Housing

Housing, the Reserve Bank, and interest rates

Michael Reddell Housing, Reserve Bank

Last week it was reported that the Reserve Bank’s chief economist Yuong Ha had told assembled journalists (at a media briefing on the Bank’s proposed new tools – all while they refuse to use the core one they already have) that

“The worse situation we’d face right now is actually if we had house prices falling.

Ha isn’t just any official. He is one of the four internal members of the Reserve Bank’s Monetary Policy Committee. He was appointed as chief economist by the Governor, but serves on the statutory MPC with the endorsement of the Bank’s Board (themselves appointed by the Minister of Finance) and of the Minister of Finance himself. His department delivers the forecasting and analysis that typically guides the rest of the MPC in their deliberations. In principle at least, he wields quite some clout.

In practice, there is reason to doubt just how much influence he has. He was appointed 18 months ago (somewhat to the surprise of many observers, and perhaps with more emphasis on his service as an Orr-lackey, including around the generation of Orr’s tree-god rhetoric, than for any particular analytical or policy depth). And in that time he appears to have given not a single on-the-record speech – this in the Orr administration that claims to be more pro-active in its external communications and speaking – or paper. It is a striking contrast to, say, the Reserve Bank of Australia or the Bank of England. And it is not as if management has held back to allow the external members of the new MPC to shine: they’ve either been unwilling to, or been forbidden from, speaking at all. And all this through turbulent and uncertain economic times.

But the Bank obviously feels they have to wheel Ha out from time to time so he gets to do the odd interview and the like. Some of them have been quite odd, and all too often reading Ha’s remarks one gets the sense that he just hasn’t really adjusted to operating in the major leagues (he’d had almost no external profile or media experience prior to taking up this job), and that many of his comments probably leave his colleagues wincing just a bit. From a senior statutory officeholder the Bank – and more importantly the country – deserves better. If they were doing their jobs, the Board and the Minister would insist on it.

As just one example, earlier in the year – mid-March actually – we saw this in the Herald reporting comments in a panel discussion Ha had participated in, and casting doubt on just how much difference asset purchase programmes might make.

yuong ha

As it happens, I think he was right then. In fact, he was running the fairly standard line the Bank had run for some time. It is just that within a few days there was going to be volte face and suddenly the Bank would be claiming that large scale asset purchases were making huge amounts of useful difference.

There was also this little snippet I’d forgotten until I went looking for the quote above.

ha apr 20

Perhaps there really is/was a good reason for the Bank’s ongoing resistance to any serious transparency, but that certainly isn’t a compelling argument.

I’m not going to try to track down all the quotes I’ve seen this year – and no doubt some have been perfectly reasonable articulations of the (poor) policy Ha is a consenting party to.

But I suspect that the most charitable interpretation of last week’s comments is that it was just another such mis-step. That Ha had simply never taken a moment to reflect on how what he was about to say would sound – most particularly in the last days of an election campaign. Or lifted his perspective from some equation in which these dubious “wealth effects” might have shown up. There was a – highly arguable – narrow point that he might have made, but instead he ranged expansive appearing the welcome New Zealand’s iniquitous house prices as somehow “a good thing”. (And, contrary to at least one commenter I saw, I don’t suppose it had anything to do with the personal financial positions of Ha or any other members of the MPC – very comfortable as they all no doubt are.)

Here is the fuller quote from the interest.co.nz article

ha quote on housing

There is a quite confused mix of things going on in those comments. On the one hand suggesting that higher house prices are “a good thing” in terms of supporting demand at present (a monetary policy commentary) and then shifting into financial stability matters for which Ha has little or no responsibility. And it is here that he suggests that falling house prices at present – any falls apparently – would represent a worrying (“worse”) situation from a financial stability perspective. But the subsequent comments are then all over the place. Clearly journalists pushed back and suggested that modest falls in house prices are hardly likely to jeopardise the stability of the financial system – as indeed the repeated Reserve Bank stress tests show – and so then Ha is left floundering, falling back on “wealth effects” again, suggesting – at least by implication – that these could threaten the financial system. It was all just very badly done (on the assumption that his remarks are fairly reported in context). And he ended up simply feeding the narrative that somehow the New Zealand economy is a house-of-cards reliant on house prices staying high, or rising, indefinitely, and that the Reserve Bank is somehow party to this conspiracy against the nation’s young and poor. And comes across as backing the reluctance of our political party leaders to do anything that might lower house prices.

I don’t really believe it is the institutional view. If I’m not a great fan of the Governor I have heard him do much better on this issue (and have even used those remarks to defend the Bank on occasion). He’s pointed out the falling house prices only pose a serious systematic threat when (a) house prices have fallen a long way, and (b) when the unemployment rate goes very high and stays high for some considerable time. That is the consistent result of the Bank’s stress tests, including those done in the last three months. One could easily add that whether one approved or not of the Bank’s LVR restrictions – I didn’t and don’t – they did have the effect that few people buying a house since 2013 will have had a deposit less than 20 per cent, and prices have mostly risen quite a bit since then. That is really quite a large buffer (ie if house prices fall even 15 per cent – a bit more than they fell in the 2008/09 recession – very few people are going to have any modest negative equity.

And I’ve heard the Governor better articulate even the wealth effect (dubious) story, to be rather clearer that the Bank has no vested interest in high or rising house prices, but that one way monetary policy can work – all else equal – is by affecting asset prices. What, of course, no one at the Bank points out is that in 2008/09 real house prices fell by 15 per cent – and took five years to get back to previous peaks – even as the Bank cut the OCR by 575 basis points). There is nothing necessary about cuts to the OCR – in recessions – driving up house prices, as for example we also saw after 1987/88 and in the late 90s. Why is that so? Because recessions typically involve income loss, heightened uncertainty, and some tightening in lending standards. (What has made the last few months a bit different? Massive income replacement in the near-term, and the removal of the LVR restrictions – temporarily ending financial repression will tend to have the sorts of effects we’ve seen.)

For myself, I remain very sceptical of the idea of any material housing wealth effect at all. The Bank has been running this line for the last 15 or so years – really since the 00s boom got into full swing – but its case has never been very persuasive, and it remains a story one hears much more vocally from our central bank than from others operating in countries with high/rising house prices. My scepticism on this count is now of long standing, and has both a conceptual and empirical strand. At a conceptual level, higher house prices do not represent greater wealth for the population as a whole (that makes them quite different from, notably, higher stock market valuations, especially those resting on business innovations and rising profit opportunities etc). There is, of course, a distributional effect affecting some people (although not generally owner-occupiers, who have a natural position owning one house and wish to consume housing services for the rest of their lives). Those holding rental properties, who can reallocate their portfolio are certainly better off when prices rise (and worse off when they fall). But their gain is exactly offset by losses to the renters, and to those in a demographic wanting to shift into home ownership.

Ha himself was asked about part of this

Asked whether there was a point at which high house prices would actually have an inverse effect – IE leave people, especially renters, with less cash to spend on stimulating the economy, Ha said this was something the RBNZ was constantly monitoring.

But it doesn’t suggest they have done any serious work on this hardly-new issue.

That it isn’t new is documented, no doubt inter alia, in this article published in the Reserve Bank Bulletin as long ago as 2011 (of which I was editor and co-author). It was mostly an article about understanding consumption behaviour in aggregate, and the abstract read as follows (emphasis added)

Household spending is typically the largest component of economy activity. This article sets out some ways of thinking about what shapes household consumption decisions and looks at New Zealand’s experience over the last decade or so – a period marked by rapid growth in asset prices and debt, and by big swings in economic performance. Large unexpected, but sustained, shifts in incomes appear to have been the biggest influence on total household consumption. Fiscal policy also appears to have played a role. It is less clear that the large increases in asset prices played a substantial role in influencing total household spending.

Among the many points traversed was this chart

housing and C

If you think there is nothing very interesting to it, that is sort of the point. Private consumption – even consumption ex housing – as a share of GNI showed no consistent trends or even cycles over (then) 20 years, and nothing to even hint at any sort of material economywide wealth effect, even as real house prices had risen enormously.

And this chart is from a followup discussion note I did a year later, showing the sharp increase in housing “wealth” over the decades.

housing and c 2

Some individuals will have felt wealthier. Some will have been wealthy. But many others will have felt or been poorer. In aggregate – as you’d expect , since we don’t export houses to any considerable degree – not much sign of any material economywide effect. I’ve seen nothing to suggest things have been different in the wake of the rise in house prices of the last decade. It is very hard to unpick what is causing what in a business cycle – and so house prices are often rising when the economy is growing quite strongly, both influenced by similar third and fourth and fifth factors. But as I noted almost a decade ago

If one looked at NZ consumption and savings data for the last decade unaware that there had been a house price and credit boom, one would not immediately think there was anything unusual to explain.

