Wheeler explains why loan-to-value ratios were introduced

Many New Zealanders consider purchasing a house to be a rock solid investment, and assume that house prices will continue to rise steadily, having never seen a bear market or experienced rapid rises in mortgage rates.

Over the past 25 years, however, many wealthy countries have experienced periods of substantial decline in house prices.

Falling house prices erode homeowners’ equity, while mortgage lenders experience losses on their loan portfolios. The resulting stress in the financial system can have long lasting adverse effects on the economy. For borrowers, it can mean years of spending cut-backs to rebuild savings. The greatest impact is on borrowers, often first-home buyers, who recently entered the market with the least equity. In the United States, real net household wealth for the median household fell 39 percent from 2007 to 2010, and a quarter of America’s mortgage holders owed more on their houses than what their houses were worth.

Our concern is that excessive increases in house prices in parts of the country, if unchecked, pose increasing risk for the financial system and the broader economy. High and rising house prices increase the risk and potential impact of a major correction in house prices, and consequential loss to lenders. In a severe downturn, such losses would be expected to significantly reduce banks’ willingness to lend. Similar views about the risks from our overvalued housing market are expressed by the IMF, OECD, and the major international credit rating agencies.