Looking beyond interest rates

Sam Birmingham runs a top quality networking site for young professionals called WeBe, which provides up-to-date information on financial matters, work-related issues, lifestyle news and reviews, and current affairs and opinion pieces. WeBe also provides a platform where members can have their voices heard, express opinions and share ideas with other like-minded Young Professionals.

Yesterday, Sam published an article on WeBe questioning if Australia has become too obsessed with interest rates and whether the RBA has the right tools at its disposal.

Sam’s article is reproduced below for your reading pleasure, followed by some suggestions of my own aimed at improving financial stability.


According to our central bank’s charter, the RBA must conduct monetary policy in such a manner as will best contribute to:

1. The stability of the currency of Australia;

2. The maintenance of full employment in Australia; and

3. The economic prosperity and welfare of the people of Australia.

Over time, the RBA’s focus has been on the inflation rate and keeping it within a target range, using their principal mechanism of monetary policy, the cash rate, which the Board of the Reserve Bank sets at their monthly meetings.

At the risk of oversimplifying, the cash rate is a liquidity tool: When the economic outlook is strong (ie. capacity constraints looming and the risk of inflation rising), the RBA raises its cash rate; lenders pass this cost on to borrowers, who must then pay more each month to service the higher interest rate; this leaves them with less money in their pockets, thereby pulling excess liquidity out of the economy… And vice versa.

On the face of it, this approach makes sense to me. However, I can’t help but feel that when millions of Australians are focused on interest rates and whether the RBA’s next move will be 25bp up or 25bp down, perhaps we’ve lost a sense of perspective.

As Deep Throat said on MacroBusiness earlier this week:

“If we hang off RBA minutes to glean anything of use or influence then we’re deluded.”

Whilst I don’t necessarily agree with DT’s calls to abolish the RBA, I do agree that there needs to be a new approach to monetary policy… Why? Because the current system is clearly out of whack:

  • Prima facie, we should be celebrating rising rates, because it means the outlook (for jobs, investment and confidence) is strong. But our response is exactly the opposite, because Australians are now so highly geared that every little rate rise stretches the household budget even further.
  • Consider the link between asset markets and rate changes over the past couple of decades: Rates bottom out, the upturn begins, the economy continues to grow, rates rise incrementally, the economy approaches the top of its cycle, markets get frothy, commentators get excited about new highs, average homeowners tighten their pursestrings, the bubble bursts, rates get slashed, the pressure come off household finances, we are encouraged to borrow and spend more in order to restore economic growth, and the cycle beings again.
  • Looking abroad, Japan’s central bank has kept rates at or near zero for years, desperately trying to stimulate growth… Where to now? And then you’ve got the US Fed who, having taken their cash rate down as far as it can go, have now resorted to quantitative easing – pumping squillions of dollars into the economy, trying to stoke growth by forcing down long-term rates and monetising Government debt in the process.

A Blunt Instrument

In the RBA’s defence, the cash rate is a one-dimensional tool when it comes to dictating monetary policy and managing the country’s economy. As far as I’m concerned, it has three main flaws:

1. Impact at the Margins

Raising the cash rate helps to suck liquidity out of the economy, but the real impact is felt by the most vulnerable households, whose budgets are already stretched and who can least afford higher rates.

Sure, if an extra $50 on your monthly mortgage bill is enough to tip you over the edge then your problem isn’t interest rates – it’s that you’ve got too much debt.

But relying on a mechanism which hits the poorest households the hardest in order to change an entire country’s saving and consumption habits is oppressive, if not discriminatory. And then you can throw in issues of generational fairness, with our wealthy (debt-free) older generations cheering every interest rate rise, whilst (highly-leveraged) younger families bear the brunt of it.

2. The Role of Intermediaries

As I explained above, the RBA sucks liquidity out of the economy by increasing its cash rate, with retail lenders then left to pass this increased cost on to their borrowing customers.

