Gareth Morgan on NZ Property

Interesting article today in the NZ Herald by Gareth Morgan, particularly in light of my observations yesterday about NZ property prices…

He expresses the view that the recent collapse of South Canterbury Finance is a reflection in part of the moral hazard created by the deposit guarantee scheme that the Government put in place in the wake of the global financial crisis. He believes that this encouraged further recklessness by SCF in the way it invested its funds, on top of its general disregard for sensible lending standards.

However more broadly he suggests that the Government, through the Reserve Bank, has been distorting property prices over many years by directing banks to favor property over other forms of lending (it turns out this is true – see documents here on the RBNZ’s capital adequacy framework). He says,

The net result is a landscape littered with half-baked hotel, apartment and vineyard developments, a rising count of empty buildings as tenants signal they cannot afford yesterday’s rent rates and a mass of residential property owner-occupiers in denial about the real value of their houses.

If they were to try to trade their houses to the extent they would have just two years ago, they’d find out they are worth 20 per cent less. When you’re geared to the gunnels, that reality doesn’t bear facing.

He believes this has created both a drag on NZ’s overall economic performance and a more specific danger of a future property market meltdown…

Reserve Bank prudential policy, wherein it has directed lending institutions to favour lending on property over all other forms of lending – in a jurisdiction where there is no tax on capital gains – has been the poison pill that has contaminated New Zealand’s economic prospects…

… If New Zealand is going to go forward in any sort of sustainable way after this meltdown of asset prices that still threatens, then the rules governing our financial sector must align with the goal of sustainable economic growth.

His arguments seem pretty sound and at least consistent with my own observations about property prices in NZ. However it would be good if there were some independent way to measure the magnitude of the impact that the Reserve Bank’s capital adequacy regime has on investing behavior. I can’t help wondering if there may be other factors at work besides this alone. The development of real wealth-creating businesses requires people with sound business ideas and skills looking for capital, not just people willing to lend. I don’t know, but maybe there is a deficit there as well.

In any case, it is tremendously disappointing that there isn’t a more vigorous economy in NZ and it would be sad if it takes a serious crisis to convince people that there is a problem. Although Morgan suggests that that is what may lie ahead, he doesn’t say what might trigger such an outcome.

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