Graham Adams goes inside the property bubble that affects everyone in the country.

Loans for residential housing can be discounted so that a $100,000 mortgage may count as, say, only a $26,000 loan on a bank's books.

Stories highlighting dramatic house price rises and a relentless diet of property porn make it easy to forget residential property’s turbulent recent history worldwide.

Meanwhile, the whole of New Zealand goes on paying the price for the madness of the Auckland housing market.

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This article first appeared in the April 2015 issue of North & South magazine. Photographs by Megan McChesney.It has been said that nothing could surprise a German housewife in the Weimar Republic after she had paid four billion Reichsmarks in October 1923 for a dozen eggs that two years earlier had cost just three Reichsmarks.A similar psychology – even if on a much milder scale – comes into play for Aucklanders when they see a rundown villa or bungalow fetching more than a million dollars after frenzied bidding at auction despite it requiring a king’s ransom in renovations (if not a complete rebuild). Or a three-bedroom bungalow fetching $256,000 more than had been paid for it a year earlier. That a modest home should increase in value by $5000 a week barely raises an eyebrow among most Aucklanders or ruffles the froth on their cappuccino.Equally, repeated reports by organisations as influential as the OECD and International Monetary Fund, as well as private banks such as Deutsche Bank, that New Zealand house prices are among the highest in the world in relation to both rents and incomes won’t impress most Aucklanders, or make the over-levered with a clutch of investment properties rush for the exits. Nor did Demographia’s annual survey in January that rated Auckland as “severely unaffordable” – slightly cheaper in relation to incomes than London, but less affordable than Los Angeles, Toronto, New York, Brisbane and Boston.And although we’re a tiny, over-indebted nation at the bottom of the South Pacific, heavily dependent on insurance payments for the rebuilding of our second-biggest city and on exporting a handful of agricultural commodities, mainly to China, no one seemed moved by ANZ economists’ recent calculations that, at around $475 billion, Auckland’s housing stock is worth more than twice our national annual GDP.Furthermore, while many people find it unremarkable that the price of milk solids halved last year, or that of oil more than halved in six months, the notion that house prices might suffer even a minor fall seems not only pre­posterous but vaguely blasphemous. The warning by Reserve Bank governor Graeme Wheeler in February that the nation’s housing market – particularly in Auckland – was at risk of a “sharp correction, leading to financial instability” (a polite way of saying banks might get into trouble) didn’t appear to alarm many.Even the prediction by investment guru and New Zealand Herald columnist Brian Gaynor in January that house prices could fall by as much as 25 per cent – and his observation that the New Zealand housing market, driven by Auckland, was beginning to look disturbingly similar to Ireland’s in the run-up to its 2008-2010 collapse – failed to excite much more than passing interest.If you want to observe for yourself the insanity of housing fever in Auckland and the dislocation between reality and housing prices, go to an auction held at a desirable property. At an onsite auction I attended in Devonport last year for a two-bedroom, concrete-block apartment, spirited bidding took the price way beyond the CV of $650,000, to a giddy $850,000. (The fact this won’t surprise Aucklanders in the slightest merely proves my point about a property market so long out of control that no one notices anymore.)The successful bidder, a silver-haired, 60-something Pakeha, told me after the auction she had been prepared to spend “as much as it took” to secure the apartment. She clearly would have bid a million or more if pushed by an enthusiastic rival with deeper pockets.Nobody ran from the room screaming, “This is madness!”, although madness was clearly afoot because there is no other plausible explanation why a good friend of mine kept bidding until she dropped out at $830,000 when she had told me repeatedly before the auction she would not go above $740,000, given she believed even that price was over­inflated (a view reinforced by the fact she had considered buying the same apartment 10 years earlier for $410,000 but considered it to be overpriced then).Part of my friend’s calculation had been the rental yield. But if the return would have been meagre at a selling price of $740,000, it would be positively dismal at $850,000 – barely three per cent – and that would effectively drop further once the cost of necessary improvements had been paid for.It’s true the apartment had a panoramic view over the harbour but it was also south-facing, vulnerable to chilly winds, and could at best be described as tired and averagely appointed, with painted concrete-block walls you’d want to immediately plaster, an ensuite bathroom that needed replacing, rotting timber on the deck out the back and a crazy loft-attic arrangement that would have made a feng-shui devotee mad with despair. The fact is, for more than a decade, Aucklanders have been living through a period of rampant property inflation and we’re inured to the madness now; we regard sky-high prices as the “new normal” – as inevitable and as uncontrollable as the weather. That some of the nation’s provinces have seen falls of more than 25 per cent since prices peaked in 2007 (not to mention falls of 50 per cent in Ireland, 45 per cent in Greece, and 30 per cent in the US and Spain) hasn’t dented Aucklanders’ belief they inhabit their own Magic Kingdom, where real estate prices can only rise.During most of the years of the boom, we’ve been told that it’s mainly because of a housing shortage and more houses need to be built as quickly as possible to bring prices down. Maybe the Weimar housewife was told that a dozen