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Debt

Written By: - Date published: 9:19 am, December 27th, 2008 - 11 comments
Categories: capitalism, economy - Tags:

A couple of good but not quite satisfying articles today. The first is Brian Gaynor’s analysis of the economy in which he lays out where we stand financially as a nation and blames the housing boom for our current account deficit:

But the message from both the GDP and current account figures is that New Zealanders have borrowed and invested far too much in residential property.

This makes the economy vulnerable to a downturn in the housing market, and does not give us a strong, diversified economic base to shield us from the worst aspects of an international recession.

While it’s a fair call the root problem of the reserve bank act isn’t dealt with by Brian. The reason we have been able to develop high debt against a housing bubble is simply our absurd use of pure monetarism to control inflation. As I’ve said before we got ourselves into a situation where debt was fueling inflation so we increased interest rates to control inflation which in turn made the profits from selling us debt even greater and ensured we’d have more debt-fueled inflation. Meanwhile our exporters suffered from our high exchange rate and many shut their doors.

Cullen made an effort to take money out of the system by holding surpluses, paying down public debt and implementing Kiwisaver and the super-fund but never addressed the core problem of the reserve bank act. I see that as his greatest failure.

It’s also worth noting that returns to offshore investors have been something like 6% of GDP (from memory, I could be wrong). That’s goes some way to explaining our current account deficit.

Henry Blodget covers the US housing bubble in this month’s edition of the Atlantic. He was a big player in the dotcom boom but got seriously burned in the 2000 crash so he knows what he’s talking about:

But most bubbles are the product of more than just bad faith, or incompetence, or rank stupidity; the interaction of human psychology with a market economy practically ensures that they will form. In this sense, bubbles are perfectly rational—or at least they’re a rational and unavoidable by-product of capitalism

Unfortunately, despite having a clear view and a damn good analysis of the market’s failure he excuses it as inevitable because:

bubbles are to free-market capitalism as hurricanes are to weather: regular, natural, and unavoidable. They have happened since the dawn of economic history, and they’ll keep happening for as long as humans walk the Earth

Some of us might have thought that after all he’s been through Blodget might not see the free-market as the last word on how to run an economy.

11 comments on “Debt ”

  1. Ianmac 1

    The finer points or even the blunter points rather escape me, but didn’t that fellow Peters repeatedly call for reform of the Reserve Bank Act? His call fell deafly on ears of course.

  2. The New Zealand housing bubble wasn’t caused only by too low interest rates and too easy access to credit and mortgages. House prices were being bid up by anyone wanting part of the rental market as that was a far more tax effective form of investment than any other – and the lack of a capital gains tax on second houses was the top heavy cherry on the cake!
    No use berating investors for making rational decisions at the time: low deposits, low interest rates, skewed market. The party may be over for now – especially for first time buyers either trapped in negative equity or unable to come up with the higher deposits – but still no sign of a level investment field or capital gains tax.
    If National and ACT don’t even follow Treasury advice, what hope is there?

  3. Ari 3

    A capital gains tax on all but your lowest-value home would probably be very helpful to prevent future such bubbles. I do think this bubble and the local recession were both influenced by our culture of debt, but I’d have to agree with U that debt wasn’t the primary cause and better monetary policy wouldn’t have defeated said bubble on its own.

  4. RedLogix 4

    The New Zealand housing bubble wasn’t caused only by too low interest rates and too easy access to credit and mortgages. House prices were being bid up by anyone wanting part of the rental market as that was a far more tax effective form of investment than any other – and the lack of a capital gains tax on second houses was the top heavy cherry on the cake!

    I know that is an attractive thesis but it’s not really true for several reasons:

    1. Real investors prefer to buy undervalued property that they can see some way to add value to. The best properties to buy for rentals are the ones that nobody else wants to buy, and the seller is willing to unload at less than market value.

    2. In the last three years most investors have had their cheque-books firmly shut (I know I have) yet the market has happily bubbled away all the same.

    3. Your argument would have more force if we were only talking about NZ, but property markets have boomed all over the world, regardless of a whole range of differing taxation regimes that apply. The US market for instance has a very different taxation system than we do, yet the bubble there was just the same.

    Many people are at a stage in their lives when it does not make sense for them to own the house they live in. Often they move on to a new job, new town, new relationship within a year or so, they have yet to save or inherit the equity they need, or they have neither the interest nor ability in maintaining a home. Whereas I do. I provide warm, clean, decent homes at price around half what it would cost my tenants to actually own. And if anyone thinks it is money for jam, I’ve definitely got an alternative view to offer you.

    Lots of people harbour a fair bit of resentment towards landlords. There are of course bastard landlords out there, and an historic legacy from the UK where the whole business is freighted with an enormous amount of class baggage… so it is kind of easy and satisfying to scapegoat the landlord for all your problems. The kind of magical ”how much nicer if he/she simply let you live in your house for free and my life would be much better” thinking.