But our banks only source a portion of their funds domestically, so what happens when their alternative funding sources are pushing funding costs in the opposite direction to the central bank? Even worse, what happens if international wholesale funding markets turn off the tap?

This problem was foreshadowed by Deep Throat:

“Due to our over reliance of offshore debt, setting the cash rate lower would certainly have a negative effect on attracting offshore lenders so whilst reducing rates to stimulate, the RBA would reduce the availability of credit. Of course the reciprocal is true as well, in which case the RBA’s monetary policy is currently all but useless at the moment.”

The bottom line is that the impact of RBA cash rate changes depends on intermediaries ability to pass it on… We shouldn’t take for granted that will always the case.

3. Without Debt…?

I appreciate that debt is, for better or worse, a fundamental driver of our capital-intensive economy and plays an important role in funding household and business sheets.

But to what extent should our central bank’s prime policy tool be driven by something which, when relied upon excessively, poses a grave risk to our economy?

An Alternative Path

I’m as pro-market as the next “neo-liberal”, but I’m not convinced that we should be abolishing the RBA and leaving monetary policy to the private banking sector. However, perhaps it’s time to revisit whether the RBA has the right tools at its disposal?

Two opportunities occur to me…

1. Superannuation

Rather than nipping and tucking the cash rate, what if the percentage of our overall remuneration which goes into compulsory superannuation were allowed to fluctuate?

This would have the same effect of increasing/decreasing the flow of money around the economy, but would spread the load across the entire workforce, rather than impacting most heavily on those who can least afford it. Also, the payment system is already well established, making it reasonably easy to administer.

On the downside, such an approach is pro-cyclical: Employees would be pumping more money into their super account when the economy is booming and markets are heading skywards – leaving their saving more exposed to the inevitable downturn.

2. Consumption Tax

Given that the Government has gutlessly excluded the GST from consideration when it comes to tax reform, I don’t hold much hope that they would allow the tax rate to be set by an independent body. However, as far as I can see, a variable rate GST is the most effective way to influence the flow of liquidity throughout our economy.

First and foremost, this approach is equitable: We all consume goods and services, hence this takes money out of everyone‘s pocket, rather than hammering the poorest and most-indebted.

Again, the payment/collection system already exists: Shops could simply mark items at their pre-GST price; the RBA would announce the GST rate at its regular meetings; and then the relevant percentage would be added to our bill at the checkout.

And finally, a fluctuating GST is counter-cyclical: It captures excess liquidity during the good times, which can then be used to fund stimulus measures in the bad times.


Thanks Sam. Your suggestions are certainly food for thought. I agree that the RBA needs more policy tools at its disposal; although I have different ideas on what these tools should be.

Given the major role that excessive credit has played in creating Australia’s housing bubble, and that the Australian banking sector faced insolvency requiring a Government bail-out during the GFC (via the bank funding and deposit guarantees), my personal view is that greater regulation of mortgage lending is required to prevent the excesses that lead to asset bubbles.

One possible option is to task the RBA with developing and implementing “macro-prudential” measures aimed at strengthening the resilience of Australia’s financial system by mitigating excessive credit and asset (house) price growth. Possible macro-prudential measures could include:

  • Setting maximum loan-to-value ratios (LVRs) for all property lending (i.e. lending by both bank and non-bank institutions). This measure would assist in both limiting a lender’s exposure to a property market downturn as well as preventing highly-leveraged property purchases. Maximum LVRs could, for example, be set at 85% (requiring a minimum 15% deposit) when a cash deposit is used and 50% when non-cash collateral (e.g. another property) is used in place of a cash deposit.
  • Placing limits on the ratio of debt service to income for housing lending. This measure would reduce the likelihood of borrower default and limits highly-leveraged property purchases. For example, a 30% limit would permit a household with a gross income of $100,000 to borrow a maximum of $380,000 at a 7% interest rate and 30-year loan term, whereas a 40% limit would permit the same household to borrow a maximum of $500,000 under the same terms.
  • Placing limits on the amount of loans that banks can extend against short-term funding sources, such as at-call deposits, and term deposits and wholesale funding with less than 12 months term-to-maturity. These types of measures: reduce the tendency of lenders to rely on short-term or unstable funding markets to support rapid lending growth; reduces the likelihood of experiencing a liquidity crisis like Australia’s banks experienced during the GFC; and reduces the overall amount of leverage in the financial system.

