Saturday, 16 July 2016

Another Asset Bubble Blowing Up

The "Free Lunch" of Endless Rising Debt

Behavioural economics is an interesting branch of the "dismal science".  It focuses upon how individual human beings make decisions about money, finance, assets, wealth, and so forth.  Oftentimes decision making is contrary to common sense--even verging on the irrational.

In New Zealand we are heading into a phase when irrational exuberance has taken over the financial decision making of many households.  It centres upon debt, household debt.  People are borrowing irrational amounts of money to fund house purchases and their lifestyles.  Debt can be like an increasing addiction to any recreational drug.  One gets away with it the first time--that is, one enjoys a reasonably pleasant experience with no long lasting damage.  The next time is easier, less resistance.  Before long, one cannot live without it.  Addiction sets in.  Decision making at that point become irrational.

New Zealand households are increasingly sitting on a mountain of debt.
New Zealand is sitting on a half-a-trillion-dollar debt bomb and Kiwis are increasingly treating their houses like cash machines, piling on the debt as they watch the value of their properties soar. Reserve Bank figures show household debt, excluding investment property, has risen 23 per cent in the past five years to $163.4 billion. Incomes have risen only 11.5 per cent.  Households are now carrying a debt level that is equivalent to 162 per cent of their annual disposable income - higher than the level reached before the global financial crisis. [NZ Herald]
House owners are taking on more and more debt, using their flexible mortgage facilities like a bank overdraft, secured against their houses.  But it feels secure and riskless because the value of their properties keeps rising.  And one of the reasons--a critical reason--why house prices keep rising is because people expect them to.  And since the "market" expects house prices to continue rising, they indeed do.  People are prepared to pay more for them, because they are "safe" investments.  What you pay for a house today will be of little moment when the value of the house will have risen by around twenty percent within twelve months.

Households are now atop a mountain of debt.  NZ businesses, thankfully, are far more conservatively geared.  Who or what is to blame?  We believe this time around the Reserve Bank is largely responsible.  It has kept interest rates unbelievably low, which encourages households to increase their borrowing. Since the price of money is is now exorbitantly low the demand for it has risen.  It's like a fix of crystal meth being priced at fifty cents.  Thus priced, the demand for the deadly drug would rise exponentially.  And so, what's a little more household debt?  It's cheap.  We can handle it.

A second failure of the RB has been to continue to allow banks to treat household debt as a near to riskless asset.  There are few, if any, limitations upon banks lending to infinity as long as it is secured by residential houses.  This is madness.  Houses are risky assets.  Ask anyone in Spain or Ireland.  The RB could and ought to solve this overnight, by requiring banks to have more capital to reserve against their massive increases in household lending.

By holding interest rates at historic lows to fight inflation, coupled with the RB's belief that debt secured by residential houses is virtually risk free, it has both caused and created one of the largest asset bubbles in New Zealand history.  In order to fight deflation, it has stimulated reckless asset inflation in housing.

In summary, New Zealand is in the middle of a housing asset bubble.  Its cause is artificial.  It rests, squarely, on the myopic policies of Reserve Bank which has convinced itself that the greatest risk facing mankind is deflation.  Fighting deflation has led to the perverse situation where the Reserve Bank will end up substantially responsible for one of the most speculative asset-inflation bubbles in our history.

When the bubble bursts, consumer demand will shrink faster than a punctured balloon.  Forced mortgagee sales will show their ugly faces once again.  Unemployment, recently falling, will turn a corner and increase.  The mirage of prosperity will disappear quicker than you can say "Reserve Bank".  And the daily hue and cry about a housing crisis will attenuate to a few mutters  The only constant will be the endless, boring demands upon the government to "do something".   Ah, but the Crown's balance sheet is already shot after borrowing up large to "do something" about the global financial crisis of several years ago.

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