Liam Dann, Mark Lister and David Snell talk about the amount of debt in New Zealand, and its possible effects on the housing market.
"We've almost got the perfect storm," says veteran fund manager Brian Gaynor as he reels off the many reasons New Zealand house prices and debt levels are soaring to precipitous heights.
There are many ingredients. But right now, New Zealand seems to have them all: not enough building, restrictions on development, surging migration, baby boomer savings, low interest rates and banks that are all too happy to lend for property investment.
"When you get the perfect storm like we did in the 1980s with the sharemarket, you see things just go up and up. People start to believe they will never fall," he says.
"People didn't believe the sharemarket would fall in the 80s. I'd come in from a trip to Australia and the guy at customs wouldn't let me in unless I gave him sharemarket tips. It was just euphoria. Everyone was talking about the sharemarket. Now everyone is talking about the property market."
"When a sharemarket boom nears peak, people get priced out of the market for the top stocks," Gaynor says.
"So they start looking at the stocks that haven't moved and that's what's happening with Hamilton, Tauranga and New Plymouth. They stop buying on fundamentals and start buying because they can afford to get in. That's classic investment stuff. Its nothing unique to housing."
But right now there's no question that it's housing that poses New Zealand's biggest debt risk, he says.
The big problem, says economist Shamubeel Eaqub, is that we have a banking system designed to view lending for property as less risky than other kinds of lending.
"Our banking regulation allows us to feed on the property market," he says.
"Of all the debt that is created in New Zealand, more and more is going towards mortgages because mortgages are less risky according to our rules and regulations."
As house prices soar, the size of mortgages has to grow with it.
There is no easy way out of the cycle. If house prices fall, then highly leveraged investors and many home buyers will be left exposed.
[In the 1980s] everyone was talking about the sharemarket. Now everyone is talking about the property market.
"When it happens it will be nasty," says Eaqub.
"There is no other way to describe it. What we have built up is ugly."
What happened to the US housing market in the global financial crisis provides a sobering example. But in New Zealand it could be even worse.
"In the US, and particularly in places like Nevada and Las Vegas, they had this massive housing boom and then the entire economy cratered."
In mid-2006, Nevada median house prices peaked at close to US$350,000. By 2012, after the GFC, they finally bottomed out -- down 64 per cent at US$125,000.
But one thing favouring the Nevada home owners -- and those in many other US states -- were laws that allowed them to walk away from a debt-laden house.
In those states, if a property ends up worth less than the mortgage, the homeowner can effectively post the keys back to the bank and leave their debt behind them.
In New Zealand there's no such escape: the debt stays with the borrower.
"In terms of the chilling effect on the entire economy it's much much bigger," Eaqub says. "In Vegas people had these enormous debts that they knew they'd never be able to pay back. In New Zealand people know they have to pay it back."
A crash would result in distressed selling and a huge slump in consumer spending, "which can have a long drawn-out effect on the economy."
That was exactly the problem in Ireland, says Gaynor.
After the GFC house prices in Dublin slumped 57 per cent from their peak and apartment prices were down more than 62 per cent.
"The worst thing about Ireland was for the young people," says Gaynor. "When the market crashed the biggest thing was the lack of mobility they had. There was no way to sell a house because if they sold they had to crystallise the losses. They were stuck."
"It's not just a Kiwi thing," says Auckland Business School's Professor Robert MacCulloch when asked about our modern debt culture. "It's tied to the rampant consumerism. People are not great savers and it is tied to the saving issue. But Kiwis are not great savers."
If a nation has good savings then it is not so dependent on foreign investment and less vulnerable to global economic shocks, MacCulloch says.
New Zealand is the seventh most indebted nation among 42 countries, as measured by the ratio of household debt to GDP. But worryingly, all of the countries with even worse ratios -- Switzerland, Australia, Denmark, the Netherlands, Canada and Norway -- have better savings rates than us.
The rules that we created in the 1980s are that if a bank lends to houses it is deemed less risky and it is cheaper for them to lend that money and they make more profit.
Debt itself is not inherently good or bad. "As a financial tool it is a wonderful invention," says MacCulloch.
"It allows you to buy a house and pay for an education. So you can smooth consumption over your life cycle.
"You need debt. It's sort of fundamental to economics. But it has morphed into speculation. You're really making a bet. then. on the asset market."
The freedom to spend and borrow what we want to has come to be seen as one of the freedoms of capitalism -- especially since the free-market reforms of the 1980s, he says.
"I do a case study with my class on the UK in the 1980s. Before the free-market reforms with Thatcher, the swings weren't as extreme. If anything, the British economy probably grew faster as you unleashed the freedom of the market ... but it has become more unstable."
That opens up a deeper political question, he says.
