Mr. Flaherty Replies to My Concerns

In January of this year I sent a letter to Jim Flaherty and my MP concerning Canada's debt load. A copy of the letter I sent is below

To

Hon. Jim Flaherty

Your MP's name here

Sirs,

I am writing you supporting potential changes to mortgage financing rules in the upcoming year. As you are undoubtedly aware, the average Canadian household debt to household income ratio has increased significantly in the past number of years and has now exceeded that of the United States. This was made possible by historically, and unsustainably, low interest rates on mortgages. As has been shown in other OECD countries, there is some evidence to suggest that households are primarily concerned with their short-term financial health -- the ability to service today's debt with low interest rates -- and less concerned with their long-term financial health -- the inability to service service tomorrow's debt with high interest rates. I have not seen any data or arguments to suggest that household debt will start decreasing in the coming year as long as interest rates remain low. My concern is that without further tightening of mortgage financing rules, Canadians will continue to take on debts that are unsustainable in the long-term.

While I am a believer in free markets, the growth in household debt is not sustainable when interest rates rise and I am not confident households will start saving while debt is so "cheap". If measures are not taken sooner rather than later, the resulting overhang of debt will put Canada at a distinct disadvantage relative to its trading partners, whose households have started to rebuild their balance sheets and will be in a much better position to weather the inevitable interest rate rises in the coming years.

Sincerely

Your Name

Your Address

In response, Mr. Flaherty sent me this response via Canada Post:

Dear (redacted):

Thank you for the correspondence of January 6, 2011 regarding Canada's housing market. Please excuse the delay in replying.

The economy remains our Government's top priority. Although Canada is still recovering from the impact of the global economic recession, we have emerged stronger than most other countries. We are helping to support both economic growth and job creation through Canada's Economic Action Plan and through important tax relief for Canadians. Furthermore, we are encouraging responsible home ownership through measures to help first-time home buyers.

Canada's strong housing sector, especially our traditionally prudent mortgage market and responsible lending practices, has also been important to our economic recovery. Unlike the citizens of other countries, such as the United States, Canadians did not face mass foreclosures on their homes, and our banks did not require taxpayer bailouts due to turmoil in the housing market.

A home is a family's most important investment, and a stable and secure housing market keeps our economy strong. That is why our Government continually monitors the housing market, ready to take careful steps to ensure its ongoing stability.

In 2008, and again in 2010, our Government took proactive steps to protect and strengthen the Canadian housing market. In 2008, we announced measures reducing the maximum amortization period for new government-backed mortgages to 35 years, requiring a 5-percent minimum down payment, bringing in new loan documentation standards, and requiring a consistent minimum credit score. In 2010, we introduced additional adjustments requiring buyers to meet a five-year, fixed-rate mortgage standard, lowering the home refinancing amount that financial institutions can offer from 95 percent to 90 percent, and requiring a 20-percent down payment to non-owner-occupied properties purchased for speculation.

Recently, we announced further important and prudent measures to encourage Canadian families to make sound investments in their homes. First, we reduced the maximum mortgage amortization period from 35 years to 30 years for new government-backed insured mortgage (that is, for mortgages with loan-to-value ratios of more than 80 percent). This measure will significantly reduce the total interest paid by Canadian families over the lifetime of their mortgages. It will also allow Canadians to build up equity in their homes more quickly and helps them pay off their mortgages before retirement.

Second, we lowered the maximum amount lenders can provide when refinancing insured mortgages from 90 percent to 85 percent of the value of the property. For example, for a home valued at $300,000, refinancing at 90 percent would allow the homeowner to access up to $270,000 whereas refinancing at 85 percent would provide the homeowner access up to $255,000. The lower refinancing limit means homeowners will keep an additional $15,000 in equity in their homes and limit the repackaging of consumer debt into mortgages guaranteed by taxpayers.

Third, we withdrew government insurance backing on home equity lines of credit (HELOCSs). Taxpayers should not bear any risk associated with such consumer credit products. These risks should be managed by the financial institutions that offer these products.

These measures underline our Government's continued action to protect the stability of the economy by ensuring lenders' practices are sustainable and the investments of Canadian families in their homes are secure. This will decrease the interest payments of Canadian families by tens of thousands of dollars over the life of a mortgage, helping to improve the financial well-being of Canadian households.

Our Government's ongoing monitoring and sound supervisory regime, along with the traditionally prudent approach taken by Canadian financial institutions to mortgage lending, has allowed Canada to maintain a strong and secure housing market.

Thank you for communicating your concerns.

Sincerely

James M. Flaherty

First, I thank the Honourable Minister for his long and detailed response. The views expressed below are my own and not necessarily those of other authors on this blog.

