• The House Price Spiral

    The OECD finding that New Zealand houses are the most overpriced in the developed world will come as no surprise to the young couples locked out of Auckland’s housing market or to those families condemned to substandard housing conditions and high rents.

    The Prime Minister, however, assures us that there is no crisis; our house prices simply reflect high levels of employment (with 6% unemployment?) and a buoyant economy (with the first glimmer of normal growth in six years?).

    More thoughtful observers, however, acknowledge the damaging impact of the crisis on our economy and social cohesion, but continue to analyse it in market terms. It is, they say, a matter of inadequate supply and excessive demand, to be resolved either by scrapping planning protections and providing more opportunities to developers, or by restricting the number of potential buyers, particularly those from overseas.

    This is, however, to mistake the real issues. Our overpriced housing market is the product of decades of mistaken policies. It is, as the OECD report says, an affordability crisis, and reflects a growing asset inflation and a capital structure that is now completely out of control.

    The housing market, it should be remembered, is unlike any other. Experience over decades has taught New Zealand house-owners that the value of their homes, unlike any other asset of remotely comparable value, will go on rising over time. In buying a house, they not only gain necessary accommodation, but also an appreciating capital asset.

    They finance the purchase of that asset – probably the most expensive they will ever buy – by obtaining a loan on mortgage. Their bank will be keen to lend to them because it is the easiest and most profitable way for the bank to make money; there is no shortage of willing customers, the returns are predictable and high, the security is almost always easily realisable, and the rate of default is in any case comparatively low.

    Once the house-buyer has bought the house, rising house prices will reduce the comparative cost of the mortgage, and the rising value of the equity (and perhaps a larger mortgage) will allow the purchase of a more expensive property next time.

    This process – which really built up a head of steam when banks moved in to replace much more conservative building societies and to dominate the mortgage market – has meant that, over a generation or two, there has been a constant injection of new mortgage finance (at a much faster rate than the growth of incomes or of most other asset values) almost every time that a house is purchased.   That repeated injection of new money has come on top of the already inflated value brought about by earlier mortgage lending and has been steadily and cumulatively built into the rising market prices of our houses.

    If there were to be a sudden increase in the number of homes being built, this would simply provide a new stimulus to the process. The main effect would be to increase the profits of both banks (who would leap at the chance of lending even more) and property speculators and developers; the affordability crisis would remain untouched.

    The problem arises, in other words, not for reasons of supply and demand, but because of the way we finance (and tax – or fail to) house purchase and ownership. It is no accident that, while marking us as the worst offender, the OECD identifies other countries, such as Australia and the UK, with similar methods of financing house purchase, as principal culprits as well.

    The scale of the problem can only be understood when we realise how powerful an impact on our economy is created by bank lending for house purchase. As the Bank of England conceded in a ground-breaking report earlier this year, by far the greatest proportion (well over 90%) of new money in our economy is created by the banks out of nothing – and most of that goes to finance house purchase.

    When the banks lend money on mortgage, they create that money by a simple book entry – the stroke of a pen, or today, a computer keyboard; the loan in no way represents real money, that is, money deposited with them. It is that bank-created money that artificially inflates the value of the class of assets into which it is principally directed – in this case, housing.

    This process then operates as a giant mechanism for transferring wealth to home-owners, whose good fortune comes at the expense of our economy as a whole and of those who are debarred by the asset inflation effect on house prices from ever sharing in it themselves.

    Our policy-makers, and certainly our Prime Minister, seem to have no glimmer of understanding of what is happening. There is just a small ray of hope; our central bankers, who have been asleep at the wheel on this issue for the last three decades, have begun to stir. The Bank of England has opened its eyes; and our own Reserve Bank’s Loan to Value Ratio restrictions on bank lending show that they, too, have recognised that something has gone wrong. Graeme Wheeler may know more than he is letting on.

    Bryan Gould

    19 May 2014

3 Comments

  1. Patricia Smith says: May 22, 2014 at 11:41 amReply

    In the 1980’s, and that is some decades ago, the banks had a formula, which they adhered to, when lending money to buy a house. If I remember they would only lend up to 75% of a registered valuation. Only one income was counted when lending and there had to be a percentage of that one income for living expenses. The Governments aim was for everybody to have a freehold house by the time they retired. Banks would not lend to those over 60/65. The Government assisted first home buyers with low supplementary loans and it seemed to work. Then the banks increased the percentage they would lend but an insurance policy had to be taken out on those loans. Then bank Managers were abolished and so nobody knew their customers’ personal affairs anymore. BUT, while I look back on those halcyon days I am beginning to wonder if I am looking through rose tinted glasses. I bought my first house in 1970 for $21,000.00. I sold it 10 years later for $43,000.00 when I went to Australia. I came back in 1983 and had to pay $108,000.00 for my next, very similiar, house. I sold that 6 years later for $176,000.00 buying another which I sold 10 years later for $$376,000.00 I am now in my last house, I hope, but I look around and prices are in cloud cuckoo land. So perhaps it is all just exponentialism at work after all and we just didn’t realise it. It will collapse one day because with exponentialism it will get to a stage where nobody will be able to buy a house at all. Then there will be tears and gnashing of teeth! Maybe there is just nothing that can be done.

  2. Brendon Harre says: June 13, 2014 at 10:56 pmReply

    Bryan the flaw in your argument is that ultimately it is land and building costs that determine housing prices not credit. Easy credit can only drive up house prices if there is restrictions on building a new house.

