RBA proves itself wrong on macroprudential

By Leith van Onselen

Back in October, the Reserve Bank of Australia’s (RBA) Head of Financial Stability, Luci Ellis, gave a speech in which she played down the need for macroprudential policy tools in Australia, such as loan-to-valuation (LTV) ratio limits, loan serviceability limits, and the like.

In the speech, Dr Ellis made the spurious claim that binding limits to LTV ratios would be ineffective, as they would only effect first-time buyers (since trading-up buyers typically have significant equity), therefore “most buyers would be little affected”. As such, Dr Ellis claims that LTV limits “would not prevent boom-bust cycles in housing prices”.

Today, the RBA has released a series of papers from the Property Markets and Financial Stability Conference, which was joint conference between the RBA and the Bank for International Settlements (BIS) held on 20-21 August 2012. One of the papers, entitled Taming the Real Estate Beast: The Effects of Monetary and Macroprudential Policies on Housing Prices and Credit, is provided below and contradicts directly Dr Ellis’ views on the effectiveness of macroprudential tools on mitigating housing boom and bust cycles.

The paper examines macroprudential policy actions by in 57 economies taken over the past 30 years, and combines this data with time series on housing prices, rent, housing credit and interest rates gives to provide a detailed picture of the key macroeconomic, institutional, monetary, and regulatory factors affecting housing markets globally.

According to the paper (my emphasis):

The results establish a link between interest rates and macroprudential policy actions and subsequent fluctuations in real housing prices and real housing credit. Higher short-term interest rates tend to slow housing price appreciation and housing credit growth, although the magnitude of the effect is modest. Actions categorised as prudential measures (maximum LTV and DSTI ratios, provisioning requirements, real estate exposure limits and risk weights) are consistently jointly significant in our regressions. Decreases in the maximum LTV ratio are associated with reductions in the growth rate of housing prices. Similarly, reductions in the maximum DSTI ratio and increases in provisioning requirements are associated with reductions in the growth rate of real housing credit. We were unable to find any consistent relationship between changes in non-interest rate monetary policy measures and either housing price or credit growth, however. Taken together, our results suggest that certain types of macroprudential policies can be effective tools for stabilising housing price and credit cycles. This is good news for central banks seeking additional flexibility in their pursuit of macroeconomic and financial stability objective.

QED.

Twitter: Leith van Onselen. He is the Chief Economist of Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. Click for a free 21 day trial.

Taming the Real Estate Beast via Macroprudential Tools

Comments

  1. So what happens if they decide to go down the macroprudential path and they screw that up like the RBA has on interest rates.

    More rules on the banking sector will just create more problems (unintended consequences).

  2. Please remember boys and girls, while reading this, that the RBA is considered one of the best in the world.

    Now be afraid.

    LTV ratios don’t affect boom and bust cycles? Pretty sure this featured prominently in the no doc/ninja loans that helped bring down the US, particularly from such companies as Countrywide.

    Unbelievable that this rubbish is still being spruiked. What does it require to change their minds, alien invasion?

  3. And if economics were physics, the RBA would start immediately on building their model around these variables identified as statistically significant in the study and discard their models in which LVRs and so on didn’t matter.

    But no doubt, Luci will be doing the circuit expounding RBA models in which interest rates and rapid household debt appreciation don’t matter and claiming that macro-prudential tools aren’t of much use: because to change the tune now after the horse has bolted would admit their egregious failures in policy over the last 20 years which has stimulated asset bubbles in this country.

  4. No LVR caps needed, just Loan-to-income at 3 Xs will do the trick.

    The “V” is the LVR can be beautifully wrong in a rising market.

  5. Luci Ellis is Head of the Financial Stability Department. Her job title describes her function. If that comes through a series of misinformed speeches, so be it. “Whatever it takes…”

  6. Although I’m not particularly in favour of any changes I will add a couple of thoughts.

    If the RBA wanted to keep prices in check, then a cap on LTV (LVR to most of us here) would be a way to do that. It wouldn’t stop an upgrader with plenty of equity from overpaying, but it would stop a market entrant with little deposit to a point. They are the inexperienced buyers, who sometimes do overpay, albeit at the bottom of the market.

