Finance Minister Bill Morneau announced a broad suite of initiatives on Oct. 3 to ensure that overheated housing markets do not compromise Canada’s economic growth. Canada Mortgage and Housing Corporation welcomes these initiatives and indeed had a hand in developing them with the Department of Finance. Part of our role is to advise the government on housing policy.
Some critics now accuse us of overlooking the “unintended consequences” of our actions. In fact, the results of these policy changes were fully intended.
The federal government requires lenders to buy insurance on mortgages where the buyer has a down payment of less than 20 per cent of the purchase price. Most people who use this support are first-time home buyers.
After the minister’s announcement, a “stress test” using the higher Bank of Canada posted rate must now be used to underwrite guaranteed mortgages. This measure will help offset the highly stimulative effect of low interest rates. Secondly, while lenders are free to offer more flexible terms, the government will no longer guarantee any mortgages on properties valued above $1-million or those with amortizations beyond 25 years. Third, Mr. Morneau also announced some income-tax changes to reduce abuse of the personal exemption from tax on the sale of homes.
By virtue of its role in guaranteeing these mortgages, the government assumes responsibility to ensure the programs support a healthy and growing economy. As such, the rules surrounding mortgage loan insurance have been tightened six times since 2008 in order to reduce housing-market risks. The IMF and OECD, among others, had called for additional action. The announcement was a further response and also proposed discussions on how these risks should be shared in the future.
Action was needed. The level of household indebtedness in Canada is now at a historic high of 168 per cent of disposable income. The Bank of Canada calls this factor the greatest vulnerability to our economy. The bank has highlighted growing debt levels among the most vulnerable homeowners as a particular cause for concern. This includes many first-time home buyers with less job tenure and higher demands on their pocket books.
Concerns about elevated prices in Vancouver and Toronto are well-known. Affordability pressures hurt lower-income households the most and cause real socioeconomic consequences. CMHC has recently observed spillover effects from Vancouver and Toronto into nearby markets. These factors will be reflected in our forthcoming Housing Market Assessment on Oct. 26. They will cause us to issue our first “red” warning for the Canadian housing market as a whole.
High levels of indebtedness coupled with elevated house prices are often followed by economic contractions. In their book House of Debt, economists Atif Mian and Amir Sufi called the relationship “so robust as to be as close to an empirical law as it gets in macroeconomics.” The conditions we now observe in Canada concern us.
These changes will both reduce home buyers’ ability to borrow and increase lenders’ funding costs. We expect mortgage rates to increase modestly in response. Our government-backed mortgage funding has encouraged some unhelpful mortgage-lending activities. These business models will have to change since government should not be supporting lending that threatens our economic stability.
We expect Mr. Morneau’s actions therefore to support our economy. Seen this way, the resulting delay in when people can purchase their first home, or their decision to buy a smaller home, rent or stay put is rather a small price to pay. And tighter lending standards will limit price increases, ultimately making houses more affordable.