Macro-prudential measures, such as those described above, offer a number of addition benefits beyond simply increasing financial system stability, reducing systemic risk, and improving housing affordability. First, they could improve the function of monetary policy, since using interest rates in response to an asset bubble/bust is a blunt instrument that can have unintended consequences in other parts of the economy. Second, fixed measures, such as maximum LVRs and debt service to income ratios, tend to be more binding during a credit boom, when banks seek to expand property lending, than in a bust, when heightened risk aversion reduces their propensity to extend loans with high LVRs or debt service ratios.

Had such macro-prudential measures been in place globally during the 2000s, it is possible that the credit excesses experienced in the lead-up to the GFC would have been much less severe, since the kinds of speculative housing lending undertaken in the United States and Europe would not have been possible. It is also likely that Australia’s house prices would never have surged like they did post-2000, since access to credit and the ability to undertake highly leveraged purchases would have been muted. Houses would likely be more affordable, even in the absence of much-needed reforms to the supply-side of the housing market.

That said, implementing such macro-prudential measures domestically in the current climate would be risky, since they could lead to an immediate contraction in housing lending, resulting in house price falls and a severe economic contraction. For this reason, it would be wise to implement such measures gradually with the goal of preventing future housing bubbles.

Realistically, the political climate would likely be most amenable to change after Australia’s housing prices have deflated somewhat, since attitudes towards housing speculation and leverage would likely become more conservative. The Reserve Bank of New Zealand, which is in the process of developing macro-prudential measures, provides a useful template of how reform could be approached by Australia’s authorities.

As argued many times before by MacroBusiness’ bloggers, the Australian Government should immediately undertake another Financial System Inquiry (FSI) to examine these financial stability issues. The previous Inquiry (the ‘Wallis’ Inquiry), completed in 1997, never envisaged systemic risk engulfing financial markets as well as intermediaries, as occurred during the GFC. Nor was the idea of macro-prudential regulation ever considered.

Furthermore, the Government’s October 2008 decision to guarantee bank funding and deposits completely ignored one of the original FSI’s key recommendations – that no government would ever guarantee any part of the financial system. The long-term implications of using the Government’s balance sheet as role of guarantor of last resort for the banks’ wholesale debts is also unclear and needs to be comprehensively examined by such an inquiry.

Cheers Leith

[email protected]


Unconventional Economist
Latest posts by Unconventional Economist (see all)


  1. I agree monetary policy needs to be complemented with other sustainable rate of growth measures. I suspect a central bank like – flexible national land tax was the obvious solution here. Henry recommends a rate of 1%. But what if this was flexible. They could control a sustainable rate of land price inflation, hence avoid asset boom/bust. We have seen the land value to GDP ratio increase from 0.5x in the 50’s to more than 2.8x in 2010.

    • I like this suggestion @aushousingcrash

      First and foremost, it would be great to see Ken Henry’s proposal implemented. Layering a floating rate over that is a creative way to improve the allocation of capital, although I wouldn’t want the rate to be set by pollies.

      Is this something you could see RBA / APRA setting?

  2. I really like the GST idea. I think it would have all the desired effects, but for one problem. Politicians. I honestly don’t trust politicians to be able to save that money in the good times, in order to spend it in the bad. Sure, we’ve had a few decent ones, but overall, politicians like to spend money.

    There would need to be some sort of measure forcing politicians to not spend GST money during the good times. Eg, when in positive growth all GST money MUST be put in to a future fund type savings account. When negative growth hits they can spend a proportion of it each year. Or something along those lines.