    It’s worth noting that we had booms when the LVR for most borrowers was 80% and credit was very hard to get. A scarcity of lending capital and an unwillingness to lend is not a solution in itself, it’s just a reason for a whole set of new problems. With some reservations, some reasonable limits could be put on consumer lending, as long as it wasn’t placed on business borrowings – my experience is that policy in consumer lending tends to migrate to other areas of lending, unfortunately.

    The DSTI for those of you not familiar with bank jargon is “Debt Servicing to Income” that’s the old 30% of income mantra. I really don’t favour that at all unless it is updated from the old axe wielding days when banks tried to use it as a scalpal.

    To explain that, a DSR (the local version of DSTI) of 30% may work for the average single joe, but be appalingly wrong for people on the income extremes. A single low income earner can probably not afford a commitment of 30% whilst a high income earner can afford a much higher debt servicing ratio (DSR)

    I’m not in favour of dumbing down our economy to accomodate the slowest of wit by checking the activities of the more nimble and more clever borrowers who manage their money well.

    In fact I’m not in favour of a world where no one is allowed to fail, it also means that no one is allowed to succeed in the true sense. We all become dumb.

    I guess that philosophically I’m at odds with the average person here on this issue, but so be it.

    • Most people, Peter, wouldn’t have much of an idea regarding your explanation. Most people go: “How much have I got; How much can I borrow = How much can I spend” That’s it. They need parameters put in place if for no other reason that they don’t have access to the information that you raise. Otherwise , like a child in a sweetshop, they risk eating themselves to death.

      • Hey! No one’s more in favour of removing interference from the markets than I am. No one is more appalled at the removal of risk premium from our markets than me, that sees risk priced at ~0%. Left to its own devices, I’d suggest 30% is more applicable for a variable mortgage rates than 5%. So let’s remove Nanny by all means….but not selectively, eh, and let’s let credit price determine property participant actions?

      • Suggestion to the Moderators – maybe a seperate (private) forum for janet and peter to have their chats it. I used to enjoy lurking the comments section!

      • “The bank wouldn’t lend me the money if they didn’t think I couldn’t afford it.”

        A lot of people make financial decisions based on this way of thinking.

        Australians are not taught financial literacy. We are taught maths but not necessarily how to apply it in real world terms.

        Teenagers should be taught percentages and how to calculate them so they understand how a credit card works and what happens to a mortgage when the rate changes. Few understand the real world applications.

        Most people don’t have a clue and this dumbing down of the population is a terrible thing.

      • A decision about lending on the scale of a mortgage is best made by the lender.

        They are the entity with the most comprehensive, up to date, and historical information.

        If lenders will not act responsibly of their own free will – as has happened across the Western world for well over a decade now – then society must force them to do so via legislation.

      • “Most people go: “How much have I got; How much can I borrow = How much can I spend””

        That’s what I did as a FHB back in 2006. Went to the bank, got pre-approved for $X and then shopped for properties within 5% of $X. Borrowed at 97% with LMI on top.

        That is what most FHBs I’ve known have ever done.

        Looking back it was pretty silly and we probably overpaid for the property also, but we knew that we’d be ok financially as took in boarders.

        I agree with you Janet that there needs to be boundaries set, otherwise borrowers will just take whatever they can get.

      • to what degree do we bubble wrap the economy for the dregs of society? I guess its hard to measure the difference between roads not taken

      • Dregs of society?

        From my experience most people are financially illiterate. So if you think that makes people dregs, then you must be one of a few who are better than the rest of us.

        Perhaps we should take the safety features out of cars, because if the dregs of society can’t drive around without crashing into each other then we can just let nature take it’s course… survival of the fittest I say! /sarcasm.

        Geez there are some elitists on this site.

