Presentation to U3A Southland series on Housing in NZ, via ZOOM, 17 February, 2023.
Throughout my life as a professional economist, I have been challenged by the question of whether goods and services should be provided privately or publicly. I recall in the 1960s, when there were strong calls for nationalisation of many things, the then leader of the Labour Party, Arnold Nordmeyer, asking a student audience whether they wanted to nationalise corner grocers. A fair question. Grocers provided goods like food which are fundamental to living but so does health care services which are largely ‘nationalised’. Why treat them differently?
Over the years, I realised the issue was not simply a matter of who should own the business, but rather how it should be regulated; that the ownership was just one means of regulating a business or industry. At the University of Sussex, where I taught, I heard that the classic Labour goal ‘the social ownership of the means of production, distribution and exchange’, should be replaced by ‘the social regulation of the means of production, distribution and exchange’.
That gives a reason for not nationalising grocery stores. A competitive market can be a very effective means of regulating businesses. I add, sixty years on, that today corner grocery stores are increasingly being replaced by a couple of supermarket chains which compete in quite different ways from grocers so their regulation needs a different approach.
These are preliminary remarks to a paper which focuses on the regulation of the housing market, indicating that what I am about to say is set in a wider context. For it is very easy to say a particular market is special, to ignore the fact that much of its speciality applies to other markets which are treated in quite different ways, and then to advocate various ad hoc interventions which lack coherence or effectiveness. A warning though. The housing market is very complicated. I am going to have to focus on some big issues and ignore others. Fortunately this is only the first of a series, and later sessions will cover issues that I have had to reluctantly leave out.
The Time Dimension in the Housing Market
So what is special about housing? It is not sufficient to say housing is necessary. So is food, clothing, healthcare and work. The list of necessities can get very long.
One of the key elements of a housing market – what makes it special and complex – is the time dimension. I warn you that economists have a lot of problems analysing time, but so does everyone else. Perhaps we are more aware of our ignorance.
First, a time dimension comes from people wanting to live in a dwelling for a long time. It would be very inconvenient if we had to move as often as we change what we eat. Doing so would also be very expensive. A rough estimate is that by the time you have paid all the bills – to real estate agents, valuers, lawyers, movers, and allowing something for for housing alterations and the like – you will have outlayed over $30,000 to change your house. Better to stay stuck in your house.
That means households need some dwelling stability. For many that means home ownership. Most people accept that there should be some private ownership, including owning one’s house. It certainly has been a driving force in New Zealand’s evolution. Almost 200 years ago Edward Gibbon Wakefield advised, ‘Possess yourself of the Soil and you are Secure.’ At first the new settlers wanted to have their own farms; as New Zealand urbanised they wanted their own houses on their own land – usually with a garden. They can alter and extend their own home. A feature of New Zealand’s housing stock is that it is very varied – heterogeneous. Even if you put New Zealanders in the same type of houses – say terraced ones or apartments – they change them.
There are at least two public advantages for home ownership. One is that the owner – their own landlord – is likely to look after their property more than a tenant would. A second is that it requires the home owner to pay off a mortgage, thereby forcing them to save. When a person starts work their main asset is their labour power; when they retire most will have built up substantial financial and physical assets on average – around two-fifths by value are in property.
Of course there are many who do not own their own houses. That includes young people who havn’t settled down. It is often lamented that home ownership rates are falling. There are many factors affecting these rates, but the most important one is that while my generation bought their first homes in their twenties, today the equivalent generation’s purchase is more likely to be in their thirties, just as they are more likely to hold off having their children. If you compare home ownership for those above the age of forty you will find that the rates are much the same as they were in the past.
The second reason for not owning a home is those who cannot afford the deposit to buy a house. The problem they have is the lack the wealth despite, in some cases, having a good income. I am not going through a full analysis, but people frequently confuse wealth and income and in the case of the housing market they try to fix up the wealth inequality problem by supplementing income. You can be sure that if they try, they will end up with a not very good policy.
If the first time dimension issue involves people’s housing preferences of wanting to live in the same place for a while, the second big issue is that dwellings themselves exist for a long time. That means it is quite difficult to add substantially to the housing stock. Build 10,000 houses and less than 1 percent has been added to the total stock of New Zealand housing. Yet it is an enormous strain on the economy to build 10,000 houses. The strain is compounded if we decide we also need to improve the quality of the existing housing by, for example, remedying damp homes.
