Can the housing market celebrate the death of macro-pru?

Despite calls for macro-prudential policies to cool the property market, recent signals show regulators are more likely to take modest steps within the existing framework.

Some recent signals indicate that regulators are taking a step back from employing macro-prudential policies in the property market, although calls for a regulatory response will no doubt step up following strong house price growth in October.

RP Data reports that for October, dwelling prices shot up 1.2 per cent, following what appears to be a pause in September. The strong monthly gain brings the annualised pace, over the second half of 2014, to 12 per cent. This will likely inflame concerns that Australia’s investor-driven property market is increasingly out of control -- well above income growth and an affront to official jawboning attempts.

While this will only serve to embolden those clamouring for a regulatory squeeze on the sector; just on the rhetoric, I’m not yet convinced that either the Australian Prudential Regulation Authority or the Reserve Bank are warming to the idea of macro-prudential policies. Indeed if anything, both regulators appear to be playing down its use, instead preferring to act within the ‘existing prudential framework’.

Higher loan-to-value ratios, popularised by the International Monetary Fund and New Zealand’s Reserve Bank (among others) have already been ruled out as a ’first line of defence’, as we found out during the RBA’s appearance to the Senate Economics References Committee. Both the deputy governor of the Reserve Bank, Philip Lowe, and the chairman of APRA, Wayne Byres, have reinforced that idea in recent speeches.

Byres noted that any action taken would seek to “avoid outright prohibitions on activities where possible” with a focus instead on “institutions setting their own appetite for risk”. Banks then would “remain free to decide their lending parameters” although “higher risk activities” would come with “commensurately higher capital requirements”, a point consistent with the RBA’s testimony to the Senate Economics Committee. APRA’s chairman continued, emphasising that this was not a new approach, but the same used from 2002 to 2004 -- although “the sources of risk are different this time around”.

Lowe for his part said that “a return to the type of heavy regulation we saw in earlier decades” was not on the agenda, and that instead investors could expect “modest and sensible changes within the existing prudential framework’. That changes would occur “within the existing prudential framework” was a point Lowe made a number of times.

What counts as ‘modest and sensible’ is obviously subjective -- although the head of the RBA’s Financial Stability department, Luci Ellis, perhaps gave some clues in a speech earlier this week.

In reiterating that the housing market wasn’t a threat to financial stability given that house prices had not risen materially above inflation over the last decade, and that mortgage repayments and the affordability of a mortgage was the best in about 10-15 years, Ellis noted that the lift in investor activity actually wasn’t much of a threat either.

This wasn’t stated explicitly, but it was certainly implied following her observation that big problems in housing tended to be caused by an oversupply of housing stock. In making that observation, Ellis then said that Australia was a long way from that position and that, importantly, the lift in building that we had seen, had not been accompanied by a lift in speculative building activity.

This is critical. Earlier in the month, the RBA had used this idea of “more speculative activity in the market than we're comfortable with” to justify further regulatory action. They simply assumed, incorrectly, that investor activity was speculative in nature. Ellis appears to refute this view, noting that speculative building activity is low and that in Australia it is demand that leads supply. That is, in the absence of demand, supply doesn’t come. Noting this, it would be inconsistent for the RBA to still view the lift in investor activity as primarily speculative.

In the absence of that, and as I have argued before, the case for macro-prudential regulation falls apart. Speculative demand in housing may not be desirable, but long-term investment certainly is – perhaps even more so now. Increasingly, I think the RBA is of a similar view -- thus the emphasis on working within ‘the existing prudential framework’.

So what might further action look like? Well, given the very specific concerns harboured by regulators and the desire to be ‘targeted’, ‘proportionate’ and ‘incentive-based’, a simple first step may be to lift the risk weighting attached to variable, interest-only investor loans. Or alternatively, to progressively reduce the risk weighting on those loans which are fixed.

Fixed rate loans can of course carry their own in-built penalties for short-term speculative players. Importantly, they also demonstrate a clear intent to hold as a long-term investor. In any case, and as Ellis noted, fixed rate loans are an important feature in ensuring financial stability either way.

Whatever action is taken, regulators are seeking to reassure the market that steps will be modest. Given the ‘last bout of speculative excess in 2002-03 ‘ended in a fizzle not a bust’, the RBA and APRA are obviously satisfied with the steps that were taken during that period -- notably that didn’t include what has come to be known as macro-prudential regulation. 

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