The Reserve Bank’s releases on proposed investor finance controls

Michael Reddell Financial stability, Reserve Bank

I noted yesterday that the Reserve Bank had also released some papers on the proposed new LVR restrictions on Thursday.  When that release was pointed out to me yesterday, the Bank’s website suggested that the papers had been released in response to an OIA request.  The papers still appear in the obscure corner of the Bank’s website where (in a welcome development) they have started publishing some of the responses they make to OIA requests.

But when I checked again this morning, the table now says of the latest release:

Date of Response Subject matter
25 June 2015 Loan-to-value ratio (LVR) restrictions, proactively released, jointly with the Treasury

Go through to the detailed page, and it suggests that the release is partly pro-active and partly a response to an OIA request.

This is information relating to loan-to-value ratio (LVR) restrictions that has been released proactively and in response to requests for information under the Official Information Act 1982 (the Act).

I’m a little confused.  But if there genuinely is a pro-active component to the Bank’s release then I welcome it, even if (say) they may just have released one additional paper to provide context for a few that were covered by the OIA.

It still leaves a little bit of a puzzle about the Treasury’s (entirely pro-active) choice to release.  Sometimes documents requested of one organisation cross-reference material generated in other organisations, but that does not appear to be the case here.  Perhaps the OIA request to the Reserve Bank included material the Bank held, even if it did not generate it.  If so, no doubt the Bank held copies of at least some of the Treasury papers?    But having been on the receiving end of numerous OIA extensions from the Bank (and recently one from Treasury), when documents written little more than 20 working days ago are pro-actively released, it has the feel of a genuinely deliberate timing choice.

But enough of the bureaucratic process stuff.  What I had intended to write about was the content of the Bank documents.  They released six, one of which (the 17 Feb one) I had previously seen.

Date Released on 25 June 2015
19/5/2015 Memo to Minister on draft consultation paper on LVR policy (PDF 818KB)
30/4/2015 Memo to Minister on estimated impact of changes to LVR policy (PDF 1.36MB)
24/4/2015 Memo to Minister on potential adjustments to LVR ratio policy (PDF 2.67MB)
21/4/2015 Memo to MFC on Proposed changes to the LVR policy (PDF 350KB)
2/4/2015 Memo to MFC on revisiting the case for regional targeting of marco-prudential policy (PDF 134KB)
17/2/2015 Memo to MFC on effectiveness of a tighter investor LVR limit (PDF 99KB)

We don’t have much context for this release.  In particular, we don’t know the scope of any OIA request the Bank may have been responding to, but if these papers are intended to reflect the analysis the Bank undertook in developing the proposed control on investor lending (and the Auckland-specific nature of the new policy), they are surprisingly short and weak.  Recall that the Bank is,  implicitly, saying the banks and borrowers are so risky and irresponsible that not one single (practical) cent can safely be lent by banks to Auckland residential property investors on LVRs over 70 per cent without jeopardising the soundness of the financial system.  That is a pretty ambitious claim.  It is not supported.

I have been critical of the Bank for not making a stronger case for its proposed controls.  The one comfort I suppose that we can take from these papers is that they are not hiding anything from us.  But if this is all there is – the extent of their engagement with the law, the economics, the stress tests, the uncertainty –  it is even less surprising that The Treasury was also not convinced that a compelling case had been made for the new controls.  Unfortunately, the Reserve Bank also continues to repeat to the Minister of Finance its claims that lending to investors is generally materially riskier than other housing lending.  An attendee at the LEANZ seminar the other night told the audience that he had gone through all the references the Bank has previously invoked in support of its claim, and had found that they simply did not say what the Bank claimed they were saying.  If that assessment is correct, it is pretty concerning, and should be so to the Board and the Minister –  charged with holding the Governor to account on our behalf.

A process issue struck me in reading the papers.  In discussing the possible new policy, the 21 April paper lists a possible timeline.  It suggests that a consultation period should end in “late June” and “Release final policy position and revised conditions of registration” in “mid-July”.  Allowing perhaps 10 working days to read, analyse, and reflect on submissions, write up recommendations to the Governor, write-up a response to submissions, and finalise the new conditions of registration themselves does not suggest that the Bank had in mind a very open process of consultation.  Actual timing slipped somewhat, as the consultative document was not released until early June, but we should hope that they take a little more than 10 working days to work through all the issues likely to be raised in submissions.

As I noted yesterday, the cause of serious scrutiny of the Governor’s proposals (and of open government more generally) would be advanced if the Bank were to publish on its website, as they are received or at least on the closing date, all the submissions they receive.  They are, after all, public, official, information.

The Treasury on the new proposed LVR limits

Michael Reddell Financial stability, Housing, Reserve Bank

UPDATE: There was also a release yesterday of some Reserve Bank papers on these issues.  The Reserve Bank papers are described as being released in response to OIA requests.  The Treasury papers were pro-actively released, but apparently in coordination with this Reserve Bank release.  I have not yet read the RB papers.

I got home late last night and missed the significance of Stuff’s story about the newly-released Treasury papers on the Reserve Bank’s proposed new LVR controls.

But reading the package of material that The Treasury released, it does not paint a particularly pretty picture.

First, it is interesting that Treasury has pro-actively released this material, about the proposed investor restriction that the Reserve Bank is currently consulting on.  It was not extracted from them reluctantly by a citizen’s Official Information Act request.  One assumes that they released the material with at least the acquiescence of the Minister of Finance.   I’m all for transparency, but this release suggests something quite uncomfortable about relationships between the Reserve Bank, Treasury, and the Minister –  something already hinted at in the Minister’s comments on a couple of occasions about the Bank’s handling of monetary policy.

I don’t agree with everything in the Treasury papers –  for example, invoking the results of a DSGE model as a basis for advice on the timing of a relaxation of LVR limits is not particularly persuasive.   But the bottom line seems to be that Treasury, the government’s chief economic policy advisers, are also not convinced that the case has been made for the proposed new investor controls.

For the moment, as they note, decision rights on these matters rest exclusively with the Governor, but if the Governor can’t make his consultative paper convincing to The Treasury  –  who are by no means as sceptical of the general case for active regulatory interventions in this area as I might be  –  it should be a little concerning to the rest of us.

