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Why the Reserve Bank worries about housing

NZ NewswireNZ Newswire 12/07/2016

The Reserve Bank is worried about the housing market and its deputy governor, Grant Spencer, has explained why, writes NZ Newswire political writer Peter Wilson.

The government calls the housing shortage a challenge, opposition parties call it a crisis.

The Reserve Bank doesn't use those terms because it doesn't play politics.

But it's worried, and deputy governor Grant Spencer has explained why.

He also explained, in a recent speech, the factors behind the shortage and the soaring prices.

© Getty

The bank isn't responsible for house prices or the shortage, but it is responsible for keeping the country's financial system in good shape.

"House prices are increasing at 13 per cent per annum nationally, and at 15-20 per cent in Auckland," Spencer said.

"Evidence from housing cycles in several advanced economies suggests that the longer this continues, the more likely there will be a severe correction."

If that happened it would pose "real risks" for financial stability and the economy.

The banks, he said, were heavily exposed with mortgages making up around 55 per cent of total assets.

Household debt, at 163 per cent of income, is at a record level.

"There is a clear risk that ongoing high house price inflation could lead to a further deterioration in the household debt-to-income ratio," Spencer said.

"While low interest rates have helped to contain debt servicing ratios (DSRs) for New Zealand as a whole, high and rising debt levels leave households very vulnerable to any further increases in interest rates or deteriorating economic conditions."

While Spencer was careful to say he didn't think interest rate rises were imminent, he explained why a small increase would have a big impact.

"This is particularly the case in Auckland, where DSRs for new buyers are close to 50 per cent," he said.

"A one percentage point rise in interest rates for these new buyers would boost the proportion of income devoted to mortgage servicing by around five percentage points."

As the Reserve Bank sees it, there's no simple policy solution to the housing shortage but it identifies the key challenge as increasing the supply of new homes.

It has no direct influence over supply, but it can influence housing demand.

It intervened in 2013 when it introduced 80 per cent loan-to-value restrictions, which meant buyers had to come up with a 20 per cent deposit based on the value of the property they were buying.

It intervened again in November last year, when it tightened the LVR restriction to 70 per cent for Auckland investors.

That worked - for a while.

Over six months, there was a two to four per cent reduction in Auckland house inflation.

But around March this year it started to accelerate again, and Auckland is now the fourth most expensive city relative to income out of 367 cities worldwide.

Spencer didn't entirely blame investors for this, but he came close.

"A dominant feature of the housing market resurgence has been an increase in investor activity," he said.

"In recent months, investors have accounted for around 43 per cent of sales in Auckland and 38 per cent in other regions.

"The prospect of capital gains appears to remain a key driver."

Another reason investors worry the Reserve Bank is that they're more likely to default on loans when times get tough.

"Rising investor participation tends to increase the financial stability risk," Spencer said.

"Evidence from the UK and Ireland shows mortgage default rates significantly higher for investors, at any given LVR."

Spencer said an important reason for this was that owner-occupier households needed to move out of their own home if they defaulted, which gave them a powerful incentive to continue servicing their mortgage if at all possible.

"Investors do not face the same incentive for their rental properties and are also more likely to face income shocks, like rental vacancy, at the same time that house prices fall."

Spencer indicated in his speech that the Reserve Bank isn't going to sit back for much longer and watch the situation deteriorate.

It could use stronger LVRs and it could introduce debt-to-income ratios (DTIs) on mortgages, he said.

DTIs limit the amount of a mortgage based on household income and have a more extreme impact than LVRs.

They're used in other countries but not in New Zealand, and the government would have to agree before they could be introduced.

Finance Minister Bill English has confirmed he's discussed DTIs with the Reserve Bank, and Spencer says it intends consulting retail banks on the viability of the measure.

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