There are many things about Canada's housing market for which the government can take some credit, namely that mortgages are generally more conservative than the filth that was promoted in the United States last decade. It should be stated, however, that the rule changes Mr. Flaherty cites as indication of his government's willingness to reduce debt loads are retrenchment of very rules his government brought in earlier last decade.

The government's "Economic Action Plan" -- "backfilling" spending when private demand was lacking -- was generally a reasonable response given the severity of the economic slowdown that started in late 2007 and continued into 2009. My concern with the implementation of this action plan, which involved heavy lending through CMHC-insured vehicles, is that it involved increasing debt loads on assets that were already showing signs of over-valuation before the recession. Unlike government debts that can be reduced through higher future taxation, consumer debts linger.

I am somewhat disappointed that the government sees "housing market stability" as a primary concern, yet certain regions of the country are, and have been, experiencing rapid house-price appreciation. Stability should not solely mean preventing price drops. The government does have at its disposal the ability to control prices on a region-by-region basis by changing CMHC policies, something it hasn't yet done (to my knowledge) for whatever reasons.

In any case, I am not expecting further changes to CMHC policy for the remainder of 2011, though I leave the door open to certain region-based measures aimed at cooling down credit hot spots more swiftly. There are a few ways by which this goal can be accomplished, including targeted capital flow restrictions, informal MOUs with big banks, and internal CMHC policy directives.

Busting the Buyers' Strike

So much for the owner-renter class struggle, according to the Sydney Morning Herald: House buyers' strike a no-go, says GetUp!

The buyers' strike of Australian property sought by a tax reform group last month has proven to be a fizzer, precisely because some people don't like the idea of lower house prices.

Online activist group GetUp! decided not to pursue a strike of home purchases to protest at the lack of affordability in the housing market because its own members did not like the idea.

"While the issue of housing affordability is clearly an issue that resonates with plenty of people, GetUp! members don't support a boycott campaign," wrote Kelsey Cooke, online community co-ordinator for GetUp! late last week.

"Over the course of the last couple of weeks, we surveyed a random segment of our membership to gauge support - only 10 per cent strongly support the campaign, and more than half the surveyed members opposed this campaign altogether."

Canada, and specifically Vancouver, can expect similar introspective strains in the coming years, between the realisation that high housing prices are the root of the problem and the unwillingness to face the personal consequences if prices drop significantly. The housing market is not going to go down without a fight.

Hat tip CanuckDownUnder at vancouvercondo.info.

Something's Happening Here

Last week was the 25th anniversary of Expo 86, the world's fair held in Vancouver in 1986, lasting from May until October. From a housing perspective 1986 is important because it corresponds to the lowest point of real prices since the mid-70s. Since then, for the past 25 years, prices have been rising and average detached houses now stand at close to ten times the nominal price of those heady days of 1986. (Graph courtesy yattermatters)

So just for fun, how many people were around before 1986 who still live in Vancouver? It's an interesting question -- how many people are old enough to remember the carnage of the second-largest bubble in Vancouver's history that occurred in the early 1980s? (Graph courtesy UBC Sauder School of Business.)

So running a few numbers we arrive at the following:

• There were 3 million people in BC in 1986.
• 676,000 people died in BC since 1986.
• Approximately 1 million people out-migrated from BC since 1986.
• The population of BC now stands at around 4.5 million

We assume that most of the people dying in BC were living in BC in the early '80s, say 80%. We then assume that 50% of the 1 million out-migrants have since returned to, and are currently residing in, BC (and were residents before 1986). From these estimates of the 3 million people who resided in the province in 1986, only about 2 million remain in the province. Therefore, only about 43% of BC's population would have any chance of experiencing the fallout of house prices in the early '80s. Practically it is even less, since many counted in that population weren't old enough to be interested in housing prices in the early '80s anyway.

Given that most people residing in BC would not have remembered Vancouver in 1986, with its bargain-basement housing prices still shivering from the sell-off earlier in the decade, it should not be surprising in the least that the majority of people view BC's, and particularly Vancouver's, real estate as a can't-lose bet. We haven't even begun to include people who rode the early '80s bust but think this time is different.

I have high confidence that most of readers here will not remember Expo 86, not least the younger demographic of people likely to be reading this post. But in the off chance you do remember Expo Ernie, monorails, and what the heck that other platform at Stadium Skytrain Station is for, here's some nostalgia, from simpler times when a house was simply a place to live:

A Tale of Two Vancities

The old adage is that markets are built on disagreement and in financial markets this is most certainly true when leverage is involved. Witness the latest "disagreement" between two mortgage lenders:

For best mortgage deal, move to B.C.

Mortgage rates are near all-time lows but for the best deal, move to British Columbia.

The province has Canada's most expensive housing but its residents are getting rockbottom rates thanks to a ferocious battle between B.C.'s credit unions and the banks.