The Neoliberal Policy Approach from Thirty Years Ago
I illustrate the consequences of the two time dimensions by going back thirty years to the early 1990s when housing policies were dramatically changed, a change which still affects our housing policy thinking. You might summarise the new framework as Ruthanasia, presaged by Rogernomics, but in the international context it would be called ‘neoliberal’.
I have written a lot on the policy changes at the time; I do not propose to discuss all their elements; only the salient ones which frame our current policies.
Rogernomics was a response to what was widely seen as too much intervention in the economy. In my judgement the balance between private and public provisions favoured the public side of the scales more than it should. Where I disagreed with the Rogernomes is that their solutions were extreme. We can see this in what they did to the housing sector.
Neoliberals thought that the housing market could be largely left to itself, just like the markets which provide food and clothing. Because they saw no specific food policy nor a specific clothing policy, they concluded there was no need for a specific housing policy. So they heavily wound back government involvement in the housing market. I am not going through a detailed account of all the winding back of public interventions they made. I focus on the big mistakes which could be summarised by saying that they ignored the peculiarities of housing in terms of those time dimension issues
The Ministry of Housing and Urban Development
When the Labour (Ardern-Peters) Government came to power in 2017, they found housing policy was scattered across a number of departments with little coherence. One is reminded of Geoffrey Palmer’s comment about how the newly elected Lange-Douglas Government in 1984 grasped the levers of power and found they were not connected to anything.
To its credit, the Ardern-Peters Labour Government established a Ministry of Housing and Urban Development. It is easy to destroy a government department but it takes time – ten years perhaps – to build up a fully effective one. This one is only four years old. Don’t be misled by a department’s glossy presentations and flowery language; it is still settling in.
Instructively, the Ministry outcomes – how it defines it success – include ‘a self-adjusting system – The system works together and with communities to review, respond and adapt.’ The expression ‘self-adjusting’ is a signal that it accepts the neoliberal belief that a housing system can be devised so that it does not need constant intervention. I wish.
Nor does the Ministry yet seem to have compiled a comprehensive historical data base. There are a number of studies with public housing data but nothing as easily accessible on private housing. The Ministry seems to think of itself as a Ministry of Public Housing.
I give a couple of examples of where a comprehensive data base was important. The First Labour Government is acclaimed for its housing policies, which included building and renting out state houses and the State Advances Corporation lending to people to buy and own their own houses. It is often overlooked that these policies were founded on a comprehensive survey of the housing market commissioned by the preceding Coalition Government – Gordon Coates actually.
That is an example of the usefulness of a good data base. The difficulties when you don’t have one are well illustrated by the current housing market.
After the neoliberal revolution, we lost interest in having a comprehensive account of the housing market. The slogan was the market would look after itself. It didn’t. Over the next quarter of a century there was a steadily growing imbalance between housing supply and demand. There was no data bank to easily monitor the deterioration, while other policies reinforced the imbalance. (Immigration is particularly relevant here, since migrants add to housing demand.)
So there does not appear to be any government agency concerned with the whole of the housing market, despite there being considerable interaction between the public and private markets. For instance if there is insufficient public housing, some people will end up in the private sector (which includes living on the street); people buying their own houses reduces pressure on public housing; the housing construction industry provides both public and private housing.
By the time the Ardern-Peters Labour Government took over, the imbalance was evident to all. The government was deemed to be at fault, although it was obvious that the imbalance had been building up over the years and that the failures should be attributed to policy slackness on the part of previous National and Labour governments. The public outcry implied the government could fix the mess created by over-reliance on the private market for a 25-year period in, say, 25 days. Five years later the government has made some progress, but frankly, if it takes its eye off the ball, the housing situation could easily regress. Without that comprehensive data base who would know – other than those marginally housed?
The Housing Bubble
Thus far I have been talking about the stock of housing. A major recent concern has been its price and affordability. There is no problem here for a neoliberal. The right price is what the market sets, and affordability reflects scarcity. Pressed, they argue the problem was the restrictions imposed on land use by urban authorities; such planning restrictions are an anathema to neoliberals. (Recall that the Ministry for Housing is also one for Urban Development, acknowledging these concerns.)
Allow me to skip a discussion on town planning (although I footnote for a country trying to reduce its carbon footprint it is odd to be extending the urban edge when our largest permanent global warmer is emissions from cars.) I am going instead to offer an alternative to the neoliberal account which explains the housing bubble.