      • not the best analogy, many of the safety features and road regulations have been shown to increase accidents… maybe a good analogy afterall

      • as i suggested the potential trade off from idiot proofing an economy is not quite known.. whether pros outweigh cons or not.. ole’ trial and error economics will prevail in the end

      • not the best analogy, many of the safety features and road regulations have been shown to increase accidents

        For example ?

      • @TSpencer, I don’t believe we should have to totally bubble wrap society, but I think there needs to be responsibility taken from all involved parties to ensure responsible lending takes place.

        The problem is that FHBs who are leveraging themselves to the hilt in order to buy are doing so with government provided funds… do away with FHOG & stamp duty subsidies and you’d probably remove a lot of those making poor financial decisions in the property market.

    • “In fact I’m not in favour of a world where no one is allowed to fail, it also means that no one is allowed to succeed in the true sense. We all become dumb.”

      We’re here because for the last 15 years precisely no one has been allowed to fail.

      Everytime the bottom of the house pyramid (FHBs) starts shrinking, threatening the price structure above them and thus the speculators/vested interests, housing lobbyists successfully get government intervention to prop up the FHB prices – financial deregulation, grants, stamp duty concessions to benefit market entry. Providing support are negative gearing, increasing costs and barriers to tenants that make rent more expensive – helping make the jump from rent to own less obviously daunting.

      Now we are at an even worse situation where not only will housing speculators fail, there will be extended failures and effects across banks, regional governments, construction, employment and super industry.

      How many housing booms occurred under DSTI and how severe where they?

      • Exactly, velocity.

        When the laissez faire Gestapo says “let them fail,” they’re talking about the “dregs” of society, not themselves.

        When the foundation of their house of cards begins to crumble, however, they’re the first ones to line up at the government trough.

        At times, the hypocrisy becomes unbearable. When a banker says “laissez faire,” what he means is anarchy for me, and the jack boot of the state against the neck of everyone else.

      • Exactly, velocity.

        When a banker says “laissez faire,” what he really means is unlimited government largesse for me, and austerity for everyone else; anarchy for me, and the jack boot of the state against the neck of everyone else.

    • I can see your point Peter, but another way of looking at it is that people with the smarts to use their money well have often accumulated quite a lot of it through, you know, adding value. These people don’t need to borrow huge amounts from a bank to fund lifestyle choices. There is of course a section of society that has little money and is also capable of speculating in a controlled and rational manner, but I believe (I accept that I don’t have the data to back this up) that they are vastly outnumbered by those with scant resources and want to borrow their way to prosperity because “that’s how it’s always worked and you can’t go wrong with bricks and mortar”.

      I think you’ll agree that this latter cohort can inflict huge damage on themselves and on society at large (won’t go into the culpability of the debt pedlars) and in my view this damage is something worth legislating against when it’s a “clear and present danger” as I now judge it to be. Obviously fair minds can differ on this point.

      Also, an obvious point that needs to be made is that it’s FHBs that provide the significant equity (one man’s equity is another’s lifetime of debt servitude) for those ahead of them so I don’t really understand the argument that macroprudential controls only impact a small segment of the market…

      • reusachtigeMEMBER

        Yeah, but it’s all crashing around you Peter. You are being proven wrong more and more each day as your precious interest rate cuts lose their effectiveness. Good times ahead, but not for those with skin in “the game” like yourself of course.

    • I would be less concerned about the prudential restrictions on individual loans if we had a taxpayer protecting mechanism for bailing in pseudo equity and long term bondholders to capitalise banks that blow there capital with bad credit or other exposures.

      Globally systemic banks are going to have bondholder bail in provisions based on a recent FT report on US and UK proposals. We need a similar mechanism for our own banks, in particular the Big 4.

    • The problem is not that individuals are not allowed to fail but that banks are not allowed to fail. And they know it and so take oversized risks and expect to dump it on the taxpayers via the government when things go wrong.

      • littguy,

        You give bankers entirely too much credit.

        Read Minsky. History is full of bankers who couldn’t manage credit risk even when their own skin was in the game.

