Matt Nolan

Gareth Morgan, housing, and blaming the RBNZ

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Lately I’ve been saying “don’t blame the RBNZ’ for things a lot (here, here).

However, Gareth Morgan’s concern about Bank policy and the housing market IS actually a legitimate area to raise concerns about Bank policy.  His view boils down to this statement:

The problem with demand for property in New Zealand is one that has arisen as a legacy from a long history now of Reserve Bank prudential policy combining with selective tax policy to provide a toxic little no brainer for property investors.

Simply put, he feels that prudential policy overtly favours housing, thereby creating the equivalent of a “tax wedge”.

So it is NOT a criticism of monetary policy and the PTA per se – but of the institutional financial framework set up by the RBNZ, which in turn has led to some type of “inefficiency” or “misallocation of resources”.

I’m not convinced, but I’m leaving my mind open. I have had similar thoughts in the past, but have in the end ruled them out – it would just take some firm evidence to lead me to re-evaluate my priors 😉 .

Update:  As if by magic, the RBNZ has a speech up defending their framework here.  Given this speech has been booked in for some time, it isn’t a direct response.  However, I would note that they point out that risk-weighting in housing is higher here than in a number of other countries (so the capital requirement for a pool of loans on housing is higher in NZ 😉 ).

Risk-weighting are set for the capital adequacy ratio for a reason, and as a result we need to articulate why these are wrong or inappropriate.  Furthermore, it isn’t clear to me that prudential policy has had a “long history” of being pro-housing – instead it has always seemed that retail banks have been pro-housing due to the fact that they see these loans as relatively lower risk, which shows up in relative interest rates and the availability of credit.  As a result, for the argument to be made needs more analysis – the burden of proof is on the analysts making the claim that prudential policy is a “causing too much investment in housing”.  A little bit more analysis in terms of numbers and counterfactual models is in order – and if these show the result and the argument could persuade more people – including the RBNZ 🙂

Note:  His movement from excessive demand for investment in housing as an “investment vehicle” to a complaint about affordability is also tenuous at best – excessive investment demand lead to a larger stock of property (that is how we get the “misallocation of investment”) and lower rents.  The yield on property falls, and ownership becomes more expensive … but the cost of buying “housing services” actually falls.  So does this imply that Bank is making housing services more affordable?  We need to be a bit more careful not to mix up issues here!

 

Matt Nolan

Fair point

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From this entertaining discussion of the Rethinking Macroeconomics II conference comes this gem (ht Economist’s View)

8) Can we realistically solve the “too big to fail” problem?

We have to solve it. If we can’t, then nationalize these behemoths and pay the people who run them the same wages as everyone else who work for the government.

Fair call, economists, like most people, despise “socialism for the rich”.  And honestly, if public institutions are always going to backstop them then nationalisation makes a lot of sense – and is how we felt here during some of the financial firm bailouts.

I can’t see the government letting banks fail, which is why I’ve been pro-deposit insurance recently (here, here).  But even down that road, have a deposit levy.  Also ask why we are going down that road, is it because we want a “risk free” rate of return for mum and dad investors no matter the cost … if that is the social preference Bair’s suggestion of nationalisation starts to make a lot more sense right 😉

Matt Nolan

Bubbles no, resilence sure, market failure yes

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Hmmm, it looks like no-one wants to dissuade people from viewing the new RBNZ tools as ways to “stop bubbles”.  I think this is a dangerous mistake.

The focus on financial stability, and system risk in the banking system, is due to concerns that a sudden shift in asset prices could lead to a breakdown in the financial system – due to concentration, bank-runs, or some concern about fragility.

This is all well and good.  I think we need to be careful with these arguments.  I think we also need to identify why and what the failures are.  But, overall this is a way forward.

And it does nothing to truly “prevent bubbles”.  If someone wants to “overpay” for something, they can, and will – and as a society we shouldn’t give two hoots about someone pissing their own money against the wall.  True story.

If we tell people the RBNZ is “stopping bubbles” they will just assume that whatever is happening isn’t a bubble.  Does this actually seem like it will help anyone?  The RBNZ can’t really control asset prices, and it definitely can’t control them in the face of “irrational exuberance” (protip, the RBNZ doesn’t control people’s expectations of future house price appreciation).  The goal is to prevent the popping of a bubble having enormous spillover effects onto the broader economy.  If the RBNZ is doing its job right we will STILL HAVE BUBBLES – and people who took on the risk will still HURT THEMSELVES.

As a result, I hate the current description.  I hate the focus on asset prices themselves, rather than the direct stability of the banking system.  And I hate that we aren’t more focused on trying to identify where the risks and failures and and how to quantify them.

Matt Nolan

Treading the thin red line

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I see that, due to concerns about systemic risk for the financial stemming from the housing market, the Reserve Bank of New Zealand has decided to increase capital requirements for high loan-value mortgages.  Fine, I think this can be fit inside our concept about why you want to deal with these types of issues, as we’ve noted here.

