Stein’s law says that if something cannot go on forever, it wont. But does a speculative bubble matter? The cryptocurrency bubble can be left to itself (tax evasion and criminal transactions aside). Why shouldn’t we do the same for housing?
There are two general reasons why we should be concerned with a house price bubble. The first, is that, dangerously, housing is currently in the middle of a Minsky speculative bubble. How close we are to the ‘Minsky Moment’ and the crash which follows one can never tell. But when a market goes into the downer it is likely to cause great distress to people and to the financial system. (Recall what happened in the US in 2008.) The second Stein’s law is the longer it goes on the more people who suffer when it stops. The sooner we ease out of the bubble, the less distressing it will be in the long run.
The second is that rising house prices compound economic inequality, especially against those who do not own their own homes. This column deals only with the dangers of a speculative bubble. The distributional issue belongs to another column, although it is kept in mind here.
Perhaps there is a third reason. Should public policy actively promote a speculative bubble in housing? It does in at least two ways.
First, the tax system favours speculation in housing over other sorts of investments. The story is complicated and various powerful resolutions, such as a comprehensive capital gains tax, have been ruled out. Recall that the Key-English Government tightened up on some of the loopholes in housing-investor tax avoidance in its first term and later introduced a limited ‘brightline’ capital gains tax for rapid housing turnover. Do not be surprised if this government removes more loopholes.
The second promotion of the speculative bubble is the way we report house price changes. Understandably real estate agents choose the statistic which encourages speculation. Thus, the current focus on the national median selling price up by 19.8% in October compared to a year earlier. However, the Real Estate Institute (REINZ) also publishes a House Price Index (HPI), which covers the price of all houses and not just those sold. It increased by 13.5% in the same period, less – but still high. The selection of houses being sold is different from the total housing stock and, not surprisingly, what is sold experiences bigger price increases than average
We need an official House Price Index. A decade ago the government turned down a proposal for Statistics New Zealand to construct one. (As usual, the government showed little foresight of impending policy challenges. We also need an official Housing Affordability Index which recognises that the cost of unit debt servicing has fallen with lower interest rates.) It would still show sharply rising house prices but be authoritative. In the interim we need to focus on the REINZ HPI. The difference will become critical as housing prices stabilise. Perhaps there should be a specific reference to housing price stability in the next Policy Targets Agreement between the Minister of Finance and the Governor of the Reserve Bank.
But how to stabilise them? Removing tax loopholes and reducing the hyping of the market is a start. But the key mechanism in a Minsky bubble is leveraged borrowing for speculation. That causes the greatest havoc when the bubble pops. On the other hand, borrowing for own-homing against one’s future earnings makes sense.
So the new LVR restrictions need to reduce the amount of highly leveraged borrowing within the housing market by requiring an increasing share of homeowner equity for mortgages beyond particular thresholds: for instance 20% equity required for borrowing up to $800,000 (that is, for houses below $1m), and 40% equity for any borrowing beyond $800,000. The immediate effect would be to continue to assist first home buyers, while reducing overall leverage in the housing market. The longer term effect would have price rises at the top of the market curbed (and that would reduce them in the middle of the market, again favouring first-time purchasers).
Meanwhile, we need to increase housing supply. In the last three years, the government has been building up capacity to do this.
For instance, underutilised suburban land could be unlocked by charging rates on the basis of it being fully developed. It would avoid the opprobrium of the central government raising taxes; it should simply facilitate local government doing so; while it would be voluntary on their part, few will not seize the opportunity, given their desperate needs (including upgrading failing parts).
Another opportunity arises from the shift to working-at-home. That will release office space in CBDs (some cities are expecting 40 percent reductions in demand). Why not convert the surplus office space into accommodation? While much will be done by private initiative, speeding up the transition requires an active government housing agency, especially targeting suitable accommodation for those in housing need.
The above measures targeted against speculation will check house price rises in the short run (say, by the end of 2021) and the supply initiatives will reinforce them in the medium run.
However, in the longer run the house price inflation will return unless investors’ financial holdings (savings) can be channelled elsewhere. Investors invest in housing because they think that will give them the best return on their savings. Today nominal interest rates are likely to be below inflation for some time in the future.
The danger is that if investors are discouraged from investing in housing, they will invest in even less-productive speculative schemes (as they did in finance companies in the first decade of this century and in cryptocurrencies in the second). Unless they are leveraged investing, there is not the same issue of financial stability but it is wastes the economy’s savings.
Can we offer new investment opportunities, to encourage them to use their savings more productively for them and the economy? The obvious need for younger investors is to save more for retirement (especially if interest rates are going to be low).
One possibility would be an EET retirement scheme, that is, Exempt deposits in the scheme, Exempt returns to savings in the scheme and Tax withdrawals from the scheme. This is the opposite of the Kiwisaver scheme which is TTE (tax, tax, exempt). So the investor gets the benefits from day one. Put $10,000 in the scheme and you get the benefits of reduced income tax as soon as you invest in the scheme.
Introducing an EET is fiscally tricky. But insofar as it encourages savings it will benefit the economy and take the pressure off the housing market. Mind you, it is not leveraged investment so the return will not be higher, nor will there be a resulting crash and losses.
If we cannot find better investments for ordinary people, we can only stabilise house prices temporarily and do little for those with inadequate accommodation.
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