Wednesday, April 16, 2008

Risk aversion - betting the house

The latest volume of NZ Economics Papers Vol 41(2) Dec 2007 (the journal of the NZ Association of Economists) has an interesting article entitled "Safe as Houses: Investor Confidence in NZ" written by Faye Braithwaite and Simon Kemp.

Here's the abstract:

We investigated the psychology of risk in the context of residential property
investment. One hunderd and thirty seven participants completed a questionnaire
that measured thier sensation-seeking, general investment risk attitude, and
attitude and confidence about investing in a term deposit, unit trust shares, a
residential property syndicate and residential property. People with higher
sensation seeking scores found shares and unit trust more attractive tha low
sensation seekers, but all groups were most confident about investing in
residential property. Overall the results indicate that New Zealanders invest
overwhelmingly in real estate beacause they trust it more than other forms of

The discussion at the end of the article notes that : "Official attempts to warn people against a housing asset bubble have not so far been very effective. Indeed, they may have been particularly ineffective with precisely those peoplem who might expect to pay most attention - the risk averse."

Herein lies much of the problem with the housing market in New zealand. Although there are regulation on the condition of a house, the market itself is fairly unregulated and for that reason is going to be clearly affected by swings in supply and demand. Yet the above research suggests that many New Zealanders do not view the housing market as being inherently risky. Even if housing is less volatile than other financial markets, the sum of money involved means that the effect on houshold balance sheets is relatively huge.

While discussion of housing affordability is worthwhile, too many people do not recognise that the current state of affairs is a direct result of our collective paradoxical love affair with housing. The cause of housing unaffordability is not because of evil property investors or even hordes of well heeled migrants. [As an aside, the same volume of NZEP has an interesting article that shows migrant couples are generally less wealthy than NZ-born couples.] It is because we have become indoctrinated into believing that owning a home is a birthright and will attempt to buy a house as soon as possible.

When will Kiwis wake up to the need for prudent financial planning? It may not be representative but when you see TV programmes such as "Money Man" and the complete lack of ability willingness to think about one's future cash flow and risks, it is easy to believe that we are in fact in a deep coma. Somewhat ironically, I note the Money Man's repeated use of "enough money for a deposit on a house" to describe how much the subjects need to save only serves to reinforce this fixation.

This leads me on to another thought. Fortunately we do not have the same extent of jingle mail as there appears to be in the US. It is perhaps because of this yearning for housing that stops this. That said, I fail to understand why people who buy houses do not stop to think about how much leeway they have to absorb higher interest costs. Possibly there is some myopia going on with a belief that a fixed mortgage means that mortgage interest rates are fixed forever, when in reality it could well mean a big jump in mortgage payments once the fixed term ends - typically every 2-3 years. This is made all the worse for new home owners for whom initial mortage payments are almost entirely interest only - in 2-3 years time the actual principle will not have gone down much and thus the effect of a rate increase will be all the worse compared to homeowners who have paid off significant chunks of their mortgage already.


Lucy said...

You are right, it seems to be driven into us that buying a property is the pinnacle of what we can achieve and the lenders and people with an interest in selling them to us make damn sure they keep that myth going.
As we can see in the markets today, they don't care how they get us to do it either.

Anonymous said...

Yet the above research suggests that many New Zealanders do not view the housing market as being inherently risky.

I'll say they don't. I don't know if NZers will ever get over their love of property though...