  7. Can someone explain what would stop the following scenario? LVR capped at 80%, property sells for $500000, customer wishes to borrow more than 80%, so bank ‘values’ the property at $600000, thus defeating the LVR cap… or bank offers customer a personal loan to the value of whatever is over the cap?

    I dont really understand how it is that banks would be unable to find ways around a LVR cap. Additionally, what happens if a customer applies for a refinance loan and values have dropped so they are now under 80%. If with current bank, are they now required to immediately repay a portion to get under cap? if the application was with a different bank, does the bank have to notify current mortgagor that they are over cap now?
    With everyone expecting property values to drop, wouldnt this just create more carnage quicker?

    • Banks lend against the lower of the valuation or the purchase price in a sale – your scenario doesn’t happen.

      • So how would LVR work… hypothetically, purchase price is $500K, valuation is $600K, is $500K considered to meet 80%LVR, or does the LVR get calculated using purchase price as the valuation? What happens if you only want to borrow $200K for a $500K property (property owner is gifting half to you, so total purchase price is $250K). I just dont see what stops this.

      • The bank would not get a valuation of $600K on a house being bought for $500K – it may have happened years ago, but not any more.
        Valuations are farmed out to accredited valuers by a computer, bank staff don’t know who is doing the valuation until the competer makes the selection and contacts the valuer.

        Under the valuers charter, they can’t place a higher than sale price on the property even if they believe that to be the case.

        The banks have changed quite a lot over the past few years, and that is one of the changes. Only a few small lenders work on the old system.

        Right here and now your scenario can’t happen, perhaps years ago it could.

      • thanks for the info Peter. I have been sceptical of calls for LVR caps due to this, so good to know it is out of banks control.

      • I agree Peter its not happening now, but I did see it from about 2002 to 2005 (with a particular valuer and group)
        Hopefully it was just a couple of bad eggs and not rampant.

      • “Under the valuers charter, they can’t place a higher than sale price on the property even if they believe that to be the case.”

        This statement implies that the valuer knows the purchase price. Why would it be necessary or ever desirable for the valuer to know the actual purchase price? Surely true independent valuation requires he value without knowledge of what the last freshly minted fool thought the property was worth.

    • thats not how valuation works as peter says, and valuers get the book thrown at them if found to be fruadulent

      • Surely, in valuers defence, they are essentially making an ‘educated guess’ at what the property might be worth… does the book get thrown at them if a house sells now for $500K (and they value it as such) and in 1 month, there is a price collapse which would see house selling for $400K??? I cant really see how, as they could always claim ‘nobody saw that coming’….

        I tend to think, its a brave person that stands between a banker and making money…

      • and an even braver valuer that helps a lender lose money – valuers are liable for their work and litigation isn’t an idle threat.

      • it is an educated guess in a sense but theres a few methodologies used (most often a combo – summation,comparable sales,residual, highest and best use, hypothetical value etc), most of the resi secondary market stuff is comparable sales (not out of line ones as shown above)… although they are backward looking in nature and are based on best available knowledge at time of val, cap rates/discount rates on commercial and market sentiment should cover any precipitous drops

      • dumb_non_economist

        An idle threat is exactly what it is. How many FHBs are able to afford the cost of legal action as well as the 2+ yrs it will take against a well funded valuer. Legal threats are cheap, legal action isn’t.

      • most valuers are smaller independents ie not massivly well funded, the big commercials arent really in resi vals, expect cbre which I believe they do resi as a training ground..

        also they tend to err on the side of caution with the vals

      • Sheesh – and you’re the guy using the throwaway coffee line. Valuation models are the most fungible and manipulated things in business and the subject of endless litigation – both regulatory and transactional.

        I’ll have a short black tks.

      • @dumb_non_economist

        Mortgage Security valuations are instructed/relied upon by the lender not the owner of the property. Therefore its the bank who sues valuers (as they suffered the loss) rather than the owner of the property. And this does happen often where the valuer is negligent, and sometimes if they aren’t.

