News reports alerted New Zealanders at the end of June 2016 to the fact that we are not as equal a society as we had thought. Just 10% of New Zealanders, it seems, own 60% of the nation’s wealth. The figures, produced by Statistics New Zealand, related to the situation as at June 2015 and may well have got worse since. The news was reported as though it had only just become apparent. Yet no one with an ounce of understanding, or with eyes to see, could be surprised at this figure, still less at the even more obvious and significant concomitant that the bottom 40% own just 3% of the wealth.

The one is the necessary consequence of the other; taken together, they tell the story of a society that is breaking apart and is now one of the most unequal in the developed world. How has this happened? It has not come about by accident. It is the inevitable result of deliberate policy – to cut taxes at the top end, to leave capital gains untaxed, to shift the tax burden towards indirect taxation which hits the poor hardest, to cut access to benefits and the value of the minimum wage, to lift pay rates and the value of bonuses, share issues and perks for the wealthy.

But we are indebted to the Prime Minister for a succinct summary of the main reason as to why inequality has widened so significantly. “The bottom 40% doesn’t own houses”, he said by way of dismissive explanation, as though this somehow demonstrated only a statistical quirk. But, for once, I can agree with John Key. There is no more powerful driver of inequality in our society than the differing fortunes of those who can afford to buy a house or houses, and those who cannot.

A homeowner in Auckland, for example, has gained $1,600 per week over the past year, simply by doing nothing. Owners of more expensive properties, or of multiple properties, have done even better. Gains of this kind – once realised – are, for homeowners at least, entirely tax-free. At the other end of the scale, those who have been unable to get themselves on to the housing ladder have struggled to find decent and affordable housing of any kind.

As housing values have risen, speculative investors have moved in to buy up the cheaper houses, raise rents so as to force out existing tenants, and then score a significant capital gain from the eventual sale of a valuable income-producing asset. This process has meant a huge shift of existing wealth from the poor to the rich. It creates a bankable capital gain for that sector of society that already enjoys the health, educational, and social advantages of living in a decent home. 

It does not represent any real new output or national wealth; it is entirely a transfer of wealth and also purchasing power from those with little to those with a lot. It has, of course, not only exacerbated the inequality in our society in an abstract or statistical sense but has worsened a number of other practical and social issues –  of homelessness, health problems, educational under-achievement, drugs and crime.

How Did We Allow This To Happen?

It’s a question that is rarely asked. All sorts of reasons are proffered to explain the Auckland housing crisis in particular, but almost all are answers to the wrong questions. No one bothers to ask the obvious and central question – where does the money to fund the rise and rise in house prices actually come from? Instead, the explanations offered for the housing crisis generally reflect the political prejudices of those providing them.

The Government is anxious to blame an imbalance of supply and demand – and, since this failure of the supposedly infallible market to achieve equilibrium cannot be admitted, it must be attributed to “rigidities” that prevent the market from operating properly. Those “rigidities” can easily, it seems, be identified. They arise it is argued, because of local government bureaucracy and the requirements of the Resource Management Act. The answer is to remove these impediments and free up more land so that private developers can build more houses for more profit.

This supposed remedy has the great advantage of not only cutting local government down to size, but also of providing valuable profit-making opportunities to the Government’s supporters who are busy making their fortunes in property development. Yet even the Government seems now to lack confidence in its own analysis. The unregulated and un-supplemented “free” market has certainly delivered major prizes to the winners, but it is increasingly clear that the market ignores the interests of a growing sector – those who can never hope to buy a house at today’s ever-inflating prices or even meet the rapidly rising rents produced by inflated capital values.

Government Indecisive; Labour A Little Better

These people are simply left behind to fend for themselves. Faced with these problems, the Government has seemed paralysed by indecision, bringing forward piecemeal initiatives on an almost daily basis, none of which form part of a coherent strategy. The Labour Opposition has done a little better. It has been on the front foot in recognising that urgent measures are needed to resolve what is becoming an all-encompassing crisis, yet even it apparently agrees that market failure and a shortage of supply are to blame.

Labour accepts, it seems, that Auckland Council, in a misguided attempt to prevent urban sprawl, has restricted the supply of land with the result that house prices have risen. But it has, at least, been prepared to supplement this analysis by proposing to use the power of Government, both central and local, to ensure that the required houses are built at affordable prices, that further houses are built to be held in public ownership and made available for rent, that the volume of emergency accommodation for the homeless is immediately increased, that Housing New Zealand is not required to extract $100 million a year from the least well-off to be paid to the Government (and even the Government now agrees with that!) and that the tax treatment of property speculators is tightened.

