If there was ever any doubt about the independence of the New Zealand Reserve Bank, there shouldn’t be any more. Not after it faced down the government and refused to allow a first home buyer exemption for its new restrictive loan-to-value ratios (LVR) on residential lending.
Effective from 1 October, 90% of a bank’s portfolio of home loans (both made and approved) must have an LVR of 80% or less, meaning that home buyers will have to front up with 20% of the purchase price.
Exemptions are limited. Existing mortgage holders can refinance to the same dollar amount, people who are buying a home can take out 12 months’ bridging finance to cover the transaction, and the government has two small schemes targeted at low income earners.
The RBNZ, however, rejected government overtures to exempt first home buyers on the grounds that, as they account for 30% of overall demand, exempting them would undermine the policy’s effectiveness. And the Prime Minister has said that the government didn’t push the matter because it “did not want to run over the top of the Reserve Bank”.
There may also have been some political posturing on the government’s part, given that its solutions to housing unaffordability are on the supply side and will take time to have an effect, and that the alternative mechanism available to the RBNZ – raising interest rates – would have been much less targeted to the issue of primary concern and much more economically damaging.
The New Zealand dollar, considered by the RBNZ to be over-valued, is already the fourth most traded currency in the world. Raising the Official Cash Rate could bring destabilising amounts of hot money into New Zealand, pushing up the exchange rate even further and putting the export sector under even more pressure.
It would also be difficult to justify a tightening in monetary policy sooner than necessary when CPI inflation is well within – indeed, is now tracking below - the RBNZ’s 1-3% target range: the RBNZ currently expects that it will need to go into tightening mode within the next two years to restrain an anticipated increase in inflationary pressures.
The RBNZ Governor, Graeme Wheeler, took the unusual step this month of writing an op-ed for the New Zealand Herald in which he signalled a likely increase in the OCR of two percentage points between 2014 and 2016. This will, of course, flow indirectly through to mortgages, which is itself likely to take some heat out of the housing market.
However the RBNZ felt that earlier action was necessary as the risks posed by galloping house prices in Auckland and Christchurch posed a clear and present threat to its statutory responsibility to promote “the maintenance of a sound and efficient financial system”.
The incentives on the banks to comply with the new lending requirements – or “speed limits”, as the RBNZ calls them – are very high: compliance constitutes a condition of registration. Non-compliance can result in deregistration for the institution, and false or misleading disclosure in the quarterly reports the bank boards are required to provide to the RBNZ will have dire consequences for directors and senior management.
Also the RBNZ has been explicit that it expects the “spirit and intent” of the restrictions to be respected and that it will clamp down on any arrangements designed to circumvent them.
The RBNZ’s exit strategy for this initiative might best be described as intuitive. The Governor has said that the LVR limits will be removed “when there is evidence of a better balance in the housing market and we are confident that their removal would not lead to a resurgence of housing credit and demand”.
Clearly it is too soon to judge what sort of timeline we may be looking at, and how effective the intervention will be. But the preliminary signs are positive in terms of the RBNZ’s objectives.
So far the most dramatic response has been from the ASB which cancelled all of its low equity mortgage pre-approvals from 4 October and reduced its pre-approval period going forward from six months to 60 days. But Westpac and ANZ have also imposed a 60 day pre-approval limit, and the BNZ has cut its back to 30 days.
Indications are also that the banks will be taking a conservative stance – limiting their new LVR lending to a point or two under the 10% cap in order to give themselves a margin for error.
The Labour Party Opposition has argued that the LVR limits should be applied only in Auckland and Christchurch because this is where the problems are being experienced. In the year to July 2013, for example, house prices rose 16% in Auckland, 10% in Christchurch and only 4% (on average) across the rest of New Zealand. But the RBNZ says, as must be correct, that geographical implementation is simply not administratively feasible.
However application of such a blunt instrument across housing markets which are subject to substantial regional variation increases the risk that there will be unintended consequences and it is inevitable that there will be collateral damage.
Possible outcomes include:
- wealth loss effects as the lending limits prevent home buyers from undertaking value-enhancing renovations or undertaking necessary repairs to retain or return value to their property
- loss of mobility in the banking sector for low income earners and mortgagees with high LVR loans as the banks, which have traditionally offered them incentives to move, are now reluctant to take them on as customers
- pressure on property developers at the lower end of the market to leave more equity in their developments so that potential buyers can meet the 20% deposit on their mortgage, and
- emergence of an as yet unregulated secondary market where non-bank lenders provide more expensive 90%+ LVR loans to people who then refinance to lower cost bank loans once they can show they’ve accrued 20% in equity value.