    Either way, I like all the ideas thought of here. I am as pro-market as anyone and a libertarian to boot and I still think the RBA really needs more power to regulate financial markets.

    • Spot on @MattR

      I think the RBA has been OK at standing up to the pollies every now and again, although I’m not convinced that they have always been willing to take them on – the criticism of the rate hike during 2007 election campaign is evidence of this.

      Further, I think most readers of this blog would agree that the RBA hasn’t done enough to quell rampant property speculation and dampen the bubble… Still, I would rather give the RBA more power than put more money in the hands of our elected representatives

  3. When Don Brash was governor of the Reserve Bank of NZ, back in the mid 1990’s, he spoke very prophetically about how urban growth restrictions driving the price of urban land up, were making his job more difficult.

    A recent OECD Report made the comment that housing cycles have increasingly come de-linked from the business cycle in recent years in several OECD nations simultaneously, and this renders monetary policy extremely difficult. House price bubbles seem to be capable of continuing to inflate even as businesses are retrenching and unemployment is rising. This is the big issue in the whole global financial crisis. All that clever monetary policy that we thought had made booms and busts a thing of the past, has been rendered impotent by urban planners acting on global warming manias.

  4. Abolishing the RBA would be the best outcome, and the first step in a return to sound money free from the boom-bust business cycle.

    • Ever since currency was invented, all economy in history suffer from bust-boom cycles. The world experienced boom-bust cycles even before banks exists!! Simply removing central banks cannot solve the problem. Instead, the system needs to be reformed.

      • True, several of history’s most famous bubbles occurred prior to fractional reserve banking. But I do believe Von Mises is right, and that there will be a final irretrievable crash because of the endless creation of “paper money”. I do not believe that the central bankers know what they are doing now.

        THIS latest bubble is the biggest ever because it is based on urban LAND and it affects nigh on everybody. It is far bigger than “share market” bubbles, and far more difficult to cope with than bubbles on the “non real” economy in which a minority of people participated with a certain discretion. But I think it could have occurred under a gold standard anyway, because it is based mostly on supply side interferences. Even under a gold standard, we would need to address those interferences to get our economies back on track.

        What was going on in the derivatives market etc, is an unfortunate diversion; that is no more the real economy, than the gambling sector is the real economy. The real damage in all this, is solid, real, property doubling (or more) in price and then halving (or more) a few years later.

        • Securitisation of mortguages is a major factor in this derivavtives monster, or casino economy, to which our banking system has a 15 trillion dollar exposure. When property prices start declining – the butterfly effect will begin. I can’t help but feel our government has played a major role in this mess through their FHB grant. It was in their best interests to keep this bubble going as $$$ flowed into their coffers.

        • “THIS latest bubble is the biggest ever because it is based on urban LAND”

          Fundamentally this is wrong. The housing bubble could never have developed without a corresponding credit bubble. Urban land restrictions simply exacerbated the effects of the bubble in sought-after urban areas.

          If you don’t have the money (easy access to credit) you could not pay the price (purchase the land – at whatever value). No buyers and the market ain’t gonna move!

          This indeed was the UE’s view prior to his conversion by Wendell Cox.

          • Exactly. ‘Boom and bust’ is a product of human psychology – when something appears to be going up in value people want in and are willing to pay more for it.

            The extremes of the cycles have got worse as a consequence of us having a system whereby money can be literally issued out of nowhere (credit) via the fractional reserve backing system.

            There are two solutions (market based vs. control based depending on your philosophical persuasion!):

            a.) Enable the market to put a price on credit. (i.e. If more people demand credit the price automatically goes up in line with increased demand for it).

            b.) Control the amount of credit that can be issued via maximum LVRs etc.

          • This thread is getting a bit skinny, see my comment down the bottom (at least, it is at the moment).

          • Conversion by Wendell Cox? I sense a conspiracy theory. Although I do agree with your point 3d1K. In my opinion, both credit factors and restricted supply are responsible for the bubble. That’s why we should tackle both.

