Our housing market is too big to fail

Bernard Hickey writes the Covid-19 crisis has again proven there’s one type of asset that New Zealanders know in their bones is too big and important to be allowed to crash: housing

Yet again, the housing market has outperformed all the understandably doomy and gloomy predictions of double-digit falls in the face of the worst economic crisis the world has seen since World War II.

Economists from various banks forecast house price deflation of 10-30 percent during the worst of the lockdown in April and May, back when house sales volumes collapsed and unemployment was tipped to surge towards 15 percent. It seemed a sensible thing to say, given New Zealand’s housing market is the best performing in the western world in the last 30 years, relative to incomes, rents and after the effects of inflation are stripped out. Prices have quadrupled in real terms since 1980, and have tripled relative to incomes in the biggest cities.

By most measures, our houses are insanely and impossibly inflated, just waiting for a mere scratch to burst the bubble and send prices 30 to 50 percent lower. That’s what happens in ‘normal’ markets where supply and demand respond to prices to achieve something sensible. Usually, when an asset market is “irrationally exuberant,” as the former Federal Reserve Chairman Alan Greenspan termed it, there is some shift in supply or demand, or some external shock, that punctures the collective delusion and the market returns to equilibrium.

Just as in 2008/09 when the Global Financial Crisis dragged the international financial system to within 24 hours of total collapse, many thought the shock of Covid-19 would be the moment of clarity and reality that brought house prices down to earth, or at least somewhere below earth orbit and into the stratosphere. All the stars seemed to align. Not only was Covid-19 supposed to be a shock to incomes of owners and tenants, but a shock to the banks lending the five-to-seven times income to rental property investors and first time home buyers. In a market pumped up by bank leverage, surely the withdrawal of the easy money would do the trick, many thought, including one or two bank economists.

More reasons to fall

But wait, there’s more in the demand shock list. There’s the collapse of our migration and educational industrial complex with the border closures that are likely to see our biggest migrant pools of India, China, the Philippines and Europe inaccessible for years to come. For more than a decade, New Zealand has relied on bringing in hundreds of thousands of cheap temporary workers and working more people harder for longer hours to grow total GDP faster than most of our peers. We didn’t improve output per hour: we just had more people working many more hours. We had had the fastest population growth in the OECD for most of the last decade, fuelled by international students and temporary work visa holders coming here for cheap education and the vaguely and not-so-vaguely dangled prospect of permanent residency.

Just before the lockdown began on March 25, New Zealand had over 340,000 non-residents here as students and travellers with work rights and workers with ‘high skilled’ temporary work visas. Most were working as kitchen hands, shelf stackers, dairy farm labourers, liquor store attendants, service station attendants, help-desk operators and in construction. Most hoped to win permanent residency, albeit with a rapidly reducing likelihood and a fast-rising waiting queue.

That’s because both the National-led and Labour-led Governments had quietly reduced that residency quota by 20 percent, even though the number of temporary workers with residency hopes had more than tripled. Many of these workers were exploited by employers owning their visas and with the power to write (or withhold) the all-important letter to Immigration NZ attesting to their very high skills as retail and hospitality managers.

It was a perfect situation for landlords, homeowners, universities, polytechs, employers and the IRD. The students and temporary workers paid income tax and GST, they provided a ready and cheap supply of very willing and often talented workers. They also created a new supply of tenants to keep rents high and to put constant downward pressure on both wages and interest rates. Falling interest rates, low wage growth, rising rents and fast population growth was more than enough to outpace any new housing supply coming on the market, which was often in the wrong place and of the wrong size: McMansions in the suburbs rather than apartments and flats in Auckland, Wellington, Christchurch and Queenstown.

This influx of guest workers also worked perfectly in tandem with the growth in the tourism and hospitality sectors, with many tourists turning into bar workers and baristas to keep rents high and wages low. Some were also used or chose to invest freshly printed money from China, Europe and the United States in assets perceived as legally and politically safer: ie two-bedroom brick and tile flats in Pakuranga. Now this influx of tourists, students, temporary workers and money-laundering visitors has stopped dead.

There was also a lot of talk in the worst of the lockdown and for much of the last three years that an activist Labour-led Government, just like the first one elected in 1935, would massively increase housing supply at the lower end through Kainga Ora or Kiwibuild, thus providing a supply shock to add to the two demand shocks.

Yet here we are in late August, with house sales volumes only barely below pre-Covid levels and the best measure of house prices showing they fell just 2.4 percent nationally between a record high in March and a trough in May. Prices bounced back to January levels in June and July. ASB's economists lowered their forecast for a fall in prices from six percent to 2.8 percent by March next year.

Why no crash?

So why didn’t the housing market crash? Put simply, it’s too big to fail and everyone knows it, and can bet on this market being the first to get bailed out by the Government specifically, and voters more generally. Just as it did during the GFC, the Reserve Bank extended emergency credit lines to banks and slashed interest rates to support both the financial system and the economy.

Almost automatically, that made housing more valuable, given home buyers can borrow more to increase the offer price and rental property investors can make bigger profits, given rents have kept rising almost everywhere (except Queenstown).

The Government and the banks then agreed to a six-month residential mortgage deferral scheme in late March, which nearly 60,000 borrowers used to delay payments on $20.2 billion worth of mortgages. The Reserve Bank also immediately removed restrictions on high loan-to-value ratio lending and postponed plans to force banks to hold more capital. Then it pledged not to introduce negative interest rates before March 2021 because it would have been too painful for the banks. This month it went further and said it was planning to print money and lend it to banks at negative interest rates, which would allow fixed mortgage rates to fall as low as 1.5 percent early next year. The Reserve Bank's own studies show that could pump another 20-30 percent into house prices.

These actions were much faster and more sweeping than the Government’s support in other areas such as tourism, international education and migration. Why so sensitive? Our banks are not-so-much banks in the traditional sense as mortgage books with bits added on. More than two-thirds of bank lending is in mortgages, much higher than it used to be and much higher than in other countries. Our banks are also much more important to the overall economy than in other countries, with bank assets worth 160 percent of GDP and three times larger than the stock market.

A housing market with bits tacked on

House prices are also much more than just another asset price. Our houses are worth $1.3 trillion collectively and represent more than two-thirds of household wealth. They also provide ready funding for most small businesses. When house prices fall, spenders close their wallets and many small businesses stop hiring.

Now economists are forecasting falls of no more than five percent and property owners can look forward to ever-lower interest rates to bolster values. The massive state house building plans have never eventuated and Prime Minister Jacinda Ardern has pledged again not to introduce a capital gains tax because she knows older property owners vote at much higher rates than younger renters.

This market is too big to fail and the Government just demonstrated yet again that betting on the bailout pays off.

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