20 August 2009

Variable gravity
The house price cycle in the US and NZ

Figure 1: House price indexes

• Idiosyncratic developments in the US mortgage
market are to blame for their ugly house price crash. 250
index March 2002 = 100 index March 2002 = 100
250
• NZ lending practices have been far more circumspect; Sources: QVNZ, ABS, Case-Shiller, Nationwide

a similar crash was never very likely here. 200

Building Society, ESRI-Permanent TSB
200
• Many factors drive house prices, and while measures
of housing affordability are useful, they are not 150 150

in themselves a reliable guide to likely future

developments. 100 100

• We expect the NZ housing market’s current second New Zealand Australia

50 US Ireland 50
wind to peter out before it comes to much, but the
UK
RBNZ is right to keep a close eye on it.
0 0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Introduction good one. But house prices alone are an insufficient measure of a
The US housing market bubble collapsed spectacularly in 2006. bubble. They may just be keeping pace with general inflation, or
The subsequent exposure of the poor quality of much US there could be changes to the tax regime that shift the investor
1
mortgage lending sparked a broader financial crisis that engulfed balance in favour of housing. Let’s consider a couple more
much of the globe. Rising unemployment, tighter credit and commonly quoted metrics of house prices versus fundamentals.
sharply higher foreclosures have reinforced a precipitous fall in
US house prices. Table 1: Median house prices as a multiple of median incomes
September
The New Zealand housing boom was more extreme in terms 2005 2006 2007 2008
of the rise in house prices, yet the US crash has been much
NZ 5.9 6.0 6.3 5.7
more painful, in terms of both house price falls and mortgage
US 4.6 3.7 3.6 3.2
foreclosures. This paper compares the development and demise
of the NZ and US house price booms, and discusses why the US Source: Demographia

bust has been so much worse. We conclude that factors unique

to the US mortgage market have primarily been to blame, and
that a US-style collapse of the housing market was never very
likely in New Zealand.
Variable gravity?
The house price boom was a global phenomenon, but cycles
were not uniform across countries. The US had a smaller increase
in house prices than NZ (+70% vs. +108%, March 2002 to peak)
but has subsequently seen a much bigger fall, with prices down
more than 30% from their peaks, versus only 10% in NZ. Other
countries we typically compare ourselves to have tended to sit
between the NZ and US on both the way up and the way down.
The US was the lesser offender by the standard affordability
measure of comparing house prices to incomes. It should be
noted, though, that individual hotspots certainly got to crazy
levels: median house prices in several cities in California hit more
than 10 times median incomes.
What about household debt levels? NZ household debt as a
percentage of disposable income rose steadily from 60% in 1991
to a peak of over 160% in early 2008. Over the same period, the
US household debt ratio rose from just under 90% to a peak of
140% in September 2007. Here again, then, the US appears the
more moderate case.

1
For example, Westpac estimates that the lift in NZ’s top marginal tax rate from
The US looks to have gotten a rough deal, and NZ a surprisingly
33% to 39% in 2000 added close to 20% to the investor value of a median house.

