’s Sunday Star-Times Rob Stock had a piece reporting widespread scepticism about the claims that both Labour and National are making.  He began with both leaders’ reluctance to even call for lower house prices.  No one much seemed persuaded by the idea that nominal house prices might hold flat and incomes rise steadily to reduce price to income ratios.  On paper it could be a plausible story, but even if so it is a solution for the next generation not the current one.   And the article also reported a great deal of scepticism about the apparent Labour aspiration to introduce a lot more lower-priced homes without having much impact on the prices of existing dwellings.    The people Stock quoted seemed a bit more optimistic that –  despite the disavowals – Labour’s plans might actually lower house prices.   Fundamentally improve the land supply situation and perhaps that might be realistic.  Without that, government-sponsored builds seem likely to substantially displace private sector builds.

But then there were the policy cues.  Yesterday morning, National announced that, if re-elected, it would increase the subsidies offered to first-home buyers.  First-home buyer grants, in a supply-constrained market, are a policy so daft that I’m not aware of any serious analyst, from any side of the political/economic debate, who thinks they are a good idea (and Treasury and the Reserve Bank have opposed them).  New Zealand was mercifully free of such subsidies for most of its history –  and policy people used to look across the Tasman, slightly disdainfully, at the grants there.   First home buyer grants are, largely, an expensive way of getting house prices a bit higher than they otherwise would be.  And here that outcome is even more likely given the announced increases in accommodation supplement payments next year.   Renters will be able to pay a bit more (so investors can afford to pay a bit more), and potential first home buyers would now also be able to pay a bit more –  perhaps especially in provincial areas where the grant goes a bit further.  Since the policy is well-foreshadowed, most of the effects will have been compounded into prices before the first young couple can get their increased grant.  And, as so often, the winners will be the people selling out of the market –  those who already have.  It is the sort of policy that gets adopted when governments have given up on  believing that they might actually fix the underlying problems –  and/or given up believing that they can convince voters that they might.    Subsidies to home buyers –  rather than fixing the underlying problem –  is like some throwback to the early 1980s (actually the last time we had such direct first-home buyer subsidies).

The messages from the other side of politics weren’t much more encouraging.  The leader of the Opposition yesterday announced her plans for the first 100 days of a Labour government.  Housing appears on the list, but the three most specific items are

  • Pass the Healthy Homes Guarantee Bill, requiring all rentals to be warm and dry
  • Ban overseas speculators from buying existing houses
  • Issue an instruction to Housing New Zealand to stop the state house sell-off

Whatever you make of the Healthy Homes Guarantee Bill, it won’t improve the affordability of housing (if anything, rather than contrary for renters).  And stopping the sell-off of state houses might (or might not) make some sense, but again it won’t alter, by one iota, the affordability of housing in New Zealand.   And, in fairness, both are probably being done for other reasons.  And so the one specific thing they’ll pledge to pass by Christmas actually designed to improve housing affordability is the proposed ban on non-resident foreigners buying existing housing.  Consistent with this, on Labour’s website, the very first thing one comes to under housing policy is

Crack down on speculators


Ban foreign speculators from buying existing homes

Reasonable people can differ on the specifics of this (and other “anti-speculation” measures –  the extension of the bright-line test for investment properties, and ring-fencing).   To me, it has the much the same feel as that around first-home buyer grants –  it is the sort of policy one adopts when one has given up on dealing with the underlying problems.    Blaming “speculators”, for the symptoms of a rigged and dysfunctional market, is a distraction strategy from way back for politicians here and abroad.

Banning non-resident foreign purchases of existing houses isn’t the worst policy imaginable –  and any adverse impact on New Zealanders is likely to be small to non-existent – but as a flagship policy for a possible new government it is hardly one that suggests a serious focus on fixing the underlying long-term problems.  Sure, it is probably quite easy legislation to draft  (though no doubt MFAT officials will be turning their minds to the issue of how to reconcile the proposed ban with, eg, the New Zealand-Korea “free trade” agreement) and comprehensively fixing the planning system isn’t.  But after years in opposition, and with policies around land supply that look promising on paper, if they were really serious about far-reaching reform in this area, one might have hoped they’d have found something specific to have done in the first 100 days –  a stake in the ground, an earnest of a serious commitment to free-up land supply later in a first term.   But when the previous leader never mentioned the issue, the current leader never does, and when there is nothing in the 100 day action plan, I’ll stick with my scepticism for the time being.

Bloodless economists probably aren’t supposed to do disgust, but that pretty much summed up my reaction to the weekend story that, less than a year out of office, John Key had sold his Parnell property, at what is apparently a very substantial profit, to enable him and his wife to downsize.    No doubt it is mostly about “time of life” thing –  kids off their hands etc –  and I’m not suggesting that the National Party’s failure to do anything much about fixing the housing market problems for nine years was mostly about personal enrichment.     But this was a leader whose approach to the increasingly severe housing disaster was to glibly call it a “quality problem” or some sort of “sign of success”.  As I put it 18 months ago

In a speech to an Auckland business audience yesterday –  there is a report here, and also video footage –  the Prime Minister repeated his breezy claims that Auckland’s “challenges” around housing and transport are “a quality problem”, and a “sign of success”, and that both the city and the country are doing “incredibly well”.

