Solving the world’s housing bubbles — the Kiwi way?

As the world’s biggest economies search for ways to let the air out of giant asset bubbles, they might find some answers in tiny New Zealand.

Fittingly, the nation that begins the developed world’s day and the central bank that pioneered inflation targeting will probably be the first to raise short-term interest rates. The move could come next year as growth returns to levels seen before the collapse of Lehman Brothers in 2008. But something far more interesting is afoot at the Reserve Bank of New Zealand’s headquarters in Wellington.

Faced with a scary housing bubble not terribly unlike that in the United States five years back, Governor Graeme Wheeler should be tapping the brakes now, and hard, or so holds classical monetary theory. Doing so, however, would jeopardise the nation’s 2.5 per cent growth amid global uncertainty. Instead, Mr Wheeler is conducting an experiment: Limits on leveraged lending.

The idea, says economist Stephen Koukoulas, is to “contain the house-price bubble without inflicting collateral damage to the rest of the economy”. Mr Koukoulas was an economic adviser to Ms Julia Gillard, Australia’s Prime Minister until June. And it is significant that he is recommending that Australia’s much larger economy emulate New Zealand’s experiment.

What about the rest of Asia, including China, home to some of the biggest property bubbles in modern history?

CRISIS LESSONS

If the world learned anything from the crises of the last 20 years — from Latin America to Asia to North America to Europe — it is the folly of one-size-fits-all remedies. But the mechanics of monetary policy are rapidly changing. Now that central banks have cut rates to zero, they are loath to use them to address bubbles for fear of wrecking the broader economy. In the best of times, monetary policy is a blunt instrument. Today’s uncertain times require more of a scalpel — something that the wonkish among us call “macroprudential policies”.

“The neoclassical synthesis, the idea that we can use monetary and fiscal policy to make the world safe for laissez-faire everywhere else, has failed the test,” Nobel laureate Paul Krugman wrote on his blog last month. “What does this mean? At the very least, it means that we need macroprudential policies — regulations and taxes designed to limit the risk of crisis — even during good years, because we now know that we can’t count on an effective clean-up when crisis strikes.

“And I don’t just mean banking regulation. The logic of this argument calls for policies that discourage leverage in general, capital controls to limit foreign borrowing, and more.”

The International Monetary Fund made such an argument in a report last week, and New Zealand is a case in point. In May, the Organization for Economic Co-operation and Development said Kiwi homes were the fourth most overvalued in the developed world, behind Belgium, Norway and Canada.

True, Canada — along with Israel, Singapore and South Korea — has tried its hands at macroprudential tweaks, but with limited success. New Zealand’s are taking the form of a “10/80 rule”, whereby only 10 per cent of new mortgages underwritten can have loan-to-valuation ratios of more than 80 per cent. The measures are designed to cap household debt as much as head off an asset bubble.

This general idea — clamping down on low-deposit borrowers — may be applicable elsewhere. Had Spain taken such creative steps in the mid-2000s, it might have avoided a crash. Recent history in the US would have been very different with a 10/80 rule. It would be harder, meanwhile, for Chinese families to buy a second or third property in Shanghai, Singapore or Sydney.

New Zealand is pushing the envelope by making penalties harsh: Banks will lose their licences if they skirt lending rules that go into effect on Oct 1. That already has the industry policing itself. A similar dynamic could well end Wall Street’s too-big-to-fail gravy train. Mandating firm limits on banks’ leverage ratios would do more than anything else to keep 2008 from happening again.

Imagine if Hong Kong unveiled such measures to puncture its swelling housing bubble. Or, if the Bank of Thailand could head off its own in Bangkok.

And what of China? Its challenge is less about low-deposit borrowers than cash-rich ones loading up on speculative investments. Higher People’s Bank of China rates and administrative steps have lost their potency. Imposing specific and strict limits on speculation — with higher taxes, if necessary — might do the job.

Asian policymakers also need to think creatively. China gets 90 per cent of its milk from New Zealand. It might want to start importing banking ideas from the place, too. BLOOMBERG

ABOUT THE AUTHOR:

Tokyo-based William Pesek won the 2010 Society of American Business Editors and Writers prize for commentary.