More generally, the Reserve Bank needs to find better, and consistent across their people and across time, ways of communicating that it is not responsible for house prices and it does not, or should not, have a view on where house prices should go (up, down, sideways). As a bank regulator, the Bank has a responsibility to ensure that banks are adequately placed to cope with sharp falls in house prices, especially those accompanied by sharp sustained rises in unemployment (which one would not expect to be the case if land use was substantially liberalised). The Bank appears to have done that – perhaps overdone it with the new capital, requirements. Beyond that, house prices are just one of those thing they may need to factor into their forecasts (of which there are many), not something it should be opining about the merits of. And while I would never encourage them to weigh in, given the Governor’s politicised remarks on all manner of other policy issues, if they are going to weigh in you might hope it was on the side of more affordable house prices and better opportunities for the young and the poor.

Finally – and this post has gone on quite long enough – you’ll have noticed the story yesterday that Heartland Bank is now offering a mortgage product at (just) less than a 2 per cent interest rate. From a housing affordability perspective this should have been a cause for muted celebration. Instead, we get headlines about driving prices to even more unaffordable levels.

The (real) cost of housing really should now be at an all-time low. The cost of using a house (rent, actual or imputed) is the cost of using a long-lived assets. With very low interest rates, the alternative returns from other assets should be expected to be very low, driving real rents down. Lower interest rates also slightly lower the cost of bringing new houses to market – holding costs of land, financing costs during the construction phase etc. And the cost of building materials themselves shouldn’t be materially affected by interest rates (and lows in interest rates are often reached in very low-inflation environments). Ah, but I hear you say, what about land, which is after all in fixed supply. But even there two things weigh against a very substantial effect. First, sustained low interest rates are often associated with low productivity growth (few investment opportunities) and that may be a true of rural land as anything else. But second, and more important, it is only the unimproved value of the land under a house (actual or potential) that should be affected by interest rates, and – in a liberal land market – that unimproved land value will be a relatively small part of the overall price of a house+land. That, of course, is not the way it is in modern New Zealand, but that has nothing whatever to do with the Reserve Bank or monetary policy, but with successive waves of central and local governments that make land – abundant in New Zealand – artificially scarce for housing purposes.

And a few days out from an election we, of course, don’t hear a single significant political party either pointing this out, or promising to make a real and substantial difference.

House prices

Michael Reddell Housing

Looking at the polls, or the flow of daily news, in many respects it no longer much matters what policy positions the leader of the National Party is enunciating. Hardly anyone supposes that the government after the election won’t be either Labour alone, or Labour and the Greens. And so if we are at all concerned about policy, what matters for the next few years is what Labour’s leader is saying, and what – as incumbent Prime Minister – she has been doing.

Three years ago we were told by the Prime Minister – and correctly so – that the housing situation in New Zealand was pretty bad (the word “crisis” was often flung around). House prices had risen enormously in the previous few years, as indeed they had under the previous Labour government, and the National government prior to that. She made much of “child poverty”, and most serious observers recognise that a significant contributor to problems in that area was the extraordinarily high level of house prices in New Zealand. A few thought Labour was getting serious about fixing the grossly-distorted housing market – making it a functioning market, rather than a thing rigged by central and local government. The Executive Director of the New Zealand Initiative had even done a joint Herald op-ed with Phil Twyford who was then Labour’s housing spokesman.

I was among those who was on record here as being sceptical. Controversial reforms only happen if they have strong backing from the leader/Prime Minister. But whether under Andrew Little or Jacinda Ardern, Labour leaders in Opposition never highlighted the core problem – the land use restrictions – and only ever cited the palliative or distraction measures Labour was proposing; ones which, if they had any effect at all, might be a few percentage points in a climate in which house prices were perhaps twice what they really should be in a functioning market with abundant land. When, with a functioning land market and the lowest interest rates in a very long time, real rents should have been cheaper than ever.

What were they proposing? There was the proposed foreign buyers ban, the extension of the bright-line test, and ring-fencing. There was the vaunted capital gains tax, and talk about immigration (although the specifics would have changed the net flow for only one year). And, of course, there was to be Kiwibuild. If you dug enough in Labour’s manifesto you might find mention of land-use reform, but it never got much attention or profile at all.

And where are we now after three years in office? The REINZ’s measure of median house prices has risen by another 27 per cent – and real house prices are so high that 27 per cent increase at these levels are much more material, and damaging, than 27 per cent increases might have been 20 years ago. There hasn’t been much general inflation in the last three years – about 5 per cent in total – so real house prices are up in excess of 20 per cent in just three years. In none of that period was the economy performing spectacularly well, and of course this year has been flat out disastrous, mostly due to events beyond the government’s control.

And what has the Labour-led government done in that time? They’ve done some of their specifics – the PM last night claimed the foreign buyers ban had made a difference – while others have just fallen by the wayside. Capital gains tax is no more, and Kiwibuild was one of the government’s more embarrassing failures – not that, even if delivered, it would have made more than a jot of difference to the underlying, land price issue. Oh, and they’ve been consulting on locking up more land – especially on the outskirts of Auckland – as allegedly “highly productive”. Thank goodness we didn’t have that sort of government when Carlaw Park was in use as market gardens or Manurewa or Lower Hutt or…..

Asked about house prices in the debate last night, the Prime Minister seemed reduced to hand-waving. Perhaps the foreign buyers’ ban did make a small difference – it is genuinely hard to tell – but even with it real house prices have still risen in excess of 20 per cent in three years. For a city with median house prices at five times median income – and Auckland, Wellington and Tauranga are far higher than that – that 20+ per cent real increase is equivalent in cost to a whole additional year’s income. (In well-functioning markets, house price to income ratios of three are quite sustainable).

She seemed reduced to claiming that she couldn’t have fixed the housing market in three years – a claim that is not only wrong, but belied by the fact that her government has shown no real sign of trying, and is not promising anything much different in the next three or six years. One might almost believe that the Prime Minister doesn’t really care about the level of house prices at all, so long as she can keep it in check as an electoral concern. And, as a statist at heart, she’ll be happy when lots more people are in state houses – perhaps a reasonable outcome in itself, for a small minority, but hardly a systematic solution to one of the most egregious policy disasters in modern New Zealand history. (On that statist note, did anyone else note that when talking about lifting living standards her only answers seemed to be higher minimum wages and the state paying “living wages”, with never a hint of firing up overall economic performance in a way that would support market-led much higher wages all round.)

But we heard nothing from the Prime Minister – last night or in other speeches or interviews – suggesting she has any sort of vision of much lower house prices in New Zealand. I saw this post on Twitter yesterday afternoon

The Little Rock metropolitan area is bigger than Wellington and Christchurch but smaller than Auckland. These houses are about as far from the centre of town as Upper Hutt is from central Wellington or Orewa to central Auckland. And just look what you get for around NZ$300000. (In a place with interest rates just as low as those in New Zealand with – for the leftwing journalists currently aggrieved at loose macro policy – a central bank doing even more to buy up all manner of assets.)

But you don’t hear the Prime Minister talking of that sort of affordability as something New Zealand should be matching. But think about the sort of difference it would make if we did – not just to people buying a house to live in, but to the cost of supplying rental accommodation as well. It isn’t some silver-bullet to the issues around poverty – 50 years of real economic underperformance aren’t just about house prices – but it would make an enormous difference, and (not incidentally) turn houses back into a (lifetime) consumption item, not something to stress about or speculate on the value of it. Fear of missing out – which has, reasonably enough, driven many younger people – would be a thing of the past.

And even if one granted – what may have been the PM’s point – that writing a robust new land use law might take some time, markets trade in a forward-looking way. If anyone really thought Labour was serious about taking steps that might make a three bedroom house on a decent section affordable again, they’d hold off buying. And those who own the artificially-scarce land available for development would be looking to offload it now – developed or not – before that scarcity premium vanished from the price. But there is no sign of any of that. Instead, we have the government’s official economic advisers forecasting a new surge in house and land prices once the immediate Covid dip has passed.

Now, we know the government has had a report recommending its own rewrite of planning law. Who knows what will come of that, but it is hard to be optimistic. Again, if it were genuinely going to open things up we’d see the smart money moving already and peripheral land prices falling. But no sign of that – any more than there was when the Auckland spatial plan was put in place.

The dominant ideology of Labour (and much more so the Greens) seems to be simply opposed to allowing the physical footprint of our cites to expand much at all, a firm opposition to allowing markets to work in determining where new development takes place (thus, in combination cementing in quasi-monopoly land prices), all while both parties are wedded to driving up the population rapidly. Of course, some of them will tell you they are keen to facilitate greater urban density in existing suburbs near the central city or around transport hubs. I don’t have too much problem with that in principle, but it don’t think it is either right – or probably politically tenable – to ride roughshod over community preferences (many/most new developments run a system of private covenants, and it isn’t obvious why existing neighbourhoods shouldn’t have that possibility if that is what most existing owners want) and – more importantly here – there is little or no evidence that the drive for density, and height, is likely to lower the cost of a constant-quality unit of housing. Sure, you economise on land – even though gardens are what many people would actually prefer (revealed preference illlustrates that) – but the cheapest way to build houses is single-level properties, and (I’m told) the per unit costs of apartment blocks of several storeys are really quite high. Unless the land market is opened, so that there is genuine amd aggressive competition to supply new development sites, it is very unlikely that anything is going to change to deliver land-abundant New Zealand the sorts of real house prices it could, quite readily, have.

