New Zealand has undertaken two policy actions lately aimed indirectly at reducing the economy’s exposure to the housing market.
The first measure, called the Open Bank Resolution (OBR) Policy, has been initiated by the Reserve Bank of New Zealand (RBNZ) and seeks to protect taxpayers from funding future bank bailouts. The OBR is intended to act as a resolution tool that puts the cost of bank failure squarely on the the bank’s shareholders and creditors rather than taxpayers, whilst ensuring the continuity of core banking services. In turn, the policy is aimed at reducing moral hazard by limiting the level of government support extended to a bank in the event of failure.
Like in Australia, New Zealand’s banks are heavily exposed to property lending, so the OBR would effectively act to protect taxpayers from the fallout from a property crash.
The RBNZ is currently undertaking public consultation and, depending upon the outcome of this consultation, plans to have the OBR policy fully operational by late 2012.
In the second policy action, the New Zealand Government has directed the newly formed Productivity Commission (modelled on the Australian body) to undertake an examination into housing affordability, with the stated aim of reducing the economy’s accumulation of debt and exposure to external shocks. According to Finance Minister Bill English:
“New Zealand experienced a sharp rise in house prices over the past decade, resulting in declines in housing affordability and home-ownership rates and large increases in household debt.
“That accumulation of debt has made the New Zealand economy more vulnerable to external shocks like the global financial crisis. It has also most likely contributed to higher interest and exchange rates, raising the cost of capital for businesses and reducing exporters’ returns,” Mr English says…
The financial stability aspects of the housing market are also captured in the Terms of Reference to the inquiry:
The debt accumulation and wealth effects associated with the rise in house prices may have also exacerbated New Zealand’s last economic cycle. Interest rates and exchange rates were arguably higher than they otherwise would have been during the upturn and there has been greater contraction in demand during the recession. Debt accumulation may also be a factor in on-going economic risks.
The inquiry appears to be similar in scope to the Australian Productivity Commission’s inquiry into housing affordability conducted in 2003, except that it is more focused on financial stability.
That the New Zealand Government is taking these steps in order to insulate its taxpayers and economy from the potential fallout from a contracting housing market is commendable.
However, the measures are probably too little too late. The New Zealand Government should have taken preventative action in the years leading up to the GFC, instead of happily sitting by and watching as household borrowings, funded by heavy offshore borrowings by the banks, fuelled a rapid rise in farm and house prices.
The property boom, in turn, led households to feel wealthier and increase their consumption. Meanwhile, the strong growth in nominal GDP and employment buoyed tax revenues and also encouraged growth in government spending, which enabled the Government to win favour with voters. The high growth rates of both private and public consumption ultimately created inflationary pressures, which drove up interest rates and the exchange rate. In turn, resources flowed into the service sectors (e.g. retail and real estate) and away from tradeable sectors, which suffered from lower export competitiveness and cheaper imports.
New Zealand’s economy appeared strong whilst asset prices and debt levels were rising. But once the tide turned, the economy was left with a pile of debt accumulated in unproductive assets (mostly inflated home values), rather than investments in productive enterprises.
As a result, the New Zealand economy is now moribund, unable to grow its way out of trouble whilst households deleverage. The Government belatedly recognises this dilemma, hence it is implementing policies aimed at rebalancing the economy away from excessive borrowing, consumption and government spending towards savings, investment and exports.
Unfortunately for New Zealand, there’s no easy solution to it’s predicament. Whenever an economy sacrifices its productive capacity by borrowing heavily to fund rising asset prices and consumption, its always a long, painful road back to solid and sustainable growth.