    Bryan you might be interested in the following analysis of Christchurch’s rental market.

    The Christchurch rental market -post earthquakes.

    Interest.co.nz medium rent chart -3 bedrooms since September 2010 -Christchurch compared to Wellington and Auckland http://www.interest.co.nz/charts/real-estate/rents-median. This shows medium rents have increased $110 from $325 per week to $435 in Christchurch. A 35% increase in three and half years. This translates to a $5,500 annual rental gain to the typical landlord and corresponding loss to the tenant for each medium rental in Christchurch.

    Christchurch rents predicted to hit Auckland levels by next year. http://www.stuff.co.nz/business/10041098/Rents-soon-to-hit-Auckland-levels

    The housing supplement is much less in Christchurch compared to the North Island, the supplement works on zones and in Christchurch the maximum supplement is $51 per week, it is $45 more in the North Island at $96 per week. http://www.stuff.co.nz/business/money/9729210/Housing-supplement-comes-up-short, “despite housing costs now matching those in much of Auckland and Wellington, the city’s zone status has not changed since 2005.” So tenants are burdened with the full cost of post earthquake rent increases without any assistance from outside agencies.

    These facts have translated to some people falling off the rental housing market completely. Here are two stories.

    http://www.stuff.co.nz/the-press/news/10120070/Life-in-a-van-beats-rental-stress

    Campbell Neil has a fulltime job, but chooses to live in his van instead of paying “ridiculous rents” for second-rate conditions.
    The 37-year-old “opted out” of Christchurch’s expensive rents and competitive housing market by moving into his van about 18 months ago.
    “Ridiculous rents, shoddy conditions and constantly being expected to bid for a roof? Get stuffed

    http://www.stuff.co.nz/national/10142203/This-isn-t-my-sob-story-I-m-lucky

    Byllie-Jean Rangihuna never expected to be homeless.

    But after six months in a leaky caravan and applying for more than 100 tenancies, the mother of three says Canterbury’s rental market is denying single-parent families the chance of a home.

    Rental conditions in Christchurch in particular and Australasia in general have led to a discussion of France’s more stable long term rental agreements here http://www.stuff.co.nz/the-press/opinion/blogs/chez-cecile/10151603/Attractions-of-rental-policy-in-France and Germany’s here http://www.macrobusiness.com.au/2014/06/why-australia-is-floored-by-expensive-housing/#comment-373997

    Plus a discussion that the pattern of rent increases in Christchurch indicates a strong single factor affecting the market -a genuine housing supply shortage http://www.interest.co.nz/opinion/70184/bernard-hickey-argues-governments-one-eyed-focus-housing-supply-blinding-it-real-deman#comment-778117 compared to Auckland where the smaller increase in rents, with more variability or spikiness indicates there are multiple factors affecting that particular housing market.

    Gerry Brownlee the government’s Minister for Canterbury’s Earthquake Recovery typical robust denial and divert blame style of public engagement has resulted in minimal public debate of the bigger picture. A recent example of Gerry Brownlee shutting down debate is here http://www.stuff.co.nz/the-press/10151605/Ceras-level-of-comms-staff-under-the-spotlight.

    Big picture items needing debate are:

    1. Why does Brownlee and his government allow some groups, such as landlords to gain so much wealth/income from another group -tenants, as a result of the earthquake?

    2. Why does Brownlee and his government deny assistance for those losing groups that is available in other parts of the country?

    3. Why did Brownlee and his government not implement stronger housing supply initiatives, he was given absolute power ‘to do what needed to be done’, so why did he do so little? Why was the Christchurch Housing Accord so pathetic -180 houses compared to 39,000 in Auckland http://www.interest.co.nz/opinion/69561/opinion-new-christchurch-housing-accord-appears-ineffectual-and-possibly-sets-bad-exam .

    Christchurch’s urban development limits could have been removed as recommended by Hugh Pavletich -a long term local housing affordability campaigner http://www.demographia.com/ .

    If that was too ‘free market’ for Brownlee a more ‘socialist’ solution like the following would have also provided affordable housing without the current congestion woes http://www.stuff.co.nz/stuff-nation/assignments/how-can-we-get-more-kiwis-into-homes/9256824/Housing-crisis-We-need-new-towns.

    4. What is Brownlee going to do about the infrastructure crisis that his ‘do nothing’ approach to Christchurch’s urban development has resulted in. Cantabrians predictably leap frogged sprawled to satellite towns as a result of Christchurch being unaffordable. Now there is a transport crisis. Gerry Brownlee is also the Minister of Transport and his NZTA is keeping an emergency report on how to alleviate congestion chokepoints away from public debate. http://www.stuff.co.nz/the-press/news/10151610/Content-of-rail-report-hush-hush-for-now

    5. Is the government’s claim of being in surplus based on inadequately funding the rebuild? As demonstrated by the inequities of the accommodation supplement and inadequate infrastructure provision. Has the government broken its 2011 election promises that the Canterbury rebuild would be the highest priority and that no one (or group) would be worse off?

    Gerry Brownlee has calculated that he is personally safe as MP for Ilam – there are more Landlords/property owners than tenants and no redzoners forced out to affordable but congestion flawed satellite towns. That National will be re-elected based on issues that affect the whole country. So local protests do not matter. http://tvnz.co.nz/national-news/praise-gerry-brownlee-hates-christchurch-plaque-5719440 . Is this true? Or have local housing problems become a national problem affecting the whole country?