But it is a balancing act, and there are some comments I’m inherently uncomfortable with.  Namely the context of these two statements:

credit is now increasing faster than the rate of income growth (figure 2.1), after declining as a ratio to income over the past four years. …
While credit is growing more slowly than in most of the decade before the financial crisis, that growth is stretching household debt-to-income ratios, which are already elevated (figure 2.2). Rising house prices, combined with a greater willingness on the part of banks to lend against low deposits, suggests that many new borrowers will be acquiring homes with higher debt levels relative to both income and assets. Low  mortgage rates are helping to keep household debt burdens manageable in the short term, but the increase in underlying indebtedness leaves households vulnerable to a reduction in incomes or a rise in interest rates.
Factually true, indeed.  But how do we unpack this?
It doesn’t matter that people are highly indebted … unless this stems from a process that involves the increasing level of debt, and the distribution of the debt burden, in such a way that it creates an externality.  Where this risk is in turn thrust onto other people.  The very idea of systemic risk.
This is well and good, I have no doubt the RBNZ took policy actions with this in mind.  But I would another two points when we think about credit growth:
  1. We should compare credit growth to average expected income growth – not current income growth.  You borrow in the basis of future income, so the comparison they laid down was a bit dodge.  4% credit growth is lower than this.
  2. New Zealand is rebuilding its (arguably) second biggest city.  It will have to accumulate a higher level of debt (especially relative to current income) to do this.  We are going to have higher current account deficits etc as a result – the idea is that this investment in a new city will create a rate of return that covers it.  If we believe the rebuild leaves some areas streched this is still not a concern – it is just when those sectors in turn threaten to undermine the financial system.  Given this, the increase in investment, activity, employment, and debt are all pretty slow – this type of counterfactual is an important element to keep in mind.

We DON’T care about financial stability because we are worried about asset prices, or bubbles.  If people want to piss their money against the wall gambling on a bubble, no policy maker should try to help them.  It is if their actions have an impact on the broader economy – if we think that financial markets are underpricing risk due to systemic risk issues for example – that we care.  Bubbles and debt don’t magically stop people working and producing in of themselves, and we have to be careful that we interpret the data with the perceived externality in mind, rather than solely being focused a moral distaste for bubbles and debt … which is policy irrelevant.

Matt Nolan

If we have a bank tax, make it a deposit levy

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I argue the deposit levy point (as a form of insurance) here.

The only point I have to add is that some may say “why charge poor old depositors”.  I’d note here that we need to think about the “incidence of tax” – if it is true that depositors have no market power, then the entire burden of the tax will fall on banks and borrowers.

This is all part of a broader debate on deposit guarantees (here, here) – if we rule them out, we rule out the justification for a levy as well.  I’d add there is a big issue I haven’t touched – what is our ability to limit deposit insurance given concerns about “bank stability”, and what do we do when banks are just too big (think Ireland and Iceland).  My real desire is to see transparent, and credible, ex-ante policy … and to be honest about the trade-offs we are facing and accepting.

Either way, my focused has switched back to methodology issues as I’ve realised I need to intensify work on my NZAE paper this year (posts here and here) … in case they actually decide to accept the abstract I’ve just submitted.  As a result, when I next get a chance to sit down there are two posts I want to write about assumptions, and then I might start blogging some of the background material I’ve already written about for the paper.

However, knowing me I’ll just start ranting about whatever I see in the paper instead 😉

Matt Nolan

The OBR is not meant to be a replacement for deposit guarantees

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I’ve noticed an interesting interpretation of the Open Bank Resolution going around New Zealand, and the world, where it is seen as a replacement for the lender of last resort function and deposit guarantees.

This has caused outrage among some – even I’ve received some emails and facebook messages from people on it.  But the OBR and implicit/explicit deposit insurance are actually two incredibly different issues.

The OBR is a scheme that helps to ensure that, when a financial institution fails, it is wound down in an orderly fashion – it is like an addition to standard bankruptcy law specifically for financial institutions.  The OBR takes the fact that, if debt has “gone bad” there are a range of creditors, and the loss needs to be attributed between them.  This is great, it makes what is going on transparent, and helps reduce the interruptions associated with the collapse of a large financial institution!

But it doesn’t say anything about the government’s willingness to allow depositors to lose out from a failure.  Any implicit government guarantee that existed still exists.  In Table 1 of the RBNZ’s recent bulletin article on the OBR this is made relatively clear – the idea of inherent insurance is not applicable to the scheme.

Now I think the logic people are taking onboard is as follows:

  1. When it is clear how a bank will be shut down, it is more likely that the government will do so instead of bailing it out.
  2. Therefore, by setting all this up, it is less likely depositors will be bailed out.

While this is true, I think that it inherently misses the point for extremely large financial institutions – such as the big banks in NZ.  Governments have an incentive to bail out depositors, and there may well be a presumed “social preference” for a risk free place to save that doesn’t lose value which is where this is coming from (given that the value of cash depreciates over time).  If we really want the government to be able to commit to not bailing out deposit, and we want society to be comfortable with it, we need to face these issues – which are separate issues from the appropriate focus of the OBR.

Personally, I think the OBR is great – I just think people’s view of its “purpose” has been stretched out of proportion.