Reader mailbag: LVR edition

By Eric Crampton 22/08/2013

A loyal reader writes, and I anonymise:

My [partner] is a [high ranking title] at [large professional services firm] and over drinks last night the young [professionals in this industry] (under 28, mostly single,
still have student loans, gross income btw 60k and 90k, most 2/3 years’
experience max) were crapping themselves re the RB’s loan
restrictions…really pissed about it. Most had planned to buy modest
apartments this year using KS… centrally imposed adverse selection bars have
costs! I said to go to Mum/Dad and/or finance houses, get a mortgage and then fold
the other debt into after a year … impossible to police?

Yes, it is impossible to police. And that’s a feature rather than a bug, if the point of the Loan-to-Value Ratio regulations is to increase the amount of collateral standing behind each home loan and thereby reduce systematic risk that could come from a housing downturn. If every one of these young professionals gets their parents to take on some of their mortgage risk by backing it with their own homes, which is effectively what they’d be doing if the parents take out a mortgage to front a 20% deposit, then the kids are less likely to default on the loan to the bank in case of downturn, though they may default on Mom and Dad, and the parents may be on the hook for some unexpected mortgage costs. But that has lower systemic risk. RBNZ noted it in their initial paper too: these workarounds are hardly unanticipated, and I don’t think they’re unwelcome. They work around the regulations in ways consistent with what the regulation should be trying to achieve.

My correspondent wonders further about effects where some young professionals have recourse to Mom and Dad and others only to the finance companies. I expect here that it has strong equity effects, but the efficiency effects still work in the right direction. Borrowers on the secondary loan market will be paying higher interest rates and so we still see a reduction in demand for highly leveraged loans at the margin. The ones most hurt by the regulations are indeed the ones with least access to family or other capital. But equity isn’t RBNZ’s job, and those would be the riskiest borrowers in any case – the ones that RBNZ is deliberately trying to knock out of the market.

The bigger problem is the one Matt Nolan points to: RBNZ is grasping at all kinds of justifications for its regulations, and some of them either are way outside of anything RBNZ should be doing, or just don’t make any darned sense. I can see some kind of case for it on systemic risk, but I would bet against the regs being justifiable on that basis. Default and bailout risk under OBR is lower than it was prior to OBR. And RBNZ simply should never ever be in the business of trying to protect investors from the risk that their investment might decrease in value. They don’t have that kind of crystal ball.

And if the regs don’t make sense on a reasonable rationale, we might start worrying rather more about the equity considerations.