What we really need to do to get house prices back on track.
Listener: 29 November, 2012.
A friend was enthusiastic about various unorthodox money measures, such as quantitative easing and cutting the official cash rate. I asked him how they would work. He had no idea. His was the New Zealand way: “Bugger the analysis; let’s get on with the policy.”
I am reminded of something French political commentator André Siegfried said 100 years ago: New Zealanders’ “outlook – not too carefully reasoned, and no doubtful scornful of scientific thought – makes them incapable of selfdistrust. Like almost all men of action, they have a contempt for theories; yet they are often captured by the first theory that turns up, if it is demonstrated to them with an appearance of logic sufficient to impose upon them. In most cases, they do not seem to see difficulties, and they propose simple solutions for the most complex problems with astonishing audacity.”
And so it is with the Government’s recently proposed package for affordable housing, which may – or may not – do some good but will have little effect on the price of housing. It, too, was bereft of any clear analysis of the history of house prices. The price of housing began to diverge from its long-run trend around 2002, about the time President George W Bush started injecting liquidity into the world economy through a very large US Government (fiscal) deficit. New Zealand banks borrowed some of these funds, which they lent to New Zealanders who used them to buy houses.
Some funds were used to build new houses. But a maximum construction effort cannot increase the total housing stock much, because additions are small compared with the houses already built. So the additional borrowing flowed into higher house prices. It was the offshore borrowing that accelerated house price rises.
Why did people use the available funds? The short answer is that although some may have prudent reasons to change their housing – relocation, retirement, change of family size – the base reason for much of the borrowing was speculation. Buyers saw housing prices were rising and used the opportunity of changing houses to make leveraged purchases – that is, to increase their debt – to obtain a better return in the long run, on the assumption house prices would rise for ever.
But we need to ask where the funds ultimately ended up. Some went on new construction, but major beneficiaries were those involved in the buying and selling – real estate agents, lawyers and valuers. Some funds were probably extracted from housing markets and used for other purposes, such as overseas travel and investment in finance companies. Hence the general mood of prosperity when the borrowing was heavy before the housing bubble popped.
The ideal would be for housing prices to return to their long-run track. When I did an analysis in April 2007, I thought housing was overvalued by about a third and that even if prices stabilised they would not be back on track before 2015 (“Housing prices relative to consumer prices” http://www.eastonbh.ac.nz/?p=837). Space restricts detailing the analytic reasons that a major slump in prices is unlikely.
What can be done? First, we need to take the speculative top off the market with some form of capital gains tax, perhaps only on second houses. Second, we need to encourage those with mortgage debt to pay down their mortgages rather than leveraging up. Can we structure the regulation of banks so they encourage people to reduce their mortgages rather than keep on borrowing more? Third, we need to give those who have paid off their mortgages better opportunities to save and invest without the need to gamble. In the jargon we need to “deepen our capital markets”.
If houses are used for speculative investments, they will not be affordable for new purchasers. The young won’t be able to buy in unless we address that core problem. In doing so, we’ll also take pressure off the exchange rate and help exporters. Easier said than done, but likely to be a lot more effective than a superficial solution proposed without analysis.