Housing on the knife’s edge

At long last, the federal government has decided to seriously address the housing price bubble that has increasingly concerned Canadians.

On the heels of multiple warnings from the Bank of Canada that Canadians have taken on too much household debt for comfort (we hold the dubious distinction of having the worst consumer debt to financial assets ratio among 20 OECD nations), the federal government announced three moves. It will reduce the maximum insurable amortization period from 35 years to 30 years as it scales back both home equity loans and the amount homeowners can refinance. With these changes, we are about half way back to where the CMHC lending standards stood in 2006 when the Harper government significantly loosened them.

With these moves, the federal government is starting to take seriously the risk of record-high housing prices and record-high household debt. The banks who provide the mortgages have been looking for action in this area for some time, even though they were unwilling to do it on their own – even, astonishingly, after loose mortgage rules in the U.S. helped feed into a global economic meltdown.

Ultimately, these federal changes will have the greatest effect on middle class Canadians – those whose largest asset is their house and whose largest debt is their mortgage (and sometime second mortgage) on that same house. This could go one of two possible ways.

The pessimistic possibility is that trying to reign in mortgage debt and housing prices could burst the housing bubble that simultaneously exists in six Canadian cities.

Developers, spooked by falling house prices, could slow down new housing starts.

Homeowners, who see their home equity loans cut and their house values decline, could scrap renovation plans or forego buying that big screen TV. Since consumer confidence – you and I opening up our wallet and buying things for our households – has been an important player in Canada’s economic recovery, a tightening of household belts could have a short-term impact on our economy and on our sense of security.

The optimistic possibility is that reverting to pre-2006 regulations could help put a lid on house prices, which have risen too much and too fast since 2001. It could also force Canadians, who used to be a nation of savers, to get back to basics and start saving again.

Perhaps it will lead to the great rethink the worldwide economic meltdown was supposed to inspire. Imagine a world in which you could own a home without being ‘house poor’ or, worse, a couple of paycheques away from financial disaster.

Whatever the outcome, there still remains a need for a more coordinated strategy to deal with high housing prices and tighter lending realities. Once you get yourself into this precarious a position, every step you take, no matter how well intentioned, may lead to disaster.

Even with the latest federal government announcements, Canada’s housing bubble remains a problem.

Between 1980 and 2001, housing prices in four of the six major markets in Canada (Edmonton, Calgary, Ottawa and Montreal) remained in a tight band of between $150,000 and $220,000 (in today’s dollars). Through two major recessions, big interest rate hikes, stock market crashes and so on, house prices just puttered along going up at about the rate of inflation.

It seems almost unimaginable today and really downright boring. In these four cities, there were no heady 10% increases a year, no bidding wars just a stodgy 2% a year, how dull.

Except for Toronto and Vancouver, which experienced three housing price declines between them brought on by interest rate hikes. When the bubbles burst, they wiped out in the worst case more than 35% of an average house’s value – a painful brush with reality.

Today it isn’t just Toronto and Vancouver; it’s all six major Canadian cities that are outside of the safety zone. House prices are no longer dull. Unfortunately, the tradeoff is endless middle class worry that the party for their biggest asset isn’t going to last.

To avoid disaster, the federal government needs to continue slowly moving back to the 2006 standard of a maximum 25-year amortization for CMHC mortgage insurance with more money down.

If these moves impact Canada’s fragile economic recovery, the federal government may have to consider additional stimulus investments to keep the recovery on track (building more affordable housing could perform double duty in this case).

Canada’s housing market is still on a knife’s edge and isn’t clear which way we’ll fall. This story is far from over. That’s why this week’s federal government announcement is a welcome change of heart. But it’s one of several changes that needs to unfold.


  • There will certainly be an impact on the construction and associated industries, which played a big part in the boom and Canada’s softer landing from the recession, but there is more of a concern from the “wealth effect” of increased or decreased consumer spending as a result of increases or decreases in household wealth.

    I did some calculations for Canada and wrote about the potential economic impact of a real estate bust back in September 2007, also focusing on the potential response of the Bank of Canada.

    At that time I estimated that the escalation of house prices above norms had added an extra approximately half a trillion worth of “wealth” for Canadians at least on paper. Calculations from the Bank of Canada suggest that there is a marginal propensity to consume of 5.7% for every dollar increase in housing wealth.

    This means that if there’s a loss of just half this excess housing inflation ($250 billion at that time), it could reduce consumer spending and presumably our growth rate by 1%. This doesn’t include the other impacts. A full-on bust could of course put the economy back into recession.

    The Bank of Canada and Finance should be well-aware of these potential impacts. Hopefully any deflation of housing prices will be gradual. However, it should also be clear that, going forward, economic growth will be slower without the benefit of these impacts.

  • I think you over state the case on the impact on new home purchases (not newly built homes). CMHC has moved to a de facto 10% down for first time home buyers with large consumer credit debt. If the gov had made 10 % across the board the new normal and 15% for those who could not prove they saved the down payment the impact on home sales and thus prices would be more significant. All this move will do is have an impact home equity financing. Major lenders were already demanding 25 years as the max for new home buyers.

    As an aside I was turned down on my first motgage application because I had no savings. When I said well actually I have forced savings plan of 600$ a month not including employer contribution to my pension plan she just looked at me like so much dust on the top of a closet shelf.

    Long way to say that 30 % of Canadians have savings that are not showing up in official statistics on personal savings.

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