Bank Lending: Restrictions and Favourites

By   /   December 10, 2014  /   19 Comments

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An important story in 2014 has been the Reserve Bank’s ‘loan-to-value ratio’ restrictions, which have made it extremely hard for first-time house buyers to get sufficient finance to buy a house.

First-Home

An important story in 2014 has been the Reserve Bank’s ‘loan-to-value ratio’ restrictions, which have made it extremely hard for first-time house buyers to get sufficient finance to buy a house.

Corran Dann in TVNZ’s  Q+A (7 Dec) suggested that the most significant person in New Zealand’s political apparatus this year was Reserve Bank Governor (pixie-in-chief) Graeme Wheeler, and especially because he has stood firm on these LVR restrictions. Dann also claimed that these restrictions had worked; that they had taken the substantial pressure off the housing market.

My point here is that we do not know for sure what the effect of the restrictions was. The best we can do is to come up with a counterfactual as to what would have been different if those restrictions had not been imposed. Certainly we can say that the ‘bottom end’ of the housing market was distinctly quieter this year. But what about the troubling top end and middle?

I suggest here is that lending to house buyers was down this year for at least one other reason: the dairy boom for the first half-and-a-bit of 2014. Banks tend to have favourite sectors to lend to. In 2013 it was very much the housing sector. But, as that year progressed, big rises in dairy prices made lending to dairy farmers seem to be a particularly attractive proposition.

I argue then that the main reason for a slight slowdown in the housing market was because banks were upping the proportion of their lending to dairy farmers.

Now, however, in late 2014 the dairy sector is looking vulnerable, and certainly is no longer flavour of the month. (Banks are said to lend umbrellas in fine weather, and to call in those umbrellas – or at least lend far fewer umbrellas – when it rains.) So that is a reason to expect more loan money to flow back into the housing market. It’s raining on the Hauraki plain.

Banks must lend. Any organisation which pays interest on deposits must make genuine investments. Otherwise those organisations would be running Ponzi schemes.

Who will the banks lend to in 2015? The government says it will be running a surplus, so it won’t be the government. Christchurch City Council should be a big borrower, but politics will ensure otherwise. The dairy sector looks to be out of favour in 2015. So, my guess is that a greater proportion of bank loans will go to housing and other forms of real estate in 2015; indeed I understand this has already happened in late 2014. With the LVRs still in place, that means speculative ‘land-banking’ is likely to flourish more than ever next year. Meanwhile, the government’s heads remain firmly buried in the fabled sand.

If we don’t want our banks to run Ponzi schemes, then our deposit-taking banks must lend. Who to? Who will be our flavour-of-the-month debtors in 2015?

When interest rates are too high, normal business debtors lose interest. (Presently the business sector in New Zealand is calling for lower interest rates.) In 2005-07 our favoured debtors were home buyers, because of (not despite) our high and rising interest rates. When interest rates rise, increasing proportions of lending go into asset speculation. The idea that rising interest rates slow down asset speculation is a complete myth. Rising interest rates accentuate speculation. 15 percent capital gain on a house makes borrowing at 10% worthwhile, with or without a capital gains tax.

New Zealand banks like to lend to business sectors which are selling plenty of stuff to ordinary New Zealanders. But, when half of us are too poor to spend much and the other half are too miserly, then banks end up lending to speculators and to the spending poor. We might not like it, but that’s what banks must do. The alternative is that they charge us fees (and pay no interest) for minding our gold.

 

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19 Comments

  1. Dorothy Bulling says:

    LVR restrictions have also hurt those older people in family sized homes who want to downsize.

    • tauputa says:

      Actually they dont hurt older people in family sized homes who want to downsize, as these people have equity. They are a contraint which affects young first home buyers, who typically dont have enough money to meet a 10% deposit on a first home.

      Im not a huge fan of LVR’s as they hammer first home buyers everywhere which is a little harsh, but they also hit them outside of auckland where there is not risk of a housing bubble – effectively stagnating wellington, dunedein and other non auckland markets to stabilize prices in auckland.

      On the other side explosive increases in house prices are bloody dangerous and the banks paranoia is post 2008 justified – I think the LVR’s should be auckland based only.

      • LVRs take me back to the days of Muldoon’s National government. Back then, it was a shortage of mortgage money that constrained demand. Now, the mortgage money is available, but demand has out-stripped supply – a failure of the market; unrestrained migration; lack of taxation disincentives to invest in property; and of course, foreign investment (whether from Boston, Berlin, or Beijing is immaterial).

        National pays lip service to a “free market”: but when push comes to shove it has a track record of interfering in the market. One could argue that Labour was more “free market” than the Nats (not meant as a compliment, by the way), but public perception has never caught up with that reality. The ghost of Muldoon should be cackling it’s head of in the coridors of Parliament as National interferes in the housing market – but not in a good way.

        • tauputa says:

          Strongly disagree with your political slant. JK actually opposed LVR’s for populist reasons, they are a creature of the reserve bank and are a pretty good way to slam the breaks on house price rises – and have been used effectively in many places – so its not really muldoonist – just pragmatic.
          I dont doubt theyre efficacy, I dont like the idea of using them over the entire country (Im not that into the way they hit new entrants in auckland but thats maybe a cruel consequence of a necessary evil).

          Long term we need more residential land in auckland – that means higher density living and more apartment living and growing the city boundaries – all this takes time in the short run it will be LVR credit controls.

          Interestingly captial gains taxes have no effect on housing bubbles – all the econometric evidence refutes it (they are a damned good way to broaden the tax base away from a narrow reliance on income and consumption taxes – but thats another story), so we are left with very little other than stimulating supply by changing council bylaws and hammering new home entrants through harsh credit constraints.