"What makes it a complex issue is that you want to unleash entrepreneurship but then you don't want people to borrow just to speculate."
Veteran fund manager Brian Gaynor. Photo / Natalie Slade
Trying to regulate for just the good stuff can lead you into a regulatory quagmire, he says.
"Then there is borrowing to buy consumer junk; can you restrict a person from doing that? So then you have to look at financial literacy."
Eaqub, who once worked in the belly of the machine with investment bank Goldman Sachs, says he is increasingly convinced that more radical regulation is required at the source -- the banks.
"The rules that we created in the 1980s are that if a bank lends to houses it is deemed less risky and it is cheaper for them to lend that money and they make more profit.
"So it's not surprising that we have seen banks lending more and more to mortgages."
The Reserve Bank has a brief to monitor the nation's financial stability, but in practice it tends to be primarily focused on the strength of the banks.
That is too narrow a focus, Eaqub says.
Banking regulation allows us to feed on the property market.
"We are told repeatedly we must have a strong banking sector to have a successful economy. But the reality is they are not the doers, they are only the facilitators. Somehow we've put the facilitators on a pedestal, in a way that has never happened before in history."
Eaqub believes the regulation the Reserve Bank has tried so far, such as loan-to-value ratios, and even proposed debt-to-income ratios, are just tinkering.
He would like to see the banks forced to tighten their capital ratios. In other words, they would have to hold more capital to balance their housing loans -- restricting the volume of mortgages they could approve.
"In reality what we want to achieve is growth in jobs and prosperity -- for that we need to support businesses and markets, and that requires a change in the way we regulate banks that takes away the bias."
He is aware this could be politically unpopular. People don't like being told they can't borrow, and the banks are a powerful political lobby.
Economist Shamubeel Eaqub. Photo / Bevan Conley
For the record, the New Zealand Bankers Association says banks are highly conscious of risk around mortage lending. Chief executive Karen Scott-Howman says it is important that they "got it right" with the individual stress tests they do on all mortgage lending.
She also notes that funding ratios have improved, with banks getting a smaller proportion of their funding from offshore than they did before the GFC.
Adjusting capital ratios further to specifically target mortgage lending is tricky because it risks limiting credit for apartments and building new houses, she says.
It is also unlikely to be popular with the public because it would inevitably raise the cost of borrowing.
Bill English certainly remains adamant that individuals are best placed to make their own choices about borrowing and spending.
It can be an internal political thing, it can be an economic thing, a geo-political thing, but something will happen one day and you don't have any idea what it will be.
But Eaqub believes the onus is on politicians, and regulators like the Reserve Bank, to lead us out of this cycle before it ends in a crash.
"When you loosen policy it is easier. When you try and be more restrictive -- even if it's going to be good for you in the long run -- people don't like it.
"This is the job of politics to have those difficult discussions and change the narrative. Ultimately it is about sacrifice; you can't have your cake and eat it too."
How long we have before we face the next crash is anyone's guess.
"Bubbles tend to run further than you expect them to," Gaynor says.
He sees two big issues that could bring it all tumbling down.
One would be a big increase in housing supply.
The other, a turnaround in the record influx of migrants -- which, history suggests, won't last.
"I've got no idea what the final trigger will be," he says.
"It can be an internal political thing, it can be an economic thing, a geo-political thing, but something will happen one day and you don't have any idea what it will be."
Critics say that is overly conservative, given that the cost of borrowing is at historic lows and there is a case for spending more now to stimulate the economy.
New Zealand's public debt was increased to get through the global financial crisis and the Christchurch quakes.
But with total gross public debt (including SOE debts) at about $113 billion -- or 30 per cent of GDP -- we look positively saintly next to the US, with 104 per cent, the UK (90 per cent) and the likes of Greece and Italy (176 per cent and 132 per cent respectively).
Treasury secretary Gabriel Makhlouf agrees that New Zealand's public debt looks low -- but given our soaring private debt, he says, it really needs to be.
"The smaller the economy the more vulnerable it is to shocks. The US can sustain 100 per cent of gross government debt to GDP because it is a super-economy, it's got the world's reserve currency.. NZ could not sustain those sorts of debt levels."
It's hardly surprising Makhlouf backs English's stance on low public debt -- he and his Treasury team advise the Government on appropriate debt levels.
So does New Zealand's high level of private debt affect that advice?
"Absolutely," says Makhlouf.
"We think about the Crown but also how the Crown acts as a buffer for the country as a whole. The fact that we used to have very low rates of net debt helped us get through the earthquakes and GFC, unlike some European countries which already had high levels of debt."
Countries like Greece were forced to run austerity programmes when they got into trouble.
They found themselves cutting spending when they needed to be stimulating the economy, Makhlouf says.
"We need to think about the big picture so that we are in a position to act appropriately if there is a shock."