For further information, questions or comments contact Brendan O’Donovan, telephone (04) 470 8250, email bodonovan@westpac.co.nz
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The New Zealand house price boom therefore, at first glance,
looked more vulnerable to a nasty bust, and there were plenty of
people predicting exactly such an outcome in 2007. House prices
in NZ had increased massively, the boom was debt-fuelled,
and houses had become outrageously expensive by standard
affordability criteria. Surely a sitting duck.
Yet NZ house prices fell only a third as much as in the US, and
we’ve gotten off pretty easily on other measures of bust as well.
The US is in a far worse state in terms of mortgage distress, with
non-performing mortgages running at 4 times NZ’s 1% of total.
US housing starts fell 80% peak to trough, while NZ dwelling
consents have fallen a smaller (though still hefty) 65%.
What was different about the US market?
The US house price crash was very unusual, both historically
and compared with other countries, in that it precipitated more
general macroeconomic problems instead of following them.
This suggests that the housing market had intrinsic problems that
made the level of prices and activity unsustainable, regardless
of the macroeconomic context. In this section we outline the
particular features that set the US housing market up for such
a nasty fall.
1) The price of credit
Figure 2 shows the deviation of mortgage interest rates from
their 10 year average in both the US and NZ. Mortgage rates
in the US remained low for longer: NZ rates starting heading
back to average in 2003, but US rates didn’t turn around in any
meaningful way until 2006, even though the Federal Reserve
started hiking in mid-2004. Monetary policy has a blunted
impact on US mortgage rates because of the prevalence of
30-year fixed rate mortgages, which can be easily refinanced
should rates fall, but left fixed if rates rise. But the overall story
is that mortgage finance was relatively cheap in NZ and the US
(and a great many other places) for a prolonged period from
2001.
Figure 2: Deviation of mortgage rates from
10-year average
% pts
2.5
2.0
US (30-year fixed rate)
1.5
NZ (weighted effective rate)
1.0
0.5
0.0
-0.5
-1.0
Sources: Bloomberg, RBNZ
-1.5
1998 1999 2000 2001 2002 2003 2004 2005
2) The availability of credit
But the key difference between NZ and the US was not the price
of credit, but rather its availability. There was a much greater
easing in credit standards in the US. In essence, the focus when
issuing loans moved from repayment ability to collateral values,
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The house price cycle in the US and NZ – 20 August 2009
as lenders increasingly assumed permanently rising house prices
and focused much less on actually getting money back via
repayments.
• “Low-doc” loans rose from around 30% of new US mortgages
in 2001 to more than half in 2006. In 2007 low-doc loans
made up only 7% of new NZ mortgages.
• Mortgages where payments don’t even cover the interest
accounted for over 7% of securitised US mortgages in the
first quarter of 2007. A further third were interest-only.
(These two loan types made up only 1% of US mortgages
in 2001). In NZ, interest-only mortgages are also popular,
particularly for investors, making up around 25 percent
of the total value of mortgages (Briggs 2007). However,
mortgages where repayments do not even cover the interest
are virtually unknown in NZ. Of US 2007 mortgages with the
option to pay less than the interest, 90% of borrowers took
that option much of the time and owed more than they did
to start with within 7 months (Mayer et al 2008).
• Adjustable-rate-mortgages (ARMs) became increasingly
popular (reaching 80% of all subprime loan originations in
2005), featuring a lower “teaser” rate for the first couple of
years. Such mortgages are unknown in NZ.
• Repayments were based on periods of up to 50 years. By
2006-07, such schedules were to be found in more than a
third of sub-prime loans. NZ has seen a mini version of the
same trend, with the RBNZ commenting in 2007 that “in
the last year or two, the standard term for a table mortgage
appears to have moved from 25 years to 30 years” (Briggs
2007).
Why did this occur?
• The government-sponsored Fannie Mae and Freddie Mac
enterprises, with their implicit government guarantee,
dominate the traditional US mortgage market and drive
competitors into edgier markets. The entrance of new
lenders over the past decade (typically national lenders into
regional markets) increased competition further.
• A much greater degree of securitisation meant that those
issuing loans were often not those taking the repayment
% pts
2.5 risk. There is direct evidence that this explicitly eased
2.0 lending standards (Ellis 2009). Strong global appetite for
1.5 risk made flicking off mortgage-backed securities easy and
1.0
highly profitable, helped by generous credit ratings, and the
quantity of securitised mortgages soared. Recent research
0.5
concludes that increased rates of securitisation directly
0.0
increased the supply of subprime loans available to home
-0.5
buyers, especially in areas of high house price appreciation
-1.0 (Nadauld and Sherlund 2009).
-1.5 • Government policy explicitly aimed to increase home
2006 2007 2008 2009
ownership for those shut out of traditional mortgage lending.
“Subprime” and “Alt-A” (near-prime) mortgage markets were
developed to achieve this, and grew quickly. From 2.6% of all
mortgage originations in 2000, subprime mortgages grew to
2
13.6% in 2006 (Mortgage Bankers Association).
2
The subprime market collapsed even more quickly: subprime loans made up only
2% of new loans at the end of 2007.
 The house price cycle in the US and NZ – 20 August 2009

• Lax regulation encouraged a proliferation of the dubious loadings. The average gearing on the US housing stock (housing
loan types described above, which are, arguably, designed debt as a percent of housing assets) has risen rapidly this decade
to persuade borrowers they can afford to borrow more than to over 60% by the end of 2008 (Figure 4). This is more than
they in fact can. In addition, anecdotal evidence suggests double the ratio in NZ. The US gearing ratio is structurally higher
a large increase in fraudulent behaviour by both borrowers because of the tax advantages to maintaining high mortgage
and mortgage brokers. debt, but it has picked up particularly fast since 2006 as house
prices have fallen, putting many households in a precarious net
US homeownership certainly did increase (Figure 3), but likely asset position.
beyond a sustainable level, given that houses were getting
steadily less affordable during that period. The home ownership Figure 4: Household gearing ratios
%
rate has fallen back in recent years as mortgage foreclosures have 70
%
70
risen. By comparison, the NZ homeownership rate fell as house
3 60 60
prices increased as a multiple of incomes. This could reflect tax NZ US

changes which have favoured landlords over leveraged owner- 50 50

occupiers. (In NZ, since 1990 unlimited mortgage interest has

40 40
been tax deductible for landlords, but not for owner-occupiers.
In the US, interest deductability is universal.) 30 30

