Chinese Buyers? No, Australian Banks

The outrage, justified or otherwise, at Labour’s disclosures about Chinese buyers in the Auckland property market have distracted the critics from the main point being made. In any market, whether for property or anything else, the introduction of a major new element of demand will have an immediate impact and will drive prices upwards. And that is true, whether the new entrants are from New Zealand, outer space or elsewhere. It is not the provenance of the new buyers that matters but the fact of the increased demand.

No one disputes that overseas buyers, many from China, are now actively involved in buying Auckland property.  In the case of these buyers, their impact is increased by the fact that they are not only a new element but in many cases have greater purchasing power than local buyers, and can therefore outbid them. And because their purchases will often be made for speculative purposes, they will be more concerned with the prospective return on their investment rather than with its immediate resale value or the property’s suitability as accommodation for themselves. These factors, taken together, have pushed up prices and help to explain why Auckland’s housing crisis is one of affordability as well as of an imbalance between supply and demand

There is, however, a further issue that is almost completely overlooked. It is not just overseas buyers, Chinese or otherwise, whose purchasing power is helping to drive prices up. That factor is significant for local buyers as well. In both cases, the fact that purchasers are willing and able to enter the market and to pay the inflated prices for Auckland property is a major factor in determining the price structure in that market.

In the case of local buyers, their willingness and ability to pay the ever-increasing prices is a reflection of several factors. If they are already home-owners in Auckland, they will be able to use the inflated sale price of their existing property to finance – at least in part – the purchase of a new one. They will also have the assurance, for the time being at least, that the rise and rise in Auckland house prices and the consequently increased equity they enjoy will relieve them of any concern about the size of the debt they have to take on.

Most importantly, their purchasing power reflects their ability to access relatively cheap mortgage finance from banks that are always keen to lend. They are therefore able to go into the market armed with a purchasing power that is hugely greater than they can command for any other purpose. There is no other market where it is not only possible but commonplace to draw on a purchasing power of up to three times one’s annual income, to pay a low interest rate on such borrowing, and to enjoy what seems to be a cast-iron guarantee that the asset purchased will provide not only huge utility (in the form of accommodation) but a substantial capital gain as well.

None of this would be possible if it were not for the continued willingness of the banks to lend for house purchase. For the banks it is a no-brainer. As the Bank of England has now confirmed, banks create the money they lend out of nothing and can charge interest on the new money for as long as it exists in the form of a debt owed to them. That is where their record and increasing profits come from. It requires little effort to attract mortgage business (since there is never a shortage of potential borrowers) and it is a more low-cost, secure and relatively risk-free business than any other form of lending.

There is virtually no constraint on the volumes of new money that the banks are able to create and lend in this way. The only limitation is the availability of new borrowers with enough security and ability to service the loan – and even those constraints are eased by the asset inflation that ever-increasing lending brings about. The banks are able in other words to go on lending ever-increasing amounts into an inflating market which they themselves create.

Much of this is unfamiliar to the banks’ customers who continue to believe that the banks lend only money that is actually deposited with them by savers. But the truth of the situation – that what the banks lend has virtually nothing to do with the much smaller volume of deposits they receive – is beginning to dawn on the authorities and, in particular, on the Reserve Bank, which is why there is increasing interest in so-called macro-prudential measures designed to restrain bank lending on mortgage.

That is also why, as Professor Laurence Murphy of Auckland University points out, freeing up more land for development will do little to help. It will simply provide yet more opportunities for banks to lend larger and larger sums of newly created money and for developers to seek larger and larger profits. The affordability crisis will go on getting worse. In other words, and at the risk of accusations of xenophobia, it is not so much Chinese buyers, as Australian-owned banks, that are responsible for our housing crisis.

Bryan Gould

16 July 2015