Central bankers' latest fad

SINGAPORE - Imagine this scenario: Home prices spike. Debt levels jump. House hunters get angry at being priced out of the market. The government and central bank step in, imposing mortgage curbs to cool property demand.

This may ring a bell for Singaporeans, but it also describes what's happening in other cash-flush Asian cities, such as Hong Kong and Kuala Lumpur, where low interest rates and a strong economy have seen property prices soar.

Elsewhere in the region, a central bank worries that 100 per cent loans for motor vehicles are causing some buyers to overstretch themselves.

To encourage prudence, it insists vehicle buyers start putting a cash down payment and taking smaller loans.

Surely this refers to cars in Singapore? Not quite - try motorcycles in Indonesia.

Even as Singaporeans marvel at - or complain about - the Government's ever- present hand in asset markets here, other economies are experiencing the same vigilant, targeted intervention.

From Gangnam to Geneva, cities plagued by volatile asset markets are seeing a new generation of central bankers turn their attention to ensuring the overall stability of their financial systems.

In the process, they are going beyond the usual arsenal of interest and exchange rates, which are traditionally used to control inflation and encourage growth.

For one thing, interest and exchange rate changes affect too wide a swathe of economic activities to target specific financial system potholes. Raising such rates would reduce borrowing and spending not just in housing markets but in other sectors as well.

For example, a country might want to raise interest rates to discourage loans and hence lower property prices.

But in a world abundant with liquidity and awash with investors seeking higher returns, higher interest rates or a strengthening currency have the perverse effect of attracting even more capital and fuelling asset price rises.

The solution: new, targeted measures to curb financial excesses more proactively and effectively, be they runaway housing markets or banks overeager to lend.

Since these measures aim to secure overall economic and financial stability, they have come to be known as "macroprudential" policies, seen as an increasingly necessary supplement to old-fashioned monetary policy that uses interest and exchange rates.

Macroprudential what?

In an article this month, the Wall Street Journal called macroprudential policies "the new fad in central banking". But they have been around for some time.

Macroprudential policy surfaced in public use around the time of the 1997 Asian financial crisis. By the 2000s, it started taking the shape they have today, especially in Asian economies.

In essence, a macroprudential measure aims to strengthen the financial system as a whole. It recognises that the actions of each bank, company and household can combine to threaten financial stability - and endanger the real economy - even if individually they appear sound.

"The macroprudential authority focuses on herd behaviour and shifts in overall risk appetite," said the International Monetary Fund (IMF) in a paper last month. "For example, individual institutional risk often appears to be low, or falling, at a time when system- wide risk is actually rising."

The housing market is the best example. If property values are rising, both home buyers' and banks' relative debt levels may seem reasonable. Banks keep lending, allowing buyers to keep pushing up home prices, making everything look safe.

But once the bubble bursts, home owners may find they owe more than their assets are worth and abandon their loans. Property companies may also go bust, hurting banks and freezing their lending to the whole economy.

Because home loans are a major part of personal and bank debt, property cycles are closely linked with the entire financial system. The more exposure banks have to mortgages, the more likely the sector will come undone by a tumbling property market - as seen most recently in the United States.

It is precisely to prevent this cycle of overleverage from getting out of hand that central banks in Asia, and other regions where asset markets have boomed as a result of extra-loose global liquidity, are taking macroprudential measures to curb their economy's exposure to housing price swings.

Curbs on loans to people

The most popular moves so far are caps on housing and vehicle loans made by financial institutions to individual borrowers.

These caps limit how much a person can borrow as a proportion of the asset price (as seen in several Asian countries from Singapore to Indonesia), how much he can borrow as a proportion of his income (Singapore, South Korea) or how long he has to repay the loan (Singapore, Canada, Malaysia).

Some central banks, such as those in Israel and Switzerland, have also ordered lenders to hold more capital for certain mortgages that they make, while New Zealand's is making banks set aside more capital during credit booms and for specific sectors.

While many of these measures were introduced only this year, others have been around for a while. Singapore and Hong Kong, for instance, both started using loan-to-value caps in the 1990s.

Some macroprudential policies also dovetail with social goals.

Soaring home prices in many countries not only cause home loan amounts to be higher, but also put homes out of reach of lower-income buyers.

Over the weekend, Taiwan said it was considering raising "luxury" taxes on properties bought and quickly resold, not just to ensure home prices remain close to fundamentals but also to narrow a rising income gap.

Do they work?

While most economists say it is too soon to tell if macroprudential controls have worked, early signs point to optimistic results.

A recent study by the Bank of International Settlements found Hong Kong's loan-to-value caps would help reduce loan delinquency rates, or delays in repayment, during a downturn.

This implies such moves could have a "significant impact in helping prevent systemic disasters", Moody's Analytics associate economist Frederick Gibson told The Straits Times.

"But if you look at house prices in Hong Kong, they are still growing very strongly, so can you really say the measures have been successful?" he added. Hong Kong home prices have surged 120 per cent since 2008, rising 28 per cent year on year in the first quarter of this year alone.

In Singapore, what started as efforts to reduce home demand - such as new taxes on buyers and sellers - have evolved into curbs aimed at reining in debt levels.

Despite that, home prices here are still rising, although no longer at an accelerating rate. But this may be too late for the 5 to 10 per cent of borrowers that the authorities have said are already overstretched by their home loans.

Still, in theory at least, macroprudential measures do make the financial system safer. Studies show economic activity is less affected by home price changes if loan-to-value ratios are lower.

One IMF survey in 2011 also estimated that for every 10 percentage point fall in loan-to-value ratios for first-time buyers, house price growth fell 10 percentage points.

Another found that tighter limits on loans relative to asset values or income led to both property transactions and prices falling.

But such measures may also backfire.

In South Korea, mortgage curbs over the last decade sent home prices slumping in 2006 and they have yet to recover, forcing already indebted home owners to take out more loans to avoid defaulting on their homes.

Despite the relatively short history of macroprudential policies and patchy data on their effectiveness, more countries are starting to consider them.

US Federal Reserve governor Sarah Bloom Raskin said recently that US regulators should use more measures to control housing bubbles, such as down payment requirements that automatically increase during booms and decline during busts.

More analysis is clearly needed for such policies, especially in terms of how to monitor and evaluate their effectiveness.

But for now, many believe macroprudential tools herald a better era of central banking policy, filling the gap between microprudential rules - the supervision of individual banks - and monetary policy.

Mr Douglas Elliott of the Brookings Institution, who has studied macroprudential policy in depth, is confident it will prove useful. But he says it is "critical not to overstate what it can achieve or the ease with which it can be implemented effectively".

"We need more refined theory, better statistics, and, unfortunately, we will also need to learn by experimentation," he told The Economist magazine last month.

Still, "any moderately intelligent macroprudential policy is likely to be better than our de facto policy of recent decades, which was never to use these tools".

Mr Gibson agrees. "Anything that strengthens bank balance sheets and helps promote prudent lending is positive. But the real test will come only if we have a financial downturn again."

fiochan@sph.com.sg

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