NZ moves to limit exposure to housing

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.

Cheers Leith

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Leith van Onselen

Comments

  1. It’s incredulous that the NZ govt and its citizens didn’t foresee this. Actually, in NZ and it’s very difficult to get a sane or balanced conversation about the issues (which are not fundamentally different from the rest of the property booms). Much like in Australia, most people are looking for justifications to explain their property-driven “wealth” and the scapegoats tend to be the leaders of collapsed finance companies that financed property developments. Why people can’t make the association between rising asset prices and the meltdown of ponzi-style finance is beyond me. I guess the mental defense mechanisms are firm.
    CLSA once speculated that a crisis among Aussie banks could be set off by a property “crash” in NZ. We may be hoping that the govt does its best t ensure that doesn’t eventuate.

    • I’ve got an article here, with some pretty vigorous spruiking for Resi property warrants in SMSF, but an interesting quote is (for why people elect to invest in resi property);

      ‘People believe “I can do better myself”, and feel they have an intuitive understanding of residential property’

      This why why they can’t foresee this. Listen to the people that are still bullish, they reflect on the previous 10-15 years of growth, and that this growth is all down to their investment prowess, their superior knowledge.

      There is no consideration, whatsoever, that the economy was structed that way to favour this sector, and that these structure are to the detriment of the broader economy.

      This is it, no understanding of utility value, of productive assets, anything. Just “ZOMG, property doubles every 7 years” while referencing the last 40 years, with 20 of those years being a high inflation environment. It wouldn’t be much good houses doubling every 7 years in inflation was at 20%.

  2. Publicly pre-emptying those defensive reactions can go a fair way to countering them, aka “I told you that you would react like this…”.

    Applies to Aussie reactions as well

    –> cred

  3. Aren’t the banks there mostly local subsidiaries of Aussie banks like CBA, ANZ and Westpac?
    .
    Hmm, Does that mean the moral hazard shifts to our shores?

      • That leaves them with a politically easy choice. Either NZ props up the banks by saving the evil Australian shareholders, or they make the evil Australian shareholders take any losses. I think I know which way the NZ voter would like it to go. That’s an advantage that our Government doesn’t have.

  4. This is a very interesting paragraph:

    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.

    Are you saying a credit bubble naturally results in economic activity shifting from the tradeable sectors to the service sector? The Dutch-Disease-doesn’t-matter crowd never fail to point out that 70% of Australia’s GDP is domestic services. I’ve never seen this as particularly good thing, more symptomatic of a distorted economy than a buffer against future external shocks, especially when so much of those domestic services depend on easy credit (property, retail etc).

      • Which is why it’s almost comical that the United States’ response to a bubble which has lead to malinvestment is printing a whole bunch of money, which leads to further malinvestment.

        I just don’t understand why people can’t grasp these concepts……….

      • New credit creation is the root cause of all bubbles.

        This way all society is impoverished, productive structure made flat and shallow. That’s how you get modern “service” economy. Manufacturing and more complex structures simply can not survive boom-bust cycles, which tends to become shorter and shorter.

        The only winners are bankers. When everyone has to work- someone can create means of exchange at a keystroke (boom credit) and acquire everything (bust and foreclosures).

        PRODUCTIVE SUSTAINABLE GROWTH AND MODERN BANKING SYSTEM ARE INCOMPATIBILE

        …and don’t confuse malinvestments with “wealth creation”

  5. What do they say? Better late than never?

    At least the NZ government has recognised the issue and are now looking to put reforms to address it. I can only hope that when problems start arrising here our government acts quickly but I doubt they will.

    There is so much evidence out there as to what is happening in our system. It is truly depressing how far people will go to ignore what is staring them right in the face.

  6. Possibly worse than the bubble in the NZ housing sector are the highly inflated asset values in their major export industry – the dairy industry (about 70 % of exports).

    The NZ dairy industry has been operating as a Ponzi scheme for a long time with asset values driven by purchasers assuming optimal management(regardless of seasons) and ever increasing land values. They are also being propped up by a labour structure based on contract labour (the sharefarming system) now supported by cheaper imported labour.

    A scary aspect is, that as in Australia with house investment, investors in dairy farms seem to like to double or triple up on their dairy investments, rather than diversify.

    If NZ ever has a Foot and MOuth disease outbreak and / or there is a proven link between paratuberculosis in cattle and Crohns disease in humans,their dairy exports will be shutdown and the bubble will deflate very quickly.

  7. Crikey! I hadn’t thought about NZ sinking our Banks! I thought we could maybe achieve that on our own!

    If you run a policy of excess credit (note Leigh Harkness post on this), you end up with either inflation (including asset prices) or imports or both. If you fund that with external borrowing and asset sales to foreign buyers your dollar is always overvalued which leads to a hollowing out of industry and and a bloated service sector which also includes Government. Note the idea of government and Service is an old notion I know.
    This has been going on for 50 years and the results were entirely predictable as far back in time as that.
    The insanity of what is going on in this country boggles the mind!

  8. “NZ Govt has directed the newly formed Productivity Commission (modelled on the Australian body) to undertake an examination into housing affordability . .”

    The Aus PC into housing affordability made recommendations in 2004 that were completely ignored by the Liberal party. Why even pretend to want to help the next generation?

    I hope NZ has a better experience than Aussies when it comes to policy makers doing the right thing by the community.

  9. The Clark Labour Government, I believe, in time will be seen as highly destructive to NZ. They presided over a housing bubble without lifting a finger. It suited them at the time because everyone felt wealthier year after year and when that happens govt’s don’t usually lose elections.
    But the legacy is horrendous and will be difficult to address.

  10. Any laws and rules and regulations must be implemented to lift up the condition of the common man and woman. Any law that favors the rich only must be stricken out of the books.

  11. Well I like the NZ Open Bank Resolution idea but I thought the Government guarantee of 2008 of the big 4’s overseas’ funding was still on the books and had not been rescinded. (I was told this last year and I have repeated this often and nobody has corrected me so I guess it must still be so) The other question is then how does the Government’s decision to permit the big 4’s to issue covered bonds affect this idea.
    The Productivity Commission’s investigation on housing – well my bet is that whatever it says nothing will be done. This is a do nothing government and it is election year. John boy himself has said he doesn’t think that housing affordability is an issue.
    I do wonder about Governments and even political parties in general. Where is the big picture in any of them? It is just all about the politics of re election. Where are the statesmen/women?Nobody seems to have even a basic understanding of how economic policies work and their effect in or outside Government. Nobody will discuss it. We have ignorant journalists who aren’t able or allowed to tell us that. We have TV that provides sound bites and mostly criminal programmes – never any intelligent interviews or if there are they are destroyed by partisan interviewers. Does this mean democracy is doomed? Will this just allow plutocracies to emerge as it has done in USA. Are NZ and Australia plutocracies now because of this lack of interest in the consequences of any economic policies.

  12. Matt,

    You are right. They sat back and did nothing. I’ll tell you why: simply they didn’t really understand what was happening. Clark was not a economically literate PM and neither was Cullen as Finance Minister. He was only there as a sop to other elements in the Labour party.

    I’ve been reading (and writing) blog posts like this for about 7 years.

    The big issue is that politicians are reluctant to take on the banks and the banking system. They also have no backbone for difficult or radical decisions.

    To be fair to National they are trying to do something though their standard neo-liberal prescription is likely to completely kill off what’s left of the economy.