          • UE – Don’t worry, no conspiracy theories here. Just a long term reader of your blog – and detected a shift of emphasis!

          • You are absolutely right. When I began blogging 11 months ago, I did not understand the supply-side issues. Like most commentators, I saw the high correlation between credit growth and house price growth and concluded that debt was the cause of housing bubbles.

            But after undertaking extensive research, I have come to understand the supply-side much better (still learning though) and now agree with the arguments put forward by Demographia, Harvard’s Glasser, etc that the supply-side is critical when analysing housing markets. In a nutshell, when housing supply is highly responsive, like in Texas and Georgia (just two examples), house prices will remain fairly stable even in the face of significant increases (decreases) in credit. But when supply constraints are in effect, increases (decreases) in credit will result in large rises (falls) in prices.

            It’s the same phenomenom whether you analyse the housing market, the oil market, or most other items: restricted supply makes a good’s price both more volatile and more expensive.

    • What do you mean ‘sound money’? Do you mean the gold standard? You know how many depressions there were in the 19th century?

      We haven’t had a major depression for 80 years because of central banks. I’d rather keep them in place and give them better tools for the job.

      • But we have had unprecedented inflation in the last 80 years as a consequence. In some ways this is just as bad if not worse for society as the old cycle of depressions was.

      • This is correct, but only because there was no such thing as a “recession” in the 19th century. Everything was a “depression”. The word “recession” only came about after the great depression, because it was so much larger than everything experienced before, a new word needed to mean “not-so-bed depression”. The depressions of the 19th century were just what we would call recessions now.

  5. Being a small business owner and adding significant value to the products that I sell, I pay a higher proportion of GST than most business.
    Why doesn’t anyone realize that GST is a tax on labour inputs?
    You put GST up and all you are doing is falling into the lap of corporations…little value added, profit on volume.
    Sure increasing GST will have the desired effect but why not tax the value not added???

    • Isn’t it ‘your customers’ that pay the GST, not ‘you’? ( as the ultimate buyer, they pay the accumulated one-off GST at point of sale). You merely collect it for the ATO, and pass it on?

  6. Variable super contributions deserves further examination. I like that idea as long as its the individual’s pre-tax contibution.

    Rates movements punish those with mortgages – and the banksters get a windfall for running loose credit.

    By bumping up super contributions (above the statutory 9%) at least the money is going into the fund – maybe this should sit as a CASH ONLY component?

    Ultimately this site has the requisite brain power behind it to be submitting draft policies as an emerging political force.

    • Thanks for the vote of confidence @HousingTroll … And yes, I definitely agree that the superannuation % should come out of total remuneration pool — ie. start with your full package, take out the compulsory, super, subtract the PAYG tax, then whatever is left over goes into take-home pay.

      To be honest, I find the thought of forcing people to allocate a certain percentage of their super account to a specific asset class a bit galling. But the sad reality is that fund managers are motivated to allocate more assets to shares, rather than bonds.

      Once Australia realises that we are massively unweight fixed income and overweight “growth”, then perhaps people will still asking why they are paying these fundies so much money to do a sub-par job?

  7. While the ideas mentioned have merit, there are a few huge problems with implementing them.

    GST is a tax, therefore the rate is determined by the Government, not the RBA. Raising tax is unpopular. This will not work.

    To allow the RBA to set tax rates will require a new constitution where the RBA havce the right to tax without representation. With interest rate, you have the right to not borrow. Everyone have to pay the GST.

    Adjustment of superannuation rate suffer from the same issue.

    Under the currenct structure, the RBA has one lever within it’s power that it doesn’t use enough. The RBA set the minimum capital reserve ratio for banks. The ratio should be lifted for banks to reflect their foreign borrowing.

    The rising price of housing is a political issue. Negative gearing, planning laws, capital gains tax discount, first home buyer grant and land tax can only be changed by the government.

    In regard to Japan, if growth is slow when interest rate is zero, how will higher interest rate help?

