The RBA's property argument is full of holes

The RBA looks to have sensibly ruled out higher loan-to-value ratios to slow house price growth, but its current proposal is still flawed simply because there’s no justification for taking any action at all.

Judging from the RBA’s appearance before the Senate Economics References Committee, it seems that regulators have ruled out higher loan-valuation ratios as a method of slowing rapid house price growth. Just as well, as they would have most certainly failed.

Now, while the RBA didn’t want to outline the tools it would use, it does seem that APRA is leaning towards making adjustments to the risk weights that will be applied to investor lending in Sydney and Melbourne only.  This hasn’t been explicitly stated, but listening to the RBA’s responses to the Senate, that’s what I took out of it.

In the RBA’s words the “response to investor housing finance growth has to be targeted and proportionate and incentive based”.  That is, the tools should not consist of hard quantitative restrictions, but rather incentives for banks to avoid certain types of lending.

Lifting the risk weights for some loans would do that by forcing banks to hold more capital against those loans.  This has the effect of lifting the cost for banks to extend credit to that market, while not explicitly prohibiting it -- which of course encourages the banks to lend elsewhere.

So, noting that only Sydney and Melbourne are of concern, with investor lead price growth well above incomes, it’s clear they’ll apply geographic targeting to those two cities only at this stage --ruling out targeting down to specific post codes.

Obviously this is a better proposal than mindlessly applying LVRs, which would have hurt first home-buyers and prevented lower income earners from taking advantage of the lowest interest rates in a generation. Having said that, the proposal to lift risk weights is still flawed for the simple reason that there is no justification for this type of action.

At this point it has to be said that the Senate Economics References Committee did a terrific job in grilling the RBA and performed a great service to the citizenry.  In particular the committee highlighted the RBA’s often inconsistent rhetoric -- noting that it was hard to reconcile their view. The Committee chair pointed out that on the one hand, the RBA was saying there is no problem. Banks are sound and there is no threat to the financial system or the broader macro economy.  Indeed the RBA’s submission to the Senate noted that:

  • House price growth since 2008 had been a little below income growth;
  • While debt to incomes was high, repayments on new housing loans are well below the decade average. That is, housing was affordable;
  • “The pick-up in investor demand has not involved a substantial lift in leverage…[and] does not pose significant risks to financial stability”;
  • Financial stress is low.

But still the RBA seemed to be suggesting that there’s a problem. When questioned as to what exactly that was (given all the points above), the Bank suggested it’s concerned about what households would react if house prices fall. It wants to avoid a situation where an upswing in house prices turns into a strong downswing -- a risk because there was “more speculative activity in market than we're comfortable with”.

It’s here that the RBA gets into trouble and where the grounds for increased regulation fall apart. Neither the RBA, Treasury nor APRA can possibly know the intent of an investor -- whether demand is speculative (ie a short-term punt) or a longer-term investment. It’s a very important distinction, because the goal of regulation is to reduce risk. Yet only short-term speculative investment poses a risk of the type that the RBA is concerned about. The assumption that all investment, or even most of it, is speculative is fraudulent. The RBA’s argument is based on a value judgment -- not evidence -- that the market is unbalanced.

Yet how can the RBA be sure that what it views as an imbalance is not simply a structural change underway? There are excellent reasons for investors to take a long-term view of property in Australia given the supporting fundamentals. Now if it is a structural change, regulators will cause more problems for the economy if they try and interfere in the manner proposed and exacerbate the housing shortage and long-term price growth. There is quite simply no way to ensure that the regulators don’t make serious mistakes -- especially as the RBA assured us that once it ‘turns the dial up’, it won’t hesitate to do so again if it’s not enough.

This highlights the problem with regulation. Excessive and arbitrary regulation, of the nature that the RBA talks about, attributes an intelligence to bureaucrats that they simply don’t have. It’s why markets moved away from this approach in the first place -- and it’s the reason why we adopted a generalised price mechanism (interest rate) as the key policy tool. It’s fairer, it works better and it avoids bureaucratic stuff ups.

The RBA warned one year ago that investors shouldn’t see house prices as a one-way bet: That they shouldn’t expect the kind of returns to property that they had become used to in the past. Over that time the RBA has been proven very wrong. House prices in Sydney and Melbourne have surged and the momentum is building elsewhere throughout the country as well.  Now we can see just how vindictively they intend to respond to that, and I can’t help but be left with the impression that the RBA’s primary motive, having been caught unawares by house prices, is retribution.

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