And that’s just a disgrace; a shameful reproach on both major parties (and their sidekicks) – but it is Labour which has been in government these last few years and almost certainly will be for the next few. It is inefficient and discourages inter-city labour mobility, but – more importantly to me – it is simply deeply unjust, with the burden falling most heavily on the young and the poor (in New Zealand that means disproportionately Maori), on new arrivals, and on those without wealthy parents, or even just on those who value self-sufficiency and earning their own way in life.

I look at my own teenage children and grow increasingly angry at the indifference of a Prime Minister who endlessly talks about “kindness” but has done nothing to fix the grossly distorted housing market, just presiding over ever-worsening imbalances. My son came home from the church youth group the other night telling me that one of the church leaders had said that he and his wife had purchased their first (inner Wellington) house for $25000 (at what would have been near the peak of the early 70s boom). That is about $250000 in today’s money. I checked that same house this morning – now almost 60 years old – and an online calculator estimates a value of $755000. Sure, real incomes are higher now, but in a functioning market that doesn’t justify higher – constant quality – real house prices. How would almost any early-mid 20s couple today purchase a first home in our cities? That should be a normal and reasonable expectation – looks still to be in much of the US – but this government seems quite content to turn the vast bulk of the country into a nation of renters. I recall going to Switzerland for a central banking course about the time I bought my first house, and being told by our hosts that prices in Berne were so high that really only department heads at the central bank owned their own houses/apartments. I was shocked – and disapproving – then, but never imagined it would be the case in land-abundant New Zealand. But something increasingly close to that is the legacy of National and Labour.

I try to be even-handed on this blog, and thus I should repeat that I have no idea if National would be any better now. They weren’t last time – despite positive rhetoric then too – but perhaps this time would have been different. But it doesn’t matter. They won’t be in government for the next few years. And all the evidence is that we have a Prime Minister who doesn’t care about lowering house prices, is uninterested in spending political capital or making the case to do so, and to the extent Labour has policy ideas in this areas none are likely to deliver real house prices lower than the disgracefully high level they were even three years ago when Labour took office.

LSAP, deposits, bonds, house prices etc

Michael Reddell Housing, Monetary policy, pandemic

There has been a flurry of commentary in the last couple of weeks about the (alleged) impact of the Reserve Bank’s Large Scale Asset Purchase programme. Much of it has seemed to me really quite confused. I don’t really want to pick on individual people – none of whom, as far as I’m aware, is a macro or monetary economist – although, for recency if nothing else, Bernard Hickey’s column yesterday is as good an example as any. But the Reserve Bank itself has not helped, tending to materially oversell what the LSAP programme has actually done.

There is, for example, a complaint (there in the headline of Hickey’s article) that “printed money being parked, not invested or spent”. But this seems to completely ignore the fact – it isn’t contested – that really only Reserve Bank actions affect the stock of settlement cash. All else equal, when the Bank buys an assets from someone in the private sector, that purchase will boost aggregate settlement cash, and only some other action by the Reserve Bank will subsequently alter the level of settlement cash. When private banks lend (borrow) more (less) aggressively, that may change an individual bank’s holding of settlement cash, but it won’t change the system total. Some of my views and interpretations may be idiosyncratic or controversial, but this one isn’t. It is totally straightforward and really beyond serious question. For anyone who wants to check out the influences on the aggregate level of settlement cash balances, the Reserve Bank produces a table – only monthly and too-long delayed in publication – detailing them (table D10 on their website). I’ll come back to those numbers.

Now, of course, the transactions that give rise to changes in settlement account balances aren’t always – or even normally – primarily with banks themselves. If the Reserve Bank bought a government bond I was holding, that would increase – more or less simultaneously – (a) my balance in my account at my bank, and (b) my bank’s balance in its account at the Reserve Bank. And because the government banks with the Reserve Bank, the same goes for (say) government pension payments: all else equal, they add to the recipient’s own deposits at his/her bank, and also to that recipient’s own bank’s deposits at the Reserve Bank (in normal times, the Reserve Bank does open market operations that roughly neutralise these fiscal flows – revenue or spending).

Much of the coverage of the LSAP purchases suggests that there has been a big net transfer of cash (deposits, settlement cash) from the Reserve Bank to private sector bondholders in recent months. Thus, we get stories and narratives about what “rich people” and other bond holders are (and aren’t – often the point) doing with all the cash they are now holding. But it simply isn’t a narrative relevant to New Zealand over recent months. The Reserve Bank publishes a table showing holdings of government securities (Table D30). Again, it is only monthly and we only have data to the end of July. But over the five months from the end of February to the end of July, secondary market holdings of New Zealand government securities (ie excluding those held by the Reserve Bank and EQC) increased by around $10 billion. It simply is not the case that funds managers, pension funds and the like (private bondholders generally) are suddenly awash with extra cash. In fact, collectively they have more tied up in loans to the Crown than they had back in February.

None of which should be really very surprising. After all, the government has run a massive (cash) fiscal deficit over the last six months – a reduced tax take and programmes that put lots of extra money into the accounts of businesses and households.

We can get a sense of just how large from that Influences on Settlement Cash table (D10) I referred to earlier. In the five months March to July the government paid out $23.8 billion more than it received. There is some seasonality in government flows, but for the same period last year the equivalent net payout (“government cash influence”) was $4.5 billion (and $4.9 billion in the same period in 2018). That is a lot of money put into the accounts of firms and households – the largest chunk will have been the wage subsidy payments, but there was also the corporate tax clawback, and various other one-offs, as well as the effect of the weaker economy in reducing the regular tax-take.

Over those five months the government has also issued, on-market as primary issuance, a great deal of debt (bonds and Treasury bills) offset by maturities (and early repurchases of maturing bonds by the Reserve Bank). Over the five months, the net of all these on-market transactions was $34.4 billion – as it happens, a whole lot more than the cash deficit for that period.

Now, of course, we know that the Reserve Bank – another arm of government – has been entering the secondary market to buy lots of government bonds. For the five months, the cash value of those purchases was $27.2 billion.

Take those two debt limbs together and issuance has exceeded RB LSAP purchases by about $7.2 billion.

And those are almost all the main influences on aggregate settlement cash balances. Other Reserve Bank liquidity management transactions can at times have a significant influence, but over these five months the net effect was tiny, at around $300m.

So broadly speaking, over the five months from the end of February to the end of July, the total level of settlement cash balances increased by about $16.4 billion (to $23.8 billion at the end of July). Roughly speaking, a cash deficit (also, coincidentally) of $23.8 billion, and net debt sales by the NZDMO/RB combined of $7.2 billion. And a few rates and mice.

Another way of looking at it is that the $23.8 billion “fiscal deficit” has been financed by $7.2 billion of net debt sales to the private sector, and by the issuance of $16.4 billion in Reserve Bank demand deposits (another name for settlement cash balances).

(And thus the biggest effect of the LSAP programme itself has really just been to change the balance between those last two numbers – consistent with the line that I keep running that to a first approximation the LSAP is just a large-scale asset swap, exchanging one set of low-yielding government liabilities (that anyone can hold) for another set of low-yielding government liabilities (that only banks can hold, while banks themselves assume new liabilities to their own depositors).

But taking the private sector as a whole what has happened over the last few months is that the fiscal policy choices (spending and revenue) have put lots more money in the pockets (and bank accounts) of firms and households. And the government as a whole (NZDMO/RB) has offset the settlement cash effects of that in part by (net) selling really rather a lot (by any normal standards) of net new bonds to private sector investors/funds managers etc. They, in turn, have less cash. Firms and ordinary households have more (at least than they otherwise would).

There have been strange arguments – and the Reserve Bank Governor sometimes feeds this silly line – that banks are not “doing their bit” by lending more to businesses, even though – we are told – they have so much more settlement cash. But this is a wrongheaded argument, because systemwide availability of settlement cash has rarely, if ever, in recent times (last couple of decades) been a significant constraints on bank lending. Aggregate settlement cash balances barely changed over the previous decade and plenty of lending occurred. In a severe and quite unexpected recession, it would generally be more reasonable to suppose that lack of demand from creditworthy borrowers, some caution among banks as to quite what really is creditworthy, and sheer uncertainty about the economic environment would explain why there wasn’t much new business lending occurring. In fact, sensible bank supervisors would typically welcome that outcome. And remember my point right at the start, even if banks were doing lots of new business lending, it would not change the level of settlement cash balances in the system as a whole by one jot.