Here is what Treasury had to say on the substance a month ago in their aide memoire to the Minister on the Bank’s consultative document:

Overall, we do not think that the consultation document makes a compelling case for the proposed use of these macroprudential settings, due to the concerns below. Nevertheless, the RBNZ does have the decision rights, and so our focus will be to work with the RBNZ to make improvements in some key areas. Our main focus will be to encourage:

  • Clarification of the problem identification, evidence and channels. We accept that house price changes can have macroeconomic implications, but the RBNZ’s mandate is to promote financial stability. Therefore, the policy should be reframed to focus more clearly on reducing systemic risk, rather than on prices in a particular market.
  • Additional evidence on the investor segment. The evidence presented is somewhat mixed on the extent that high-LVR investors underpin systemic fragility, as they are a relatively small part of the market and many may be able to alter their portfolio. Similarly, we will be asking the RBNZ to provide further information on the extent to which the increase in investor activity may have been encouraged by the original LVR policy.
  • Discussion on the risks of relaxation of the speed limit outside of Auckland should credit growth and prices pick up again. Although we appreciate that the policy was designed to be temporary, and that the RBNZ prefer light touch regulation, there are a number of potential downsides. In this case, the policy rule is not clear, and the RBNZ policy settings are reactive to recent data. This may lead to an active management of policy settings, which may increase market uncertainty and reduce RBNZ credibility. This is particularly important around LVR limits – Treasury modelling using a DSGE framework suggests that the costs of taking the limits off early may be greater than leaving them in place for longer.
  • Evidence from policy evaluation and additional cost benefit analysis of this policy to be published, including with respect to the other options available. The consultation paper contains little discussion on some of the possible unintended consequences, such as: increased risk of disintermediation or higher non-bank lending; the possibility of shifting demand towards cashed-up buyers; or risks that investors leverage up property outside of Auckland. We will also be asking the RBNZ for more detailed evaluation on the impact of the existing LVR policy, and of the unintended consequences compared with the impacts anticipated in the Regulatory Impact Statement.

The points expressed about process are also a bit disconcerting:

Process

A robust process of consultation is a characteristic of good regulatory practice and should occur within government at the options stage well before the policy is made public.

The late notice and lack of consultation complicates the ability of government agencies to coordinate, which could lead to government policy that conflicts or pays inadequate attention to government’s wider economic objectives.

We will raise these issues with RBNZ and propose process changes to address these concerns.

As I noted in my address last night, under the current Reserve Bank Act model the Governor comes close to being prosecutor, judge, and jury in his own case.  That is a dangerous feature.  Managing the risk makes it all the more important that the Bank goes out of its way to engage pro-actively with the Minister and with Treasury when it is proposing new regulatory measures.  Consultation matters for a whole variety of reasons, but Treasury’s views and questions can, among other things, offer one arms-length test of just how persuasive the Bank’s arguments are.

A more pro-active release policy from the Bank would also be welcome.  Perhaps, for example, the Reserve Bank could consider posting all submissions on the current consultative document on the Reserve Bank website, as and when they are received.  These proposals need all the scrutiny and debate they can get.

Housing, financial stresses, and the regulatory role of the Reserve Bank

Michael Reddell Financial stability, Housing, Reserve Bank

Last night I spoke to the Wellington branch of LEANZ on “Housing, financial stresses, and the regulatory role of the Reserve Bank”. They had a good turnout and some stimulating discussion ensued.

The text of my address is here

Housing, financial stresses, and the regulatory role of the Reserve Bank LEANZ seminar 25 June 2015

The presentation was organised in three parts:
• Making the case that high house (and land) prices in Auckland are largely a predictable outcome of the interaction of supply restrictions and high target levels of non-citizen immigration. With, say, 1980s levels of non-citizen immigration, New Zealand’s population would be flat or falling slightly. Much of that ground will be familiar to regular readers of this blog.   It matters because what has raised house prices in New Zealand is very different from what raised them in the crisis countries. In the United States, government policy initiatives systematically drove lending standards downwards in the decade prior to the crash, and in Ireland and Spain, imposing a German interest rate on economies that probably needed something more like a New Zealand interest rate systematically distorted credit conditions across whole economies. New Zealand – and other countries with floating exchange rates and private sector housing finance markets – had no such problems.  Credit was needed to support higher house prices in other advanced economy, but it was not the driving force behind the boom.

If I am right that the New Zealand house price issues result from the interaction of our planning regime and our immigration policy, then these are structural policy choices that systematically overprice houses, largely independently of the banking and financial system.  They are not ephemeral pressures –  here today and gone tomorrow.  They have been building for decades.  I hope they are reversed one day, but there is no market pressures that will compel them to (any more than there are market pressures that compel the reversal of planning restrictions in Sydney, London, or San Francisco).  These distortions are not making credit available too easily and too cheaply right across the economy  (which is the single big difference between NZ or Australia, and say the Irish, US or Spanish situations).  They are simply making houses less affordable.   The Reserve Bank has no better information than you, I, or the young buyers in Auckland do, on whether and when those policy distortions will ever be reversed.   And even if the policy distortions were corrected, it is pretty clear that real excess capacity (too many houses, too many commercial buildings) is a much bigger threat than simply an adjustment in the price of banking collateral.   No one thinks Auckland has too many houses, or too much developed land.

• The core of the paper was the proposition that the Reserve Bank’s actual and proposed LVR restrictions appear both unwarranted by, and inconsistent with, the Reserve Bank’s statutory mandate to promote the soundness and efficiency of the system. In subsequent discussion, a very senior lawyer went so far as to suggest that the Bank might even be acting ultra vires. My arguments around the LVR policies had a number of dimensions including:
o The almost total absence of any sustained comparative analysis of the international experience of the last decades, including the issue of why some countries (Spain, Ireland, and the United States) had very nasty financial crises and housing busts, and others (New Zealand, Australia, the UK, and Canada) did not.
o The lack of any engagement with New Zealand’s own experience in the last decade. Risks appeared much greater in 2007 than they are now, and yet the banking system came through a severe recession, and sluggish recovery, unscathed.
o The lack of willingness to engage openly with the results of the one piece of sustained work the Bank has done, the 2014 stress tests, which suggested that the New Zealand banking system, on the current composition of their asset portfolios, could relatively easily withstand even a very severe shock.
o The failure to address the efficiency dimension of the Bank’s statutory responsibility. Both the actual and proposed LVR controls will impair the efficiency of the financial system.
o The failure to identify and address the distributional implications of the controls.
o The failure to grapple with the limitations of the Bank’s (and everyone else’s) knowledge. There might be an arguable case for controls if we could be sure a crash was coming 12 months hence, but in fact the Bank has no better information than you or I do as to when, or if, there will be a substantial fall in nominal house prices.