Speculative bubbles are common. You have met many such bubbles through your life. The Global Financial Crisis of 2008 was an example, as was the New Zealand finance companies crash about the same time. The 1987 share market crash was another example, as was the 1928 Wall St Crash, but that was before our time. There are at least two major bubbles going on at the moment – one in the crypto-currency market and one in the Chinese Financial System. There are probably others – we often find out about them too late.
Hyman Minsky was not recognised until after he was dead, but today his work is considered a powerful way to understand speculative bubbles. So powerful that I am going to explain it in some detail before applying it to the housing market.
Minsky argued that ‘the financial system swings between robustness and fragility and these swings are an integral part of the process that generates business cycle’. He concluded that such financial instability – and the booms and busts that accompany it – are inevitable in a so-called ‘free’ market economy – unless government steps in to control through regulation, central bank action and other tools – a policy conclusion which neoliberal economists find uncomfortable.
His key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector. There are three types of borrowers that contribute to the accumulation of insolvent debt: hedge borrowers, speculative borrowers, and Ponzi borrowers.
The hedge borrower can make debt payments which cover interest and principal from current cash flows from investments.
For the speculative borrower, the cash flow from investments can cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal.
The Ponzi borrower – named after Charles Ponzi who ran the famous ‘Ponzi scheme’ in 1920 – believes that the appreciation of the value of the asset will be sufficient to refinance the debt for their insufficient cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat.
These three types of borrowers each dominate in one of the three phases of the financial bubble.
During the Hedge Phase, banks and borrowers are cautious. Loans are minimal so that borrowers can afford to repay both the initial principal and the interest. It is the ‘Goldilocks’ phase of debt accumulation – ‘not too hot not too cold’.
The Speculative Phase emerges as confidence in the financial system recovers during the Hedge Phase. Borrowers no longer invest on the basis that they can pay both principal and interest. Instead loans are issued where the borrower can afford only to pay the interest. As the loan principle comes up for payment, they rely on being able to refinance (‘rollover’) their debt, borrowing the principal again. The decline towards financial instability begins.
As confidence continues to grow, investors move into the Ponzi Phase in which they neither pay the interest on the loans nor repay the principal. They rely on the capital appreciation from what they have invested to finance their investing.
Eventually, Stern’s law– if something cannot go on for ever, it will stop – takes its toll. The asset-price appreciation that the Ponzi investors rely upon cannot go on forever either, especially as it needs to accelerate. Some Ponzi investors withdraw, and there are not enough new investors introducing new cash to fund the withdrawing Ponzi investors. And so the bubble pops at the ‘Minsky Moment’.
After the Minsky Moment, everyone tries to get out of their investment commitments, turning them back into cash. Ponzi borrowers are forced to, because they have no cash; speculative borrowers can no longer refinance the principal even if they are still able to cover interest payments. All the borrowers have been borrowing from someone else who may be unable to recover what they have lent. The result is a line of collapsing financial dominoes, with innocent lenders suffering as well as guilty borrowers.
Not every one suffers. There are those who have taken their margin on each transaction, such as sharebrokers, investment advisers, real estate agents, investment promoters. All have an incentive to encourage speculative investment, which biases the public view towards investing in low quality activities. Others who are beneficiaries are those who invest and cash up before the Minsky Moment. There is also a more sophisticated group of investors who ‘short’ the market, that is, contracts to sell the assets at high prices after the Minsky Moment; you may have seen the film based on Michael Lewis’ The Big Short, which described it happening after the Global Financial Crisis.
The New Zealand Housing Bubble
Minsky developed his theory for financial markets which involve paper assets – such as shares. The housing market is a little different but it fits Minsky’s model well.
Today the housing market is largely funded from borrowing from banks. From the 1980s, after the financial liberalisation which, among other things, ended the trading banks having separate savings banks, the housing market was in Minsky’s Hedge Phase. The banks lending was cautious with their funds for lending largely coming from deposits and loan repayments. Mortgages were advanced on the basis that borrowers could afford to pay the interest and repay the initial principal over a long period reflecting their working lifetime.<><>
Minsky’s Speculative Phase began in the early 2000s, where following 9/11, the George W Bush administration flooded international markets with dollar liquidity. Our trading banks turned to those international markets for additional funds, which were used to increase the supply of mortgages.<><>
Some simple economics. It became easier to purchase a house because there were more funds. But the supply of housing did not increase much. So the price of housing rose. You can see the change in trend quite markedly in the graphs. Borrowers still serviced their mortgages but they were now getting a higher return from their investment in housing, from the capital gain from the faster appreciation of prices.