So then we get to the question of house prices. Many people – me included – expected that we would have seen house prices beginning to fall already. Severe recessions and considerable uncertainty tends to have that affect. Often, tighter bank lending standards reinforce that. So what did we miss? I can’t speak for anyone else, but for me:

  • I have not been surprised by the extent of the fall in retail interest rates.  That fall has been small in total, and modest by the standards of significant past recessions.  When people idly talk about lower lending rates driving up house prices, they seem completely oblivious to the way –  whether over 1990/91, after 1997/98, or in 2008/09 –  falling interest rates initially went hand in hand with flat or falling house prices.  Interest rates were, after all, falling for a reason in the middle of a recession.  One can argue that trend lower interest rates are raising trend house prices (I don’t think so, but that is for another day) but there isn’t really a credible story that this modest fall in interest rates –  amid a big and uncertain recession –  is raising house prices now, in and of itself,
  • we also know that people who usually hold bonds are not suddenly finding themselves at a loose end, unable to invest their cash in government bonds and having to fall back on buying a house instead.  The aggregate figures tell us instead they are holding a lot more bonds than they were (and as a trustee of super funds that do have substantial bond exposures, I know our advisers have not come and urged us to sell out and buy houses).
  • but we’ve also had a highly unusual combination of events that together probably do explain why, to now anyway, house prices are holding up in most places, perhaps even rising.  
  • we’d never previously gone into a recession with binding LVR limits in place.  The Bank removed those limits when the recession began –  sensibly enough –  for a flawed policy –  and consistent with the way they’d always talked of operating, enabling some people who regulation had forced out of the market to get back in.  Regulatory credit constraints were eased.
  • We also had the mortgage holiday scheme, which had two legs to it.  The first was that banks generally agreed to show forbearance to people who would have otherwise had trouble servicing their mortgage over this period, allowing them to defer to later payments due now.  Mostly that was probably pretty sensible, and banks might done something along those lines for most customers even with no heavy-handed government involvement.  But then the Reserve Bank engaged in questionable regulatory forbearance, telling banks that even though the credit quality of their residential loan books had deteriorated –  people unable to pay, even if perhaps just for a time, but with threats of rising unemployment –  they could pretend otherwise, at least for the purposes of the capital requirements the Reserve Bank imposes on locally-incorporated banks.
  • And, third, we’ve had an unprecedented series of fiscal support measures, putting lots (and lots) of taxpayer money into the accounts of businesses (mostly, directly) and households, to offset to a considerable extent the immediate substantial loss of market incomes and GDP.

My approach then is to reason from the counterfactual.   Suppose these actions had not been taken, what then would we have expected to have seen in house prices?

I reckon it would be a safe bet that house prices would have fallen.  Sure, retail interest rates would still have come down, but as I noted earlier that happens in almost every recession, and the falls are typically larger than those we’ve seen this year.   But even just suppose the virus had done as it did, here and abroad, and that the anti-virus choices (policy and private) were as they were.  There would have been a huge increase, almost immediately, in unemployment, and a large number of households would have been thrown onto no more than the unemployment benefit, and many of those that weren’t would have running very scared.  The cashed-up might still have been interested in buying, at low interest rates, but there would have lots of sellers –  whether forced by the bank, or people just needing to cut their debt urgently –  and that wave of desired selling would have fed doubts that would have left buyers more wary than otherwise.    But it was the fiscal policy choices that put additional money in the pockets of those who might otherwise have been rushing to sell.

The thing is, that for all the moans and laments about house prices rising a little, no one seems to have been arguing that we should not have taken a generous approach to supporting households through recent months.  Given the logic of the LVRs, probably most people think it reasonable that those restrictions were suspended.   Few people think banks should have been more hard-hearted (even if a few geeks like me might be uneasy about the capital relief the RB provided). 

And it is those that are the choices that really mattered.  (They are also why I remain sceptical that any strength in the housing market will last much longer, given that the fiscal support is rapidly coming to an end, unemployment is rising (and is expected to continue to do so), the world economy looks sick, we’ve been reminded afresh of virus uncertainty, and deferred debt has not gone away.  Time will tell.)

Now none of this is to suggest we should be at all comfortable with the level of house prices in New Zealand.  They are a disgrace, and the direct responsibility of successive governments of all stripes, and of their local authority counterparts.    But given that all of them refuse to address the real issues –  opening up land use on the fringes of our towns and cities in ways that would bring land prices dramatically down – they can’t really be surprised by where we are now.

And it is has nothing whatever to do with the LSAP programme:

  •  which has not put more money in the hands of people who buy houses,
  • has not made any material difference to wholesale or retail interest rates over the relatively short-term maturities most New Zealand borrowers borrow at (even if there is a case that the might have a material difference to long-term rates, benefiting really only the government as borrower),
  • may have actually held short-term interest rates up a little, if the Reserve Bank is being honest in its claim that it preferred using the LSAP to cutting the OCR further this year,and
  • which has not enabled, empowered, or encouraged the government to run any larger deficits than it would otherwise have chosen to run (which could readily have been financed on-market, except perhaps in the torrid week or two in late March when global bond markets were dysfunctional.   Government deficits put money in the pockets of people.  Most people –  me included –  think they were right to do so (even if we might quibble about details).

Observant readers may have noticed that the government issued much more debt over those five months than the deficits it ran.  Without the LSAP, these transactions in isolation would have tended to drain the level of settlement cash.  But that would not have happened in practice.   Either the NZDMO would have spread out its issuance a bit more, or the Reserve Bank would have done (routine for it) open market operations to stabilise the aggregate level of settlement cash balances at levels consistent with their target level of short-term interest rates.

Other observant readers might wonder how the LSAP can be so relatively unimportant (in many ways almost as unimportant as the MMT authors might suggest).  A key issue here is that the yields the (whole of) government is paying on bonds is very similar now to the yield (the OCR) it is paying on unlimited settlement cash balances.   One could imagine a different world in which things would work out differently.  It used to be common for settlement cash balances to earn either zero interest, or a materially below market rate.  So if, say, the Reserve Bank was buying bonds at yields of 10  per cent –  where they were in the early 1990s –  and paying zero interest (or even a significant margin below market) on settlement cash balances, each individual bank would be very keen to get rid of any settlement cash building up in its account.  They still couldn’t change the total level of settlement cash balances but they could, for example, bid deposit rates down aggressively, which would (among other things) be expected to materially weaken the exchange rate.  But on current policy –  only adopted in March –  the Bank pays the full OCR on all and any settlement cash balances.  25 basis points isn’t a great return, but it is probably high enough –  relative say to bank bill yields – that banks aren’t desperate to offload settlement cash.  The transmission mechanism is then muted, as a matter of policy choice.

Finally, note that –  because of the inadequacies of the Bank’s data publication (influences on settlement cash really should be daily, published daily, in times like this) – all my numbers refer only to the period to the end of July.  But note that since the end of July the level of settlement cash balances has fallen further ($19 billion as of last Friday).  I haven’t tried to unpick what specifically has gone on in any detail, but my guess is that the cash fiscal deficit has diminished, while heavy bond and bill issuance by DMO has continued.  The Reserve Bank has stepped-up its own purchases but the bottom line remains one in which (a) if anything the Bank is draining funds from banks, although in doing so not really constraining any one or any thing, while (b) it is fiscal choices –  pretty widely supported ones –  that have still been putting money in the pockets of people who might, for example, be holding houses (and owing the attendant debt).  Unsurprisingly, bank deposits have risen in recent months, exactly as one should have expected.

And there endeth the lecture,  My son (doing Scholarship economics) asked about this stuff the other day and I ran him through most of this material.  My wife suggested I’d had my best schoolmaster’s voice on at the time.  I suspect the tone of this post is somewhat similar.  I hope the substance is some help in clarifying some of the issues. 

Two charts

Michael Reddell Fiscal policy, Housing, pandemic

….on unrelated matters.

One of the objections sometimes raised to my advocacy of a deeply negative OCR is along the lines of “it will only lift asset prices”, with the implication –  and sometimes directly stated –  that that is what has happened in the last decade or so, even as policy rates in most of the advanced world fell from materially positive numbers to somewhere near zero.   In 2007, policy rates in the US and the UK had been over 5 per cent, in the euro-area 4 per cent, and in New Zealand and Australia higher than all those rates.   Only Japan was then in the extreme low interest rate club.

The asset price that tends to attract most attention in New Zealand is house prices (really house+ land).  The Bank for International Settlements maintain a nice quarterly database of real house prices for a large group of advanced and emerging economies.

Here is what has happened to real house prices for the largest advanced economies, and for the advanced economies as a whole, over the 12 years from the end of 2007 to the end of last year.

house prices to end 2019

Very little change at all.

The aggregate advanced economy measure only starts in December 2007, and for quite a lot of countries the data starts getting thin for earlier periods.   But for the UK, the euro-area, and the US, I had a look at the previous decade –  over which period policy interest rates hadn’t changed much at all (ups and downs of course during the period) – and in each case real house prices increases were much more rapid in that period than in the more recent (extremely low interest rate) one.   The US had experienced a 53 per cent increase in house prices –  and they had already fallen back from peak by the end of 2007 –  and the euro-area a 40 per cent increase.  In Japan –  very low interest rates throughout –  real house prices had fallen substantially over the 1997 to 2007 period.