Perhaps that is how it appears when you are already wealthy, live in a large house in a prime inner suburb, and have a taxpayer-provided chauffeur at your constant disposal.  Neither housing nor traffic problems must impinge terribly much.

And so, having moved on from public life, Key now extracts what is reported to be several million dollars of profits which are really just monopoly rents.  Keep the land supply market dysfunctional, boost the population considerably, allow house prices to be driven up to an extent that an ever-larger proportion of the young and the poor can’t afford to buy, and then simply take your own profits.   It is, in effect, money taken at the expense of the poor of Auckland –  not because any of them could afford Parnell, but because most of the increase in Parnell land prices is a reflection of the same common factor that has driven prices high across Auckland.  It is easy to be indifferent to a problem when you yourself benefit – even just passively –  from that continuing indifference.    The record, the policies, National is campaigning on today, including around housing and land, are more or less exactly the same as those of the first eight years of a National government, under John Key –  who has now cashed-out millions of dollars personally, made from his government’s refusal to fix the housing market.

Putting disgust aside and returning to the numbers, one often hears the current Prime Minister talking of 10000 houses a year now being built in Auckland, as if somehow this is the answer to the past policy failure.    It is often complemented by references to bureaucrats’ claims that tens of thousands of new houses are in the pipeline – I think I’ve even heard references to some multiples of Hamilton being built in the next few years.    (I’m not sure why we should be impressed by that figure, when New Zealand’s population is currently growing by as much as Hamilton every two years).

Of course, as Core Logic has pointed out, the actual increase in the housing stock is much less than the number of new dwellings being consented (many new builds require the demolition of existing houses), but even just focusing on building permits, is there any sign that the number of permits being granted in Auckland is getting ahead of the population growth?

The chart below uses official data.  It shows the number of building permits being granted in Auckland each (June) year relative to the (SNZ) estimated increased in the population over that same year.  Comparisons that look just at consents per capita are meaningless –  it is increases in the population that (are the biggest factor that) increase the need for accommodation.    The data are only annual, but for the year to June, so the actual building consents numbers are almost right up to date.    The population estimates for individual areas for June 2017 won’t be out until later next month.  But Auckland’s population is estimated by SNZ to have increased by 2.82 per cent in the year to June 2015 and by 2.83 per cent in the year to June 2016, and there has been no material change in net migration inflows over the most recent year.  So I’ve assumed a population increase in Auckland of another 2.82 per cent in the year to June 2017.   It is a rough estimate, but it would be surprising if the SNZ estimate next month was materially different.

building permits per person increase

So, yes, in annual terms, the number of building permits for new dwellings per person increase in the population has increased, but not by much.  But in the last two years, the rate of consenting has still been lower than in any year in the first decade of the data series.    It is unspectacular at best.  Sure, there is a lot of building going on right now, but then there are huge (government-abetted) increases in the population which don’t yet show any sign of abating.

And if there is a lot of house-building activity going on at present, there are straws in the wind suggesting there will be less in future.  At a national level we’ve already seen some of that already in the building work put in place data released last week.  But here is a chart of Auckland new dwelling permits.  The data are noisy from month to month, so here I’ve taken the annual growth rate in the three-monthly total (eg May to July 2017 over May to July 2016) and shown the data for (a) the total number of new dwellings consented, and (b) for the total floor area of those consented new dwellings.

building permits 2

Both annual growth rates are now (a) well below where they were, and (b) actually are negative.  In other words, in annual terms the volume of new housing being consented in Auckland is dropping.  And there is no sign that the rate of population increase is.

Views will differ on whether these numbers reflect capacity constraints or the limits of effective demand at the prevailing (extremely high) prices.  My own bias tends towards the latter story –  and Rodney Dickens at SRA has done some analysis taking the same view.  But whichever story you think is more convincing, the numbers don’t suggest any near-term lift in the overall supply of houses relative to the increase in the population.  Taken together with the lack of much land-use regulation reform, it all provides little reason to think that housing affordability in our largest city is likely to improve much, or for long, on anything like current policies.  Meanwhile, the system will remain skewed to those who have, and against those who have not, and we can only expect yet more ad hoc measures –  whether from the elected government or outfits like the Reserve Bank –  to paper over the symptoms of housing market failure.