        @Brendanb

        Valuers aren’t usually liable for large movements in the market post valuation, unless perhaps if it was foreseeable and the valuer didn’t highlight the risk to the lender.

        @China-Bob

        Valuers are there to report the market, not judge it. An arm’s length sale after a proper marketing campaign is the best indicator of the current market value. As such, a valuer shouldn’t/wouldn’t complete a valuation report on a property that sold without knowing the sale price and the conditions of the sale.

  8. To take a more abstract view, credit (leverage) amplifies the oscillations in the system. There are various, imperfect, ways of damping those oscillations. Limiting loan to value, ie consumer leverage, is mechanism for damping part of the financial system. It can of course be gamed, and is by no means the complete solution. However, the lessons from the US debacle are pretty clear: simple rules are more effective than complex rules, being overly levered during a period of mean reversion is ugly.

  9. I don’t think anyone who believes ‘the market is always right’ should be overlooking financial stability in the RBA. After all, if the market is always right, the post shouldn’t even be necessary!

    One of the thing people haven’t though about is this : how can the RBA set the LVR ratio? It can only do so in two ways: by decree, which will be ineffective and easily bypassed, or by buying up mortgages in the secondary market.

    Would we be comfortable with a RBA buying up mortgages? On the other hand, it will reduce the bank’s reliance on wholesale foreign capital, and the RBA can even link the amount of mortgage it buys to Australia’s term of trade. It will however be a huge expansion of RBA’s power.

    • but thats what been called for at the IMF since the crisis, more macroprudential policy which based on expertise they suggest should be merged with CB’s

      the one policy one target measure days are numbered for better or worse

  10. “LTV ratios would be ineffective, as they would only effect first-time buyers (since trading-up buyers typically have significant equity), therefore “most buyers would be little affected”.”

    So in her mind FHB grants and stamp duty concessions are harmless?

    • how would they affect re-financing during a property slump/crash??? could they cause more homes to be repossessed than otherwise would be the case?

  11. This is all very fine, but there is currently no political will to make any change.

    How many voters are already firmly hooked into “investment” properties by the barb of unrealized negative equity?

    Even reforms aimed at land banking – a far easier target than controlling bank lending are completely off the menu.

    They’ll wait till the market correction following the recession we deserve to have does the job before anyone lifts a finger.

  12. reusachtigeMEMBER

    Why set LVRs? In pretty much all countries that have been burnt with a housing crash banks a too scared to lend unless their own stringent LVRs are met. Hence, I want the biggest burn of all to happen here. It’s friggen government interference keeping the needed burn at bay so more government interference isn’t the answer. It’s the massive crash and burn we need!

  13. More top down intervention is not the answer.

    Here’s a thought: Remove all government incentives, subsidies, grants, tax-breaks from the the buying and selling of property and see what happens. If there is a drop in prices, don’t start handing cash to everyone.

    Lets see where we land, I have a feeling it’ll be a better place than here.

  14. In the past a lot of the banks had a stricter limit on how much they would lend you. If you required or wanted additional funds then you took out a second mortgage, most likely with a finance company (usually owned by the bank), at a higher interest rate. The finance companies would generally raise their funds through debentures. This didn’t prevent bubbles or crashes even though credit was rationed.

    If we are to look at LVRs then we should be careful that we don’t unduly impact the FHB market by potentially starting with investment properties / interest only loans.

  15. Keen for thoughts…

    If you wanted to put >250K (so ignore FCS, please) cash somewhere safer than an ADI account, where would you head?

  16. For mine all this chitter chatter on monetary v macro-prudential stuff still seems to miss the point – that there just doesn’t seem to be any social benefit in allowing speculation in established residential housing.

    Given that credit is endless in an asset price boom, limiting speculative behaviour that allows multiple acquisitions seems to be a critical piece of the puzzle.

    I’m disinclined to see individual leverage ratios as useful as they would just be prejudicial to those without asset backing. Limitations on overall debt to banks for residential housing for investors may be preferable.