Of course, within these aggregates for the last decade or so there is a lot of cross-country variation.  We all know real house prices in New Zealand and Australia have risen a lot.   In some other countries, they’ve fallen a lot.    But even in New Zealand, Australia and Canada, the rate of increase has been less in the last (low interest rate) 12 years than it was in the previous decade.

That shouldn’t really be a surprise.  After all, in principle, houses are reproducible assets (some labour, some timber, some concrete, some fittings) and in few countries is very much of land built on.   Moreover, interest rates aren’t where they’ve been as the result of some toss of a coin, or a draw from a random number generator; they reflect underlying changes in savings/investment imbalances, which central banks adjust policy rates to more or less reflect.

When a wide range of countries have had fairly similar interest rate experiences (and inflation outcomes; the check on whether monetary policy is out of step), and yet have had very different house price experiences, it probably suggests that some non-interest rate factors have been at work.   Of course, in some cases, that might just mean working off past crises –  although if you want to cite the US there (a) recall that by the end of 2007 real house prices had already fallen by 15 per cent from peak, and (b) that in the boom years nationwide real house prices in the US never rose as much as they did in, for example, Australia and New Zealand.

A more plausible story is that some combination and land-use restrictions and population pressures continue to explain a lot about differential house prices performance in the years since 2007.   In New Zealand and Australia, for example, we have had tight planning restrictions and rapid population growth.    I don’t know much about planning rules in central and eastern Europe, but there isn’t much population growth (deliberate understatement here) in countries with strong economic growth such as Bulgaria, Romania, Slovenia, Slovakia and the Baltics.   It isn’t a simple one-for-one story, but taken across the advanced economies as a whole it just doesn’t look as though low interest rates are a credible part of the house price story –  house prices, in aggregate, not having done much at all.

Of course, had central banks completely ignored the market signals re savings/investment pressures and simply held policy rates up then no doubt house prices would have been lower.  Then again, we’d also have had persistent deflation and (more importantly) unemployment rates that stayed much higher for longer and more persistent losses of output.

On a completely different topic, I found myself yesterday on an email exchange with some fiscal hawks, very worried about the future level of public debt.

I’ve noted previously that on the Treasury budget numbers our ratio of net debt to GDP in 2023/24 would still be sufficiently modest by international standards that if we had had that high a debt ratio last year, we’d still have been (narrowly) in the less-indebted half of the OECD.

Another way of looking at things is to take the government at their word and assume that by the end of the forecast period the Budget is more or less back to balance, such that the nominal level of debt stabilises at the level forecast for the end of 2023/24.

If that were to happen that what happens to the debt ratio depends on how much growth in nominal GDP the economy manages in the years ahead.   If we assume that the terms of trade is stable (or that the only safe prediction is that we don’t know, so assume no change), then there are three components to the rate of growth of nominal GDP.    As an illustrative experiment I jotted down a range of possible average outcomes for each.

Average annual growth
Low High Average
Population 0 1 0.5
Productivity 0 1.5 0.75
Inflation 1 2 1.5
2.75

So I’d assume growth in nominal GDP averaging 2.75 per cent over the decades beyond 2024.  Of course, there will be booms and recessions in that time, but this is just an average.   And then I’ve taken two alternative scenarios –  one in which nominal GDP growth averages 2.25 per cent, and one in which it averages 3.25 per cent.   Those aren’t extremes, and one could envisage even higher or lower numbers.

But this is what a net debt chart looks like out to 2064.

net debt scenarios

Even on the worst of these scenarios this (exaggerated, because it excludes NZSF assets) net debt measure is back to 30 per cent of GDP by 2050.   That doesn’t seem too bad to me for a one in a hundred year shock (as the government likes to claim) or –  less pardonably –  a one in 160 year shock as the Reserve Bank Governor was talking up the other day.

Of course, fiscal hawks will say, “but what if another really nasty shocks happens in the meantime?”.  Well, of course we would have to face that if it comes –  and it could –  but, as I noted, our net debt at peak is not high by pre-crisis international standards, and isn’t even high by our own longer-term historical standards.

Governments might choose to lower the debt faster, although if real servicing costs remain low it is difficult to see why one would, since faster consolidation involves either higher taxes than otherwise (with real deadweight costs) or less spending than otherwise (and while each bit of spending has its own antagonists, there is a case to be made for most of it).   There is precisely no evidence that anything important would suffer if our net public debt took a trajectory something like the central scenario in that graph.

(Of course, it is a purely illustrative scenario, and the composition of nominal GDP growth does matter to the budgetary implications –  eg faster population growth means more infrastructure demand, faster inflation might mean some unanticipated inflation tax, faster productivity is more like pure gain –  but there is no reason to suppose that if governments can get back to balance (as they repeatedly have now for decades) that we will need anything much beyond that.  Getting back to balance will require discipline and focus –  and a strong credible recovery would help –  but since most of the fiscal measures to date have been avowedly temporary, doing so should not be beyond our political system, whichever group of parties happens to be governing by then.

Free up housing by shaking up politics

Michael Reddell Housing

No one much thinks that either National or Labour-led governments are going to do anything serious about freeing up land use and markedly lowering house prices (and price to income ratios).  A few individual figures in the two parties occasionally talk a good game, but their governments don’t do what is necessary to make a difference.  All indications are that the parties don’t really care that much –  sure, they seem to need to be seen to show a bit of concern from time to time, but affordable housing across the board seems to be rapidly becoming one of those things our political leaders would prefer people just forgot about.  Get used to living in expensive dog-boxes on tiny sections or in apartments – all this in a country with abundant land.

Graeme Farr isn’t willing to give up.  He’s launched House Club, a club and political party in one, designed to make affordable housing an option again.  As the website puts it, the gist is

House Club does not want to change any of the crazy number of rules and regulations that affect housing – it just wants it’s own areas where none of them apply! 

House Club creates its own “Club Zone” which is outside the RMA, the Building Act and council zoning rules and can have from 5 to 5,000+ houses.

Here is the fuller text on what a “Club Zone” is

A Club Zone is land where building does not have to comply to the RMA, the Building Act or local council zoning. This is nothing new – until the 1980’s the Government and its departments like the Post Office, Railways and Ministry of Works did not need to get building or resource consents for anything they built on Government owned land. In some US states such as Texas there are no town planning rules. This was the same in NZ until 1953 and the Town and Country Planning Act – yet houses build before this act are equally sought after and valued than later ones – often more so!

House Club decides solely on where a Club Zone is created. The land can be bought outright by House Club or it can award a group or private landowner a Club Zone – or a combination of both. Each Club Zone site can determine it’s own rules or convenants to suit its purpose, but these will need to be approved by House Club if it is not a partner or owner.

He is planning to have House Club become a registered political party –  for which he needs at least 500 members ($3 for three years’ membership) –  contesting the party vote in this year’s election, aiming for 5 per cent of the vote and the balance of power, with a single issue they’d be looking for action on.  In concrete terms,

House Club will provide houses for UNDER $300K for a 100m2 three bedroom home on a proper section within 30 minutes drive of the centre of Auckland, Wellington or Christchurch and even closer in other cities and towns. 

“Proper section”?  Well, according to a Westpac survey last year, 90 per cent of New Zealanders wanted a backyard.

More generally on the House Club model

House Club will contain many Sub-Clubs who want to do their own thing – House Club55 for low cost seniors housing, Tiny House Club for tiny house villages, Eco House Club and Co-House Club for eco and co-housing schemes and Private House Club for selected private developers who want to provide low cost housing to Club members.

When Graeme first told me about this idea a few months ago it was in the context of retirement villages

1. I am thinking large scale ones – say 200 to 2000+ houses like they build in the US. They are super cheap there and most are freehold titles. I can send examples – you would not believe the prices they can achieve using economies of scale.

2. Dairy factories and timber mills are usually permitted activities in rural zones – so a retirement village will most likely have less affects

3. Retirement villages are better than standard fringe housing as they do not need things like jobs, schools, public transport, wastewater pipes, roads etc. Residents don’t travel at peak hours – they have their own buses. The councils do not need to provide infrastructure like a standard subdivision.

As I noted then, I couldn’t imagine wanting to live in such as village, but it is clear that lots of people do.   And as the website indicates, the model generalises.

The vision is for developments of the fringes of existing cities/towns

Developing in the fringes is not only cheaper but faster too. If the density is kept low then the rural road network and infrastructure that exists around most cities will be sufficient for the intial Club Zones. Modern self contained wastewater plants can service the zones if trunk connections are not nearby. Freshwater and stormwater can be collected and disposed of on site if need be and most rural roads have a power network.  

What about building standards?

Do Club Zone houses need to comply to standards likeNZS3604?

A:   No they don’t as long as they are only one or two storeys.  There would be well over a million houses in NZ which come nowhere near to complying to standards like NZS3604 and you can legally buy these – often at very high prices.  Builders will probably choose to use some standards as a selling feature but making them not compulsory means you can import a house kit or building materials from overseas without restriction. This undermines the local materials supply cartels which contribute to the very high building prices here.