 

Land prices on the developable fringe of Auckland

It is now pretty well-recognised that local authority zoning decisions can materially affect land values, creating an artificial scarcity in developable land and driving up the price of such land relative to the price land would otherwise command for alternative uses.    The best-known empirical study on this effect around Auckland (and the metropolitan urban limit in particular) was by Grimes and Aitken, summarised as follows:

We capture the impact of the MUL boundary on land prices by separately allowing for land which is: (i) well inside the MUL boundary,(ii) just within the boundary, (iii) sitting astride the boundary, (iv) sitting just outside the boundary, (v) sitting just a little further beyond the boundary, and (vi) sitting well beyond the boundary. We find a boundary land value ratio of between 7.9 and 13.2 (i.e. land just inside the MUL is worth around ten times more per hectare than land just outside it)

In a well-functioning liberal market, one might normally suppose that developable land on the periphery of an urban area would trade for around the value of that land in its best alternative use – typically agriculture.   If it went for much more than the agricultural use value, most farmers would be well-advised to sell, and they would do so until the prices in the alternative uses were more or less equalised.   The median sale price of dairy land is around $50000 per hectare.

Everyone knows that that is not remotely how things are in our highly distorted market.  But sometimes concrete examples bring home the point more starkly.

The other day a reader who knows something about property sent me a copy of a real estate agent’s newsletter on recent land sales in Dairy Flat, an –  as yet –  largely undeveloped area between Albany and Whangaparoa/Orewa, which is apparently classified as a “future urban zone”.    As my reader noted, the area does not yet have wastewater connections, so in his words “it is ages from development”.     Here were the sales in  July.

Total price ($) Parcel size (hectares)
1950000 1.557
1478000 1
2450000 2.493
2976000 3.189
1250000 0.303
1950000 0.9809

The average price of this land was $1.266m per hectare.

In our subsequent exchange, my reader noted that the value of this land for agricultural purposes might not be much more than $30000 per hectare.  He went on to point out that not that long ago 3800 hectares of forest land –  a little further inland than Dairy Flat, but similar terrian and a similar distance from central Auckland – had sold for $1700 per hectare.    In other words, the preferentially-zoned Dairy Flat land was selling as 750 times the price of the forest land.

Perhaps $1.266m per hectare doesn’t sound too bad.   But this is the unimproved value of the land –  none of any relevant earthworks have been done, no suburban streeets been formed, no development levies incorporated.  Even the holding costs for the few years until development actually occurs won’t be trivial (at, say, a low end estimate of a 10 per cent per annum cost of capital).  By the time tiny suburban sections are being sold to potential residents, they will have to be very expensive to cover the costs of someone now paying $1.266m per hectare.

And most of this “value” is simply added by politicians and bureaucrats drawing lines on a map.  It is obscene, and unnecessary.  It continues to skew the game against the young and those on relatively low incomes and/or limited access to credit, in favour of those who already have, or who can lobby councils to draw the lines in suitably limited places.

And, although I don’t have a time series of this sort of data, it doesn’t speak of any confidence among those actually buying and selling land right now that the next government –  of whatever political stripe – will make much difference in sorting out the shameful disgrace that is the New Zealand housing and urban land market.    I’ve long been sceptical, but these people are putting real money on such a call.  Perhaps they’ll be wrong and lose the lot.   But what reason is there to believe that is likely, when not one of our major political figures will even suggest that much lower house and land prices would be a desirable outcome towards which their party would be working?

Capital gains tax: quite a few reasons for scepticism

Going through some old papers to refresh my memory on capital gains tax (CGT) debates, I found reference to a note I’d written back in 2011 headed “A Capital Gains Tax for New Zealand: Ten reasons to be sceptical”.  Unfortunately, I couldn’t find the note itself, so you won’t get all 10 reasons today.    But here are some of the reasons why I’m sceptical of the sort of real world CGTs that could follow from this year’s election.  Mostly, repeated calls for CGTs – whether from political parties, or from bodies like the IMF and OECD –  seem to be about some misplaced rhetorical sense of “fairness” or are cover for a failure to confront and deal directly with the real problems in the regulation of the housing and urban land markets.

Anyway, here are some of the points I make:

  • in a well-functioning efficient market, there are typically no real (ie inflation adjusted) expected capital gains.    An individual participant might expect an asset price to rise for some reason, but that participant will be balanced by others expecting it to fall.  If it were not so then, typically, the price would already have adjusted.  In well-functioning markets, there aren’t free lunches.    It also means that, on average, capital losses will be pretty common too, and thus a tax system that treated capital gains and losses symmetrically wouldn’t raise much money on average over time.   A CGT is no magic money tree.   And there is no strong efficiency argument for taxing windfalls.
  • if you thought, for some reason, that people were inefficiently reluctant to take risk, there might be some argument for a properly symmetrical CGT.  In such a system, the government would take, say, a third of your gains, but would also remit a third of your losses (the overall risks being pooled by the state).    The variance of an individual’s private after-tax returns would be reduced, and they might be more willing to take risk.   But, in fact, no CGT system I’m aware of is properly symmetrical –  there are typically tough restrictions on claiming refunds in respect of capital losses (one might only be able to do so by offsetting them against future gains).  There are some reasonable base-protection arguments for these restrictions, but they undermine the case for a CGT itself.
  • All real world CGTs are based on realised gains (and losses to an extent).   That makes it not a pure CGT, but in significant part a turnover tax –  if you never trade, you never pay (“never” isn’t literal, but tax deferred for decades discounts to a very small present value).    And that creates lock-in problems, where people are very reluctant to sell, even if their circumstances change or if a new potential owner could make much more of the asset, for fear of crystallising a CGT liability.  In other words, introducing a CGT introduces a new inefficiency to asset markets, making it less likely that over time assets will be owned by the parties best able to utilise them.
  • Basing a CGT on realised gains will also, over time, bias the ownership of assets subject to CGT to those most able to avoid realising the gains.  A long-lived pension fund, or even a very wealthy family, will typically be better able to  count on not having to sell than, say, an individual starting out with one or two rental properties, or some other small business, where changed circumstances (eg a recesssion or a divorce) might compel early liquidation.  Large funds are also typically better able to take advantage of loss-offsetting provisions.  The democratisation of finance and asset holding it certainly isn’t.
  • CGTs in many countries exclude “the family home” altogether.  In other countries, they provide “rollover relief”, enabling any tax liability to be deferred.  Most advocates of a CGT here seem to favour the exclusion of the family home, even though unleveraged owners of family homes already have the most favourable tax treatment in our system.  Again, a CGT applied to investment properties but not owner-occupied ones would simply trade one (possible) distortion for another.
  • In practice, most of the arguments made for a CGT in New Zealand have to do with the housing market.   But, on the one hand, all major (and minor?) parties claim that they have the fix for the housing market (various combinations of RMA reform, infrastructure reforms, changes to immigration, restrictions on foreign ownership, state building programmes or whatever).  If they are right, there is no reason to expect significant systematic real capital gains in houses.  If anything, real house prices should be falling –  a long way, for a long time.    Of course, prices in some localities might still rise at some point, if unexpected new opportunities appear.  But “unexpected” is the operative word.   Enthusiasm for a CGT, at least at a political level, seems to involve a concession that the parties don’t believe, or aren’t really serious about their housing reform policies.
  • Oh, and no one I’m aware of anywhere argues that a realisation-based CGT applied to (a minority of) housing has made any very material difference to the level of house prices, or indeed to cycles in house prices.
  • In general, capital gains taxes amount to double-taxation.    Think of a business or a farm.  If the owner makes a success of the business, or product selling prices improve, expected profits will increase.  If and when those profits are achieved, they would, in the normal course of affairs, be subject to income tax.  The value of the business is the discounted value of the expected future profits.  It will rise when the expected profits rise.  Tax that gain and you will be taxing twice the same increase in profits –  only with a CGT you tax it before it has even happened.   Of course, at least in principle, there is a double deduction for losses, but as noted above utilising losses (whether of income, or capital) is a lot more difficult.    If you think that New Zealand has had less business investment than might, in some sense, have been desirable,  you might want to be cautious about applauding a new tax that would fall heavily on those who took business risks and succeeded.
  • Perhaps double taxation of expected business profits doesn’t bother you.  But trying reasoning by analogy with wages.   If the market value of your particular skills has gone up, your wages would be expected to rise.  When they do you will pay taxes on those higher wages.  But by the logic of a CGT, we should capitalise the value of your expected future labour income and tax your on both that “capital gain” and on the later actual earnings.  Fortunately, we abolished slavery long ago, but in principle the two cases aren’t much different: if there is a case for a CGT on the value of a business, it isn’t obvious why one shouldn’t have one on the value of a person’s human capital.
  • (I should note here, for the purists, that there are other concepts of double-taxation often referred to in tax literature, none of which invalidate the point I’m making here.)
  • Real world CGTs also tend to complicate fiscal management?  Why?   Because CGT revenue tends to peak when asset markets and the economy are doing well, and when other government revenue sources are performing well.  CGT revenue doesn’t increase a little as the economy improves and asset markets increase, it increases multiplicatively.  And then dries up almost completely.  Think of a simple example in which real asset prices had been increasing at 1 per cent per annum, and then some shock boost asset prices by 10 per cent.  CGT revenue might easily rise by 100 per cent in that year (setting aside issues around the timing of realisations).  And then in a period of falling asset prices there will be almost no CGT revenue at all.   Strongly pro-cyclical revenue sources create serious fiscal management problems, because in the good times they create a pot of money that invites politicians to (compete to) spend it.  If asset booms run for several years, politicians start to treat the revenue gains as permanent, and increase spending accordingly. And if/when asset markets correct –  often associated with recession and downturns in other revenue sources-  the drying up of CGT revenue increases the pressure on the budget in already tough times.     It is easy to talk about ringfencing such revenue (mentally, if not legally) but such devices rarely seem to work.

