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A sharp rise in unemployment beyond currently forecast levels could cause an even more dramatic collapse in house prices, as modeled by the Reserve Bank.
Banks would need a multi-million dollar bailout if the Covid-19 pandemic pushed unemployment to close to 18 percent and remained in double figures for four years, the Reserve Bank predicted.
The bank forecast in August that unemployment would peak at 8.1 percent, causing a 9 percent drop in property prices “from high to low.”
But it has also modeled two “pessimistic scenarios” during which an increase in unemployment between 13.4% and 17.7% could cause house prices to fall between 37 and 50%.
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That would cause huge bad debts for the banks.
The likelihood of those scenarios occurring has been lowered somewhat since they were originally developed in late March and early April, the Reserve Bank said in a report Thursday.
STACY SQUIRES / Stuff
The relationship between unemployment and house prices may be far from a straight line at higher unemployment rates.
But a series of new adverse shocks could bring them “quickly back within the range of plausible results,” he warned.
In the “very severe scenario” modeled by the Reserve Bank, banks would need a bailout of $ 7 billion in the third year of the crisis to stay afloat and continue lending, he predicted.
“While these scenarios are severe, they are unprecedented internationally, and the economic costs of such bank failures are significant,” said Lieutenant Governor Geoff Bascand.
Governor Adrian Orr has frequently suggested that Covid has been an illustration of why the central bank was right last year in requiring banks to build up their capital reserves in anticipation of a deep crisis.
Although some economists have been surprised by the way property prices have held up so far during the pandemic, the Reserve Bank’s scenarios imply that price declines could become exponential if unemployment rises above a certain level. .
The bank pointed to Ireland, where house prices were cut in half between 2006 and 2012, as an example of what is happening.
He said in his report that the initiation of Covid had made clear to banks and regulators the importance of considering more severe “black swan” events in stress test scenarios.
His general assessment was that in the basic “pessimistic” scenario, banks could survive on their own capital, but rebuilding their capital reserves as the economy recovers would be a major challenge.
Bascand said he also assumed that banks would act rationally and that they could see how the crisis would unfold, which “is not the case in real time.”
