The OECD finding that New Zealand houses are the most overpriced in the developed world will come as no surprise to the young couples locked out of Auckland’s housing market or to those families condemned to substandard housing conditions and high rents.

The Prime Minister, however, assures us that there is no crisis; our house prices simply reflect high levels of employment (with 6% unemployment?) and a buoyant economy (with the first glimmer of normal growth in six years?).

More thoughtful observers, however, acknowledge the damaging impact of the crisis on our economy and social cohesion, but continue to analyse it in market terms. It is, they say, a matter of inadequate supply and excessive demand, to be resolved either by scrapping planning protections and providing more opportunities to developers, or by restricting the number of potential buyers, particularly those from overseas.

This is, however, to mistake the real issues. Our overpriced housing market is the product of decades of mistaken policies. It is, as the OECD report says, an affordability crisis, and reflects a growing asset inflation and a capital structure that is now completely out of control.

The housing market, it should be remembered, is unlike any other. Experience over decades has taught New Zealand house-owners that the value of their homes, unlike any other asset of remotely comparable value, will go on rising over time. In buying a house, they not only gain necessary accommodation, but also an appreciating capital asset.

They finance the purchase of that asset – probably the most expensive they will ever buy – by obtaining a loan on mortgage. Their bank will be keen to lend to them because it is the easiest and most profitable way for the bank to make money; there is no shortage of willing customers, the returns are predictable and high, the security is almost always easily realisable, and the rate of default is in any case comparatively low.

Once the house-buyer has bought the house, rising house prices will reduce the comparative cost of the mortgage, and the rising value of the equity (and perhaps a larger mortgage) will allow the purchase of a more expensive property next time.

This process – which really built up a head of steam when banks moved in to replace much more conservative building societies and to dominate the mortgage market – has meant that, over a generation or two, there has been a constant injection of new mortgage finance (at a much faster rate than the growth of incomes or of most other asset values) almost every time that a house is purchased.   That repeated injection of new money has come on top of the already inflated value brought about by earlier mortgage lending and has been steadily and cumulatively built into the rising market prices of our houses.

If there were to be a sudden increase in the number of homes being built, this would simply provide a new stimulus to the process. The main effect would be to increase the profits of both banks (who would leap at the chance of lending even more) and property speculators and developers; the affordability crisis would remain untouched.

The problem arises, in other words, not for reasons of supply and demand, but because of the way we finance (and tax – or fail to) house purchase and ownership. It is no accident that, while marking us as the worst offender, the OECD identifies other countries, such as Australia and the UK, with similar methods of financing house purchase, as principal culprits as well.

The scale of the problem can only be understood when we realise how powerful an impact on our economy is created by bank lending for house purchase. As the Bank of England conceded in a ground-breaking report earlier this year, by far the greatest proportion (well over 90%) of new money in our economy is created by the banks out of nothing – and most of that goes to finance house purchase.

When the banks lend money on mortgage, they create that money by a simple book entry – the stroke of a pen, or today, a computer keyboard; the loan in no way represents real money, that is, money deposited with them. It is that bank-created money that artificially inflates the value of the class of assets into which it is principally directed – in this case, housing.

This process then operates as a giant mechanism for transferring wealth to home-owners, whose good fortune comes at the expense of our economy as a whole and of those who are debarred by the asset inflation effect on house prices from ever sharing in it themselves.

Our policy-makers, and certainly our Prime Minister, seem to have no glimmer of understanding of what is happening. There is just a small ray of hope; our central bankers, who have been asleep at the wheel on this issue for the last three decades, have begun to stir. The Bank of England has opened its eyes; and our own Reserve Bank’s Loan to Value Ratio restrictions on bank lending show that they, too, have recognised that something has gone wrong. Graeme Wheeler may know more than he is letting on.

Bryan Gould

19 May 2014