Michael Rehm: Lending not house supply needs correction

Unbridled bank lending is the driving force behind house price growth, Michael Rehm writes. Photo / Michael Craig

We keep hearing that Auckland's housing supply has lagged behind rising demand, driven by population growth, and that's what has pushed up house prices. Both National and Labour say the main fixes are "supply-side": Auckland needs to intensify and expand.

But flooding the market with new homes is no silver bullet - and may even send prices higher. A largely overlooked driving force behind house price growth in Auckland - and many other housing markets - is unbridled bank lending.

During deregulation of the financial sector in the 1980s, longstanding restrictions on how much and where banks lent were lifted. Banks were actively encouraged to compete for market share and profit. In New Zealand, banks shifted from lending to economically productive activities to the unproductive housing sector. In 1984, manufacturing and business accounted for 40 per cent of bank lending, housing for less than 14 per cent; in 2016, 9 per cent of lending went to manufacturing and business, while 52 per cent went to housing.

An OECD report has estimated that financial deregulation increased real house prices by as much as 30 per cent in the average OECD country over 1980 to 2005.

Alarmingly, banks seem genuinely unaware that their own activities are fuelling house prices, while the onus for reining in mortgage debt is overwhelmingly put on borrowers. In reality, home-lending is completely controlled by banks.

Ironic then that in July, ANZ bank CEO David Hisco proclaimed that the Auckland housing market was over-cooked without realising he was a head chef.

Hisco's explanation hit the common notes of insufficient housing supply and high immigration. But permanent immigrants to New Zealand, of which I am one, generally begin their time here as renters and not homeowners. Data isn't available here, but a 2015 report by Oxford University found that 74 per cent of recent immigrants to the UK resided in private rental accommodation.

What about supply? The argument goes that if we dramatically increase supply, house prices will either fall outright or plateau. Recently Arthur Grimes, former Chief Economist of the Reserve Bank, suggested that 150,000 homes - a 30 per cent boost to supply - be built in Auckland over five years in order to reduce house prices by 40 per cent.

During its Herculean 2002-2007 home-building boom, Dublin, which has a similar population to Auckland, erected 99,041 new dwellings, increasing its housing stock by 27 per cent and oversupplying the market.

Did this massive new supply crash or stall the housing market? No: over the same period Dublin experienced an 85 per cent increase in prices. Instead of taming the market this flood of new dwellings helped fuel a speculative housing bubble that ended dramatically when the easy money was cut off during the global financial crisis.

Of course, supply and demand play a role in determining house prices. But for owner-occupants to make their eye-watering winning bids at home auctions, or investors to purchase rental properties yielding returns at or below term deposit rates, two things are needed:

• Market participants, including lenders, must firmly believe that house prices will continue to rise.
• Lenders and borrowers must collude to further leverage against borrower income.

With slightly inflated home loan pre-approvals in-hand house hunters can succeed at auction. News reports of higher house prices, incessant immigration, and Auckland's inability to adequately supply the market with new houses reinforces the notion that house prices "must" continue to rise. The next wave of prospective buyers sit down with their mortgage broker and the cycle repeats.

Sadly, there is no way of backing out of Auckland's housing affordability crisis without economic pain and political fallout. If policy-makers genuinely wish to make housing affordable once more, prices must be brought down.

The fastest and best way to do this is by restricting lending. Loan-to-value limits are helpful, but debt-to-income (DTI) ratios are likely to be fairer and more effective. DTI ratios limit borrowing to a multiple of household income. Finance Minister Bill English is currently considering a request by the Reserve Bank to add DTI limits to its toolbox. Auckland can't afford for him to say no.

If New Zealand were to adopt the Bank of England's DTI limit of 4.5, demand from Auckland property investors would be drastically curtailed. To avoid locking out first-home buyers, an exemption could be made to those meeting the criteria for a KiwiSaver HomeStart grant, minus the contribution requirement. That said, it might be in their best interest not to buy into Auckland's over-cooked market right now if the Reserve Bank declares war on house prices and implements policies to rein them in.

Dr Michael Rehm is Senior Lecturer in the Department of Property at the University of Auckland Business School.