Wednesday, 28 January 2009

Goff's goof. (updated)

Having made comments on Goff's idea that people should be able to easily break out of their fixed rate mortgage contracts over at TVHE and Monkey with Typewriter I thought I may as well comment here as well.

I take from what I have read that Phil Goff has suggested that people should be able to easily break out of their fixed rate mortgage contracts to enable them to jump to a lower interest rate. This is not a good idea.

As Matt Nolan points out one problem with contracts is what economists call the "hold-up problem". The hold-up problem is where one party to a contractual relationship exploits the other party's vulnerability due to relationship-specific assets. You try to write a contract complete enough for this problem not to occur. (Insofar as the contract is still incomplete hold-up can still occur. But there are other ways around it, such as determining ownership of assets.) But if you can't deal with it then under-investment can occur since the fear of hold-up can stop parties making the efficient levels of investment.

But if Goff's suggestion was actually implemented, this would not be your normal hold-up. In this case, one party to the contract isn't holding up the other, as such. Here the government would be holding-up one party, in this particular case the banks. The banks have made a specific investment, the loan, and are being forced to renegotiate it, not by the other party, as would be the case under the standard hold-up problem, but by a third party, the government.

I’m sure if banks had thought for a moment that the government would act in this way, they would not have made as many loans as they did, that is, under-investment would have occurred. Some borrowers would have missed out on loans. And if the government does act in the manner Goff suggests, how will banks act in the future? What will they do to protect themselves from this kind of thing happening again? Whatever they do, it won't be good for their customers. Either fewer loans would be made or the conditions of the loans and the interest rates charged would be worse than if the government doesn't intervene. Or may be both.

I wonder if rates where going up, and the banks were in hardship would Goff call for banks to be able to easily break out of their fixed rate contracts to jump to a higher interest rate? I think not. There aren't many votes for Labour among bankers. I think Goff is just playing politics.

Update: Matt Nolan at TVHE points out that in addition to the above there is another problem with Goff's idea: "households are willing to take more risk with their mortgage - as they realise the government will intervene to help them out."

1 comment:

Michael said...

Bankers are probably the most unionised white collar workforce in NZ, and most would be shaking their heads at Goff. The reason fixed rates are offered is that banks borrow for a fixed term and put a margin on.

I'm on 7.74% for the next 8 months, after watching rates go up and up over the past two and a bit years. So while new rates are lower I've done better than floating.

If I'd had enough foresight I could have broken in October for no penalty, and then refix in three months when rates bottom out at 4-5%.