Canada's Housing Bubble

Dec 01, 2011 Don Cayo Vancouver Sun

For most Canadians, a property mortgage is a type of forced savings plan where the principal payments are socked away while the equity of the property and house grows over the years.

Federal Finance Minister Jim Flaherty not only changed the rules governing Canada’s mortgage market last month, he also rekindled a debate about how and how much Ottawa ought to intrude into the home-financing arena.

Flaherty flexed his muscles on three of the feds’ policy levers in order to raise the bar for a minimally qualified borrower to get a mortgage. First and most significantly, he shortened the maximum amortization period on any government-insured mortgage from 35 to 30 years (and since any borrower with a downpayment of less than 20 per cent must have government-backed insurance, that means almost every buyer who wants or needs a loan stretched out for that long). Then he reduced the upper limit Canadians can borrow against their home equity from 90 to 85 per cent, and he made lines of credit secured by home equity ineligible for government-backed insurance.

But he left in place both the requirement for a five-per-cent downpayment, and a provision that just 50 per cent of condo fees are treated as an expense against income when assessing an applicant for a mortgage.

This spurred a predictable debate between those who think he should back off and leave the checks and balances to the market, and those who think he should have been tougher on the downpayment requirement and the condo fees.

I think we’re going to have to see what impact these moves have on consumer debt levels — now, on average, about one and half times the average annual disposable income — before judging whether or far enough, too far or just right.

But it seems to me he skated around the elephant in the room — the massive involvement of the federal government in the business of lending, not just in setting the policies that govern how lenders must behave.

The federal government, through its Crown corporation CMHC, hugely dominates Canada’s mortgage insurance market. This means the federal government — and ultimately this means you and me — is theoretically on the hook for about half a trillion dollars. And while Canada-wide mortgage defaults adding up to anything approaching that scale may be unimaginable, so — I remind you — was the massive collapse of the housing market in the U.S. right up to the point where it happened.

Finn Poschmann, the vice president for research at the C.D. Howe Institute, doesn’t think thid is a business the federal government should be in, or a risk — no matter the odds against a bad outcome — that should be taken on with taxpayers’ money.

“Private insurers are able to manage such exposures, provided that they are adequately capitalized, prudently managed and regulated, and able to access liquid financial markets,” he argues in a paper released today.

He notes that, on one hand, this would not interfere with Ottawa’s policy-making ability and, on the other, it would not let taxpayers entirely off the hook. He sees a continuing role for CMHC as a backstop to the lending industry’s own measures to limit and absorb defaults.

This would “limit government policy to its more clearly justifiable economic role – assisting in the managing of undiversifiable risks that markets on their own, in times of financial crisis, may not be able to manage well,” he argued.

“Further, this approach would leave unfettered the ability of the federal government to regulate minimum prudential standards for mortgage lending and insurance.”

Poschmann also calls for tighter rules that would put CMHC on a more equal footing with other market participants, and for tweaking the rules for issuing bonds in order to give Canadian institutions better access to low-cost capital in the international market.

But it strikes me that the dramatic change of role he proposes for CMHC is potentially by far the most significant.

The problems in the U.S. housing market, and the much better performance in Canada thanks to our more effective regulations, convince me that their is an important role for government in setting the rules for, among other things, mortgage lending. But I am uncomfortable in any market where the regulator is also a major player. It’s too easy to imagine — or remember — situations where the financially prudent choice is to do one thing, but the politically expedient option is something altogether different.

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