None of this means that I think there is no case for changes in elements of our tax system as they affect housing.  The ability for business borrowers to deduct the full amount of nominal interest, even though a significant portion of that interest is simply compensation for inflation (rather than a real cost), is a systematic bias.  It doesn’t really benefit new buyers of investment properties (the benefit is, in principle, already priced into the market) but it is a systematic distortion for which there is no good economic justification   Inflation-indexing key elements of our tax system is highly desirable –  at least if we can’t prudently lower the medium-term inflation target –  and might be a good topic for a tax working group.  In the process, it would also ease the tax burden on people reliant on fixed interest earnings (much of which is also just inflation compensation, not a real income).

Of course, at the same time it would be desirable to look again at a couple of systematic distortions that work against owners of investment properties.  Houses are normal goods and (physically) depreciate.  And yet depreciation is no longer deductible.  Perhaps there was a half-defensible case for that when prices were rising seemingly inexorably –  but even then most of the increase was in land value, not in value of the structures on the land –  but there is no justification if land reform and (eg) new state building is going to fix the housing market.    Similarly, when the PIE system was introduced a decade or so ago, it gave systematic tax advantages to entities with 20 or more unrelated investors.  Most New Zealand rental properties historically haven’t been held in such entities.  There is no good economic justification for this distinction, which in practice both puts residential investment at a relative tax disadvantage as a saving option, and creates a bias towards institutional vehicles for holding such assets.  Institutional vehicles have their own fundamental advantages –  greater opportunities for diversification and liquidity –  but it isn’t obvious why the tax system should be skewing people towards such vehicles rather than self–managed options.  As noted above, any CGT will only reinforce that bias.  Funds managers, and associated lawyers and accountants, would welcome that. It isn’t obvious why New Zealand savers should do so.

I see that there are more than 10 bullet points in the list above.  I’m not sure it covers all the issues I raised in my paper a few years ago, but it is enough to be going on with.

And in all this in a country where we systematically over-tax capital income already.  I commend to readers a comment on yesterday’s tax post by Andrew Coleman, of Otago University (and formerly Treasury).  As Andrew noted:

Somehow, New Zealand’s policy advising community decided it would restrict most of its attention to the ways income tax could be perfected rather than question whether income taxes (which are particularly distortionary when applied to capital incomes) should be replaced by other taxes. It is almost as if we have the Stockholm Tax Syndrome – fallen in love with a system that abuses us.

A broad-based capital gains tax would just reinforce that problem.

 

Debating housing

The centrepieces of the two weekend TV current affairs shows were political debates: The Nation had Phil Twyford and Amy Adams on housing, and Q&A had Grant Robertson and Steven Joyce on the economy more generally (but with a large chunk on housing).   I only saw the Q&A debate, but I have glanced through the transcript of Twyford/Adams.

In the course of his debate, Phil Twyford was asked how much house prices should be relative to income.    His response was excellent

Twyford: Ideally, they should be three times. If we had a housing market that was working properly, your housing would be— the median price would be about three to four times the median household income.

Grant Robertson repeated those sorts of numbers in his exchange with Steven Joyce.  It was good, clear, encouraging stuff.    A reminder of just how totally out of whack things are in the New Zealand house and urban land market.   And a suggestion that the main opposition party wants things to be materially different and better.

But I can’t help wondering in which decade they expect things to be more or less okay again.   In time for, say, my children –  perhaps 10 to 15 years from now –  or will it only be the grandchildren?

Don’t get me wrong.   Watching the Robertson/Joyce debate, as someone who has no idea who he will vote for, I thought Robertson had much the better of the housing side of the debate.   The current government seems reduced to some mix of lamenting that it is “a global problem”, reluctantly conceding that Auckland prices are a bit too high, and claiming that just over the horizon there is a wave of supply that will substantially address the problems.   So if I’m critical of Labour here, take for granted that almost all the criticisms apply with more force to National.

Here is Phil Twyford avoiding suggesting that Labour wants house prices to come down

So is it Labour’s goal to get it down to that – about four times?
Twyford: We want to stabilise the housing market and stop these ridiculous, year on year, capital gains that have made housing unaffordable for a whole generation of young Kiwis.
But in essence, you’re going to drop the value of houses, if you want them to be four times the price of the average income.
Twyford: Well, we’re going to build through KiwiBuild. We’re going to 100,000 affordable homes.
I want to come to KiwiBuild in a moment. I just want to talk to you about the price.
Twyford: That will make housing affordable for young Kiwi families. That’s our policy.

Stabilising the housing market, and ending rapid house price appreciation, isn’t a recipe for fixing up the housing market for the current generation of young people.

Grant Robertson was much the same –  reiterating the goal of house prices of 3 to 4 times income, but he couldn’t or wouldn’t say how long it would take.  There was plenty of talk about building “affordable houses” (around $600000?) and “cracking down on speculators” and beyond that it all seemed to be down to growing incomes.   But there wasn’t even a mention of freeing up land supply –  a topic where formal Labour policy looks better than anything else on offer from major parties.  Even though, the largest single component in the increase in New Zealand (especially Auckland) house prices has been the land component.