These measures promise some alleviation of the most pressing problem and the one that has been hogging the headlines – the plight of that growing number of Kiwis, in Auckland and elsewhere, who literally sleep in a car because they have no home, no washing or toilet facilities, no home comforts, nowhere to relax at the end of the day, nowhere to call their own. That element of the crisis surely demands the fastest possible solution. That will not be achieved by firing the starting gun for another round of property development.

The crisis has arisen because we have not been building homes for years for that significant sector of our society who simply cannot afford either purchase prices or rents – those whom the market, in other words, totally overlooks and does not provide for. Our decade-long failure to concern ourselves with this group of our fellow citizens has led inexorably to the current crisis of homelessness. It can be remedied only by making good – and fast – our past failures. That means a publicly funded building programme of decent houses at reasonable rents in the areas where they are needed. 

But, it will be argued, homelessness is only one aspect of a malfunctioning housing market. It surely stands to reason that an increase in the supply of housing will help to resolve the separate problem of unaffordability by bringing prices down? Isn’t the National/Labour cross-party consensus right on the money? And doesn’t the enthusiastic support from Business New Zealand, the Property Developers Association and the real estate industry show that the politicians have at last agreed on the right solution?

It is certainly true that property developers, the banks, speculative investors, all love the idea – I can hear them salivating from here. Any concept of sensible planning and land use, any concern for other interests such as our important horticulture industry, any reckoning of what further urban sprawl would mean in terms of infrastructure costs and longer travel distances are swept aside. Economists may see, and warn about, all the signs of a rapidly inflating bubble, but those who are responsible for the inflating are not to be deterred.

As the consensus promises to provide yet wider opportunities for profitable investment, property developers stand ready to bid up the prices of the newly available land, the banks stand ready to lend virtually without limit to both the developers and the eventual purchasers of the new houses, and the inflow of new lending and credit into the housing market ensures that the bellows applied to housing prices will continue to blow fiercely.

As another round of house price increases is generated, the gap between those who are already in the housing market or who are able to borrow, and those who are not and cannot grows, ever wider. And the diversion of yet more of the country’s finances into speculative rather than productive activities leaves us even more dangerously exposed to the risk of a housing bubble that one day is certain to burst.

Housing Is Unlike Any Other Market

While most seem agreed that the problems of unaffordability are the result of market failure, no one, it seems, bothers to ask whether the housing market is really just another market, operating according to the normal laws of supply and demand or whether, on the contrary, it doesn’t exhibit such unusual characteristics as to make it completely atypical. The housing market is, after all, like no other. The asset that is traded provides an essential element of life and valuable utility – a place to live.

It retains and almost invariably, if history is anything to go by, increases its value, rather than – as with most commodities – being consumed or otherwise losing value with the passage of time. Most importantly, it involves an asset for whose purchase most prospective purchasers are able to command resources far in excess of their purchasing power in respect of any other commodity. Today’s house prices could not have reached anything remotely like their current level if it were not for the fact that purchasers are able to raise large sums (up to nine times their annual income) on mortgage, secured by the assurance that – when they come to sell (or the bank forecloses) – other purchasers will be able to borrow, and pay, even more.

There is no other market that a prospective purchaser can enter armed with such a boost to his or her purchasing power or with such an assurance that his or her purchase will increase in value. What explains this extraordinary, not to say unique, market we have developed for housing? It is the constant availability of mortgage finance at ever-increasing levels that is the central element in the structure of house prices. It is that single centrally important element that allows the housing market to operate in a way like no other and that produces such anti-social and irresponsible consequences.

We get closer to understanding the problem when we recall the hugely significant change that occurred three decades ago in the way mortgage finance was provided. Up until that point, mortgage finance was largely provided by building societies - mutual societies which relied for the funds they loaned for house purchase on the savings provided to them by their members. But in the 1980s, the building societies demutualised and became trading companies.

Banks Create Tsunami Of New Credit

Even more importantly, they were muscled aside by the banks which rapidly discovered that lending on mortgages was easy, secure and extremely profitable. The new dominance of the banks in mortgage lending was given added significance by a power that the banks have and building societies did not. Whereas the building societies were limited by the resources made available to them by lenders, the banks suffered no such constraint. They were able to create mortgage finance out of nothing, by the stroke of a pen.

There was virtually no limit as to how much they could lend, provided that there was adequate security for the loans they made. And that problem – adequate security – was easily taken care of because they could simply go on lending to new generations of borrowers and purchasers who could afford, with the banks’ help, to pay the ever-inflating prices and thereby maintain the ever-rising price structure. The banks had discovered a huge machine for generating profits.

