One of the major downsides of the 2008 financial crisis has been the re-emergence of ‘macro-prudential’ regulation. This sort of regulation, hoping to limit systemic risk in the banking sector, is currently fashionable but signals a return to the 1970s mentality of economic fine-tuning, albeit with different tools. It also adds to moral hazard as government effectively designs and then approves levels of bank probity.

Of particular concern are reports on one of the macro-prudential tools that the Reserve Bank seems likely to employ over the next few weeks: limiting the loan-to-value ratio (LVR) for bank mortgages.

As has been widely reported, the Reserve Bank will compel commercial banks to lift the deposit needed for a new home to 20% of the total value of the loan. For a $400,000 house, an $80,000 down payment would be required.

The obvious trigger behind the introduction of an LVR ratio is the perceived price bubble in Auckland’s real estate market. At least in part, it is considered an alternative to raising interest rates at a time when inflation is low, and the rest of the economy is far from overheating.

There also seems to be a paternalistic element: If there is a bubble, and if it pops with a big bang, many people could hold negative equity in their homes.

For potential first home buyers, this is an unhelpful policy. It effectively penalises first-time home buyers, low on equity, to which a bank may have otherwise provided a loan. An LVR also does nothing to increase supply. It punishes potential owners today for the sins of central government and local councils, and whose regulatory creep has suppressed housing supply for decades.

This policy will likely have a short-term effect on demand, and the housing market may cool off a little. However, it will have unintended consequences if the results of similar policies abroad are anything to go by.

This policy also treats symptoms rather than causes by artificially restricting demand, rather than treating supply. This ‘macro-prudential tool’ could have the very imprudent effect of stalling new housing supply in the short term and thereby increasing prices in the long term.

It is a policy which actively advantages those with houses and equity over those with no house and little equity, and where the unintended consequences are unknown.

Let the fine-tuning begin.