There was almost a domestic financial crash. In 2008, trading banks were borrowing about $30 billion a month in offshore markets, partly to increase their advances but mainly to roll over existing borrowing which was short term – three months – much shorter than the mortgage advances they were making to house owners. During the GFC, financial markets almost seized up (as the jargon would have it), that is international lenders in crisis became unwilling to roll over their past advances – to everyone, not just to New Zealand banks. Fortunately, skilled international cooperation between the central banks of the world prevented the catastrophe. If you want to see what could have happened you might look at the experience of the British mortgage lender Northern Rock (Building Society), which crashed in 2007 and had to be nationalised.
New Zealand managed to get through the GFC reasonably lightly compared to some other countries, and the rise in house prices checked somewhat.<><>
However after 2013 the housing market moved into a Ponzi Phase in which people were paying too much for the houses they purchased. It was partly over-confidence but nominal interest rates were low, which meant that house purchasers could service larger mortgages. Again there was not much increase in the housing stock, so the price of housing went up dramatically.
The government tried to restrain the house price rises including imposing a capital gains tax on houses which were quickly resold and loan-to-value requirements on lenders. Additionally, it ring-fenced rental income so that landlord losses could no longer be charged against other income – the capital gains they were making remained untaxed. There was borrowing guidance given by the Reserve Bank to the trading banks.
Competition among the trading banks stimulated the lending markets and house prices. Moreover the real estate industry and those advertising real estate – including their journalists – encouraged the view that house purchasing was a good investment, with the implication that it was better to purchase now than later, when prices would be higher.<><>
By 2021 house prices were about double what they would have been had the mild increases of the 1990s had continued.
The inevitable happened, especially when mortgage interest rates began rising following rising international interest rates. Because housing is heterogeneous by housing type and location there was not a single Minsky Moment, so house prices began to fall in different regions at different times. By the end of 2021 they were falling everywhere.
People selling houses were now taking capital losses relative to the market peak; some even sold below what they originally paid for the house. Rising interest rates mean that many mortgage holders are finding it difficult to service their debt when it has to be rolled over and have to cut back on other spending. Because the trading banks factored in their lending criteria the probability that interest rates would rise there are, currently, only a few forced house sales, but numbers are rising.
Even so, current housing prices remain badly out of line with consumer prices and affordability. One benefit is that it is easier to become a first-home owner, but for some the required debt servicing is still unaffordable, even if they have a deposit.
So the housing bubble has popped. You could criticise the government or the Reserve Bank for popping it, but it would have happened anyway – Stern’s law cannot be avoided. The longer the Ponzi Phase of the bubble lasted, the worse would be the following downturn and the more innocent who suffer. The measures that were taken to reduce the bubble, and hence the muddle which follows the Minsky Moments, were not enough to prevent it.
It is difficult for the government to soften the effects of the bust, because those that benefited from the upswing – those who sold out early, cashing up their capital gains, or who benefited from the transactions – are not going to give up their winnings. Because there was no capital gains tax on house price gains, there is no capital reserve to support those suffering capital losses, assuming they warranted such support.
Creeping Away from the Neoliberal Framework
With hindsight Minsky’s analysis is obvious – even if it was not at the time. I promise you that there will be another Minsky bubble in some financial market which will suck in naive investors. What I cannot tell you is how long the current downswing will go on, how far housing prices will fall before the market recovers.
The standard neoliberal analysis concludes market prices cannot get badly out of line with fundamentals so Minsky bubbles cannot happen; there is no need for special market regulation. They fail to heed the comments of Alan Greenspan, once chair of the American Fed (central bank), and a famous proponent of neoliberal policies for financial markets. ‘I made a mistake in presuming that the self-interest of organisations, specifically banks, is such that they were best capable of protecting shareholders and equity in the firms … I discovered a flaw in the model.’
And so, step by step, the harsh realities of the housing market are forcing us to revise the neoliberal policy framework which was adopted in the early 1990s. We have many steps to go.
A pundit column which summarises the first half of the paper is here.