eggs cost four billion Reichsmarks because of an egg shortage and if only more chooks were put to work laying eggs, the price would come down, but it is generally agreed the real reason was, by mid-1923, Germany had nearly 1800 banknote printing presses and 133 companies the government had authorised to print and issue banknotes.In fact, anyone who studies the history of financial manias – whether real estate, railways, canals, shares or even tulips – will come back to the role of easy credit, which both sparks bubbles and fuels them. As Charles P. Kindleberger says in his seminal Manias, Panics and Crashes: A History of Financial Crises: “Speculative manias gather speed through expansion of money and credit or perhaps, in some cases, get started because of an initial expansion of money and credit.... Tulipmania, part of speculative excitement over many objects, was fattened on personal credit.”And Carmen Reinhart and Kenneth Rogoff concluded in their 2011 history This Time Is Different, which tracked financial follies over eight centuries, that all you need for a bubble is ready credit and collective gullibility.The easy availability of credit is readily demonstrated: simply go to a bank to borrow money to buy a house in Auckland, and you’ll be astonished at how much more they are willing to lend than you want to spend or you calculate you can actually afford – an obvious spur to ramping up prices.If you’re young, unable to save or without the advantage of a leg-up from family, the credit spigot has been largely turned off by the loan-to-value (LVR) restrictions put in place in October 2013 by the Reserve Bank’s Graeme Wheeler. But for those affluent enough to be able to save (or lucky enough to be given) a substantial deposit, or anyone with another property to offer as collateral, credit is abundant and easy to get.If you want to see concrete evidence of the banks’ largesse, look at Reserve Bank figures. Lending took off from 2000, with housing loans from banks and other lending institutions soaring from $65 billion in December 2000 to $196 billion in December 2014.The credit tsunami for housing is, of course, an official policy sanctioned by the Reserve Bank, itself acting on the recommendations of the Bank for International Settlements – the bankers’ bank in Basel, Switzerland. Banking regulations allow banks to favour mortgage lending over any other kind through risk-weightings that deem housing to be, well, as “safe as houses”. While most business loans have to be assessed at their full amount on a bank’s books, loans for residential housing can be heavily discounted.Risk-weightings at the “standardised banks” such as Kiwibank, TSB, SBS and the Co-operative Bank start from 35 per cent, but a Reserve Bank spokesman told North & South that risk weights for the Big Four’s housing loans “are generally between 26 and 31 per cent”.Consequently, a $100,000 mortgage may be counted as only a $26,000 loan on their ledgers – meaning banks can hose the housing market with money since they have to hold less cash in their reserves.This – along with housing’s tax-favoured status – has long irked economist Gareth Morgan. He argues that if mortgage risk-weightings did not favour housing so heavily, the demand-driven boom would dwindle. As he told the National Business Review last October : “There is a speculative demand for housing in Auckland that unnecessarily boosts the demand for housing well beyond what the demand for accommodation would imply. This is driven by the toxic mix of a tax break on housing along with the Reserve Bank directive to banks to lend on mortgages as first preference. Get rid of those and the demand will fall back to a level that is commensurate with the demand for accommodation.”Morgan’s has been a lonely voice in New Zealand in highlighting the role the banks play in goosing housing markets, but recently he’s been joined by the likes of the Economist. It pointed out in January that the huge rise in house prices around the Western world began with directives from Basel in 1988 for banks to favour mortgage lending. The result nearly 30 years later, the Economist said , is that “far from channelling money to companies, modern banks resemble ‘real-estate funds’.” Easy credit, however, is clearly not enough on its own to drive a housing bubble because banks can’t force customers to borrow. So people need to be persuaded to take on debt to buy houses at higher and higher prices. And that can only happen when buyers are afflicted by “collective gullibility”.The primary way to engineer the necessary gullibility is to promulgate the belief that housing is always a one-way bet. The Global Financial Crisis proved this belief to be spectacularly untrue, even in New Zealand, when inflation-adjusted prices nation­wide fell by 15 per cent. The Reserve Bank responded by cutting the official cash rate from 8.25 per cent to 2.5 per cent between July 2008 and April 2009. This helped push floating mortgage rates down from above 10 per cent to less than six per cent and was instrumental in quelling what would undoubtedly have been much greater price falls.And, of course, in the 1970s, inflation-adjusted house prices in New Zealand fell by around 35 per cent, although the severity of that fall was masked by galloping inflation.Nevertheless, stories highlighting dramatic house price rises, churned out mainly by newspapers, and a relentless diet of property porn of the DIY kind in magazines and television programmes, make it easy to forget residential property’s turbulent recent history worldwide.It is not enough, however, just to ignore history; it is also essential to manu­facture reasons why the surge in prices is rational. The most common reason put about – and one touted all around the world whenever prices rise – is a housing shortage, even when there is very little evidence to support it. (A shortage of houses was widely used to justify the booms in Ireland and Spain before the GFC yet entire suburbs have been bulldozed in both nations in the past five years to reduce a persistent oversupply.)As NZIER economist Shamubeel