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Thursday, Apr 19, 2018
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Maybe New Zealand has the answer to asset bubbles

TOKYO — 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 steadily returns to levels seen before the collapse of Lehman Brothers Holdings Inc. 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, Gov. Graeme Wheeler should be tapping the brakes now, and hard, or so holds classical monetary theory. Doing so, however, would jeopardize the nation’s 2.5 percent growth amid general global uncertainty. Instead, 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.” Koukoulas was an economic adviser to Julia Gillard, Australia’s prime minister until June. And it’s significant that he’s 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?

If the world learned anything from the crises of the past 20 years — from Latin America to Asia to North America to Europe — it’s the folly of one-size-fits-all remedies. Nor is there obvious utility to comparing a $160 billion first-world economy such as New Zealand’s with an $8.2 trillion developing one managed by Communist Party bureaucrats and a state-run central bank.

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 cleanup 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 a similar argument in a report last week, and New Zealand is a case in point. In May, the Organization for Economic Cooperation and Development said Kiwi homes were the fourth-most overvalued in the developed world, behind only 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 what bankers are calling a “10/80 rule,” whereby only 10 percent of new mortgages underwritten can have loan-to-valuation ratios of more than 80 percent. 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 U.S. would have been very different with a 10/80 rule. Tighter leverage requirements mean fewer high-risk mortgages for Wall Street to securitize into toxic debt instruments. 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 licenses if they skirt lending rules that go into effect on Oct. 1. That already has the industry policing itself. The New Zealand Herald reported last week that banks have “started tightening up their lending criteria” for fear of even approaching the upper limit of lending ceilings.

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 policy makers also need to think creatively. China gets 90 percent of its milk from New Zealand. It might want to start importing banking ideas from the place, too.

William Pesek is a Bloomberg View columnist.

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