On the other side of the exchange Steven Joyce was taunting Robertson with the suggestion that “Labour wants to crash house prices with a punitive capital gains tax” –  as if, whatever the (de)merits of a CGT, much lower house prices would be the worst thing in the world.

Lifting growth in productivity and real incomes is highly desirable.   All else equal, flat nominal house prices and faster income growth is a recipe for improved housing affordability.  But how long might it take on reasonable assumptions?

I’ve shown similar charts on this point previously.  Here I assume a starting point of a price to income ratio of 10 (around current Auckland levels) and that (a) nominal house prices hold at current levels for the indefinite future, and (b) incomes grow at a rate equal to 2 per cent (midpoint inflation target) plus the rate of economywide productivity growth.  I’m just going to assume that the 2 per cent average inflation could be achieved quite easily if the government wanted to. Productivity is the harder issue.  Here I’m showing four lines using:

  • actual productivity growth (GDP per hour worked) over the last decade (just under 0.6 per cent per annum),
  • actual productivity growth over the last thirty years (for which we have quarterly real GDP and hours data), of just under 1.2 per cent per annum,
  • productivity growth of 1.5 per cent per annum, and
  • productivity growth of 2 per cent per annum.

The straight line on the chart is at a price to income ratio of 3.5 (ie the midpoint of the 3 to 4 times income Labour is talking of).

house price to income ratio with flat nominal house prices

On the best of these scenarios, price to income ratios get to 3.5 in about 27 years time.   If we manage productivity growth equal to that for the last 30 years –  which itself would be quite an achievement at present – we’d be waiting almost 35 years.

Affordable housing, and a functional housing market, for the current generation simply requires a fall in nominal house prices.   And yet no major party politicians seems to have the courage, or the self-belief (in their ability to communicate and take people with them), to make that simple point.

For most existing home-owners, the market value of their house does not matter a great deal.  A large proportion of home-owners have a modest mortgage or none at all, so negative equity isn’t a risk.  And since most people retire in the same city they’ve spent their working lives in, their house price doesn’t even affect very materially their own expected future purchasing power.

Fear of falling house prices seems to reduce to two particular dimensions:

  • people who, having bought in perhaps the last five years, would find themselves with negative equity if house prices fell markedly (in turn divisible between new owner-occupiers and purchasers of additional rental properties), and
  • some generalised fear that a fall in house prices goes hand in hand with economic disaster, serious recessions and the sort of experience the US or Ireland had.

The latter is mostly a category error.  In both the US and Ireland, there was material overbuilding (excess stocks of actual houses).  There is no prospect of that situation in New Zealand on any of the policies of the major parties.  In Ireland, the situation had been compounded by joining the euro, which gave Ireland interest rates set in Frankfurt that bore no relationship to the needs of the Irish economy.  In the US, there had been persistent official efforts –  from Congress, the Fed, and successive Administrations –  to encourage, or compel, the financial system to take on housing lending risk that the private sector would be unlikely to have assumed willingly.   None of that resembles New Zealand.  Not only do we set our own interest rates, but to the extent there is state involvement in the housing finance market it is reducing the supply of credit.

A severe recession could, at least for a time, lower New Zealand house prices.  Recessions –  severe or otherwise –  aren’t things to welcome.  But the sort of land market liberalisation (with associated infrastructure rules) that might, as a matter of policy, set out to materially lower New Zealand house and land prices would be most unlikely to materially dampen demand or economic activity.  If anything, it could represent a material boost to demand, as building became more affordable.   (And if some people would find themselves with negative equity, whole swathes of younger generations would suddenly face new opportunities and less of a desperate need to save.)

What about the people facing negative equity?  I don’t have any particular sympathy with those who’ve purchased investment properties in recent years and might face being wiped out.   They’d have taken a business and investment risk –  in this case on the regulatory distortions never being fixed –  and lost.  That happens in all sorts of market –  think of the people with exposures to shares after 1987, or in finance companies 10 years ago.  Or those with businesses based in import licenses in earlier decades.  It is tough for them individually, and almost all of them have votes.  But it was a business risk, and a conscious voluntary choice.

I’m much more sympathetic to those who bought a first house and could face a large chunk of negative equity.    I touched on this in a post a few weeks ago

No one will much care about rental property owners who might lose in this transition –  they bought a business, took a risk, and it didn’t pay off.  That is what happens when regulated industries are reformed and freed up.    It isn’t credible –  and arguably isn’t fair –  that existing owner-occupiers (especially those who just happened to buy in the last five years) should bear all the losses.   Compensation isn’t ideal but even the libertarians at the New Zealand Initiative recognise that sometimes it can be the path to enabling vital reforms to occur.  So promise a scheme in which, say, owner-occupiers selling within 10 years of purchase at less than, say, 75 per cent of what they paid for a house, could claim half of any additional losses back from the government (up to a maximum of say $100000).  It would be expensive but (a) the costs would spread over multiple years, and (b) who wants to pretend that the current disastrous housing market isn’t costly in all sorts of fiscal (accommodation supplements) and non-fiscal ways.

