The Reserve Bank of Australia (RBA) and the Reserve Bank of New Zealand (RBNZ) could not be more different.
The RBA’s speeches and commentary often feel like they have come directly out of a bank’s economics/marketing department, aimed squarely at appeasing foreign bond investors, rather than telling it as it is.
According to the RBA: Australian housing is not particularly overvalued; the banks’ lending standards are sound, financial regulation is the best in the world, and macro-prudential policies are not required (despite the shift globally to such rules and the RBA’s own research showing they work); the banks’ massive external liabilities do not pose a problem and might even be desirable; and the potential headwinds facing the economy are mild.
Now compare this approach to the RBNZ, which has recently implemented macro-prudential controls on high risk mortgage lending, consistently warns that New Zealand housing is significantly overvalued and that the banks’ high level of external liabilities poses a risk to financial stability, and has openly pressured the various levels of government to get their act together on housing policy.
Perhaps the differences between the two central banks’ stances can best be illustrated by an example. Yesterday, the new RBNZ Governor, Graham Wheeler, spoke candidly about his experience living in the US in the lead-up to the GFC, and how it has influenced his view of risk and shaped the RBNZ’s crackdown on high risk mortgage lending. From Interest.co.nz:
The Reserve Bank said last month banks must limit new residential mortgage lending at loan to value ratios (LVRs) above 80% to no more than 10% of the dollar value of their new housing lending flows from October 1…
“I lived in the States for 15 years. And during the period 2003 to 2007 it was an extraordinary period in the global economy,” said Wheeler. “You had the fastest global growth for four decades.”
‘The new normal isn’t going back to 2003-07′
This meant that when policy makers talked about the new normal this did not mean going back to the extraordinary period between 2003 and 2007.
“You did see very rapid increases in house prices in many, many countries. And for us (New Zealand) we had the most rapid house price inflation amongst all the OECD countries. And as I said, Auckland house prices are currently 22% above where they were in 2007,” Wheeler added.
“But what I saw in the States did influence the way I did think, to some extent, about this issue. What you saw as the global financial crisis came, you saw basically 25% of America’s 50 million mortgage holders with negative equity. That’s a quarter of all mortgage holders had negative equity. Another 5% had equity of less than 5%.”
“And you saw median real household wealth fall in the US by 39% between 2008 and 2010. Now clearly house prices were overvalued in the US. They’re significantly overvalued in New Zealand, and to the extent that you did get a rapid correction in house prices, it would have very, very significant effects, we believe, for potentially the financial stability and output and employment growth in this economy.”
“And the most severely effected would be those who have just come into the housing market with very low deposits.”
The RBA’s Luci Ellis published a research paper arguing that the huge run-up in housing values (and bank balance sheets) was not a major concern for financial stability in the US or globally:
The resulting expansion in both sides of the household balance sheet is an important development for policy-makers to monitor, but it is probably not of itself a cause of financial instability…
Particularly in North American markets, simple ratios have given way to credit scoring and risk-based pricing, so that loan sizes and pricing are more closely tailored to individual borrowers’ circumstances. To the extent that this reduces the margin of safety for some borrowers who are now able to borrow more than the older practices would have implied, this might mean that more households are facing greater financial risks than previously.
But overall, this easing of financial constraints is a reflection of their ability to repay and withstand those risks. Therefore it cannot be assumed that a shift away from the earlier lending practices based on rigid ratios implies that financial vulnerability has increased in any significant way…
The most important lesson to draw from recent international experience is that a run-up in housing prices and debt need not be dangerous for the macroeconomy, was probably inevitable, and might even be desirable.
Within two years, home prices in the US and elsewhere began to collapse, bringing the world financial system to its knees. And despite her questionable reading of the situation, Ms Ellis was promoted to the Head of Financial Stability at the RBA in September 2008. She has since repeatedly defended extended house prices.
It’s not all one way traffic. The Deputy Governor, Phil Lowe, has published papers arguing that central banks can and should use monetary policy to prevent asset price bubbles. Most notably he did so when working at the BIS in 2001, even as the world was mesmerized by Alan Greenspan’s credo that a central bank can never be sure its looking at a bubble and should only ever clean up after the event.
Nor was it always quite so clear in New Zealand. Wheeler’s predecessor until last year, Allan Bollard, often played down the efficacy of macroprudential measures and attacked them as vestigial. He did, however, begin the research and approval process for their implementation.
As I’ve written before, this more frank approach to the issues has a very large upside for the central bank, its legacy and the economy. I don’t hold the RBA fully responsible for what has transpired in Australian housing markets. The fact is politicians at all levels have abandoned clear-thinking economics to manage the market failure around housing, from local government urban containment to federal government demand pumping grants. That has left the RBA as the sole manager of the issue, with its only tool a sledge hammer to boost or reduce credit.
As discussed, the upside for the bank in being more honest is that it gives itself more tools in this context. But just as importantly, it forces greater transparency onto the failure of government policy. In New Zealand, the discussion and creation of macroprudential tools is forcing the government to adjust its policy framework so that housing supply restrictions are removed and the market can function more effectively to clear excess demand.
This microeconomic reform will boost growth as more houses are built. It will help prevent future price spikes and the build up of financial risks because the market functions more on fundamental demand than it does speculation. And, as a result, it means the central bank is not longer carrying the can alone if it all goes pear-shaped.
Sure, short term, the embrace of macroprudential tools takes some courage to see off the howls of vested interests. But longer term, there really is no downside for the RBA in the embrace of macroprudential tools and lots of risks in failing to do so.