• Discussion of the regulatory powers of the Bank, and its governance. As I put it in the conclusion:

These concerns bring into focus the weaknesses that have become increasingly apparent in the Reserve Bank Act. That Act was a considerable step forward in 1989, at a time when only a modest and limited role was envisaged for the Reserve Bank. But it is now 2015, and the legislation is not consistent with the sorts of discretionary policy activities the Bank is now undertaking, with modern expectations for governance in the New Zealand public sector, or with how these things are done in other similar countries. Doing some serious work on changing the single decision-maker model would be an excellent place to start, but it is only a start. A much more extensive rethink and rewrite of the Act, and the Bank’s powers, is needed to put in place a much more conventional model of governance and accountability, especially in these regulatory areas.

Trade agreements, TPP, and the Australian Productivity Commission

Michael Reddell Australia, FTAs

I’m on a tight deadline today and wasn’t going to write anything here, but a reader pointed me in the direction of the Australian Productivity Commission’s newly-published Trade and Assistance Review 2013-14, which devotes an entire chapter to “Issues and concerns with preferential trade agreements” (pages 61-86 here).

As the Sydney Morning Herald summarised it:

The Productivity Commission has launched a scathing attack on Australia’s latest series of free trade agreements, saying they grant legal rights to foreign investors not available to Australians, expose the government to potentially large unfunded liabilities and add extra costs on businesses attempting to comply with them.

Allowing for the relative restraint of bureaucratic language on the one hand, and newspaper style on the other, “scathing attack” doesn’t seem like an unfair description.  Perhaps as importantly, the report raises serious questions about TPP, (although the APC has not seen the documents being negotiated).

As regards rules of origin (whether for goods or services) the APC makes their points about cost and complexity by simply relentlessly listing the different rules of origin in the various Australian FTAs for the item “Bed linen, table linen, toilet linen and kitchen linen”.  They report estimates that “the cost associated with origin requirements could be as high as 25 per cent of the value of goods trade with ASEAN”.  By contrast, unilateral abolition of domestic tariffs, or comprehensive multilateral agreements avoids these costs.  The APC makes quite a lot of the point that time, and political capital, spent negotiating FTAs may be, in part, at the expense of unilateral liberalisation of international trade and domestic competition-enhancing reforms.

The APC report also devotes considerable space to investor-state dispute settlement (ISDS) provisions.  They seem very sceptical of the case for these provisions (and note that 40 per cent of those launched last year were taken against developed countries – presumably countries with robust domestic legal systems).  As they note, signing up to ISDS provisions involves new, unfunded, contingent liabilities for governments while, in their view, there is no sign that the ISDS provisions Australia has already signed have done anything to increase either inward or outward Australian foreign investment.  They also note that the Chief Justice of the High Court of Australia has publicly expressed concern about the risk that ISDS provisions could undermine the authority of domestic courts.

Finally, the APC notes the difficulty of assessing the potential impacts of trade agreements.  They argue that this makes a ‘compelling case for the negotiated text of an agreement to be comprehensively analysed before signing”.  At least in Australia, actual analysis and evaluation appears to have fallen far short of this standard.

Trade agreements aren’t going to be a much of a theme on this blog, but I found it interesting that as orthodox and pro-market body as the APC felt it appropriate to reiterate its scepticism on FTAs in this way.    Here are the key points from the APC document.

apc

For New Zealand, there still seem to be some important questions to be answered around TPP, and before it reaches a point where a government majority simply votes a signed agreement through the House.   There is no sign yet of material dairy trade liberalisation, intellectual property protections are likely to make us worse off (and perhaps also the ordinary citizens of other countries, even those who host large intellectual property owners), while further ISDS provisions, for which there is no identified market failure, seem set to strengthen the hand of foreign investors relative to domestic ones, undermining the primacy of our own Parliament and courts, for no obvious gain.   I am also uneasy about the provisions that get inserted in these agreements to limit the ability of countries to respond to economic and financial crises.  I was involved in work on these while I was at the Reserve Bank, and again it is not obvious what the problems are with existing multilateral provisions (IMF and WTO).

I remain uneasy that New Zealand might end up signing an agreement primarily because of the momentum in the process, and the desire of our own elites not to self-exclude from “the club”, rather than because there are demonstrable gains to the national welfare of New Zealanders.  If so, it would be cause for concern.  I wonder what sort of robust economic evaluation is envisaged here before MPs are asked to vote on any agreement?

Real economic costs of financial crises – part 1

Michael Reddell Financial stability, New Zealand economic performance

A couple of days ago I looked at how one might best classify countries, as to whether or not they had experienced a “financial crisis” since 2007.  But this chart is one reason why I’ve become increasingly sceptical that “financial crises”, however one defines them, have large or enduring adverse real economic effects.  I think I first saw it in a sets of slides by Nobel laureate Robert Lucas, and every so often I would use it to try to stir up a bit of debate at the Reserve Bank.

maddisonUS

It is a quite simple chart of real per capita GDP for the United States, back as far as 1870.  These are Angus Maddison’s estimates, the most widely used set of (estimated) historical data, and as Maddison died a few years ago they only come as far forward as 2008.  The simple observation is that a linear trend drawn through this series captures almost all of what is going on.  More than perhaps any other country for which there are reasonable estimates, the United States has managed pretty steady long-term average growth rates over almost 140 years.  And yet, this was a country that experienced numerous financial crises in the first half the period.  Lists differ a little, but a reasonable list for the US would show crises in 1873, 1884, 1893, 1896, 1901, 1907, perhaps 1914, and 1929-33.  There were far more crises than any other advanced countries experienced.