B.C. home prices, Vancouver in particular, have long outpaced the rest of the country. The Canadian Real Estate Association said nationally home prices were up 8.9% in March from a year ago, but take out B.C. and the percentage shrinks to 4.3%.

The credit unions are another factor behind the higher prices in the province -loans from credit unions are as low as 3.64% on a five-year fixed rate closed mortgage. Canadians in other provinces, even hard negotiators, are lucky to get 4.19% from big banks...

But bond yields have dropped 30 basis points since April 11 and the banks have been slow to compensate for the situation, waiting to see if rates go back up. Mr. McLister says the banks raise rates more quickly than they lower them.

"We just have retail deposits and that's what we use for funding," says Norman Krannitz, vice-president of treasury of Coast Capital. "We looked at our deposits rates and they weren't going up so we decided to ride it out. We love the business we are getting."

Wow. Vancity is pulling out all the stops to get market share of BC's piping hot real estate market (well parts of BC's real estate market are hot, others not so much but that's a different story). How, then, does one square this with this announcement?

Home Capital ramps up uninsured mortgage lending

Home Capital Group made a strong return to uninsured mortgage lending in the first quarter, after scaling back considerably over the last year to avoid excessive losses from risky loans...

[CEO Gerald Soloway] said the company is being cautious when considering loans that will go toward properties in Vancouver or downtown Toronto, because the markets are showing signs of overheating. The company would rather lend in a stable market, than one that is posting swings in either direction.

So here we have two seemingly divergent assessments of Vancouver's housing market. On one hand, Vancity is aggressively offering mortgages, even fixed rate ones, to the mortgage market including those in Vancouver proper (one assumes). At the same time HCG is backing away from markets that they feel are in asset price bubbles. What's going on?

First we should point out that 5 year rates were on their way down -- yet again -- so we should expect a dropping of prime rates in the next month or so from the big 5 banks, barring any significant shift in debt markets. Nonetheless Vancity is financing 5 year rates from its deposits, not exclusively securitizing or duration-matching them as other lenders often do. HCG does something similar to Vancity in part but with a catch, that it is rated as investment grade BBB and not regionally-focused.

So on one side we have publicly-traded HCG with national exposure to mortgage assets and has its debts regularly rated and reviewed, so it seems reasonable there is some outside pressure to look more critically at certain regions of the country to assess default risk: bond analysts would certainly raise their eyebrows from behind those thick glasses if they didn't. Vancity, on the other hand, is primarily financed through BC-based deposits and is member-owned; it has more correlated exposure to mortgage default risk and deposit withdrawals, and by all accounts seems relatively unworried with the state of Vancouver's real estate market. Why would they? Is anyone even asking uncomfortable questions in the boardroom?

Does Vancity have some special insight into aggressively lending into Vancouver's real estate market, one where price-income ratios are among the highest in the English-speaking world, or is HCG raising a big red flag avoiding the "miracle" of Vancouver's housing market? We shall see!

Who to listen to

I don't know. But I do know that Paul Krugman was recently rated as the "top prognosticator" by a recent Hamilton University analytical survey (PDF).

The Hamilton students sampled the predictions of 26 individuals who wrote columns in major print media and who appeared on the three major Sunday news shows – Face the Nation, Meet the Press, and This Week – and evaluated the accuracy of 472 predictions made during the 16-month period. They used a scale of 1 to 5 (1 being “will not happen, 5 being “will absolutely happen”) to rate the accuracy of each, and then divided them into three categories: The Good, The Bad, and The Ugly...

The top prognosticators – led by New York Times columnist Paul Krugman – scored above five points and were labeled “Good,” while those scoring between zero and five were “Bad.” Anyone scoring less than zero (which was possible because prognosticators lost points for inaccurate predictions) were put into “The Ugly” category. Syndicated columnist Cal Thomas came up short and scored the lowest of the 26.

Take the survey for what it's worth, but Krugman recently highlighted the dangers of over-leverage, namely it being a harbinger of subsequent financial problems:

When I wrote the first edition of The Return of Depression Economics, I was reacting in large part to the Asian financial crisis, which I thought could presage similarly difficult crises here in America. Sadly, I was right.

But what made Asia so vulnerable then but not so vulnerable now? Even then, the best available stories ... focused on issues of balance sheets and leverage. And it’s now standard to focus on household leverage as a key part of what went wrong in 2008:

[end quote]

Now if we put this measure beside the equivalent Canadian measure it looks all the more interesting (courtesy theeconomyanalyst.com):

Looking at disposable income isn't quite an apples-apples comparison due to Canada's greater contribution to social services like education and health care. Also the normalization of the scales can add in some debate over the relative peaks. Insofar as the debt-to-disposable-income ratio was brought forward before the GFC by Krugman, a pundit with a proven track record, and comparing the order of magnitude of debts Canadian households are currently carrying, irrespective of some tax policy differences, it should give policymakers some food for thought in the coming year.