20 20
Figure 3: Home ownership rate
% % 10 10
76 76 Sources: RBNZ, Federal Reserve, US Census Bureau

0 0
74 74
1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
NZ US
72 72

70
68
66
64
Sources: Statistics NZ, US Census Bureau
62
1990 1992 1994 1996 1998 2000 2002 2004
The consequence of the easier availability of credit was heavier
debt loading, making homeowners vulnerable to any fall in
house prices or interruption to incomes. Loan to value ratios
(LVRs) started (increasingly) high and stayed high. In 2005
around 7% of new mortgage borrowers put no money down
4
at all. And the US LVRs are likely understated, if anything, due
to the increasingly popular (and oddly, legal) practice of taking
“silent seconds” – an undisclosed second mortgage on the
property with another lender (by 2006 more than 9% of total
mortgage originations featured such a silent second, a virtually
unknown feature in 1999).
There was little incentive for US borrowers to reduce their
mortgage debt burden either, thanks to:
• cheap and easy refinancing,
• tax advantages of keeping LVRs high (US mortgage interest
payments are tax deductible) and,
• as mentioned, ever more loans where payments made no
inroads on the principal, and sometimes went backwards.
No official data exists on US loan to value ratios for existing
mortgages. However, estimates suggest up to 10% of US
mortgage borrowers are currently in a negative equity position,
much higher than is typical in housing busts. This reflects both
a particularly nasty nominal house price fall, and higher debt
70
3) Incentives to foreclose
With dizzying levels of debt, once capital gains slowed or reversed
68
many US households had little ability to refinance if they ran
66 into repayment difficulties. However, there were additional
factors that explain why US foreclosure rates skyrocketed. In
64
many states, it is either not possible or prohibitively expensive
62 to chase borrowers for any discrepancy between the realised
2006 2008
value of the house in a foreclosure versus the outstanding
debt. This increases the incentive for borrowers to default.
Foreclosure proceedings are quick and cheap compared to
many other countries. This increases the lenders’ incentive to
foreclose. A third factor is that many of the dodgier types of
loans essentially require frequent refinancing – giving the lender
an effective out-clause, as they can refuse to refinance if things
are looking dubious.
Higher rates of foreclosure (Figure 5) mean more mortgagee
sales, pushing down prices faster than otherwise.
The more creative types of loans have had the most dramatic
defaults. Although subprime adjustable rate mortgages
represent only 6.8 percent of outstanding mortgages in the
US, they account for 43 percent of home foreclosures. Riskier
lending has higher foreclosure rates everywhere. The difference
is the proportion of loans that fall into these dodgy categories,
which has driven up arrears and foreclosure rates in the US.
Mortgage arrears in NZ are running at less than 1% of total
5
mortgages outstanding, and foreclosures under 0.3%, whereas
3
Note: The NZ home ownership rate in recent years is understated because of the
increasing popularity of trusts as a form of ownership. The RBNZ estimates that if
this is taken into account the home ownership rate over the decade to 2001 drops
by 4.4 rather than 6.0 percentage points.
4
No new loan LVR data is available for NZ. In December 2008 the stock of
outstanding mortgages with LVRs over 90% was 8.6%.
5
Westpac estimate using Terralink, Statistics NZ and RBNZ data.

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 The house price cycle in the US and NZ – 20 August 2009

Figure 5 shows that US foreclosure rates are running at more House prices are sticky, and because of the heterogeneity of
than ten times that. Foreclosures can bring prices down very individual houses, it always takes time for signs of trouble to
quickly when they become a significant proportion of the sales. filter through to hyped-up property investors. But in the US, the
Foreclosure (mortgagee) sales made up 3.3% of NZ house signals seem to have been particularly slow. Tax advantages of
sales in the year to May; in the US, such sales made up 20% owner-occupied over rental housing meant property speculators
of nationwide house sales in 2008, and over 50% in some tended to “buy and flip” rather than rent out investor properties.
regions. In markets like NZ where speculators must rent out investor
properties to claim the full tax advantages, falling rents or
Figure 5: US foreclosures as a % of total mortgages vacancies provide relatively prompt signals that the market is
25
% %
25
becoming oversupplied. Signals via falling house prices tend to
Source: Bloomberg be much slower and murkier.
20 20
Total Prime
It is also notable that the areas with the largest increases in
15
Sub-prime ARMs Sub-prime
15
housing supply were the areas with the largest increases (and
subsequent largest falls) in house prices. This highlights that
10 10 increasing house prices can quite quickly lead to a positive
supply response, but that the ability of this supply response to
5 5 dampen price momentum can be regrettably slow.

