Beware a return to bad habits

Reserve Bank Governor Alan Bollard is worried about deja vu when it comes to New Zealanders' love for property investment and consumption, rather than saving and investing to produce more exports.

Bollard believes we could be making the same mistake all over again and there appears to be nothing he can do.

His bluntest instrument is the Official Cash Rate and he has promised to sit on that for the next year or so. Bollard's decision this week to leave the OCR at a record low of 2.5 per cent is consistent with his promise to keep it at that rate or lower until late next year.

The economy is crawling towards recovery, but may yet go through more dips before anything sustainable arrives.

Bollard can't cut interest rates, but neither can he raise them much without damaging a fragile recovery. Some exporters would argue he should cut rates to bring down a painfully high New Zealand dollar.

Yet consumers seem to be slipping back into their bad old habits. Home buyers and investors are hitting the open homes again and there is ample anecdotal evidence of renewed heat in the housing market as spring arrives. This is exactly what Bollard does not want.

New Zealand's economy is careering towards a credit rating downgrade and foreign lending freeze unless New Zealanders save more, spend less and invest more in the productive sector. More property investment will simply tip that balance even further in the wrong direction.

So what can Bollard and policymakers do? They seem to be powerless, but there are some tweaks they could make to restrain the banks' ability to lend heavily into property.

The Reserve Bank looked at other tools for influencing the housing market and the broader economy in 2006 when it was pushing up the OCR in vain to cool a housing market that refused to listen. It looked at a mortgage interest levy, a discretionary limit on bank loan to value ratios and linking bank capital to cyclical risk.

In the end none was adopted, partly because the Reserve Bank was going through the complicated business of converting to Basel II, the new set of international rules for measuring capital adequacy.

Under Basel 1 banks had to put aside a set amount of capital for different types of loans. This was known as risk weighting. Residential lending was given a 50 per cent risk weighting, while other loans were given a 100 per cent risk weighting. This encouraged banks to lend more on property because they didn't have to put aside so much capital for this lending.

Under Basel II the banks were allowed to set their risk weightings according to their own experience of losses, which meant they could lend even more into housing because loss rates on home loans were very low, meaning they could set their risk weightings lower than 50 per cent. However, under Basel II the Reserve Bank has the right to impose a discretionary "scalar" to these risk weightings for mortgages if it thinks the banks' own assessments are too optimistic.

The Reserve Bank has already imposed a 15 per cent discretionary scalar to the capital adequacy requirements and in May in its Financial Stability Report it imposed extra restrictions on how the banks calculated their risk weightings for rural lending.

Changing the discretionary scalar could be a way for the Reserve Bank to push the banks to lend less on property without having to change the OCR or damage other types of lending. It could even reduce the risk weightings for business loans to encourage lending to business.

The Reserve Bank has to look at innovations if it wants to break out from its own Catch 22.