House price crash warning: 'It's impossible to save people from their mistakes forever'

Wednesday, 3 November 2021

There will be a “day of reckoning” for people who have borrowed too much, or invested in things without understanding the risks involved, a top economist is warning.

The Reserve Bank issued its latest financial stability report on Wednesday, which highlighted its concerns about “unsustainable” house prices. It said there was a heightened risk of correction in the market.

“The further house prices rise above their sustainable level, the larger the realignment could be.”

The Reserve Bank said the number of factors that pointed to a drop in house prices was growing.

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Population growth had dropped significantly since Covid-19 hit and house building had reached record levels. The last peak in house building, in the 1970s, coincided with a drop in house prices, in real terms.

The Reserve Bank says the supply of housing is increasing, which will take away some of the pressure for house prices to rise.

Housing demand had been underpinned by low mortgage rates and owners tapping into their equity, but mortgage rates were increasing and lending criteria had tightened.

“Recent high-loan-to-value borrowers are vulnerable to a decline in prices from their current levels. Also, while current debt servicing costs are quite low, higher mortgage rates could see debt servicing costs rise substantially for some borrowers as a share of their income, creating financial stress and reducing aggregate demand,” the bank said.

Land now accounted for 60 per cent of a median house price, compared to 40 per cent five years ago, the bank said, which reflected the constraints on land availability.

“New building intensification rules will allow for more dwellings to be built within existing urban areas. By easing one of the constraints on new housing supply, these policy changes should support supply responsiveness and a greater moderation of rent and house prices than would otherwise have been the case.

“Further, policy actions earlier this year are moderating housing demand from investors. Effective housing investment returns have declined for existing houses following the removal of the tax deductibility of interest expenses from rental income.”

ANZ chief economist Sharon Zollner said, in some ways it was not too hard to draw parallels with 2007, just before the global financial crisis hit.

“What I think is true is people have been making investments without worrying too much about whether they understand all the risks, like the subprime crisis back then. Now you could look sideways at crypto but in the New Zealand context, it’s all housing. After a 31 per cent increase in prices in a year, it has to be fragile.”

She said the fact that house prices had risen so much made people think that the market was bulletproof and unstoppable, but the increases made it more susceptible to a fall.

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She said there were a lot of asset prices and debt positions around the world that had been based on an assumption that interest rates would stay low for a very long time. “People are starting to reassess that now. It’s not just in New Zealand that inflation is rather startling, it’s everywhere.

“Mortgage rates are going up very, very quickly. The rate of change is very unusual.”

Global debt had increased significantly since the global financial crisis, and since Covid-19 hit.

“Debt has increased everywhere. Debt is borrowing from the future and there’s always a risk that future might arrive in a lumpy fashion. Firms or households or governments have got fewer options if things turn pear shaped if they have got a lot of debt. That’s the risk sitting in the background.

“It's been so long since rates have gone up that there are investors, people in financial markets who’ve never seen a rising interest rate. It’s highly likely that some people have maybe misjudged the risks in their financial decisions.”

Zollner said, while this was a necessary part of a business cycle, central banks had tried to avoid it for many years. “But it’s impossible to save everyone from their investing mistakes forever. There’s a chance some people have started to think central banks are omnipotent and can always step in and save them. Whether you’re talking about house prices in New Zealand or equities in the US, central banks have done that quite successfully since 2000. But it's just too good to be true that central banks can somehow save you every time.

“It’s not to say there’s going to be a global financial crisis but at some point there will be a day of reckoning.

“For a long time in the US, for example, how risky your firm is hasn’t made all that much difference to your borrowing costs.

“Central banks have been deliberately distorting the price of risk. If the price is distorted, people will demand too much or too little of it.

“You potentially store up risk for somewhere down the track. That’s the concern – how many cans have we kicked down the road and how much road is left?”

Rosie Collins, an economist at Sense Partners, said while housing was even more unaffordable now than it had been before the global financial crisis, there had been a number of predictions of a house price crash that had not proven true.

“[After a] more than 30 per cent increase in prices in the last year, the risk of a correction may be high, but do we believe these forecasts any more?

”The Reserve Bank is tightening lending conditions, this could stop people borrowing more and more to pay more and more. But very few will be forced to sell at current very low interest rates and very low unemployment. There is no catalyst. Unlike the global financial crisis, the pandemic has loosened the fiscal policy tap. Governments are more comfortable spending than before. If we start to freefall towards doom, fiscal policy is a proven antidote. Just look at how wage subsidies have protected business failures and unemployment so far.”