    The real driver of real estate prices is something called the LVR (Loan to Value Ratio). Traditionally it was limited to 80%. This means that if you have say $30,000 saved as a deposit, you can bid up to $150,000 on a home. This used to be fairly typical. But when everyone started to believe that prices would forever rise, the banks moved LVR’s closer and closer to 100%, reasoning that the ratio would improve to a safer level with a few years anyway, the same person with $30,000 equity, but a 95% LVR loan, could now bid up to $600,000 on a property. And with many households boasting two or more incomes, the serviceability was not too bad.

    It was this leveraging effect, and this alone, that has been the common feature of all the property bubbles that have just popped all over the world.

  5. rave 5

    Red Logix

    You should look elsewhere to perform your social service which sounds like a rationalisation of private charity to me.

    A much more equitable social democratic scheme would be for the state to own the land and to impose a capital gains tax on the unearned increment. Individual owners of houses would be able to reap the improved value instead of landlords, but there would be no speculation on housing.

    There would be no huge rush to augment low wages by borrowing 100% from Aussie banks that you can’t possibly pay back when the overinflated housing values go poof.

    Of course a socialist scheme would provide housing as well as land and people would rent their houses a social goods and not personal property.

  6. RedLogix 6

    I’ve advocated many times here that all residential land should be leasehold. Instead of rates, we would pay rent to the local council on the land portion of property value.

    The main effect of this would be to stop the banks from being able to include the land as part of the security, and off their books as an asset. This would hugely reduce speculative lending by the banks and this one move alone would dramatically dampen out the peaks and troughs of the property market, while still allowing people the opportunity to purchase a home of their own, modify and improve it if they wish, and retain the benefit from doing so.

    Of course a socialist scheme would provide housing as well as land and people would rent their houses a social goods and not personal property.

    Which is pretty much how the Soviets did it, with mixed results. Yes it offered tremendous security, but at the cost of a dreadful uniformity. The standard 13 storey Soviet era apartment building was not a thing of beauty. Not sure most of us would gladly live in one.

  7. RedLogix 7

    Sorry but I’m stuck in moderation.

    [lprent: released]

  8. rave 8

    Redlogix

    I think that we put far too much energy into DIY in housing. Ive done it myself. It is a sort of booby prize for living in a dull, conservative bourgeois society. I see it as a sort of macho cultural thing that survives the family farm where straightening the No8 wire was the measure of manhood. A sad shadow of what might be. A bit like Vigil.

    I think if the houses as well as the land was publicly owned and of course if we were paid a living wage, we could find much more creative outlets for our energy and skills. It comes back to this thing about individualism and identity. Who wants to be known as someone who added a couple of rooms, or designed a bach? Who wants to be identified as the guy who put his mind in neutral while he found a square?

    I wouldnt mind living in the Hundertwasserhaus in Vienna even though H was a kind of extreme individualist.

  9. RedLogix 9

    I think if the houses as well as the land was publicly owned and of course if we were paid a living wage, we could find much more creative outlets for our energy and skills.

    My observations in Russia would more or less back this idea; the street markets were full of astonishingly beautiful and painstakingly made crafts. Partly because cooped up inside for seven months every winter, left many long hours to be filled, plus the TV was not all that good, and partly because the Russians have a very deep tradition of fine artisianship. (Of course many just blotted out their empty lives with vodka, and that is something else to be thought about as well.)

    But I’m not quite willing to make the step to full public housing as you advocate. The system we do have is very embedded into our identity, most people would consider my ideas about leaseholding all residential land a heresy; what you are suggesting is right off the end of the needle for most NZ’ers. More plausibly you could consider ‘collective housing’ such as EarthSong in West Auckland as an achievable step in the direction you are thinking of.

  10. uroskin 10

    RedLogix: Perhaps you should take walk down Hobson Street in Auckland. The apartment blocks look just like Soviet Russia, only newer and mostly privately owned and rented out. But a good percentage of them are now being sold or leased to Housing New Zealand. So there goes the neighbourhood.

  11. merl 11

    The real driver of real estate prices is something called the LVR (Loan to Value Ratio). Traditionally it was limited to 80%. This means that if you have say $30,000 saved as a deposit, you can bid up to $150,000 on a home. This used to be fairly typical. But when everyone started to believe that prices would forever rise, the banks moved LVR’s closer and closer to 100%, reasoning that the ratio would improve to a safer level with a few years anyway

    RedLogix, my understanding of how the LVR degraded was by Fannie Mae and Freddie Mac being asked (nod nod wink wink) by congress to relax the barriers to poor people owning their own homes who could not attain the 20% threshold.

    So they started requiring higher and higher %’s and since they are 50% of the US mortgage market what they did became the norm. Then of course those other things you mentioned happened to cause it to spiral out into a bubble, but it was the US mortgage market that drove this speculative bubble in the world.

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