On the issue of housing booms, Min Zhu, the deputy managing director of the International Monetary Fund, told a German audience earlier this month that the ratios of house prices to rents and incomes could provide an initial check on whether house prices were out of line with economic fundamentals.
That’s hardly a controversial proposition. But the significance of the speech was not so much its content as its politics.
The speech marked another concerted push by the IMF to exploit concerns about the interaction of housing and debt to carve out a more active role for the IMF in the global financial scene.
Reinforcing the IMF strategy, Min Zhu added blogging to his managing director’s duties declaring in his first contribution: “(The) era of benign neglect of house price booms is over.”
At the same time, the IMF launched a new website, Global Housing Watch, which readers were told would “bring together housing market information to keep track of boom and bust cycles and nudge policy makers to take early action to moderate housing booms.”
The idea of the IMF giving a gentle “nudge” has a touch of Orwell. Perhaps I’m too sensitive. However, what initially attracted my attention to the IMF’s policy nudging ambitions in the first place was the high and unflattering profile Min Zhu accorded Australia in the IMF press handouts.
Nominating the countries with the worst ratios of housing prices and rents to income he cited, in the following order, Australia, Belgium, Canada, Norway and Sweden.
We certainly rank poorly on those particular league tables. On houses prices-to-income ratios, we were third last beating only Belgium and Canada.
On the house price-to-rent ratio, we were five rungs from the bottom coming in ahead of Canada (the worst), New Zealand, Norway and Belgium.
So why were we, and not Canada or Belgium, given the worst guy role in Min Zhu’s speech and blog?
High stakes for IMF
It may seem unbelievably petty for such an international institution to juggle an obscure league table, but the stakes are high and the rewards both financial and reputational would be brilliant for an IMF that is struggling to restore its global relevance.
There is no doubt that the global financial crisis exposed the risks involved in having a hugely interconnected global financial system operating under a host of country-based regulators.
Min Zhu in his speech made three valid points:
Housing is an essential sector of the economy but also one that has been the source of vulnerabilities and crises.
Although detecting overvaluation in housing markets is still more of an art than a science, IMF research shows that of the nearly 50 systemic banking crises in recent decades, more than two thirds were preceded by boom-bust patterns in house prices.
The policy toolkit to manage housing booms is still under construction. He said: “A variety of tools have been used and the evidence suggests some short-run success.”
The policy toolkit favoured by the IMF is based on three policy arms: microprudential (MiP), macroprudential (MaP), and monetary policy (MoP).
The task of MiP, if such a model was adopted, would be to supervise the local regulatory requirements and ensure the resilience of individual financial institutions. That’s what APRA does now.
Macroprudential (MaP) policies would be aimed at increasing the resilience of the system as a whole. Before the GFC most banks, including our Reserve Bank, depended on setting official interest rates to create and anchor inflation expectations. Success in this endeavour
was seen as sufficient to deliver financial stability. This proved to be wishful thinking as many banks had over-leveraged themselves to ride the subprime housing boom.
Post GFC many central banks and prudential regulators have widened their macroprudential arsenals beyond the interest rate weapon of monetary policy (MoP).
MaP tools not new
Macroprudential tools are not new, and they have had a mixed record in the past. They have, for example, been employed to limit loan-to-value (LTV) ratios and debt-to-income (DTI) ratios and sectoral capital requirements.LTV requirements can cap the size of a mortgage relative to the value of a property, effectively imposing a minimum down payment. DTI caps can be used to limit household debt accumulation.
The suggestions are that it’s at the MaP level that the IMF could gain entry either directly or indirectly into macroprudential oversight and regulation.
The Reserve Bank argues that the IMF’s narrow focus on household debt and housing booms is misconceived; that while debt and booms may be part of the problem they are not the totality.
Luci Ellis, who heads up the Reserve Bank’s Financial Stability Department, defines the goal of financial stability as furthering the welfare of society, which could be threatened by disruptions that are harmful to output and employment.
In a recent speech she said: “Property markets, asset prices, credit and the array of other variables we look at in financial stability circles are not objectives. They are information variables. They are useful, but we should not define our performance in terms of having control over these variables.
“What matters more are the risk of a crisis and the severity of the resulting effects on output.”
Crisis risk is complex
That risk is not confined to debt and booms.
It is multifaceted and complex and as such does not render itself to simple solutions and single tools. In addition, a successful financial stability policy, even at the national level, needs to be coordinated across several public agencies.
Ellis contends: “The rationale for carving out particular bits of the prudential framework under separate governance – which is what people mean nowadays by ‘prudential tools’ – appears to be that supervisors cannot be relied on to discharge their duties with system-like concerns in mind.
“That might be true in some countries, but not in Australia.”
Ellis left no doubt about the Reserve Bank’s attitude to the IMF’s ambitions: “By now it should be clear that the Australian authorities’ views on this supposedly new (IMF) toolkit are a bit different from those in some other jurisdictions. We view macroprudential policy as something to be subsumed into the broader financial stability framework.”
In the short run, it is difficult to believe that the Reserve Bank and APRA backed by Treasury will not keep the IMF wolf outside the door.
But many central banks including some of the most illustrious, but not our Reserve, failed miserably in their prudential management leading up to the global financial crisis.
Systemic risk has not been exorcised.
Nor have the IMF ambitions.
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