Those numbers were made up on the the fly, but even on later reflection they look like a reasonable basis for something that might not be unreasonable, and also might not be unbearably expensive.  It would recognise that people need to bear some material risk themselves (a 25 per cent fall in nominal house prices is not small).  But it is also designed in recognition of the fact that since 2013, it has been hard for first home buyers to get a mortgage above an initial LVR of 80 per cent, so that not many would be in negative equity now even if house prices fell by 25 per cent from here.

Since many people will stay in their existing house for a long time if they have to, and the scheme only compensates if the house is sold, that also limits the potential fiscal cost.  In fact, the biggest pool of owner-occupiers who would sell at a material loss would be those forced in the event of new severe recession (unemployment is typically the biggest threat to the ability to service mortgage debt) and (a) those people would naturally command a degree of public sympathy and (b) land liberalisation would be a stimulatory policy, reducing the chances of a near-term future recession.  There would be some voluntary sellers, to capture the compensation, but the cost of selling and buying a house, and of moving house, is not trivial.   If 100000 households were to claim the maximum compensation of $100000 that would be total additional government expenditure of around $1 billion, spread over a considerable period of time.   And to claim $100000, you’d have to have bought say a $1 million first house and seen house prices fall 45 per cent from your entry price.

It isn’t a perfect scheme by any means, and lots of details would need to be fleshed out.   One could relatively easily restrict it to apply only to those in a first owner-occupied house, again the people who will naturally command the most sympathy anyway.    But if something of this sort could be done for, say $1 billion, and it helped the pave the way for a genuine structural fix in the housing market –  a willingness to actively embrace lower house prices –  it would seem likely to offer more value than, say, the least valuable of the proposed 10 new “roads of national significance”, which are estimated to cost on  average just over $1 billion each.  How much congestion is there on the existing road from Levin to Sanson?

And three final points on housing:

  • it was depressing to read the housing section of Jacinda Ardern’s campaign opening speech.  It wasn’t the focus of her speech, but –  just like Andrew Little at his conference speech earlier in the year –  there was reference to dealing to “speculators”, barring foreign purchasers, and to the state building more houses, but not a word –  not even hint –  about freeing up the land market in a way that might make those price to income aspirations achievable,
  • it was slightly strange listening to Robertson and Joyce debating the possibilities of a capital gains tax, focused on housing.  Weirdly Robertson didn’t take the opportunity to rule out applying a CGT to unrealised gains –  even though he surely really realises that, whatever the theoretical appeal, there is no way anyone is going apply a CGT to anything other than realisations.  But it was even more strange to hear this debate going on after both sides were insisting they “had a plan” to fix housing.  If they really did then surely there would be few/no systematic capital gains in the housing market for decades to come?
  • and finally, Steven Joyce ran his line that house prices are a global problem.  This seemed to be a variant of the sort of “problems of success” line John Key often ran.  Out of curiosity, I dug out the OECD’s real house prices series this morning.   They don’t have data for quite every country, but here is the change in real house prices from 2007 to 2016 (annual data) for the countries they have the data for.    There are a few countries that have done worse, but not many.  In the median OECD country, real house prices have fallen over the last decade.

house prices last decade

Mostly, the countries that have been about as bad as us have also had quite rapid population growth (Israel, Australia and Luxembourg in the lead on that count) –  not, of course, that either Finance spokesperson suggested doing anything about that.

What about a longer-term comparison.  There are lots of gaps in the OECD data for earlier decades, but here are real house prices increases for the countries they have data for over the three decades to 2016.

house prices since 86

Worst of them all, without even the income growth to match.

We need to face up to the importance of lowering house prices, of adopting policies likely to sustainably make that happen, and – if necessary –  consider compensation packages for some to help make that transition possible.

Submission on the DTI proposals

Submissions close today on the Reserve Bank’s consultation on its proposal to add a debt to income limit tool to the approved list of possible direct controls on bank housing lending.

Despite the Prime Minister’s comments the other day, I don’t regard this as a “dead duck” at all.  The Reserve Bank won’t be coming back to the Minister of Finance with its recommendation, in light of the consultation, until after the election, and who knows what the political or housing market climate will be like by then.  Graeme Wheeler will be gone by then, and so the Reserve Bank’s decision will be in the hands of the (illegally appointed) acting Governor, Grant Spencer, and new Head of Financial Stability (and presumed Governor-aspirant) Geoff Bascand.  Perhaps they will have less appetite for controls than Wheeler has had –  both come from backgrounds that were not particularly keen on direct interventions –  but for now we have to assume that the proposal will continue to move ahead.

