(Corrects description of earthquake damage in 10th paragraph.)
Perhaps the Federal Reserve has something to learn from the central bank of New Zealand about how to manage a mortgage market. Unlike the Fed, which has been sharply criticized for having failed to keep the U.S. housing bubble from expanding, the Reserve Bank of New Zealand is sounding the alarm over rising housing prices and imposing limits on mortgages.
Risks associated with excessive increases in house prices, and the potential that the bubble might burst, have become a major threat to the country’s financial system, the Reserve Bank warns.
The New Zealand housing market is indeed heating up. Over the past year, house prices in Auckland have risen 17 percent, and in Christchurch, they’re up 8 percent. Those two markets account for half of home sales across the country.
Relative to income, New Zealand housing prices are now more than 20 percent above their historical average. International organizations such as the International Monetary Fund and the Organization for Economic Cooperation and Development share the Reserve Bank’s concerns that real estate may be overvalued.
So what is the central bank in New Zealand doing about it? In October, it put a limit on high loan-to-value mortgages. Each bank must see that no more than 10 percent of its new mortgages finance more than 80 percent of a house’s value. Before the limit took effect, such mortgages had reached 30 percent of new originations.
Such limits on high loan-to-value mortgages are becoming more common internationally; Canada, Israel, Singapore and Sweden are among the countries using them. And they have been found effective “in containing exuberant mortgage loan growth, speculative real estate transactions, and house price accelerations,” according a June 2013 IMF review of studies. During downswings, the review found, such measures can reduce “fire-sale dynamics” and loan losses.
The New Zealand restriction is a bit uncommon in that it is not absolute. (Most countries simply prohibit high loan-to-value mortgages.) Each bank can still issue some of them. Other exemptions raise the effective limit on the riskiest mortgages to 15 percent.
The restriction is expected to reduce home sales by 5 percent, according to a technical analysis from the Reserve Bank. That, in turn, will keep house prices 1 percent to 4 percent lower than they would otherwise be after two years.
This is a rather small constraint on housing prices, given how rapidly they have been rising. Nonetheless, the limit may help reduce the risks of a potential housing bubble. And the central bank itself says it is helping to avoid the alternative of raising interest rates.
The fundamental reason housing is getting so much more expensive in New Zealand is on the supply side. Earthquakes in 2010 and 2011 damaged much of the housing stock in Christchurch. In Auckland, land-use regulations -- including a zoning restriction called the Metropolitan Urban Limit -- constrain new construction. Bill English, New Zealand’s finance minister, rightly believes that these supply problems must be addressed for the housing market to stabilize.
Even so, the Reserve Bank of New Zealand deserves credit. As I learned from conversations in Wellington last week, the mortgage limits are controversial. But they seem likely to help head off a crisis or contain the damage should one occur. Think of how much better off the U.S. economy might have been if the Fed had tried that.
(Peter Orszag is vice chairman of corporate and investment banking and chairman of the financial strategy and solutions group at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration.)
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