Members buying in the Club Zones will accept they are paying much less for having a house which may contain building products which are not made in New Zealand or made to a ‘special’ NZ standard. Most imported mass production materials are made to adequate or better standards than we have here anyway. At present aluminium windows made for Australia do not comply to the NZ standard NZS4211:2008 – yet they have hurricanes in Australia. The current review of the Building Act will tighten importing rules – supported of course by the NZ Building Industry Federation who represent the local suppliers and manufacturers.

In other words, seeking to address both the land and construction cost elements of our current house prices.

And in a telling, if more lighthearted, response to a suggestion that there might be 2500 rules governing building a house

It is hard to add up all the rules and regulations the Government and councils have made for building a house but it is true pleasure craft in New Zealand need to comply to no construction rules at all, irrespective of size. You can build a 100 metre boat and unless you are using it for commercial use or charters there are no regulations at all – you can build it out of blotting paper if you like. This applies to around one million boats in New Zealand and could of course equally apply to basic housing.

There is even a, perhaps tongue in cheek, plastic bag policy.

It isn’t a first-best policy option by any means, but no significant party shows any sign of championing first-best reforms, and local governments are mostly the enemy of anything that would seriously liberalise market (the mayor of Wellington – sworn enemy of the backyard – is quoted on the front page of this morning’s paper talking of “if you can squeeze twice as many houses on the same land why wouldn’t you?” –  this about privately owned land, for privately-owned houses).

But as a second-best option I think it has a lot going for it and, at very least, deserves some serious scrutiny and debate.  I don’t need a house myself, but I’ve just signed up (to support a good cause rather than deciding, at this stage, to vote for them).  I don’t suppose it is likely House Club will get to 5 per cent –  it is hard – but it would be much better, for members and for wider New Zealand, if they did manage to do so, or even if they just managed to put some more pressure on National and Labour to take seriously the plight of our younger generation – including my kids 10 years or less hence –  for whom the elite message seems to be that home ownership is for the especially fortunate, the abnormally determined etc, not a normal and everyday part of life for people across the economic spectrum.

Here, again, is the link to the website.

Housing unaffordability

Michael Reddell Housing

The annual Demographia report on housing affordability across a range of English-speaking advanced countries was released earlier this week.

If you are a New Zealander who cares at all about efficiency, fairness (especially to the rising generation), functioning markets it makes pretty bleak reading.   The focus of the analysis is on the ratio of median house prices to median household income.   Here is ratio for the median urban market in each of the countries they look at

demographia 2020 2

(They also look at the two city states Singapore  (which is in the middle of the pack) and Hong Kong (which is off the charts, see below).

And here is a chart focused just on fairly large cities (>1 million people).  I’ve shown the ten cities with the lowest price to income ratios, the ten with the highest ratios, and a selection (every ten or so rank places) of those in-between.

demographia 2020 1

and here are the New Zealand cities in the wider sample

demographia 2020 3

You’ll see people sometimes talk about Christchurch house prices being affordable again but it is worth keeping that claim in perspective –  and, in fact, rubbishing it lest anyone think that the Christchurch outcomes are in some sense good or acceptable.

The Demographia reports looks at just over 300 urban housing markets.  In 46 of them, mostly in the US but not exclusively, the estimated price to income ratio is three or less (what the Demographia authors regards as a normal longer-term level), and 103 have ratios of 3.5 or less.   There are large cities and small cities. Fast-growing places and stagnating ones.  A house price to income ratio of 5.4 (Christchurch at present) mightn’t be the worst in the world, but by no stretch of the imagination is it good.   We –  and people in Christchurch –  shouldn’t be settling for it.  Only 60 cities in the entire sample are worse, on this count, than Christchurch.  And Christchurch is a fairly small city with abundant land, and yet its house price to income ratio is the same as those for Miami and New York.

This particular isn’t perfect by any means. No indicator is.    Among other things, median household income is likely to be partly endogenous to house prices: more people working (particularly both parents of young children) and for longer hours to attempt to afford a house.    And if house sizes are probably fairly similar across New Zealand, Australia, Canada, and the US as a whole, the typical house in the UK is considerably smaller than in those other markets, and no attempt is made to adjust for this difference –  whether across countries or across major cities.   Auckland might be in the top 10 most unaffordable ‘major markets’ but on average you will be getting more house and land for your money in Auckland than in London (let alone Hong Kong). But while it is fair to recognise this latter point, to make very much of it is simply a cop-out.  You won’t be getting more house for your money –  and quite possibly less – in Auckland, Wellington or Tauranga than in Lincoln, Nebraska (ratio 3.3) or Louisville, Kentucky (3.2) or the dozens of other affordable cities across the United States.

One of my slight frustrations with the Demographia report is that it does only focus on English-speaking countries.  While they are often the ones we like to compare ourselves to, it would be more reassuring if there was data on a range of continental European countries and Japan/South Korea. Russia wasn’t one of the countries I had in mind  but in this year’s report, they have a snapshot on Russian cities.   Across Russia, population growth certainly isn’t a factor in driving house prices, although some individual cities (including Moscow and St Petersburg) are growing. Most of the 17 cities have price to income ratios of three or less (and while Russian houses/apartments are probably fairly small, Russian incomes are fairly low even by New Zealand standards).  But both Moscow and St Petersburg have price to income ratios of 4.2.  That’s above the Demographia threshold, but well below Christchurch, Wellington, Auckland (or Tauranga).

There was a little media coverage of the Demographia report.  But just a few months out from another election, where is the sense of scandal, of outrage, of a commitment to produce very different outcomes in the future?  No significant political party is willing to talk in terms of dramatically lowering house prices, or of making the structural changes (mostly to land use policies) that would bring it about, or about supporting in the transition people caught out by the rigged market our central and local government politicians have delivered in the last 30 years.  The scandal –  the sheer unaffordability –  that is so recent now seems to be taken for granted as something normal, inevitable etc.  It is highly abnormal. It is a disgrace.  The burden falls most heavily on the youngest and most marginal parts of the population.  It is indefensible.  And yet neither National nor Labour (nor NZ First nor the Greens) are interested in serious change making a serious and sustained difference.  Oh, they’ll tweak things at the margin, but none of them will talk about aiming for price to income ratios of three, or of rendering incredible the notion that small houses on tiny sections in Berhampore would sell for $1million.

 

The void where hope might have been

Michael Reddell Housing, National Party

If, as I do, you’ve lived for almost 25 years 100 yards or so from the old Erskine College you have a fairly good sense of what National was on about in this snippet from their new “Building NZ, RMA Reform and Housing” policy discussion document released yesterday.

Objections to proposals for residential reuse of the old Erskine School site in Wellington held it up for more than 20 years. It involved claims that the decaying buildings had heritage value, as well as the routine RMA neighbour objections. Long after the school closed the buildings were red-stickered by Wellington City Council as being unsafe for occupancy. After two decades of costly objections and delays, development eventually started on the site providing 94 dwellings for families.

The school closed in 1985.  Some of the land was developed decades ago, but the main site is only now getting the first few occupants in the new (eye-wateringly expensive, at least on the advert I followed up) townhouses.

But if there seem to be some hints of some modest good things in the document, it is hard to be that positive  Every so often Opposition parties talk a good game about fixing (or rather, freeing) the housing market –  the one that results in such appallingly high price-to-income ratios, systematically skewing opportunity away from the young.   And then nothing very much that matters happens.  It has been that way for 30 years now, even as the problem has got worse and the imbalances more entrenched.

National talked a good game leading up to 2008.  And then accomplished almost nothing –  people from David Seymour to David Parker argue they made things worse – including when they had a clear absolute majority with ACT.  Some elements of Labour –  well, mostly just Phil Twyford – talked a good game prior to 2017.  Twyford can still give a pretty good speech on the subject, but are real house/land prices higher or lower than they were when Labour took office two years ago?  Higher of course.  And these are asset markets, that trade not just on how things are right now –  policymaking and legislating takes time – but on best credible expectations about the future.

And now we have National in Opposition again, trying to shape the best policies for New Zealand –  oops, the best policies they think they might win on –  heading towards next year’s election.  They seem to have given up already.

Oh, I know the headlines don’t say that.   They’ll report National talking of splitting the Resource Management Act in two, to have separate regimes for urban development and for wider environmental resource utilisation issues.  But then the current government is already looking at that option in one of their numerous working groups and consultative processes.    Have land prices on the edges of our cities been falling towards the value in the best alternative (agricultural?) use?  Not that I’ve noticed.  In principle, the idea of  splitting the Act sounds appealing, although with the caution that various experts have posed that there is a risk of creating huge uncertainty for a decade or two as courts define the implications and limits of a whole new regime.