And yet, there is no sign that they permanently impaired growth, or income.  One never knows the counterfactual, but right through this period the US kept on towards establishing the dominant position it was to hold in the decades after World War Two.  Even the Great Depression, awful as it was (costly as it was to many people) does not look to have had permanent adverse effects.  Another source I’ve bored people with over the past few years is Alexander Field’s excellent relatively recent book on US economic growth, productivity, and the Great Depression, A Great Leap Forward.  Field reports the best estimates for TFP growth in the US over the last century, and growth was faster from 1929 to 1941 than in any of the other periods he presents.  One might quibble about when to start and end these sub-periods, but 1929 was before the downturn became well-established, and 1941 is around when GDP per capita got back to pre-crisis trend (before temporarily going well above it in World War Two).

fieldtfp

The United States in the Great Depression had almost all the factors that are often cited to explain why financial crises might have permanent or very long-lasting adverse effects:

  • Lots of bank failures, and in a system without nationwide banks, disrupting the intermediation process.
  • Lots of corporate failures
  • Big changes in the price level (steep deflation)
  • Huge regulatory uncertainty (including around the robustness of the judicial system –  see, eg Roosevelt’s attempt to stack the Supreme Court)
  • Significant fiscal costs (in this case, not bank bailouts, but the defaults by other Western countries on the huge US World War One loans).

And yet the underlying rate of innovation is estimated to have gone on just as strongly as before.

This is not, remotely, to trivialise the Great Depression.  But it still looks a lot more like an event that became as severe as it was because of inadequate demand, and was resolved when sufficient strong aggregate demand returned (in the US case not until World War 2).  Output lost in the interim is a real and substantial cost to the people involved, but the numbers get really big if something changes the long-term future path of growth.  And there is no sign of that having happened in the many financial crises the US experienced from the 1870s to the 1930s.

A few years ago, Andy Haldane of the Bank of England got a lot coverage for a speech in which he presented this table, suggesting that the cost of the 2008 financial crisis could be huge –  100 per cent or more of annual GDP.

haldane

If so, it could be argued that everything should be done, all resources of the state thrown at, avoiding such events, which –  as Haldane put it –  our children and probably our grandchildren might be paying for.  But if there is little or no permanent reduction in the future path of per capita income, as a result of the financial crisis itself, the real economic costs of crises are much much smaller.  And the benefits of any regulatory measures to reduce the risk of crises are commensurately smaller –  all the more so when we allow for how little any of us know about the long-term costs and benefits of such regulatory restrictions.  Even recessions occurring at the time of a financial crisis can’t all (or perhaps even mostly) automatically be ascribed to the crisis itself.

I’ll have a few more posts on related issues in the next few days or weeks.  But recall where I started on this, and where I will loop back to. Per capita income GDP growth in New Zealand and the United States since 2008 has been very similar, even though New Zealand had only a minor domestic financial crisis, while the US was at the epicentre of a major global liquidity event,  and many significant US institutions failed or came close to failing, and US lenders experienced very large losses.   Sadly, as earlier posts have illustrated the relative productivity performance in New Zealand (relative to the US)  has been even weaker.

us vs nz 2

Immigration policy: 106 per cent of net new housing demand

Michael Reddell Housing, Immigration

I’ve just read Shamubeel and Serena Eaqub’s book Generation Rent¸one of the Bridget Williams Books series of short, often stimulating, books on New Zealand issues.    Housing is perhaps the ultimate topical issue, and I hope the Eaqubs’ contribution is widely read.

There is plenty in that I agree with, as well as quite a bit that I disagree with.  I might come back to the rest of the book when I have a bit more time, but today I wanted to focus on just one “framing” issue.   How one frames an issue often influences how readers think about it.

The Eaqubs have collected the data from old Yearbooks, and censuses, to show where population-based pressures on housing demand have arisen from over last fifty years (strictly, from the 1961 Census to the 2013 Census).  They present the influences under the following headings:

  • Natural increase,
  • Change in average household size, and
  • Net migration

Under this decomposition 61 per cent of the increase in the number of households has arisen from natural increase, 30 per cent from a reduction in average household size.  The remaining 9 per cent results from net migration.

Put that way, it allows them to present migration (and, hence migration policy) as a fairly minor issue, only really material in a short-term or cyclical sense. As we know net migration is quite variable and not particularly forecastable in the short-term.

But there is another way to look at the numbers.  The New Zealand government has no ability to control the movements of New Zealand citizens, inwards or outwards, so discussions of the role of immigration policy really should focus on the movement of non-New Zealand citizens.   Non-citizens can only come and live in New Zealand with the permission of the New Zealand government –  active permission is required in most cases, while policy allows Australian citizens to come and stay without prior approval.    There are lags in the system, and not everyone who is approved actually comes (or stays) but by and large we can think of the net flow of non-NZ citizens as the contribution of immigration policy.  Since 1960, there has been a net inflow of non-New Zealand citizens every (March) year except 1979.  If economic conditions here are poor, non-New Zealand citizens can leave again too.  In that sense the net inflow of non-New Zealand citizens understate the role of immigration policy in boosting demand for housing.

So what has the impact of non-NZ citizen net migration to New Zealand been?   In the 52 years from April 1961 to March 2013 there was a net inflow of 1139351 non-New Zealanders.  Over the same period (between the two censuses), the number of private occupied dwellings in New Zealand has increased by 918000.  With around 2.7 people per dwelling, the net inflow of non-New Zealand citizens has contributed 46 per cent of the total increase in the demand for houses since 1961.

The impact doesn’t happen all at once –  in 1961, people didn’t live at 2.7 per dwelling, but they do now.  And, of course, many of the non-New Zealanders who migrated in 1960s will have died by now.  But most of them will have had children or grandchildren since they moved to New Zealand –  and since the average birth rate in New Zealand has been above replacement, the effective contribution to housing demand from immigration policy is likely to have been higher than suggested by the raw numbers.  As birth rates have dropped, that may not be so in future.