0 0 Was a US-style bust every likely in NZ?

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Only if access to credit was shut down. This was a real risk when
international funding markets were at their wobbliest, with NZ
banks sourcing around a third of their funding offshore due to
4) A massive build-up of oversupply a dearth of national savings. But now that risk seems to have
Supply responsiveness is normally considered to be a good thing dissipated, the NZ housing market is on a firmer footing.
in markets. It should, in theory, prevent big changes in prices in
response to increases in demand. But it can be a mixed blessing The US housing market featured much easier credit, higher loan-
in long-lived asset markets if it means supply reacts sharply to to-value ratios, greater incentives on both sides to foreclose
what turns out to be a temporary increase in demand. when things started to turn to custard, and a much greater
supply overhang depressing prices. Essentially, houses were sold
The housing supply overhang in the US is huge, and has been to a lot of people who could not afford to pay for them. This is
a key driver of the very large price falls seen over the past two a recipe for a massive bust.
years. Oversupply indicators such as rental and owner-occupied
vacancy rates, as well as the percentage of the housing stock New Zealand lenders have behaved very differently from their
for sale (or similarly, months supply of housing) have all lifted US counterparts, partly because of tighter regulation, and
sharply (Figure 6). partly because our financial sector did not go down the path
of securitising mortgage lending to the same extent – less than
Figure 6: Oversupply in the US housing market 1% of NZ mortgages are securitised, versus around 75% in the
11
% %
3.0
US. Rather, NZ has retained the tried-and-true system where
Rental vacancy rate (LHS) the organisation that decides to lend the money takes the risk.
10
Homeowner vacancy rate (RHS)
2.5 Although mortgage foreclosures are rising in NZ in step with
% of housing stock for sale (RHS)
unemployment, there is not a huge number of homeowners
9 2.0 who can’t realistically afford to pay the mortgage, as is the case
in the US.
8 1.5
Although the NZ housing market still looks “overvalued”
7 1.0 relative to historical price/income ratios, there is no reason to
Source: US Census Bureau
conclude it will rapidly revert. Historically, this doesn’t tend
6 0.5 to be the case, and there is in fact no theoretical reason why
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
it should. House prices will be determined by a multitude of
factors that affect demand and supply, not just incomes (tax
Some argue that housing supply is particularly responsive in the structures, credit availability, average inflation, interest rates,
US due to relaxed zoning rules and a fairly dispersed population, demographics, immigration...) And in New Zealand, housing
but this isn’t necessary to explain the dynamics seen. A more demand is rising thanks to the net migration turnaround and
compelling argument is that messages about oversupply took a a drop in interest rates versus a year ago, while supply growth
particularly long time to come through in prices, and even more will continue to be constrained by tighter credit and general
simply, that lax credit standards meant the increase in demand nervousness about the economic situation. But it would be a
was enormous. And unsustainable. brave person who predicted an imminent NZ house price boom

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 The house price cycle in the US and NZ – 20 August 2009

starting from the current stretched levels of affordability, and

we are predicting only slight rises over the next 18 months,
particularly now longer interest rates have risen.

It is clear that “what goes up must come down” is too

simplistic when it comes to forecasting house prices. It is
dangerous to focus on just one factor, such as house prices
versus incomes, in predicting how a housing market will evolve.
Similarly, international comparisons are fraught with difficulty.
As this article shows, market-specific idiosyncrasies can have an
enormous impact on the sizes of both booms and busts.

References
Briggs, P (2007), “Lessons learned from the Economics Department’s
research work on household balance sheets and related issues.”
Reserve Bank of New Zealand: Bulletin, Vol. 70, No. 4, December.
Ellis, L (2009), “Only in America? Must housing booms always end in
housing meltdowns?” Draft paper prepared for RBNZ workshop, 17
June 2009.
Mayer, C., Pence, K. and Sherlund, S. (2008): “The rise in mortgage
defaults”. Federal Reserve Finance and Economics Discussion Series
2008-59.
Nadauld, T. and Sherlund, S. (2009): “The role of the securitization
process in the expansion of subprime credit,” Federal Reserve Finance
and Economics Discussion Series 2009-28.

Brendan O’Donovan, Chief Economist, Ph: (64-4) 470 8250

Sharon Zöllner, Economist, Ph: (64-4) 381 1426

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