But what is striking is how little specific there is about how differently things might actually operate under new National legislation.  National grappled with these issues in government for nine years, with ready access to experts inside and outside government.  They’ve now had two years in Opposition, with key former ministers (eg Amy Adams and Nick Smith) still on board, and yet nine months out from an election we have page after page of ideas from other people (notably the Environmental Defence Society) and discussions of how things are done in Scotland, South Australia, and Queensland, but little or nothing specific, and nothing that articulates any sort of National vision of a radically more functional future system.     And nothing that, for example, notes that Scotland has little population growth and the big cities in Queensland and South Australia have house price to income ratios well in excess of six –  classified in the annual Demographia rankings as “severely unaffordable” –  when both Brisbane and Adelaide not that many decades ago had price to income ratios of three.

And, sadly here I add an “of course”, there is not a single reference anywhere in the document to that myriad of thriving growing US cities where house price to income ratios today  –  10 years into an economic growth phase, with interest rates almost as low as those here now –  are anywhere from 2.5 to 4.    Or how we might be able to deliver those sorts of outcomes for New Zealanders.

I got to the end of the document last night and was rather struck by the lack of apparent ambition and by what appeared to be an avoidance of directly addressing the main issues.  So I checked the entire document and neither ‘land prices’ nor ‘house prices’ appear at all.   And yet every serious analyst knows that one of the key presenting issues is how large a share of the cost of an urban house+land is the price of the land under the house.  We aren’t short of land in New Zealand –  far from it.   Fly in and out of even Wellington or Auckland –  let alone most provincial cities –  and it is striking just how much land is close by the existing urban areas.  And yet our governments –  central and local –  have managed to create an artificial scarcity that often means that well over half the cost of a house+land in our cities is the price of the land.  It is crazy –  and we aren’t just talking close-in places like Mount Victoria or Parnell, with distinct locational advantages.   But it is worse than crazy, it is a chosen evil that governments do to our younger generations.    National can do all it likes –  and there looks to be good stuff that could and should be done –  but unless they end the artificial (government created and maintained) scarcity of (potentially) urban land, they will never make any serious inroads in fixing housing affordability.    There wasn’t even any sign in the document of National pushing back against the current proposal to worsen the situation around so-called “highly productive land”.    No hint of, for example, a flagship stake in the ground, promising (say) to enact a presumptive right to build two-storey housing on (almost) any land.

And so one comes away from the document with a sense that National really doesn’t care that much about severely unaffordable housing and rigged land markets, or they are scared and don’t trust themselves to actually be able to sell the case for change and what it might take to bring that change about.   Probably only they know the answer to which influence is more important, and perhaps not even they do (since the human capacity for barely conscious self-deception is pretty well-developed).    And so the government-created disaster, and all the attendant injustices, will go on.  It doesn’t make National any worse than the Labour-New Zealand First-Greens government, but what consolation is that to anyone (other than those sitting on existing artificially high-priced assets)?   On these issues –  as on so many –  they are really two sides of the same coin, largely protecting the status quo and wasting the offices of government which could be occupied by an –  as yet non-existent party –  that might be really willing to address the core issues to promise to get house and land prices a long way down, and perhaps even offer some sort of limited compensation scheme for those who –  largely through no fault of their own –  have taken on very large debts in recent years to get into any sort of home of their own.

Instead, all we get is small-target stuff, with nothing to scare the horses, no bold messages to sell, and little or no prospect of overdue real change and improvement.  Much like –  again from both parties –  the failure to even begin to get to grips with the decades-long productivity failure.  I’m guessing National – like Labour –  would be quite happy if several decades hence houses were once again affordable (perhaps three times income) more or less by accident.  But they won’t promise to get house and land prices down, they won’t do what it would take to fix this massive failure of our government.  And, so it seems, they’d mostly also be happy with just a bit of marginal product differentiation and just little enough action to keep the public angst (my children should be in the house market 10 years from now) more or less in check.

 

The unimaginable dystopias we live in

Michael Reddell Housing

I’m not sure if it was planned but there was a distinctly dystopian tinge to the magazine section of the Sunday Star-Times yesterday.

The Editor’s Note dealt with the pervasiveness of dystopian themes in the modern books being read by children and “young adults”.    There have been plenty of these in and through our household –  the Wellington libraries seem abundantly stocked with them.  I’ve even read a couple –  the kids seem to like the idea (nay, strongly urge) that Dad occasionally reads one of their books.  I haven’t yet succeeded in getting my youngest to read 1984,  Brave New World, or Children of Men, although she and I both recently read The Handmaid’s Tale and The Testaments –  and I couldn’t really disagree with her, not wholly favourable, assessment of the latter as “like a young adult dystopian book”.  I guess there are all sorts of reasons for liking these dystopian books, some of which are probably less than entirely healthy, but it is interesting to ponder the alternative societies, rules, norms (and lack of them) depicted by the authors.

A bit later in the same magazine section there was just such a portrait, “Dark Days in Dystopia”, but this time about a real place, the state of California.  The column first ran in The Times (UK) and is by Gerard Baker the (British) former editor-in-chief of the Wall St Journal.   It is online only behind the paywall of The Times but the gist is in the lead blurb

“California used to represent a fantasy of Hollywood glamour and wholesome hippie-ness combined.  But now, with blackouts, crippling taxation and unaffordable housing, the Golden State is a feudal society of super-rich and serfs”

Not being that into eiher Hollywood or hippies, I guess my impression of California decades gone by was a bit different, with an emphasis on mild weather, sunny optimism, and widely-spread prosperity.  In childhood TV terms, The Brady Bunch.  In US political terms, it isn’t that long since California was a Republican state – middle (suburban) America.

Baker’s article touches on various aspects of how California has gone bad.  But the revealed preferences of individuals are often as telling as anything and –  as he notes – Americans (net) have been leaving California for years (in the ten years to 2016, a net 1 million left).

Baker makes quite a bit of the breathtakingly high tax rates in California, but his main focus is on housing, “almost unimaginably unaffordable for most Californians” which is, of course “an entirely human-made debacle”.  He quotes a (Democrat-sympathising) academic, Joel Kotkin, who “describes California as a reimagining of medieval feudalism” in which underneath the “wealthy elites” who promote and champion the panoply of problematic policies

are the modern serfs, who can barely afford the land they must rent from their masters. They have no assets, no stake in their economy and, thanks to prohibitive housing costs, have limited mobility.

The column ends

California has always been eyed as a signpost to the future.  The dystopia there might be a warning to voters everywhere.

The column might seem a touch over-written to you (it probably does to me as well) but it was some of the concrete details in the midst of the rhetoric that I latched onto.

The median home price in California is $614000 (NZ$959000), almost three times the national average. The California Association of Realtors’ housing affordability index estimates the percentage of households that can afford to purchase the median-priced home.  For California, that number was 31 per cent….for the US as a whole it was 56 per cent.

But what about New Zealand?

The median house price here is now $607500 (in October, according to REINZ).  That is a lot cheaper than California, of course.  But we, on average, are a lot poorer than Californians.

Average GDP per capita in California is about US$66000.  Here, it about NZ$62000.

In other words, the ratio of house prices to income (this time proxied by GDP per capita) is much the same here –  just a bit worse –  than in California.   I’m a bit wary of median household income figures –  just because I know the data less well – which are more often used for house price comparisons, but it doesn’t look as if the comparisons would be much different in one used that data.   We have our own human-made housing dystopia, without even the consolation of those hugely successful tech companies that also still characterise California.  We have an ongoing productivity failure.   And with few/no offsetting compensations –  between volcanoes and earthquakes, probably much the same sort of natural disaster risk, and –  for those in Auckland in particular –  congestion that seems to rank high (badly) by advanced world standards.   Who’d have imagined just a few decades ago the local dystopia we’ve let our “leaders” create?

And what of the prospects of the next generation?  One of the downsides of living with me, is that my kids get to hear my fulminations about the disgraceful government failure that is our housing market, which in turns engenders occasional, slightly despairing, comments from them about the unlikelihood of ever being able to afford a house in New Zealand.

I was having one of these conversations with one of my daughters the other day.  She was asking how much I’d paid for my first house, which is just down the street and which we walk past quite frequently.  I told her I’d paid $155000, which brought gasps of astonishment. I did hasten to point out that there was this thing called inflation and in today’s dollars that was something like $290000, but it didn’t really change the point (in our unprepossessing but pleasant suburb the median house price now appears to have passed $900000).

When we have these conversations I periodically point out that real mortgage interest rates in 1989 were a lot higher than they are now, that first home buyers probably shouldn’t be expected to buy a median house, and that there are cheaper parts of cheaper suburbs (without, say, having to fall back on the desperate expedient of relocating to my childhood home of Kawerau, where median prices have recently rocketed back up to…about $290000).  I think the kids are right to be uneasy, but smart hardworking well-educated people who marry sensibly will probably eventually be more or less okay.