They could charge interest on money they themselves created, and they could ensure that their lending was virtually risk-free by virtue of their willingness to go on lending so that prices (and the value of the assets that provided their security) kept on rising. The result is that the Auckland market is the product of a veritable tsunami of new credit flooding into it day by day, week by week, month by month – and 47% of that lending has gone to speculators, not homeowners.

Without this huge volume of new credit created by our banks and made available for the sole purpose of buying property, the housing market would be unrecognisable. Little wonder that the average house price in Auckland is now close to a million dollars and is rising at 14% a year – and even faster elsewhere. This change in the funding of house purchase – the most important change in our monetary conditions for generations – is only dimly understood.

A former Governor of the Reserve Bank of New Zealand – Don Brash, no less - scoffed at the notion that the banks did anything other than act as intermediaries, lending to some what they were in turn loaned by others. Yet the Bank of England conceded, in an important paper in its Quarterly Bulletin of March 2014, that 97% of all money in the UK is created out of nothing by bank lending and the greater part of that goes on house purchases. The greater part of new money in our economy, in other words, is created by the banks for the exclusive use of those who are already well-off. Don Brash may by now, one hopes, have made a meal of his earlier words.

We are in exactly the same situation as in the UK; and that means that there is no solution to housing unaffordability until the banks are made to behave more responsibly. Our old friends – our Australian-owned banks – already do great damage to our economy, through the repatriation to Australia of the huge profits they make from fuelling the housing and mortgage market in New Zealand. Their activities mean a burden on our balance of payments of over $4 billion – money just siphoned out of our economy and spirited away. What do we get in return for this? An unstable market that is out of control, driven only by the banks’ drive for profits, and worsening social problems and inequality.

The Reserve Bank is becoming uncomfortably aware of the instability of the situation we find ourselves in. If borrowers began to find it hard to keep up their interest payments so that house prices turned down rather than up, and the banks should suddenly start to incur significant bad debts, the whole ramshackle structure could come tumbling down. The Reserve Bank certainly recognises the problem, but actually doing something effective seems beyond it. Its duty is to maintain the banks’ viability, which can all too easily mean simply the banks’ profitability. And the Reserve Bank is, after all, a bank itself; its loyalty is to the banking system rather than to the economy as a whole. 

National Belatedly Awakes To Risk

Even the National government has belatedly woken up to the risk – hence the tentative proposal of a possible land tax to be levied on foreign buyers in an attempt to cool the market and John Key’s urging that the Reserve Bank should put in place further macro-prudential measures to restrain bank lending. It remains to be seen what will come of it but it is nevertheless to be taken seriously, for at least two reasons.

First, it is an acknowledgment by John Key that housing affordability is now an issue of major public concern, not just because of the difficulty it creates for those seeking to start a new life in a new home, but for what it is doing to social cohesion. The Government is, of course, cautious in dealing with it is because Auckland homeowners are naturally (and short-sightedly) very happy with what is happening. They are inclined to thank the Government for the cosy glow that getting richer without any effort can produce.

The second point to notice is that a land tax would endorse an analysis of what lies behind soaring land prices that has so far been rejected by the Government – and most others. A land tax for foreigners would represent an attempt to discourage investment and thereby reduce the volume of demand and purchasing power that is currently fuelling the Auckland market – but this focus on the level of demand is at odds with the reasoning so far adopted by the Government and by most so-called experts. 

If the problem can be eased by reducing the level of demand, why does that argument not apply to the whole market and not just to foreigners? And if the volume of purchasing power coming into the market is a central factor in causing prices to rise, as it surely is, then why do we not look at where the overwhelmingly greater part of that purchasing power really comes from? Tweaking interest rates or imposing a low rate of land tax in an attempt to cool the housing market are both likely to be ineffective for as long as the market is awash with constantly growing volumes of new credit.

Small marginal increases in the cost of investing in property will be quickly swamped by the tidal wave of new credit and by the capital gains thereby created, and will just become another (small) factor to be added into the price structure. It is unlikely that Government will have the courage to tackle the banks (or their home-owning supporters) on this issue. Any action that might be taken would, in any case, have to be taken gradually and cautiously, so as to avoid a bursting of the bubble and great damage as a result both to individual family budgets and the national economy.

It Is Now Up To The Reserve Bank

It must devise “macro-prudential” measures that will effectively restrain bank lending on mortgage. The longer the current situation prevails, the more damaging and dangerous it becomes. The proposed solution of making ever more land available to property speculators and the banks that finance them, in other words, may in due course bring housing values down all right, but not in the way that is foreseen – and a crash of that kind would be at huge cost to the national economy.