The GFC has been one of the largest macroeconomic events in the past 70 years. Policy lessons are now being drawn and policy paradigms adjusted as a result of that experience. While much of this remains a work-in-progress, some of the issues and new policy directions are already becoming reasonably clear.
House price inflation and leverage
One of the main lessons from the crisis has been that asset price inflation, including house price inflation, matters, particularly if financed by credit (ie, monetary) expansion. While the experiences of the last decade – both the ‘dot.com’ bubble and subsequent house price boom – are consistent with the view that asset price inflation cannot permanently stray from well-anchored CPI inflation, there is now a better appreciation of the macroeconomic consequences that can result if re-anchoring involves significant de-leveraging. Indeed, the fallout from the GFC has seen a number of OECD economies thrown into severe recessions as a result of banking failures and credit lines being cut.
This brings developments in credit markets, and asset prices, squarely back into the policy frame. While there is little policy desire for a return to the money and credit targeting regimes of the 1970s, there is renewed appreciation of how shifts in financial risk appetite can be a driver of credit expansion (and contraction) and a channel of influence on the macro-economy, particularly on asset prices.
Prior to the GFC, the incentives and disciplines imposed by stakeholders on financial institutions (shareholders, bondholders and depositors), combined with supervisory oversight, were considered sufficient to keep lending institutions’ risk appetites reasonably well anchored. This did not mean that individual banks could not or would not over-reach, but it was thought that incentives were such that bank failures would be only isolated events, attributable to circumstances idiosyncratic to the individual banks involved.
This view, however, is now being re-evaluated, in the wake of the GFC. Greater recognition is now being given to how systemic shifts in lending risk appetites can under-cut, possibly at times even overwhelm, what the central bank is doing with its monetary policy rate. That is reflected in the reforms now emanating from the crisis, important elements of which involve strengthening the policy framework in ways that it is hoped will better anchor risk-taking, system-wide.
Against this backdrop, the boom and bust in housing markets in the 2000s can be seen more as a symptom than a cause of the ensuing macro-instability. The roots of the GFC crisis were mostly in the financial, rather than in the housing, market. While the effects on housing markets have been considerable, the effects mostly are cyclical in nature. House prices in many countries rose to unprecedented levels, but have since turned down.
In that sense, the effects on housing affordability of the financial turbulence of the 2000s – the run-up to the GFC and the subsequent collapse – can be viewed as temporary (although less so for those who bought near the peak, particularly if they over-stretched themselves). Nonetheless, ‘temporary’ can stretch to quite a long run of years. Whereas in some countries the adjustment in house prices back to more ‘normal’ levels has been quite rapid, in New Zealand house prices remain well above historic norms. By how much and
how quickly they adjust from here will depend on both macro-economic factors and the extent to which structural impediments to adjustment can be eased. The latter is discussed elsewhere in this report.
Global integration
A second feature of the GFC has been the extent to which it has been global. To be sure, different
countries and regions have been affected in different ways. But it is no coincidence that housing booms and busts occurred more or less simultaneously across a number of OECD countries. As outlined in Chapter 2, a set of global influences, including both commonality in policy frameworks and global financial linkages, have played a role. This reflects a world that is becoming increasingly globally integrated. Even housing markets, which might have been thought of as falling on the ‘non-tradable’ side of the ‘tradables/non- tradable’ divide, are globally connected, particularly if global trade is taken to include trade in capital.
Housing and macro-stability: important interdependencies
Finally, the events of the past few years have highlighted important interdependencies between housing and the macro-economy. As discussed above, these run in both directions: macro-stability matters for how effectively the housing sector meets the housing needs of the community; and developments in the housing sector have an important influence on the economy as a whole.
With the benefit of hindsight, the macro conditions in the few years running up to the GFC, at least from the perspective of the housing sector, were not as ‘moderate’ as implied by the description of this period as ‘the great moderation’. What does this imply about the way policy might have been managed differently, if policy makers could have known then what they know now? Such an examination needs to consider how the housing sector itself contributed to the ensuing instability. Specific points in that connection include:
Home lending is not necessarily ‘as safe as houses’. Prudential regulations and practices that assume otherwise can be, and in some countries were, more a source of instability than stability. There is a need for policy regimes to always be alert to how markets and practices are changing in ways that are not anticipated.
Similarly, subsidies and assistance for housing may end up not helping, but instead hurting, those they are intended to help. If widely available, and therefore not well-targeted, subsidies tend to be
capitalised into house prices and improve the welfare of people that already own houses as much, if not more, than new entrants.
It is also evident that the house sector more generally was one of the main engines of the pre-crisis expansion: credit was the fuel, and much of that fuel was channelled into, or via, the housing sector. The scale of housing equity withdrawal was one manifestation of the impetus that the housing sector was delivering to the macro-economy. That points to macro policy makers – monetary, prudential and/or fiscal – needing to keep a weather eye on the housing market, as much as a driver, as a potential casualty of macro-economic instability.
The role of housing supply
Housing markets that show large variations in prices can complicate macro-economic and financial management. The Reserve Bank of New Zealand suggests that it is well‐established in the international literature that different housing supply regimes go a long way to explaining differences in cyclical house price behaviour, and that given that the demand for houses can change quickly:
…it is important that the supply of houses quickly responds to changes in demand. Supply response moderates potentially damaging swings in house prices. Policy can have an influence on housing market outcomes through a variety of channels, in particular over the longer‐term, by helping ensure that the regulatory regime facilitates the ready adjustment of supply to demand. (sub. 37, p.1)
The Reserve Bank encourages the Commission to focus on a policy framework so that supply is more responsive to price signals.
This focus is supported by two recent studies that used US data to investigate the relationship between land supply and macroeconomic variables such as interest rates and income growth. Huang and Tang
(2011) in a study of 300 US cities showed that more restrictive residential land use regulations and geographic land constraints are linked to larger booms and busts in housing prices. Further, natural and man-made constraints also amplified price responses to the subprime mortgage credit expansion during the decade, leading to greater price increases in the boom and subsequently bigger losses.
Evans and Guthrie (forthcoming) in a study of 95 US cities show that in those cities that had an unconstrained supply of land, price movements can be explained by ‘fundamentals’ such as income, interest rates and construction costs. In cities where development opportunities are constrained, small changes in expectations regarding long-run average income growth rates and real interest rates can generate very large price movements.
These studies highlight the sensitivity of house prices and rents to incomes and interest rates where land is constrained. They imply that imposed limits on land use can accelerate price increases when there are changes in interest rates and income growth rates.
Concluding observation
Insights into house price cycles can be gained from analysing global as well as New Zealand-specific factors. It is difficult even with the benefit of hindsight to untangle the causes of movements in house prices and the relative contributions of the ‘fundamentals’ on the demand and supply-side of housing markets. Both, however, are likely to matter. Subsequent chapters move away from macroeconomics, to explore how urban land use planning, infrastructure charging and characteristics of the building industry affect the responsiveness of the supply side of housing markets (and hence the nature of house price cycles) and identify ways to improve responsiveness.
4 Housing affordability: distribution and
trends
4.1 Introduction
This chapter considers how the broad price trends outlined in Chapter 2 have affected the affordability of housing for home buyers and renters. It also outlines differences in affordability across regions and income levels. The chapter considers four questions:
Why does housing affordability matter?
How has housing affordability changed for potential home buyers?
How has affordability changed for renters?
What conclusions can be drawn about affordability?