Honohan criticises government housing policy as ‘reactive’ and inflationary

Former Central Bank of Ireland governor Patrick Honohan has launched a scathing critique of government housing policy, describing it as "reactive", "short-termist" and ultimately inflationary.

He said the help-to-buy scheme was a “poorly designed response” to the Central Bank’s mortgage measures, which had added to existing price pressures in the market.

Speaking at a two-day webinar event on the Central Bank’s mortgage rules, Prof Honohan outlined how the mortgage measures were introduced under his watch in 2015 in response to a rapid surge in house prices and “the fact that mortgages were once again being granted at very high loan-to-value ratios”.

House prices in Dublin rose by 46 per cent in just 18 months prior to the introduction of the rules, he said. “There was clear danger a credit-price spiral would return.”

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Prof Honohan, who served as Central Bank governor from 2009 to 2015, said the loan-to-value restriction was designed “to protect the operational sovereignty of the banking system” while the loan-to-income curb was introduced to protect the borrower “from the crippling effects of overindebtedness”.

The ratios, criticised by some in the industry as being too restrictive, were informed by a huge tranche of loan data obtained from the banks as part of the post-crash stress tests, Prof Honohan said.

He also noted that there was “quite a lot of pushback” against the measures, including a written submission from the Department of Finance, but that the Dáil deferred to the regulator in passing the legislation.

Prof Honohan insisted the measures had had “macroeconomic bite” in easing house price inflation, noting that prices rose by just 4 per cent in the 18 months that followed their introduction, even though price control was not the main objective.

However, he said a number of factors since then had propelled prices forward again, including the help-to-buy scheme.

“They [the then government] just basically paid some of the deposit for some categories of borrowers and this, and other things, resulted in further upward movement in price,” he said.

‘Problematic’

He admitted, however, that the rapid rise in house prices relative to income had made the rule limiting buyers to borrowing just 3½ times their income “problematic”.

However, increasing this ceiling to four or five may just drive prices up further, he said. Prof Honohan also questioned – in retrospect – whether the rules may have increased pressure on rents.

He said a number of factors were driving house prices here, including population growth, immigration, the strength of the economy and, more recently, Covid-19.

Another factor, he said, was government policy, which had been “very reactive, very short-termist with subsidies introduced just to relieve certain pressure points without enough consideration of their systemic effect and who’s actually going to benefit or lose out”.

The webinar, part of the Central Bank's framework review of the measures, also heard from Reserve Bank of New Zealand (RBNZ) deputy governor Christian Hawkesby, who outlined the country's experience.

“What we’ve found in practice is that house prices are driven by many factors, with the level of interest rates a much stronger determinant than macroprudential settings,” Mr Hawkesby said.

“The main benefit that we’ve found from imposing loan-to-value restrictions on the flow of new mortgages is the way that it has helped over time strengthen the quality of the asset book in the banking system,” he said.

Mr Hawkesby said the stock of high loan-to-value mortgages fell from about 20 per cent to about 5 per cent since the introduction of the rules.

“The measures have strengthened the resilience of our financial system to withstand a shock,” he said.

New Zealand was one of the first countries to impose restrictions around mortgage lending in a bid to manage rising property values.

Affordability problem

House prices have surged in New Zealand over the past decade, creating significant affordability challenges similar to those in Ireland.

The situation has been compounded by ultra-low interest rates and more recently by a faster-than-expected economic recovery from the pandemic.

Many view interest rates as the chief driver of property prices globally. A significant 2019 Bank of England study suggests the surge in house prices in the UK – they’ve quadrupled since the 1980s – has been driven not by a lack of supply but by low interest rates.

The rationale is that housing is a highly financialised asset and low interest rates increase the value of future income flows.

This incentivises banks to lend more, investors to invest more and people to borrow more, thus inflating housing values.