But in the course of our conversation I got to think about my parents.  They bought a first house (new) in Christchurch in 1962, just before I was born.  It wasn’t a particularly big house, but it was an 809 square metre section –  bigger than most Island Bay sections. My father was 27.  Dad had gone to work at 16 –  as probably most people did in 1950 – working as a clerk at the BNZ and by this time he had his own small newsagent’s shop in Riccarton, but was just about to move back to a salaried position.  Mum didn’t work after I was born –  as probably most mothers didn’t in those days.   There wasn’t –  at least that I’m aware –  family money behind them.    But at 27, on a single income (not supported by tertiary qualifications or lots of overtime), they had their own (new) house in one of our bigger cities.

I don’t suppose it seemed extraordinary then.  It was what young couples typically did.

I’m not suggesting it is impossible now: there are, from the time to time, those stories of extraordinary young people who through hard work, thrift and a focus on one goal have purchased a house very young. But it is extraordinarily difficult now for those who are poorer, less-skilled, less well-qualified, with children.   Almost inconceivable for young people earning average incomes for their age to even think of doing it on a single income in any of our bigger cities, at least without enormous sacrifices of material living standards.    Perhaps simply impossible in Auckland.  And if the groups most severely affected aren’t exclusively Maori and Pacific, they are disproportionately so.

It is a human-made dystopia.  And the humans who lead our governments (central and local) seem quite uninterested in doing anything serious to fix the problems.

Falling population shares: a highly-productive big city

Michael Reddell Housing, Population, Productivity, UK

Writing about Wales the other day I included this chart

wales 1

The comparable chart for Scotland is even more stark (16 per cent of the Great Britain population in 1801 and just over 8 per cent now).

But what really caught my eye when pulling together the numbers was this chart.

london 19.png

I guess part of my brain knew that greater London’s population had fallen for several decades, but that bit never quite connected with the bits thinking about world cities, agglomeration and so on and so forth.  London is one of the great world cities, a key financial centre in an age when capital is more mobile than it was for decades after the war.  There is no other really great city in the UK, the UK’s population hasn’t increased that rapidly by New World standards, and yet the share of the UK population resident in greater London is less now than it was for decades prior to World War Two (true even using the orange dot –  for which there is no time series – the estimate of the population of the (defined by contiguity of population rather than local authority boundaries) of the greater London urban area.

(As it happens, on checking one finds that the New York metropolitan area population is also lower now, as a percentage of the total US population, than it was several decades ago – I could only see data back to 1950.  But the US is different  –  there are multiple very large cities and the spread of air-conditioning greatly affected the liveability of many of those places.)

As you may recall from Saturday’s post, estimated GDP per capita in London is 188 per cent of that of the EU as a whole (and about 180 per cent of the UK as a whole).  The only other (Eurostat-defined) region that comes even close to London is (close to London) “Berkshire, Buckinghamshire, and Oxfordshire” (at 151 per cent of EU as a whole).

These have the feel of places where if more people were able to live there more people would be better off.  The whole of the UK might even be better off on average (a larger proportion of the population able to do more highly-productive jobs), even if the London premium over the rest of the country narrowed somewhat.

And yet, of course, as everyone knows London house prices are really expensive –  price to income ratios similar to those in Auckland (with incomes higher), typically for small houses and small sections.  You can tell similar stories about San Francisco/San Jose or New York (where GDP per capita are well above those of the US as a whole).   Rigged housing and land markets really seem to have visible consequences in pricing people out of working in highly productive cities.

Where the story is much less compelling is in Auckland (or Sydney or Melbourne). I wish it were otherwise –  I’m a strong supporter of land use liberalisation –  but

(a) on the one hand, the populations of those cities (urban areas) have actually increased very substantially as a share of national population (especially Auckland: 8.5 per cent of the population in 1901, and about 33.5 per cent now), and

(b) in none of the Australasian cities do the estimates for GDP per capita show up with any very substantial margin over the rest of the country (see, by contrast, London above).  People who just don’t earn that much (or produce that much) have found a way to live in those cities anyway.

Fixing the New Zealand urban housing markets is, or should be, a matter of dealing to one of the grosser injustices in our economic system, but it is far from obvious that there is a compelling case in issues around productivity and wider economic performance.  If anything, there are probably already more people in Auckland – and perhaps Sydney/Melbourne –  that there really are highly-productive opportunities that are either waiting for them now or would spring up were housing once again as affordable as it should be.

 

Rents should have been falling

Michael Reddell Housing

Statistics New Zealand this morning released its monthly residential rentals series. I don’t usually pay any attention to these data but since I’d been thinking about the very low level of real interest rates, I decided to take a quick look for once.

The series goes back to November 2006.   They have both stock and flow-based measures, the latter being available on a regional basis.   Nominal rents have risen by about 50 per cent since 2006, and these are the changes in real (CPI-adjusted) rentals on each of these measures over that period.

rents

Something like a 15-20 per cent increase (depending whether you prefer the stock or flow measure) over 13 years might not seem too bad.  That’s a rate of increase of about 1 per cent per annum.

But that really is the wrong way to look at the issue.  After all, renting a house/flat involves paying for the use of a long-lived asset.    And the key influence that should influence any change in the supply price of such assets is changes in the cost of finance, returns to alternative uses of money etc.

In November 2006 the real 10 year government bond rates was about 3.25 per cent (roughly so whether one uses the one indexed bond then on issue or takes a nominal bond yield and subtracts surveyed medium-term inflation expectations).  The real 10 year bond rate is now about 0.15 per cent.   What about the risk premium?  The Treasury guidance to government agencies suggests using an equity risk premium of 7 per cent.  One could play around with different estimates, and with assumptions about how much diversification housing might add to a portfolio.  But it doesn’t seem unreasonable to work with a rough estimate that the required rate of return should have fallen by perhaps a third since 2006.    All else equal, in a well-functioning market, we might reasonably have expected to have seen a significant fall in real rentals over that period.

Of course the standard counter is “oh but falling interest rates raise the price of fixed assets”.  Often enough that isn’t even true for assets in genuinely fixed supply –  since long-term real interest rates rise and fall for reasons that often have something to do with the expected future returns in the wider economy –  but even to the extent it is true, in a well-functioning housing market the only component of a “house plus land” bundle that is in genuinely fixed supply is unimproved land itself.    The supply of anything else can be augmented, and in a well-functioning market almost without effective limit.

In a free market, in a country with as much land and as few people as New Zealand, most unimproved land isn’t very valuable at all.  Just suppose it was worth $50000 a hectare (and actual New Zealand farmland traded at a median of just under $25000 a hectare most recently) and that you could get 7 houses to a hectare (a decent sized section and the associated roads and footpaths), the value of the unimproved land under a standalone house would be worth less than $10000.   As something like a perpetuity, the lower interest rates might have raised that value by a third, an amount that –  relative to New Zealand median residential prices –  is really almost lost in the rounding.

The substantial reduction in real interest rates shouldn’t dramatically affect the supply price of new building.   Raw materials prices –  timber, cement, fittings etc –  should not be affected.  Nor, really, should the price of labour: perhaps interest rates are low partly because productivity growth is low but, broadly speaking, any such weakness will be matched over time by lower growth in real wages.    If anything, there is an in-principle argument that much lower interest rates may have lowered the supply price of new developments, because there is often quite a lag between acquiring land for development and being able to put the finished product on the market (inevitable market delays and regulatory delays),  Lower interest rates mean lower costs of financing those lags.

In a well-functioning market it might not have been unreasonable to have expected, say, no change in nominal rents nationwide over the 13 years, not a 50 per cent increase.

But, of course, we don’t have a well-functioning market at all.  We have one consistently and systematically rigged against competition and development by local councils and their central government enablers.   There is no scarcity of unimproved land in New Zealand. But councils –  councillors and staff planners – combine to create an artificial scarcity of developable land, such that in the face of one of the largest falls in real interest rates in history, to unprecedentedly low levels, rental housing is not abundant and cheap (as readily reproducible longlived assets should be in this climate) but scarce and expensive.  Utter government failure if ever I saw one.

Bits of both arms of government occasionally talk a good game about freeing up land supply, but it is central government that is currently consulting on making less peripheral land available.  It is a senior member of the Labour Party council –  a Wellington city councillor –  who when she rang me on a canvassing call a few weeks ago offered the unprompted observation (when I asked about fixing housing) that she didn’t want any more of that “sprawl” –  this in a city with abundant, if often undulating, land.    In many cases, their vision is to have us packed in like sardines –  more “efficient” like that, supposedly –  and they feed that personal preference, or sense of inevitability, by making land so expensive that many people feel they no longer have that historic New World option of space –  in cities that, by global standards, remain pretty small.

When people complain about rents, and particularly the plight of people at the bottom with few choices but to rent, they need to sheet home responsibility to our governors –  central and local.  Perhaps a future National government would be different, but they too talked a good talk when they were last in Opposition and did nothing then.  There isn’t yet much reason to think they’d be different next time.

Whatever the other risks, downsides, and complications of exceptionally low interest rates, the market has delivered a climate in which the real cost of decent housing should never have been cheaper.  It takes governments –  central and local, left and right ( in this area a distinction without a difference as they all enable planners) –  to have produced rising real rents in a decade like this.