    • I understand your comments @Ronin8317

      Whilst there are certainly impediments to what I have proposed, the purpose of my article was just to stimulate some discussion around (a) whether the RBA needs more tools at its disposal and (b) if so, what other options might be out there.

      It’s worth remembering that it wasn’t that long ago when interest rates were NOT set an independent body, so perhaps it’s not such a quantum leap to empower the RBA (or similar) to adjust the rate of GST as required? That’s not to say that the Govt stops collecting the proceeds, but by taking the rate decision out of Govt hands at least it hopefully makes it a bit more likely that the hard decisions will be taken every now and again.

      RE Japan: I’m not saying that a higher interest rate will help… What I’m saying is that, once rates go that low there is limited scope left for central banks to move – if the economy starts to pick up then there is every chance that a few rate hikes will knock that growth on the head.

      • There are some very difficult technical questions in regard to a variable rate GST, especially when calculating rebates.

        ‘Hard’ decisions must be made by politicians so the citizens can hold them accountable. Currently, the RBA follow basic rules in relation to inflation and interest rate, and the only decision they made relates to which inflation forecast to believe.

        Interest rate is a ‘blunt instrument’, however adjusting GST or superannuation rate is even MORE blunt. We need policies which targets the overheated sector of the economy without slowing down everything else.

        • I couldn’t agree more re. hard decisions and why they must be made by politicians, whom electors can then hold accountable…

          However, IMHO the reality is that we – the electors – no longer hold pollies accountable for their decisions; particularly when it comes to their long-term impact.

          Sadly, the majority of voters can be bought off to the extent that the majority of policies are now based on short-term popularity; as opposed to sound decision-making and long-term problem-solving.

          It troubles me to say it, but in such a situation, perhaps we need to give some power to those who are willing to take the “hard” decisions (irrespective of how unpopular it might make them in the short-term) because it is the right thing to do in the longer-term…?

  8. I like the idea of combining RBA and APRA, and letting the change the capital reserve requirement, like the Chinese do.
    This should keep the banks on their toe and allows some control over the issuance of new debt.
    Also the pricing of risk on lending to the household sector should be aligned with lending to the productive (business) sector. Banks and property investors have misused this regulatory arbitrage to play poker with Mr Moral Hazard.

    • Deus Forex Machina

      Yeah Mav, that’s what we used to do in the old days of the LGS (liguid goverment securities) and PAR (prime assets ratio) numbers. I agree I think this approach is really elegant but as the Chinese are finding now, and would have happened to us pre-GFC, this has little impact on the “shadow” banking system.
      Its the problem of policy by decree versus actual monetary targets…

  9. Deus Forex Machina

    Leith, thanks mate…this is another super post…love the super idea…productive use of the increased cost as opposed to just “wasted” on higher interest charges

    But can I just stick up for the banking system a little. The Government here, and in many places, was forced into the guarantee by the chain of events that the irish started by guaranteeing their banks (not such a flash idea) and a bunch of countries followed suit. We then had 1 bank that was about to fail and I’ve heard from a Senior Government Minister, in a public forum, that they figured that if the 1 went down then they’d have to guarantee the whole system anyway so they decided to guarantee the whole system to stop the one going down. Not sure the whole system was in strife though or that they would have needed to guarantee anything if the irish and their European cousins hadn’t moved first.
    Once again the external sector imported problems into the Australian economy or specifically this time the banking sector. As an aside the Basel III rules coming in for banks will address many issues raised here for banking stability but unfortunately not the baseball bat of RBA interest rates.
    Once again brilliant post…cheers DFM

    • Only speculating here, but would the world have been a different place except for accounting entries on Fed’s balance sheet if Lehman wasn’t allowed to go under!

      Confidence drives financial systems and to a crude extent capital allocation decisions. And from my understanding of literature confidence can and does fall out of rational world every so often. For good or worse, the Nov 2008 period of Govt actions did rewrite what would have been not so rosy writings on wall. We are not at all different here in Australia and only reflect marginal appetite for risk in the investor world!