Since 1961 there has been a variety of changes in immigration policy.  From the late 1970s to the late 1980s, inflows of non-New Zealanders were very small.  But what about the most recent since immigration policy was changed to actively pursue much larger inflows (at present, policy aims at 135000 to 150000 permanent residence approvals on a three year rolling basis)?

From 1991 to 2013, non-New Zealand citizen immigration accounted for around 71 per cent of the change in the number of households (or dwellings required).  For the last two intercensal periods the contributions of non-New Zealand citizen net immigration were as follows:

  • 2001 to 2006        70 per cent
  • 2006 to 2013       106 per cent

Even I was a little taken aback by the last number but, of course, it just reflects two things:

  • The chart I showed the other day illustrating that with no (or much lower) non-citizen immigration New Zealand’s population would now be flat or slightly falling
  • No change in the average person per dwelling number between 2006 and 2013.

non citizen plt to households

These numbers aren’t precise.  It is quite possible that new immigrants start off with a higher than average persons per dwelling –  as, on average, non-New Zealand immigrants are poorer than the average resident population.  And the number of people per dwelling is itself partly endogenous to house prices –  if house prices had not been so high, more people would have been able to fulfil their desire to, for example, live on their own.  It is also possible that without the high level of non-New Zealand inflow, the outflow of New Zealanders (which, all else equal, massively reduced the demand for housing) would have been a bit smaller.

But what the numbers do make clear is that immigration policy choices made by successive New Zealand governments account for a very large share of the new household formation, and housing demand, in New Zealand.  If anything, that share has been rising as natural increase slowed.

And, of course, these numbers also tell us nothing about what the appropriate target rate of non-citizen immigration is.  But, unless we can construct a regulatory environment in which the supply of housing and urban land are hugely more responsive to demand than they have been in recent decades, then any conversations around demand influences, and the potential influence of policy on them, needs to engage seriously with the role of immigration policy.  At present –  given what it is knows about supply responsiveness – the government’s immigration policy is actively driving house prices, especially in Auckland, at the reach of too many of those who would like to buy –  citizen or not.

ISDS provisions

Michael Reddell FTAs

In his column in the latest New Yorker James Surowecki looks at Investor-State Dispute Settlement (ISDS) provisions that feature in many bilateral and multilateral trade and investment agreements.  These provisions allow individual investors in some circumstances to seek redress against domestic governments not just in domestic courts, but before an international arbitration tribunal (most commonly the ICSID, which is based at the World Bank).

As Surowecki notes, “these provisions have been opposed by an unusual coalition of progressives and conservatives”.

Advocates argue that ISDS provisions help to encourage foreign investment.  For some of the opponents, that would almost be enough of an argument itself.  For them, foreign investment itself is threatening.   But plenty of people who are generally keen on pretty open foreign investment are also somewhat wary.  I reckon that regulatory obstacles, and screening regimes, in respect of foreign investment  in New Zealand should be materially reduced, but partly because I think foreign investment should be treated as similarly to domestic investment as possible, I’m not sure why we should be providing separate remedies, and separate quasi-judicial fora, for disputes taken by foreign investors.  If we do need greater protection for investors, and for citizens, against arbitrary actions of governments lets have that debate domestically, amend our domestic laws accordingly, and provide equal protection to all.

The first such ISDS provision apparently dates back only to a Germany-Pakistan agreement in 1959.  And, of course, a great deal of foreign investment happened before then – in fact, the whole first great age of globalisation, prior to World War One,  Huge amounts of debt and equity finance went abroad from Europe (the UK in particular) into colonies of settlement in particular.  That included countries with pretty good legal institutions from the start (such as New Zealand) as well as places like the new, and often shaky, states of central and south America.  And it wasn’t just colonies of settlement  –  destinations included Turkey, Persia and China.

Last week I was reading a fascinating older book about just these sorts of issues.  Finance, Trade, and Politics: British Foreign Policy 1815-1914 by D C M Platt, who went on to become a pretty eminent economic historian, looks in detail at how the British government dealt with the interests abroad of British lenders and investors (be they debt holders or concessionionaires or….).  The short answer is that, unless there were really pressing political considerations involved, or the initial obligations themselves arose out of an inter-governmental agreement, the British government took the stance, and held to it pretty firmly, that difficulties with foreign governments were mattered to be dealt with by the investors themselves in the courts, tribunals, and political processes of the country concerned.

The government, and Foreign Office officials, were constantly lobbied to provide additional support to British investors, and the pretty consistent response was “no”.  Governments were typically sympathetic, but they took the view that investors dealing in foreign countries needed to look after themselves.  This, recall, was the government of the strongest power at the time, the government of the country that was, by far, the largest source of foreign debt and equity finance.  And it was a great age of financial globalisation.  And not an ISDS in sight.  If the approach wasn’t followed perfectly, it still looks to me like a pretty good model, that worked pretty well.  Surowecki suggests that “in the old days, aggrieved American investors would call in the Navy to protect their interests”.  If so, it certainly wasn’t how the British did things.

A common argument from defenders of ISDS provisions is that very few claims are lodged, and in very few cases do ruling go against national governments.  But Surowecki notes that ‘nearly 100 have been filed in the past two years, as against some five hundred in the previous quarter century before that”, presumably partly a reflection of that fact that such provisions are becoming more common, but also (perhaps) of a greater degree of activism. He reports that investor-protection is an increasingly prominent part of US law-school curricula.

The other argument is that inclusion of ISDS provisions helps encourage foreign investment.  But the evidence I’ve read suggests, unsurprisingly, that this is true only for recipient countries that have had poor quality domestic legal systems.  For them, the offer of ISDS provisions is a credibility-enhancing device, designed to provide potential investors greater reason for confidence in the security of their investment.  The evidence also suggests that there are few or no gains in foreign investment flows between pairs of countries (eg US and UK) that already have perfectly good domestic legal systems.

