A housing policy lesson from New Zealand

New Zealand’s recently-introduced restrictions on residential mortgage lending have quickly cooled its overheated property market. It’s a valuable lesson Australian policymakers should take on board.

Australia and New Zealand share a lot in common and throughout history Australia has learned much from its little neighbour across the Tasman Sea. From voting rights to same-sex marriage, the Kiwis have often paved the way for their bigger and more conservative mate.

New Zealand is once again leading the way; this time with regards to housing policy and it is lesson that Australian policymakers should take on board.

On October 1, the Reserve Bank of New Zealand introduced temporary restrictions on residential mortgage lending, with high loan-to-valuation ratios. Banks were required to restrict new residential mortgage lending with LVRs over 80 per cent (meaning a deposit of under 20 per cent) to no more than 10 per cent of the value of their total residential mortgage lending.

These measures were undertaken to cool a housing market which had rapidly gained momentum and manage the systemic risks that can develop during boom periods. By reducing the level of risky lending and protecting lenders from their worst instincts, macroprudential policies can reduce the volatility of the boom-bust housing cycle.

Since the restrictions were implemented in October, the New Zealand housing market has slowed rapidly. Both housing loans and house prices are now on the decline and risky lending by low income households has dropped significantly.

The policies have worked exactly as intended. Loans with LVRs over 80 per cent have declined from a quarter of new bank mortgage lending to just 5 per cent after only a few months. These are data that is difficult to ignore.

The Australian housing market shares a number of similarities to New Zealand. Rising leverage and risky lending is a common feature and a high population concentration in urban areas has encouraged price growth to be more resilient than in the likes of the United States.

It has created the sense that property busts only happen to other countries; that we are somehow different or exempt. Surely it couldn’t happen in Australia?  Not with our 22 years of uninterrupted economic growth and once-in-a-lifetime resources boom. Right?

Except that Australia is very much part of the housing boom and bust cycle. House prices have fallen significantly on two separate occasions since the onset of the global financial crisis, despite the fact that we avoided a significant slowdown in the broader economy.

What would happen if the economy suffers a genuine setback, such as rising unemployment, a sharp fall in mining investment or government austerity measures? How does a combination of the three sound?

Macroprudential policies are one way to address a housing market that has become increasingly volatile. But these policies are not about saying that a bust is imminent. Rather it is an acknowledgement that no matter how smart you are or how many analysts you have there is a good chance that your economic forecasts will be wrong more often than they are right. Just ask the RBA.

Put succinctly, it is about risk mitigation and that cannot be overlooked when you are dealing with a $5 trillion asset class. Housing accounts for 60 per cent of household wealth and most of their debt. Our major banks have massive exposure to housing assets and state governments are overly reliant on stamp duty to balance the books. Even if you do not think there is a property bubble or that a bust is imminent, you’d be silly to ignore the downside risks if your forecast proves incorrect.

The RBNZ rightly acknowledged that historically low interest rates, which were necessary to support the broader economy, can give rise to risky lending by banks and a willingness to take on too much risk by households.

The RBA finds itself in the same predicament. Low interest rates are necessary to support an economy that is failing to create jobs and is faced with an impending decline in mining investment. But low interest rates have also encouraged banks to increase the share of loans with LVRs over 80 per cent and rampant property speculation in Sydney.

Macroprudential policies allow the RBA and Australian Prudential Regulation Authority to address the latter without removing the benefits of low interest rates for the rest of the economy. If the RBA wants to keep rates low, and they should, then they must follow the lead of the RBNZ.

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