  10. Why does competent ‘Joe’ have to pay more for shelter,fuel ,water food power , and in general increasing monthly costs..and also pay a
    ‘Higher rate’ on the loan for his home…
    via ‘variable rate changes’..
    Should the bakery ,’He works’, pay him more..
    cheers JR

  11. Great suggestions and I feel humbled by the thoughts of both UE and SB. Good work guys.
    If I could add 2 points to the debate.
    1. I am not a fan of absolute rules in running a financial system. Rather than having restrictions on lending practices, increasing risk should be met with increased capital and liquidity requirements. Regulation could include the non ADIs as well.
    2. Technology and the internet are an important part of the debate and we should be thinking of solutions which use these tools for better oversight. However, the it can be used for evil as well. I often blame Bill gates and Microsoft for causing the GFC. Without complex spreadsheet models and analysis that few baby boomers or older could understand, would the GFC have happened?

  12. Leith – What are your thoughts on allowing a housing loan to be repaid (in full) by “handing back the keys”?

    After all, the loan’s security & purpose is the house. I see some merit in it because banks would have explicit downside risk and hence they would hopefully value property very conservatively and make borrowing as strict/tight as possible (both excellent things).

    Policy adherance and controls (eg. APRA) are one thing, but business longevity is another, which I believe things like this could address.

    • Andy. It’s a good idea in theory. But then you look at California and non-recourse lending didn’t work out too well. Whilst it should, in theory, make lenders behave more prudently, buyers will have greater incentive to speculate in the knowledge that they have a way out (“jingle mail”) should prices fall.

      • Thanks Leith, and yes I agree it makes it far more attractive for speculators.

        Still, banks have one of the most privileged rights in the economy (to lend money and charge interest for it) and they always have the option to lend or not. If they write a loan for a property, with that property as security, with a reasonable margin of safety (eg. the 85% LVR you mentioned), and charge interest for it, then surely they should share in the downside value risk should it occur – or is it pretty much risk free for them?

        I’d really like to understand from a economists POV what is so wrong about having non-recourse lending, because it is about the only way I would consider borrowing for a property (unless of course they fall massively to reasonable value).

        • I think one of the reasons why non-recourse lending failed in the US was because most mortgages were securitised and the risk was shifted onto unsuspecting purchasers, so the lenders had little incentive to monitor risks.

          Don’t get me wrong, I am not opposed to non-recourse lending. I just wouldn’t expect it to necessarily lead to more responsible lending/borrowing.

    • I can see why people get excited by the concept of “jingle mail” but I’m not as optimistic that it would reduce risk taking.

      (a) Sure, banks are incentivised to take upside risks (increased bonuses etc) and downside risks are mitigated by Govt guarantees, but how does “jingle mail” fix that? After all, the borrowers now have virtually the same set of incentives (speculative profit in rising market; Govt implements FHOB / RMBS purchases / etc to stop prices from falling)

      Whatever happened to letting people fail or succeed on their own merits?

      (b) This is straight off the top of my head, but I suspect that “jingle mail” might end up being another example of Prisoner’s Dilemma and, in practice, fails for that reason.

      Looking at the incentives again, if Banker A’s bonus is measured on his ability to outperform the his peers (ie. sell more loans) then he might be keen to keep dishing out of dosh, knowing that Banker B won’t be as reckless and that the entire market is less likely to crash in the event of a downturn… But when Banker B applies the same logic (as happened in the US), then the logic falls apart

  13. 3d1k: you have clearly missed all the hard work some of us have done explaining all this to people like you. Do take a look at my argument with Cameron Murray on the “Unconventional Economist” thread about “NZ considering new tools” a couple back before this one.

    Any spatial plan has to include MORE THAN 30 YEARS SUPPLY, if price inflation is to be averted. By the way, because urban circumferences are so lengthy, this involves a surprisingly close actual position of the boundary in kilometers from the existing built-up area. If you look at, say, “5 years supply” on a map, it will be visually pitifully small.