Eaqub told North & South: “People latch onto a shortage as a way of justifying paying over the odds for a property by reference to forces outside themselves and over which they have no control. (‘It’s not my fault.’) And it also helps convince them there is a rational basis for their purchase.”And it’s especially easy to convince people that rising house prices mean demand for accommodation is overwhelming supply when cashed-up foreigners looking for a bolt hole are welcomed to New Zealand with open arms and stories of overseas buyers buying swathes of houses are commonly reported.For years, several of the nation’s most prominent economists regularly pointed out Auckland wasn’t suffering from a housing shortage – so that couldn’t have been the cause of rising house prices. Gareth Morgan, for instance, told the NZ Herald in June 2013 : “Yes, it is a supply issue – but not supply of property, rather supply of finance.” Last May, Eaqub told the NBR : “There is no housing shortage in Auckland. If there’s a real shortage of houses you would see both house and rental prices rising. In Auckland, that’s not happening. In Christchurch, where there are real housing shortages, rents are rising.”Even a New Zealand Herald editorial last August stated : “The problem is not primarily one of supply. People are housed. The problem is that so many are trapped in rented houses because it has become so much harder to buy one.“The rate of home ownership in New Zealand has declined because so many established home owners have bought two, three, four or 10 houses. They are re-mortgaging their home to buy rental property, not so much for the rent but for the capital gain when they sell. Rent in Auckland has not been rising at a rate that would be occurring if there really was a housing shortage. The central problem is not supply, it is the demand for investment property.”These occasional voices of sanity pointing out the difference between a shortage of accommodation and a shortage of houses wanted as investments were drowned out by a barrage of property propaganda from politicians, the media and others with an interest in building, advertising and selling more and more houses and peddling the idea that Auckland was desperately short of them. Now, however, the worm seems to have turned and Auckland has finally got the housing shortage so many have long promoted as a reason for soaring prices.When I spoke to Eaqub in mid-January and pointed out that, for most of the previous year, Auckland rents had risen somewhere between two per cent (according to Trade Me) and 4.6 per cent (according to Barfoot & Thompson), and asked whether that indicated a housing shortage, he replied with an emphatic “no.” He saw the steady (but not spectacular) rise in rents since 2011 at around three to four per cent as roughly reflecting wage rises and consistent with a “relatively normal rental market”. He contrasted it to the early 2000s when a huge influx of immigrants saw rents spiralling upwards; in 2002, Eaqub says, they rose on average by 12 per cent in a year.Six weeks later, in late February, Trade Me figures were released showing that median rents in Auckland were 6.7 per cent higher this January than in January 2014. Eaqub agreed the supposed “housing shortages” that have been used to explain soaring prices for the past decade are arriving.“I believe this is finally when the migration numbers are becoming a reality. This surge in population growth is beginning to add to demand and the earliest indications are in surging asking rents for homes in Auckland,” he told North & South.“The migration boost will be keenly felt through 2015 and the biggest increase will be through the first half of 2015. We expect to see significant increases in demand for housing. Mythical housing shortages of the past will become a reality and we expect to see that being reflected in the residential rental market.”Expect more headlines then about rising rents justifying even higher house prices, but be aware the worm may turn again.The Reserve Bank – which noted in late February that Auckland’s median house price was 50 per cent above the 2007 level – has signalled it will be looking at further measures to quell housing demand. Initially, it had mulled effectively raising the risk-weighting for investors who own more than five houses. In 2013, the bank said it was “of the view that anyone with more than five properties, regardless of whatever other income sources or revenue streams may exist, should be treated as running a small business. To avoid further confusion, this would mean treating those loans as corporate property loans.”However, the bank was obliged to return to the drawing board to refine the proposal after it met heavy opposition, not least from the commercial banks themselves.This month, the Reserve Bank proposed that all residential property loans to investors should be treated as a specific asset sub-class with appropriate capital held against them. A likely consequence is that interest rates for investors will rise compared to loans made to owner-occupiers and that loans for investment properties may be harder to get. The bank expects the new measures to be under way by July 1.For the moment, however, the momentum of the Auckland market seems unstoppable. But, as the NZ Herald’s business editor, Liam Dann, wrote in late January : “Right now it genuinely is hard to imagine a serious downturn in Auckland property prices [but] how about a scenario where RMA reforms and special housing zones actually work well? What if the big boost in housing supply coincides with a capital gains tax introduced by a new government? Meanwhile, the Australian economy booms and immigration trends reverse…”Meanwhile, the whole of New Zealand goes on paying the price for the madness of the Auckland housing market, with LVR restrictions that also hit first-home buyers in provincial cities and towns, an overvalued dollar boosted by the inflow of mortgage funds that crimps profits from exports, and interest rates that are higher than they would be if Auckland housing hadn’t gone ballistic.