Trading Bank Bubble? in NZ

Here is some math for you all. What is 51% of $400b? The simple calculation says $200b. However when half of all trading bank lending is on the personal housing market the correct answer is a giant speculative bubble.

That 200b number looks like a very measurable and  indicator of financial health and flawed banking policy. As Gaynor remarks

“As bank lending has become the lifeblood of the housing sector, the banks will have to keep lending even if the market softens. Lenders’ rise to dominance one of key developments of past decades.”

That makes lopsided trading bank lending a structural problem for the NZ economy. If I understand his column correctly the lack of lending controls on trading banks has meant that they go where the profits are best and that has weakened the economy to the point where the banks have to prop up all that home lending as it is half of their business.

Trading Banks in New Zealand - Table

The table comes from an article by Bryan Gaynor who does great analysis but very much pulls his punches and is careful not to upset any vested interests.

The way that a nation creates wealth is to do something productive with all that investment. Investing in housing is unproductive unless property speculation is the main objective.

What I find surprising about Gaynor’s column is that you won’t see the word bubble anywhere in there at all. In Brian Gaynor: Banks long shadow over NZ economy

Gaynor sets out some of the history behind this. The following paragraphs are the ones most interesting to me.

“• Finally, on February 11, 1985 all reserve asset ratio requirements were removed. Thus, in less than seven months, Sir Roger Douglas and the Labour Government had removed all trading bank controls. This allowed them to have unprecedented freedom to set borrowing and lending interest rates and to determine to whom they lent.

These measures have had a huge impact on the New Zealand economy and have allowed the four major trading banks — ANZ, ASB, Bank of New Zealand and Westpac — to be a dominant force in the domestic economy and to be extremely profitable.

As bank lending has become the life blood of the housing sector, then the banks will have to keep lending even if the market softens.

For example, in March 1984 the trading banks, including their fully owned private savings banks, represented 47.5 per cent of the total assets of M3 institutions whereas they now represent a staggering 97 per cent. Meanwhile, the finance company sector’s share of M3 assets has declined from 18.4 per cent in 1984 to less than 3 per cent today.”

That highlighted sentence in the middle about banks being complicit in the property bubble is the key one. This has become a structural problem for them. Echoes of too big to fail here.
I think there are a number of other factors at play here too. Just my opinion but…

1. Banks are increasingly staffed by lowest cost staff who have minimal training in business and who insist that business lending is often secured over personal property. Yes – you can get business finance but at higher rates and so some of that “personal housing” also covers a hidden amount of business lending.

2. Up to 20% of the NZ population “the brain drain diaspora” lives offshore. 500k of them in Australia and many more in global cities around the world where their skills are in high demand. The downside of this is that the quality of management in NZ is very low. If you are bright it doesn’t take long to get head hunted or bored here.

3. The NZ stock market is tiny compared to housing. I remember Black Monday in Oct 1987. While markets are now more resilient – globalisation and automated trading means confidence in stock markets is still not high. I’d say boomers who remember that ( especially) have kept away.

New Zealand’s market was hit especially hard, falling about 60% from its 1987 peak, and taking several years to recover.

4. As Gaynor says – financial deregulation has enabled the pillaging of business and personal accounts to the tune of billions. Except he says it more diplomatically.

“The banks are also extremely profitable. According to Reserve Bank statistics, our 20 trading banks had combined net earnings after tax of $5.1 billion for the 2015 calendar year, compared with $1.0 billion two decades earlier.”

Economists and others agonise over what the various measures of productivity should be and why we don’t see as much “productivity” as we should. There are many reasons for that and some is clearly to do this the difficulty with measuring the impact of global business on local ones and new technologies generally. For example open source software which has created huge businesses around the world is a conundrum since the source IP is free to use for all.

When I look at the table of trading bank lending I wonder about the differences between consumption and production or creation of wealth. Surely in a healthy economy the percentage of funding going to Manufacturing, Commerce and so on should be much higher than that going to the housing sector.

As I understand it this a debate that economists like to have. As John Papola writes in Think Consumption Is The ‘Engine’ Of Our Economy? Think Again.

“For example, during our past two decades of booms and busts, investment collapsed first, bringing employment down with it. Consumption spending actually increased throughout the 2001 recession (financed, in part, by artificially easy credit) even as employment was falling along with investment. During our continuing crisis, consumption spending returned to its all-time high in 2011–yet investment to this day remains at decade lows, producing the worst recovery in growth and employment since the Great Depression. Labor force participation hasn’t been this low since the 1980s. But why?
As John Stuart Mill put it two centuries ago, “the demand for commodities is not the demand for labor.” Consumer demand does not necessarily translate into increased employment. That’s because “consumers” don’t employ people. Businesses do. Since new hires are a risky and costly investment with unknown future returns, employers must rely on their expectations about the future and weigh those decision very carefully.”

Now if the banks have invested half of their total lending to something that is non- productive ( personal housing) then they, and we, are somewhat screwed if investment stops as those tiny productive sectors have to support a huge pile of debt.

And just to top it all off Panama firm talked up NZ’s lax rules – report some of that same deregulation is now destroying NZ’s business reputation on the global stage.

Another legacy of banking deregulation in 1988 that needs to be fixed.