From a New Zealand perspective, one argument might be “we have a good legal system, so there might be no gain, but there is no probable cost either”.  I’m not entirely convinced.  After all, Philip Morris is pursuing an ISDS case against Australia over plain-packaging of cigarettes, a remedy that would presumably not be open to them under Australian domestic law.  I’m not expressing (and don’t have) a strong view on that, as yet unresolved, case, but it seems to me that advocates of such ISDS provisions need to make a stronger case for why different remedies should be opened up to foreign investors, and why the domestic courts and domestic political process –  on which the rest of us must rely –  are not sufficient.  There may be such a case, but I’ve not yet seen it.

The unease should be heightened when we recognise the limitations of the ISDS process.  There are a couple of useful backgrounders on ISDS issues by Gary Clive Hufbauer on the Peterson Institute website (eg here).  Hufbauer is a supporter of ISDS provisions, but he draws attention to both the lack of appeal provisions in ISDS tribunals, and the lack of transparency (“ICSID does not require parties to post their briefs and arbitration decisions on the web so that the public knows the arguments and the rationale for any award”.   Appeal provisions are pretty fundamental to our system of justice.

Perhaps the argument for New Zealand signing up to such provisions, whether in TPP or other agreements, is that it helps New Zealand firms investing abroad.  But at a pragmatic level, the countries we are negotiating TPP with now almost all have pretty good domestic legal systems.  And why does the New Zealand government think it is part of its role to negotiate provisions to allow New Zealand investors more rights in respect of investment in overseas countries than those countries provide to their own domestic investors?   The hands-off approach was good enough for Palmerston, Gladstone, and generations of their contemporaries.

ISDS provisions are probably not the most important aspect of TPP, or other similar agreements.  But there doesn’t seem to be much else on offer.  Countries like New Zealand seem fairly certain to be losers from extended intellectual property protections, and the comments from John Key and Tim Groser still don’t suggest any prospect of great movement on dairy protectionism.  And if the strongest argument for TPP really is something like strengthening the US relative to China (a goal which I have no particular problem with),the longer-term success of any such strategy depends on perceptions of legitimacy.  Given the unease many people seem to feel about ISDS provisions, which can look (whether or not they are) like something that is “designed to put corporate interests above public ones”, and the limited evidence of any real economic gains from such provisions, it isn’t obvious why ISDS provisions serve the interests of ordinary citizens or governments, in democratic countries with robust legal and political systems. In the words of a contributor at Forbes, (not, probably, high on Jane Kelsey’s regular reading list) ISDS provisions seem disconcertingly like a “subsidy to business that comes at the expense of domestic investment and the rule of law”

Financial crises since 2007

Michael Reddell Financial stability, New Zealand economic performance

I’ve been working my way through a series of posts on the post-2007 economic experience of a large number of advanced countries, with a particular focus on trying to make some sense of New Zealand’s (no better than middling) experience.

Today I wanted to have a quick initial look at the incidence of financial crises, since the shorthand for what has gone in recent years has often been “since the financial crisis” or “since the [so-called] GFC”.  Many authors, including some pretty serious and respected ones, have ascribed much of the poor economic performance to the “financial crisis”, adducing the experience as evidence supporting a case for much tighter regulatory restrictions all round.  And there are plenty of theoretical discussions as to how financial crises might have detrimental economic effects.

But what do we mean by a “financial crisis”?  Many authors who try to classify events do so by looking at the gross or net fiscal costs of a crisis (eg the costs of bailouts, recapitalisations, guarantee schemes and so on).  I’ve long thought that was a flawed basis for classification, for a variety of reasons:

  • A country that allowed its banks to fail, with no bail-outs, might have no direct fiscal costs at all, yet on any plain reading could have experienced a very substantial crisis.
  • Most (though not all) of any fiscal support for troubled financial institutions tends to benefit citizens of the country concerned, and so redistributes wealth rather than destroying it.  There may be all sorts of adverse incentive effects, and deadweight losses from the taxes required to cover the fiscal costs, but the level of fiscal support is not a very meaningful indicator of the cost to society.  In rare cases (eg Ireland) the fiscal costs themselves can become quite directly problematic, in terms of on-going market access, but that is not the general experience.
  • A country’s banking system might be very highly capitalised, such that no banks actually failed even under severe stress, and yet on most reckonings the country concerned would have experienced a financial crisis.
  • In some cases, banks will have experienced the bulk of their losses on offshore operations, while the intermediation business in the home economy might have been fine.  The home government might choose to bailout the bank concerned, but there are few obvious reasons to think that those offshore losses (and the choice to bail) will have much effect on the home economy.  A good example, in the most episode, was the losses sustained by German banks.  On many classifications, Germany shows up as having had a financial crisis, and yet almost all of the increased loan losses resulted from offshore exposures (particularly in the United States housing finance market).  If we are trying to understand the economic implications, it probably makes more sense to think of those losses as a US event than a German event.

So instead, I proposed a classification based on non-performing loan data, which the World Bank collects and reports by country.   The proposition here is that, if there are sustained economic consequences from something we can label a “financial crisis”, they are likely to arise primarily from the initial misallocation of resources that led to the loan losses in the first place.  Gross over-investment in a particular sector (say, commercial property in New Zealand in the late 1980s, or in Ireland in the last decade) eventually leads to losses.  The projects don’t live up to expectations, and real resources devoted to those projects can’t easily or quickly be reoriented to other uses. Buildings lie empty, or even half-completed. If there are problems, they arise whether or not any bank ever fails, or is bailed-out by the state.  And banks have to reassess their entire models for generating income, and are likely to become more risk averse as a result of the losses their shareholders faced.  There might be additional costs if a large number of major financial institutions actually close their doors permanently after a crisis (that argument is part of the case for the OBR tool in New Zealand), but relatively few major institutions actually closed their doors in the period since 2007.

The table below classifies countries based on data on banks’ non-performing loans (NPL) from the World Bank’s World Development Indicators. The 20 countries that had a substantial increase in the stock of domestic NPLs after 2007 (the final two columns), are treated as having experienced a domestic financial crisis.

Non-performing loans since 2007
NPLs
Source: World Bank.

