Household debt in New Zealand is now equivalent to 163% of annual household disposable income – see graph below. Record low interest rates has seen credit growth rising at a pace not seen since 2008. How do low interest rates contribute to this?
Household debt as a share of disposable income (including investment housing)
Low borrowing rates have made it easier to purchase property with bank funds especially as the supply of housing hasn’t matched the increase in demand. The strong growth in property prices has meant that those who already own a house are using that security to purchase additional property. According to the IMF New Zealand has the highest ‘House Price-to-Income Ratio’ – see graph below.
Other parts of the world are experiencing high household-debt to income levels (see graph below) but does high debt levels mean that the economy is going to hit a major recession? Since the credit crisis of 2008 the global financial system has seen tighter regulations put in place to improve stability with banks limiting access to credit so there is less exposure to the risks associated with highly leverage lending.
Growth in house prices and household credit 2011 – 2015.
However debt servicing remains tolerable with low interest rates and much of the debt secured against investment housing. Also debt-to-asset ratios have fallen to levels that were experienced in 2007 but this has eventuated from low interest rates which have boosted house prices. Ultimately with a fall in house prices, and depending on its severity, those who recently entered the property market would suffer some degree of hardship whilst those already well established in the market might have a financial buffer.
Debt and future growth in New Zealand
Household debt still has implications for the long-term growth of the economy.
- With larger proportions of their income being allocated to debt consumers have less disposable income for other goods and services which creates less aggregate demand.
- High debt levels mean households have more exposure to unfavorable economic conditions that could lead to rising unemployment. In this case they have less money to fall back on.
Source: Westpac Economics Overview – August 2016
There has been a lot of talk in the media about an Auckland housing bubble and its impact on the New Zealand economy. Below is a very informative graph I got from http://www.housepricecrash.co.uk which looks at the anatomy of a bubble.
When house prices are increasing rapidly we tend to feel better off but also have increased mortgage debt. House price inflation is a zero-sum game in that society as a whole does not benefit from a rise in house prices as those on the property ladder can only gain at the expense of prospective homeowners that cannot afford to enter the market. Over a short period of time house price inflation can provide a boost to economic growth if they deceive people into believing they are wealthier.
However, when a business invests it tends to have a positive-sum game in that if it employs 50 more workers that doesn’t mean that there are 50 other workers in the economy that are going to lose their jobs. This is real GDP growth rather than investing in property which tends not to generate growth as it is a finished asset – however some will argue that maintenance will always be needed.
Brian Gaynor wrote a piece in the NZ Herald comparing features of the Irish and New Zealand economies. One area that he focused on was the increase in residential property prices from 1995 – 2015.
Ireland – 199%
New Zealand – 232%
Although New Zealand house prices have been increased by a larger percentage it is interesting to note that they have been relatively steady whereas Irish prices peaked in mid-2007 and then plunged 50% by early 2013. Since then they have recovered 31% but are still 35% below their highs in 2007.
Dublin house prices (average) – 2007 = $730,000 2015 = $485,000
Auckland house prices (average) – 2015 = $771,000
LTV – Loan to Value
Like the RBNZ the Irish central bank has introduced new regulations regarding mortgage lending by regulated financial services providers. These included mortgages of no more than 80 per cent of LTV (loan to value) on the principal private dwelling and no more than 70 per cent LTV on investment properties. Additionally mortgage loans on the principal private dwelling are restricted to 3.5 times gross income in Ireland but this ratio in New Zealand is 6 times although 9 times gross income in Auckland.
The two countries tax policy are interesting when you compare how they impact companies and individuals. The message for the New Zealand economy is that the experience of the Irish economy shows that countries take a long time to recover from the impact of housing collapse.
An interesting paper* by the Harvard Economics Department looked at the Danish mortgage market and the fact that people tend to ignore the chance to save money when they can refinance their mortgage at any time without incurring a penalty. They identify those that are attentive to mortgage market changes and refinance their mortgage as ‘levelheads’. On the contrary those that are inattentive and experience inertia are seen as ‘woodheads’
The researchers found that many household characteristics move inertia and inattention in the same direction, so these attributes are positively correlated across households. Younger, better educated, and higher-income households have less inertia and less inattention. Almost three times as many homeowners refinanced in 2010, after rates had fallen sharply, than in 2011 when interest rates briefly spiked higher again. But woodheads were prevalent in 2010 as only 44% of those with a mortgage rate of more than 6% refinanced their loans even though rates of nearly 4% were available. On average woodsheds paid an extra 1.5% of interest as a result of their lethargic attitude.
The figure below illustrates the history of refinancing activity in our sample of Danish fixed-rate mortgages. In each plot, the bars (left vertical axis) represent the number of refinancing households, while the solid line (right vertical axis) shows the history of the mortgage interest rate. The top panel shades each of the bars according to the coupon rate on the old mortgage from which households refinance. The bottom panel shades each of the bars according to the coupon rate on the new mortgage into which households refinance.
*“Inattention and Inertia in Household Finance: Evidence from the Danish Mortgage Market” by Andersen S, Campbell JY, Meisner-Nielsen K, Ramadorai T. 2015
Here is a graphic from The Economist showing the least affordable houses globally.The Survey from Demographia ranks urban housing markets into four categories based on their Median Multiple, from “Affordable” (3.0 or less) to “Severely Unaffordable” (5.1 & Over)
Severely unaffordable markets are also more attractive to buyers seeking extraordinary returns on investment and short term profits. This further raises prices in markets where urban fringe development is largely prohibited by urban containment’s land rationing policies. Substantial international investor activity has been reported in London, Vancouver, the US West Coast markets of Vancouver, Seattle, the San Francisco Bay Area, Los Angeles and San Diego and others. These price increases make such metropolitan areas less livable for average and lower income households.
The key to preserving housing affordability is a “competitive land supply,” which appears to be incompatible with urban containment policy both in economic theory and practice. Further, out-of-control house price escalation destabilizes economies, retarding metropolitan area economic growth and job creation.
The distribution of housing affordability in the 85 major metropolitan markets (those with more than 1,000,000 residents) has deteriorated over the past year – see graphs.
Hong Kong is least affordable followed by Australia and New Zealand.
Hong Kong – least affordable, with a Median Multiple of 14.9
Auckland – Multiple of 8.4
London – Multiple of 7.3
Source: 10th Annual Demographia International Housing Affordability: Survey: 2014
New Zealand households have gone through a period of deleveraging since the GFC in 2007 in which borrowing against the house has dropped significantly. Consequently household savings has gone up. However the increase in household debt from 2000 to 2007 was rapid and is forecast to increase further especially with house price inflation on the rise. But this house inflation doesn’t correlate to the economic conditions of the country and RBNZ Governor can be justified in saying that house prices are over-valued. Graph below from the BNZ Economy Watch.