As I noted earlier in the week, there is a lot of useful and detailed material in Ian Harrison’s paper on the DTIs, which I gather he is putting in as a submission.

I ummed and aahed about whether to make a submission.  In one sense, it is a pure waste of time, since the Bank is unlikely to grapple very seriously with any points I make.  But, on other hand, it is good to have alternative perspectives, and questions, on the issue out there, and just possibly it might provide some angles for people with a bit more influence than I have.

So I did write a fairly brief submission.  My overview and summary is here

Overview

I am firmly against adding any sort of serviceability restriction (henceforward “DTI”) to the list of possible controls.  The Reserve Bank has failed to mount a convincing case, and has not demonstrated that it (or anyone) has the level of knowledge required for such restrictions to operate in a way likely to make New Zealanders as a whole better off.  Such restrictions would appear to go well beyond the Reserve Bank’s statutory mandate (contributing little or nothing to soundness and eroding the efficiency of the financial system), and a better cost-benefit analysis would in any case suggest that such controls would probably be welfare-detracting.   Other instruments (such as capital requirements and associated risk weights) that do not impinge directly on the borrowing and lending options open to individuals and firms remain a superior way to manage any future risks to the soundness of the financial system.  Serious microeconomic reform remains the best route to fix the serious housing affordability/land price problems.

As a reminder, the Reserve Bank has no statutory mandate to target house prices or the level (or growth rates) of credit in the New Zealand economy.   It also has no “house purchaser or borrower protection” mandate.  Restrictions of the sort proposed in the consultative document would represent serious regulatory over-reach.

The fact that a handful of advanced economies have deployed somewhat similar tools is little comfort or basis for support for the Reserve Bank’s own proposals.  Bad policy elsewhere isn’t a good reason to adopt bad policy here.  But more specifically, the interests of regulators themselves and of citizens are not necessarily, or naturally, well-aligned, a point that Reserve Bank material rarely if ever addresses.  For example, the Reserve Bank makes much of the British and Irish DTI limits (which do not apply to investment properties, where the consultative document says the Reserve Bank would want to focus), but never addresses the institutional incentives facing regulators in those countries following the financial crises each experienced in 2008/09 (the typical regulator incentive in the wake of a crisis to overdo caution –  and “to be seen to be doing something”, in the regulator’s own bureau-protection interests).     On the flip side, neither in the current consultative document nor in past Reserve Bank material has the Bank seriously engaged with the experience of housing loan portfolios in floating exchange rate countries during the 2008/09 crisis.  In countries like ours –  including Australia, Canada, the UK, Norway, Sweden, as well as New Zealand –  residential loan books emerged largely unscathed, despite big credit and housing booms in the prior years, and the subsequent nasty recession and, in most of these countries, a sustained period of surprisingly low income growth.

There has also been no evidence presented that banks have been systematically poor at making and managing portfolios of loans secured by residential mortgage, let alone that citizens should have any confidence in the ability of (and incentives on) regulators to do the job better.    Anyone can suppress overall credit creation with tough enough controls, but to what end, at what cost, to whom?     Controls of the sort now proposed, and the sorts of LVR restrictions already extensively used, seem to represent ill-targeted measures, based on an inadequate model of house and land prices.  They temporarily paper over symptoms –  house prices driven high by the failures of regulation elsewhere require high levels of credit – rather than address the structural causes of the housing market problems.     And because they seem to be premised on a model that wrongly treats credit as a leading factor in the housing market problems, they also do little to address any (limited) financial stability risks.  And in the process, they systematically favour some groups in society over others –  the sorts of distributional choices that, if made at all, should be made only by elected politicians, not by an unelected official.

A reasonable starting proposition would be that in the 25 years prior to the imposition of LVR restrictions the New Zealand housing finance market had been efficient and well-functioning.  Lenders lost little money, more borrowers could get better access to credit than in the earlier regulated decades, borrowers had no need to concern themselves with the changing details of Reserve Bank regulatory restrictions, there were no rewards to special interest group lobbying and rent-seeking, and competitive neutrality among different classes of lending institutions prevailed.  Perhaps the Reserve Bank would disagree with that characterisation of the market, but if so then, in proposing still further extensions of its regulatory intervention powers, surely the onus should be on you to make your case, not simply to ignore the past, apparently successful, experience?

Anyone interested can read the whole document here

Submission to RBNZ consultation on DTI proposal Aug 2017

The DTI proposal is a tool to address, inefficiently, a problem that isn’t there (threats to the soundness of the financial system), while appearing to try to do something about an actual serious problem (house and urban land prices), of successive governments’ making, about which the DTI tool can do little or nothing useful.  It won’t help, and if anything it distracts attention from the real issues, and from those really responsible, for the disaster that is the New Zealand housing “market”.

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 interest.co.nz 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.