Note:

Very low and stable: NPLs:                     less than 2.5 percent of loans throughout, remaining at a stable percent of loans

Moderate and stable: NPLs:                  2.5 to 5.2 percent of loans throughout, remaining at a stable percent of loans

Moderate and small increase:               : NPLs greater than 2.5 percent of loans throughout, increasing by less than 2.5 percentage points

Mostly, the classification looks intuitive, and much as expected. All advanced countries that had a support programme with the IMF during that period are in the financial crisis category. At the other end of the spectrum, the commodity-exporting advanced countries (including New Zealand) all avoided a domestic financial crisis on this, as well as other, measures.

Two points may be worth noting. First, although the extreme liquidity crisis in the United States in 2008/09 attracted headlines – and had global ramifications – loan losses in the United States have been overshadowed by those in many European economies.  One element of this is that more loans in the United States were not on the books of banks (and this is bank data). Second, although some banks in countries such as Germany and Switzerland got into material difficulties, in most cases those were the result of losses incurred in the United States.  As discussed earlier, these losses probably had different implications for the performance of the home (German or Swiss) economy than losses arising out of domestic lending business.

If this classification looks broadly sensible, it is somewhat ad hoc, and might not easily generalise to other crises and other times, even if broadly comparable data were available for earlier periods.

One can’t just jump from this classification to the chart of GDP per capita performance to see whether countries that had financial crises, on this measure, did worse than those that did not.  Apart from the many other influences on any country’s performance, it is also important to recognise that any causation can run in both directions.  The argument that a quite-unexpected period of very weak economic performance will have generated large loan losses (many projects will have been based on assumptions that, however apparently reasonable, did not play out as expected) is at least as strong (I’d argue stronger) than the proposition that “financial crises” themselves cause sustained economic underperformance.  Loan losses did not cause Greece’s problems, but were an integral of an overall process of economic mismanagement and misallocation of resources that led to Greece’s disastrous underperformance in recent years.

And what of New Zealand?  We have had pretty low banking system NPLs throughout.  Finance company losses mattered a lot to investors in those companies, but were still quite modest relative to the overall stock of loans in New Zealand.  There were fiscal costs, through the deposit guarantee scheme, but without the international rush to guarantee schemes there would have been much the same loan losses and probably no direct fiscal costs.

As no major institutions failed, and (economywide) there was little evidence of sustained over-investment in any particular class of asset, one would not generally think of New Zealand having experienced a domestic financial crisis.  Funding was disrupted for a time in late 2008/09, and that was among the factors inducing a greater degree of caution among lenders, but 6-7 years on it seems unlikely that any domestic financial stresses have materially affected New Zealand’s overall performance.  For some sub-sectors, the picture might have been a little different, as finance companies had been major financiers for property developments, but for the economy as a whole the effect seems likely to have been quite peripheral.  And yet, our economic performance has been similar to that of the United States, the epicentre of the initial crisis, and where the increase in actual loan losses was substantial.

Central banks blogging

Michael Reddell Central banks, Reserve Bank

The Bank of England has launched a new staff blog, and the fact of the blog –  rather than the initial content –  has attracted some attention.  The Bank of England summarises its aim this way:

Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England or its policy committees.

Tony Yates, a former BOE staffer, seems surprisingly optimistic.

There is a growing number of ex central bank bloggers, eminent (Bernanke) or otherwise, but central bank blogs are uncommon, if not entirely new.  The New York Fed has been running the Liberty Street Economics blog for a while, and Macroblog at the Atlanta Fed has been around for even longer.  At a supranational level, there is the iMFdirect blog.

But a blog is just a technology, one of many “communications channel” that central banks, as powerful public institutions can use.   The interesting point is the suggestion that the BOE blog will be a vehicle in which staff can “share views that challenge –  or support –  prevailing orthodoxies”.

That certainly would represent quite a change for most central banks.  But again, it is along a spectrum.  Many/most central banks have long published research and discussion paper series, which typically carry a disclaimer that the views were those of the authors and not necessarily those of the institution (at the Reserve Bank, we drew a strong distinction between Bulletin articles which carried no disclaimer, and thus could be taken as, in some sense, the views of the Bank, and other papers). Central bank analysts and researchers give conference papers, dealing with a variety of technical or policy issues, which carry similar disclaimers.  And not that many years ago, I heard Janet Yellen, then only vice-chair of the Fed, give a speech at a conference, and that speech also carried the standard disclaimer[1].

But the truth is that most central banks –  and I’m sure other government agencies, even those with operational independence, are no different –  typically have quite strict, but not always clear (to themselves or staff), limits to what staff are allowed to say in such documents or papers.   I’m still somewhat surprised, and impressed, that senior Fed researcher Robert Hetzel has been able to publish major books carefully (but critically) reviewing the Fed’s conduct of monetary policy.  Perhaps it is an advantage to be a very big but decentralised central banking system.

Tony Yates gives some of the flavour of this (historically quite tight) control in a BOE context, and I have also heard some BOE horror stories from people who used to work there.  It will be interesting to watch the BOE experiment, but I suspect it will end up being a channel primarily for the sorts of pieces on the blog today –  one on a topic not related to the Bank’s responsibilities at all, and one a nice, but anodyne, piece of analysis illuminating the rather obvious point that risks of deflation rise if shocks happen when conventional monetary policy has reached its limit.

And that is fine.  Openness and transparency in powerful public agencies are important, and there is far too little of both.  But the ability to have robust debate within an organisation in the formative stages of policy development is also important.   Great leaders can probably cope with challenge and scrutiny wherever it comes from, but on average we have to expect average leaders.  Often enough, they will feel threatened if someone down the organisation is being used by external critics to bash the organisation.  I’ve mentioned earlier how Graeme Wheeler got the Ombudsman to block release of a discussion note I had written, some time previously, on governance issues.    I think he was worried that the Green Party –  who have championed the cause of reform and greater transparency at the Reserve Bank –  would use my note to “politicise the issue” [aren’t institutional design and governance issues appropriately political choices?] and to undermine his own preferred approach to reform.