    The famous Korean housing bubble of the late 1980′s, involved median multiples going as high as “15″; under conditions of almost total absence of mortgage lending per se. Young Koreans traditionally saved up to 90% of the value of their first home. Korea’s national savings rate ballooned for years as desperate young people worked themselves to the bone saving more and more money chasing a rising target. The reason: the establishment of “Green Belts” around Korean cities. The definitive work on this is Lawrence M. Hannah; Kyung-Hwan Kim; and Edwin S. Mills; (1993) “Land Use Controls and Housing Prices in Korea”.

    There are also numerous papers in the USA that purport to show that land use controls were “responsible for X percent of price inflation”, and “easy credit” was responsible for the rest. This fails to explain why so many markets did NOT have “100 minus X” percent inflation when they had the easy credit but not the land use controls. These theoretical difficulties have been admirably surmounted in an unfortunately little-known paper by Stephen Malpezzi and Susan Wachter, where they show that a high proportion of “demand” is speculative, and ENDOGENOUS to the supply inelasticity that results from land use controls. That is, it is triggered BY the supply constraints; it would not have existed otherwise.

    • As mentioned above, I’m a long term reader of UE and have followed the arguments presented both here and on UE’s previous blog. I still get ‘stuck’ on the point that if credit was not available it would not be possible to bid up the price of property. From an anecdotal perspective, I would say that a major contributing factor to housing bubbles is the speculative “got get in either (a) while I still can; or (b) to make serious money”. This may well create ‘shortages’ in some markets and so the whole spiral continues.

      I still stick with No Money No Buy. ie. impossible without easy (and generous) credit.

  14. The papers of Paul Cheshire and his colleagues at the London School of Economics show that Britain, since the 1947 Town and Country Planning Act, has had a series of land price bubbles of increasing volatility.

    Urban growth controls, of themselves, have this effect. Britain just happens to be an earlier example. Allow fringe development, and you do not have land price bubbles, regardless of the credit situation. You might get some “over-production of houses”, but do the maths – this is a small price to pay for affordable and stable house prices. The point is that the fluctuations occur in production quantity instead of in price. PRICE fluctuations affect the entire “stock” of land and buildings within the urban limit. You can easily get 100,000 homes blowing out in price by $200,000 each; which could have been averted by accepting the risk of the occasional oversupply of a few hundred homes at $200,000 each or less. (While the entire market stays at an average of $200,000 or less instead of blowing out to double that). Extrapolate this across an entire nation, and you have serious problems.

    The cost of land also happens to seriously affect labour productivity, international competitiveness, loss of industry, reduced new business start-ups, reduced “churn” of land use to more efficient uses, reduced infill development; and numerous other problems besides first home buyers being stuffed for life.

  15. I’d suggest limiting government-backed residential loans based on rental value for owner-occupiers only. Any additional funds beyond rental value — a consumer surplus by any other name — can be done through private financing on the open market. Investor loans can be done without government support too; if incentives are needed to build rental units, do it through property tax breaks. Oh, and ensure an explicit guarantee the government would not bail out any open market loans.

    My worry is even that won’t be enough. Anything more, IMO, is a net impediment to economic growth.

  16. UE

    I agree that restricted land use practices (supply) can affect housing prices. One of many factors.

    Most property is purchased by the ‘ordinary’ person, needing finance to secure the property. Once: you would apply for a housing loan, bankers being conservative, as they once were, advise $100,000 is the maximum you can borrow. $100,000 – that’s it. Finito. It doesn’t matter what number of restrictive land practices are in place. Eventually, the price of property will meet with market. Every seller wants a buyer. Without easy (and generous) credit price spirals are far more difficult to achieve.

    Will post a link to an interesting article below.

    • UE – having trouble getting this link to publish!


      (have removed http component of address to see if that fixes it)