Housing Bubble Prompts New Borrowing Rules
Finance Minister Flaherty’s announcement of restrictions on mortgage lending deserves some credit (pun intended.)Â But there is a bit more to this than is immediately apparent.
The government has decided that, to qualify for government-backed mortgage insurance, the amortization period of a mortgage should be no more than 30 years (down from 35 years now, and 40 years in 2006, but still above the maximum period of 25 years which was in place until Flaherty hiked it to 40 years in 2006.)Â In addition, refinancing will be limited to 85% of home equity against a current 90%, and the government will no longer guarantee home equity lines of credit.
At one level, this is a good thing. As widely noted, stricter controls on the extension ofÂ mortgage credit should allow the Bank of Canada to defer interest rate increases, and thus somewhat lower the cost of borrowing for business and governments.Â The announcement vindicates the case that progressive economists have advanced for selective credit controls as opposed to a one size fits all interest rates.Â For example, much of the pain of ultra high interest rates could have been avoided in the late 1980s and early 1990s if the government had acted to deal directly with a housing bubble rather than deflate the whole economy.
The precise rationale for these changesÂ is, however, a bit murky.
A lot of the commentary in the media cites concern over the growing debt load of (some) Canadian households. Seen from this perspective, the new rules will limit the growth of “frivolous” borrowing, as Flaherty put it quite explicitly.
“On Monday, Mr. Flaherty indicated the government is particularly concerned about Canadians using home-backed lines of credit for frivolous purchases.
â€œSome of those loans are not used to create housing,â€ he said. â€œTheyâ€™re used to buy boats and cars and big-screen TVs, things like that. And thatâ€™s not the business that [mortgage] insurance was designed for.â€
But will the new rules really reduce the growth of excessive household debt, or just get the government off the hook?
It strikes me that the new rules are just as likely to force “frivolous” borrowers to shift from low interest rate home equity lines of credit to very high interest credit cards and other forms of consumer debt such as unsecured lines of credit.Â They may borrow less, but at much higher cost. In short, if the concern is high debt, why not take action to lower very high interest rates on credit cards as Jack Layton has been demanding?
I suspect the real rationale is growing concern over Canada’s housing bubble. As I argued in a post almost one year ago,Â and as David Macdonald argued in a fine CCPA report last August, house prices have increased much faster than overall prices since 2000 and have clearly got far ahead of where they should be relative to household incomes and rents. This has been denied by some bank economists and met with pat government assurances that all is well, but there is probably growing unease in the corridors of power.
Given that the great majority of Canadians mortgages are insured by the government, any crash in prices could result in seemingly risk-free obligationsÂ rapidly turning into costly government liabilities to the banks. Given that Canadian house prices are roughly at US pre housing crash levels, why would CMHC not start to look increasinglyÂ like Fanny Mae and Freddie Mac which incurred huge losses and had to be taken over by the US government?
It is worth noting that the government’s media release was titledÂ “The Harper Government Takes Prudent Action to Support the Long-Term Stability of Canada’s Housing Market.” Changes to the mortgage rules will clearly lower demand for housing at the margin and will, Doug Porter estimates, reduce house prices by as much as 7%.
In short, Flaherty’s goal is to gently deflate the housing bubble which he inherited and then further inflated through ill-judged changes to the mortgage rules in 2006.Â It will be recalled that those changes were opposed by the then Governor of the Bank of Canada, David Dodge.