In many ways, a central bank blog is not much different than what we were trying to do at the Reserve Bank when we set up the Analytical Notes series a few years ago (a product I edited) –  or the Fed’s FEDS Notes series.  Our idea was that analytical pieces, that weren’t heading for journal publication, could be published, carrying a disclaimer that they were the views of individuals not the Bank.  Since any of this material would have been discoverable under the OIA, it was thought good for openness, and for staff themselves, to have a vehicle for putting such material in the public domain.  Sometimes it was actively used by the institution to get supporting material out for scrutiny.  There are quite a few interesting papers in this series, and I’ve already linked to several of them, but I’m pretty sure there was nothing in them that challenged current orthodoxies.  Prone to challenge orthodoxy as I was personally, I was pretty good at judging what could be got out the door, and phrasing things accordingly.

I’m not suggesting that the Reserve Bank has typically been a monolith in how staff participated in external events.  We hosted, with Treasury, an exchange rate policy forum a couple of years ago  –  to which a range of business and other people were invited.   All the papers were published with no “censorship” (at least for the Reserve Bank ones) and are still on official websites.  My paper involved a fairly critical perspective on New Zealand’s immigration policy and the potential adverse macroeconomic implications (not, of course, that the Reserve Bank is responsible for immigration policy).  I’ve given discussant comments at international central banking conferences casting doubt on the benefits of publishing extensive central bank forecasts, and have a chapter in a recent (fairly obscure) book suggesting, with all sorts of caveats, that we should not automatically think of inflation targeting as the ‘end of history’ (although this did prompt efforts at censorship by one new Deputy Governor).

But all that is different from whether staff should be able to question, in public, current policy preferences and frameworks.  Much as I think the Governor’s LVR policies are unnecessary, inappropriate and costly, I really don’t see that it is appropriate, or in the interests of good government processes, for staff to be saying so, even with all the qualifications in the world, in public fora.  And I’ve thought the Governor’s monetary policy decisions over the last few years were wrong, but no matter how carefully crafted the argument was, it wouldn’t have been appropriate to run that argument in public as a staff member.  In fact, I did a variety of speaking engagements in which I persuasively made the case for the Governor’s stance.  That was the external-facing bit of the job.  And rightly so.

Perhaps in some idealised world all debate could or should be open –  Tom Scott once ran a cartoon satirising Don Brash’s commitment to open comment and suggesting Don would have liked to broadcast all monetary policy deliberations live  –  but it isn’t the world we live in.  Organisations need to be able to have robust debate internally, without the sense of a simultaneous parallel track being pursued externally by people who happen to disagree on a particular issue.  And as I listen to accounts of people reluctant to comment on this or that issue because, for example, it might affect their future consulting opportunities, it is a reminder of why it is not a realistic alternative vision.

Now, I’m quite sure the Bank of England has no intention of allowing that level of dissent or openness either.  Perhaps pieces that “challenge current current orthodoxies” will be published when Mark Carney or Andy Haldane themselves want to challenge such “orthodoxies”, but it will be a surprise if we see pieces directly challenging views advanced by those senior managers.  The blog might also be used actively at times as a place for testing the waterr –  putting an idea or some analysis out, in a controlled way, but with some plausible deniability (‘it was just the author’s view”).

I’m not critical of that approach.  If I have a criticism, it is that perhaps the Bank of England is overselling what the blog can be.  If it can be a vehicle for some shorter and more informal pieces of analysis, or for translating into English some of the more technical working papers, it will probably serve a useful purpose.  And its existence is something of a “brand marker” –  the Bank’s current management wanting to mark itself out from the past.

In the end, there are always going to be judgements about the appropriate level of openness.  It will depend on the person, the issue, and even the specific external environment.  For some issues, treated in some ways, at some times, senior management will be comfortable with alternative perspectives (perhaps even quite critical, but well-argued, ones) from staff being published.  On other issues, the market or political sensitivities just make it unrealistic.

There are delicate balances to be struck.  For example, if central banks want to have and retain top-flight researchers there needs to be a reasonable commitment to a willingness to publish.  And a willingness to publish a range of views can help signal a general openness to challenge and the contest of ideas.  And engagement with alternative perspectives –  genuine engagement, not just an evangelisation exercise –  is important.  But robust internal debate –  with ex post scrutiny and document discovery –  remains far more important to well-functioning central banks.  Central banks, and those holding them to account, should be much more concerned to establish that those processes and cultures are in place.  In my observation and experience, that increasingly has not been the case at the Reserve Bank of New Zealand.

[1] It struck me at the time, because at much the same time the Reserve Bank Communications Department was trying to insist that we should not use the disclaimer in any presentation, on the grounds that when anyone was speaking anywhere they were speaking “for the Bank”.

“Market failure” or failure to let the market work

Michael Reddell Housing

Brian Fallow has a piece in the Herald today, prompted by the Productivity Commission report,  that champions more active government involvement in the housing market, with barely a hint that anything governments do ever goes wrong.  The words “masterplanned”, when uttered of the activities of government entities, other than tongue in cheek, should send something of a shiver of alarm through the citizenry, rather than a frisson of excitement.  The track record isn’t good.

But what struck me was the claim that the Productivity Commission’s report “is unequivocal about the fact that we are dealing with market failure here”.    Where, I wondered, was the evidence of the market being allowed to work?   One might more accurately sum up the Auckland property market as the most probable outcome of two sets of government policies.  Restrict the supply of land, and at the same time actively take steps to maintain rapid population growth, and what would one expect but high land prices?  One might more accurately call it “policy success”  (predictable outcome of deliberately chosen measures, if anyone had actually done the analysis) than “market failure”.  But surely no politician was ever dumb, or venal, enough to have wished for the sorts of outcomes we’ve seen in Auckland in particular in recent decades?

Which is not to disagree with Fallow’s concluding observation “the status quo is perilously unsatisfactory”.  Well, yes, but instead of proposing providing new compulsory acquisition powers –  not just to elected ministers, as at present, but to unelected, barely accountable, appointees – how about giving the market a chance?  Free up land supply (zone it all residential, as a default) and urban land will quite quickly become affordable again, and arguments about “hold-outs” surely become moot (if any land can be built on).  Oh, and our ancient freedoms are respected as well.

It is a sobering reflection on the growth of the regulatory state that yet more encroachments on peoples’ liberties, with even fewer protections, are proposed in the week in which we mark the 800th anniversary of Magna Carta.