How to heal the housing market

Macroprudential policies that restrict credit growth will do little to alleviate Australia's housing affordability crisis and could even act against the national interest. But there is another solution.

Five years after the GFC, many nations appear to be lurching head first into yet another housing crisis. In response, increased macroprudential regulation has become the policy du jour, proudly advocated by the International Monetary Fund and widely adopted around the world.

The Reserve Bank of New Zealand only last year decided to limit the proportion of bank loans with a loan-to-valuation (LVR) of more than 80 per cent, to 10 per cent of new lending. Similarly, the Bank of England announced in June that it would restrict the proportion of loans that are 4.5 times the borrower’s income to 15 per cent of new lending. Lenders are also required to assess a borrower’s capacity to absorb a 3 per cent interest rate hike in the first three years of the loan.

In the Australian context, I don’t think there should be much doubt that we will follow the same path. While the RBA has offered mixed rhetoric on the issue, such reservations aren’t shared by the head of the Commonwealth Treasury, Dr Martin Parkinson, who only last week advocated a role for increased regulation though macroprudential policies.

Suspicion should be raised, however, when what were previously well accepted principles are so easily cast aside.

Deregulation was embraced for many reasons: efficiency, productivity, equity. Regulation simply wasn’t working, and the GFC was a modern case in point: a perfect example of bureaucratic bungling and its disastrous consequences. Against that backdrop, the move to re-regulate now isn’t so much an evolution of thought, but rather an intellectual corrosion.

Remember that the US housing crisis was not result of insufficient regulation. Instead the crisis was caused by a combination of a housing glut, excessively low interest rates and a generous system of exemptions from existing regulatory oversight.

Subprime mortgage corporations come to mind here, as do actions taken by Freddie Mac and Fannie Mae, both of which contributed to the explosion in alternative lending such as subprime and Alt-A loans. Outright fraud in the rating of many mortgage products associated with subprime lending exacerbated the problem, as did the ease with which households could default.

High LVRs themselves did not cause the US housing recession or the global financial crisis. Indeed LVRs overall remained quite constant. Little changed from what was ‘normal’ in the lead-up. That loan-to value ratios subsequently spiked during the US housing recession was a simple reflection of the ensuing house price slump, which in turn was exacerbated by the ease at which mortgage holders could default.

Against that backdrop, moves to re-regulate must be viewed as a draconian intrusion of bureaucrats into the free market. The Reserve Bank of New Zealand’s actions highlight this perfectly. At the time loan-to value restrictions were put in place, it was not clear that there were any policy grounds for lifting the regulatory burden. Lending growth was (and is) quite modest.

Consequently, the decision simply deprives some citizens, who may have otherwise been able to service their debt happily without incidence, of a home. They have been denied access to credit for no good reason -- a deprivation based purely on the arbitrary assessment of a bureaucrat with absolutely no regard to personal circumstances. In a free-market capitalist democracy, this is not acceptable.   

Such decisions can even act against the national interest. Consider that the decision to restrict credit growth could hamper the provision of adequate housing stock. House prices are surging for a reason; something that bureaucrats don’t seem to be able to get their heads around. There is a price signal trying to give policymakers a message that there is policy failure in some other area. In this case, the provision of affordable housing for the citizenry. Hiding behind increased regulation is the wrong way to address it. It can't address it.

So what remains? House prices are surging and history shows that it is probably desirable to moderate this in some way. Increased regulation (not no regulation) is clearly not the right answer.

Moreover, as I outlined in my piece (Stop blaming investors for the housing shortage, July 16) attacking investors is not the correct approach either. Investors did not cause this housing crisis. That they have sought take advantage of this ultra-low rate environment to purchase an asset in tight supply is not a crime; it is shrewd investment.  The housing affordability crisis, rapidly rising prices -- all of that is due mainly to insufficient housing stock, a lack of infrastructure and excessively low interest rates -- basically a failure of government policy. One of the unfortunate consequences of this global move or discussion of macroprudential controls is that it distracts from the real causes not only of the financial crisis, but also Australia’s current housing crisis.

The best way to fix this current dilemma is quite simple. Build more houses and associated infrastructure, enforce existing regulations and keep interest rates appropriately calibrated. 

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