          It makes me wonder why the heck people returning home head for auckland ok I get why they dont want to go to shakey CH CH, but bad traffic and housing scarcity make auckland a bad destination

        • Nehemia Wall says:

          When demand outstrips supply it is not a failure of the market. In fact these sorts of imbalances prove the market works because the market rebalances. Unless it is prevented from doing so. In the case of housing (which I assume you are referring to), our mayor is obsessed with public transport, and therefore Council policies have forced intensification on the city rather than the far more favourable sprawl. That has restricted land available, reduced supply and increased prices. Left alone, the market would have freed land for construction in sub-rural outlying areas of Auckland, and at least some of the heat would have been taken out of Aucklands property prices.

          LVR’s are a blunt instrument that may have achieved some short term gain but in reality are simply a market interference to fix another market interference.

          • LVR’s are a blunt instrument that may have achieved some short term gain but in reality are simply a market interference to fix another market interference.

            Of course they are.

            They remind me of Muldoon’s attempts to control the economy. That failed as well. National is adept at hopeless management of the economy, with the result being that poverty is growing; inequality is worsening; and unemplyment/underemployment is persistently high.

            An epic fail from a free market party.

            • Nehemia Wall says:

              LVR’s are not any political parties policy. We have an independent Reserve Bank. They are RB policy.

              Yes Muldoon was hopeless, but thankfully since 1984 we have pursued an economic policy direction (with some possible exceptions, such as 2005 through 2008) that has survived changes of Govt and left NZ as one of the worlds strongest and most balanced economies.

  2. Brigid says:

    Are you saying that the bulk of bank lending is from savings?

    • Keith Rankin says:

      I’m saying that there’s heaps of savings held at present as bank deposits, and whoever the banks lend to pay the interest on those savings.

      • tauputa says:

        Banks can always borrow from other banks locally or overseas and theyre is always the infamous carry trade so maligned post 2008, so your idea that banks are somehow constrained by local savings conditions is a bit out of date (Im sure Milton Friedman would like what you say though).

        Banks from my reading are constrained by credit worthy customers – not from lack of savings/money.

        Banks to tend to loosen credit restrictions during times of expansion (Ive read this in my intellectual travels and friends in the Banking sector confirm it too), so during times of rising milk prices banks may get looser with the lending to dairy farms and during times of rising residential property prices they ease up on lending restrictions to home buyers – Im guessing thats what you mean by flavour of the month lending.

        • Keith Rankin says:

          idea that banks are somehow constrained by local savings conditions

          Whose idea was this? Certainly it doesn’t resemble anything I said!

          I only said that depositors’ interest has to be paid by someone.

      • Korakys says:

        I would reckon that the great majority of those savings are from the rich (ie; those that have money with the bank for investment, not cashflow, purposes).

  3. Liberty4NZ says:

    Actually, as money is ALWAYS issued as debt, it always has been and is in fact a giant ponzi scheme, as there is not enough money in circulation to ever repay the debt, plus the interest. In a nutshell, as the money to pay the interest is also initially issued as debt, it is mathematically impossible to repay all debt. That is why our system has so many winners and losers so to speak. Do some research, fascinating and scary stuff.

    • mikesh says:

      “Actually, as money is ALWAYS issued as debt,”

      Except, of course when the bank pays its staff salaries, or its shareholders dividends.

  4. NicTheNZer says:

    Very weak Keith. If banks want to lend to dairy farmers and home owners they can. Putting it across as a choice is very miss leading. They don’t face a lending constraint so it’s not a choice of alternatives.

    • Keith Rankin says:

      Banks collectively face prudential lending constraints. Individually, banks are constrained by their competitors’ lending policies and practices.

      There is often a scarcity of good customers to lend to. Banks do lend to sectors in differing relative proportions over time, depending on their assessments of risk and return. Dairy was flavour of the month a year ago. Dairy is not banks’ flavour of the month this month. Housing was flavour of the month in November.

      • Nic the NZer says:

        I noticed the comments above along the same lines as my own. You are clearly arguing a quantitative constraint on bank lending,

        “I argue then that the main reason for a slight slowdown in the housing market was because banks were upping the proportion of their lending to dairy farmers.”

        This statement clearly says that the banks have turned from the dairy to the housing market and that is the cause of the slowdown in the housing market. This is only true if the banks face a quantitative constraint, which they don’t. None of the constraints you mentioned above are quantitative constraints. If the banks don’t face a quantitative constraint on lending then the cause of their lending switching from housing to dairy lies elsewhere (e.g in factors around each sector).

        The proportion of bank lending to housing vs dairy is largely irrelevant compared to the unique factors which effect lending to either of those sectors. Or to put this another way, housing and dairy markets are largely independent markets, and banks lending to both doesn’t make them any more interdependent.

        To the extent that housing and dairy are interdependent, the whole discussion is largely miss-leading. While a downturn in dairy prices is likely to cause a slow down in lending to the dairy industry, the income the dairy industry was receiving for its exports is boosting the NZ economy and GDP. This is more likely to be a boost for the housing markets as is lending to the dairy sector itself.

      • Keith Rankin says:

        Yes, banks are constrained by a combination of prudence and competition.

        Recessions come about in large part when banks tighten their self-imposed constraints; ie when they tighten their lending criteria.

        For any given level of collective self-imposed constraint on the part of banks, increased lending to one sector does lead to less lending to other sectors than would otherwise have happened.