Housing Bubble Prompts New Borrowing Rules

Finance Minister Flaherty’s announcement of restrictions on mortgage lending deserves some credit (pun intended.)  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.)  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 of  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.  The announcement vindicates the case that progressive economists have advanced for selective credit controls as opposed to a one size fits all interest rates.  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 changes  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.

“Some of those loans are not used to create housing,” he said. “They’re used to buy boats and cars and big-screen TVs, things like that. And that’s not the business that [mortgage] insurance was designed for.”

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.  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,  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 obligations  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 increasingly  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 titled  “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.  It will be recalled that those changes were opposed by the then Governor of the Bank of Canada, David Dodge.


  • “I suspect the real rationale is growing concern over Canada’s housing bubble”

    Obviously, but finance minister can’t just say there is a housing bubble, or it might burst.

  • I think we’re calling it a housing bubble, but when it breaks, we’re going to have thousands of “middle-class homeless.” All those who can’t afford their homes when the interest rates finally spike, will have to sell, and what, look for something smaller? I don’t see many of those around. 1000 sq foot house? No such thing available any more. Condos? Sold before they’re listed. Winnipeg has NO vacancy. 1%. If someone sells, there’s nothing to buy in their price and size range, and there’s nothing to rent. Get into carpentry, because the only option will be to take those 3000 sq ft monstrosities and turn it into 2 units, on that suburban crescent….

  • One of the problems that I have with slowing the housing market down with such financing moves, is the braking power can be highly variant and could be just the nasty that pushes our already teetering economy further out on the high wire. I know we progressives have been calling for such measures rather than an increase in interest rates, however, my thinking is it needs to be reinforced with some other stimulative measures within the economy. If one is going to decrease the economies reliance on the indebted consumer, then either the government, business or exports must come forward. Exports are out, business is languishing, especially manufacturing, and governments are on the austerity pathway.

    So one can argue that by letting a bit of air out of the housing sector without some other plan is definitely a mistake. it was estimated that housing prices could fall by 7%, and I do wonder what kind of effect it will have on overall consumption. I guess we will find out soon enough.

    I do realize a housing bubble is a double edged sword, but under the current incarnation of the ongoing financialization of the economy, this is how it works. So until changes are made, the tories are basically saying, this is about as good as it gets right now.

    Now- just wait for the dollar to kill off exports even further!

  • See my comment on the last post on housing at the PEF. To which I would add so what. My mortgage says I cannot have access to cheaper mortgage backed financing until after 20%. I suspect most major banks were similar. So the rule change effects marginal mortgage lenders. The way I read the new rules is that the cons are doing everything they can to look like they are addressing debt levels without really moving against hyped house prices. Which makes sense politically. Who wants to fight an election on the fact that it was their government which blew a hole in housing valuations. That it is not the conservative base.

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