Housing inflation distorts economy

The housing inflation of the mid-2000s represented a giant game of pass-the-parcel happily hosted...
The housing inflation of the mid-2000s represented a giant game of pass-the-parcel happily hosted by the banking and real estate sectors. Photo by ODT Files.
The last thing New Zealand needs is a resurgent housing market, writes Peter Lyons.

There are early signs of a housing market resurgence, particularly in parts of Auckland and Christchurch. Real estate pundits are suggesting this is a sign of the elusive economic recovery. Surging house prices are the last thing we need for a sustainable recovery. We appear to have learnt nothing from the past few years.

A renewal of housing inflation in certain areas is due to a convergence of events affecting both the demand and supply sides of the housing market. The Christchurch earthquake has depleted the housing stock in that city and contributed to increased migration to Auckland. Low interest rates due to the long downturn has made mortgage finance more attractive for the moment. Banks are also relaxing their lending criteria after the scare of 2008.

On the supply side, construction of new housing has been dismal over the past few years. Many construction firms have downsized or disappeared.

The availability of mezzanine finance for property development dried up following the finance company collapses. Restrictive council bylaws, zoning and consent requirements also hinder the supply of new houses.

There are key reasons why resurgence in house price inflation is the last thing our economy needs.

Reason 1: Countries become wealthier by increasing their ability to produce saleable goods and services. No country in history has become wealthy by bidding up the prices of its existing housing stock. If this is a real economic recovery, where are the new industries?

Reason 2: A large portion of our mortgage finance comes from overseas. The banking system borrows cheaply overseas and pumps this into our mortgage market. The net effect is to increase New Zealand's indebtedness to the rest of the world. Unfortunately there is no corresponding increase in our ability to repay this debt. That villa in Ponsonby or Fendalton is still the same house it was 10 years ago but now it has a large debt against it owed to overseas lenders.

Reason 3: The funds tied up in our inflated housing market could have been used to start new businesses or buy back shares in existing businesses such as the banks that we used to own.

Reason 4: House price inflation will further harm those people whose homes were destroyed by the Christchurch earthquake. It will make it harder for them to buy back into the market.

Reason 5: House price inflation will continue to magnify generational inequalities in this country. Young New Zealanders will be less able to own their own homes. Those able to buy into the market will be paying back massive mortgages over many years. This reduces their ability to save and invest in enterprises that increase New Zealand's productive capacity and earnings potential.

Reason 6: As banks and other financial institutions borrow from overseas to fund our mortgages, this drives up the value of the New Zealand dollar. This makes our export sector less competitive.

Reason 7: As we sink deeper into debt with the rest of the world, more of our productive assets such as dairy farms will be sold. Ironically, in seeking to own the expensive roofs over our heads we increase the risk of becoming tenants in our own country.

Reason 8: If house price inflation surges again, the Reserve Bank will eventually push up interest rates. As people struggle to service their mortgages this will reduce demand in other parts of the economy, leading to less employment and output.

Reason 9: The housing inflation of the mid-2000s represented a giant game of pass-the-parcel happily hosted by the banking and real estate sectors. Bidding up our existing housing stock with borrowed money does not create sustained employment or output or tax revenue or export earnings. It is an illusionary and ultimately destructive road to riches for a nation.

Reason 10: There is ample historical evidence of nations that declined because they failed to set their economic parameters correctly. Unless we sort this problem, our children and grandchildren will look back at this period in our history and reflect on how badly we got it wrong.

Peter Lyons teaches economics at Saint Peters College in Epsom and has written several economic texts.


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