House rules

The Bank of Canada will be keeping interest rates at rock bottom levels for as long as it possibly can -- there's no doubt about that. Unfortunately, there's also no doubt that low interest rates are pushing housing prices, especially in Toronto and Vancouver, to stratospheric levels, setting the stage for big problems when rates finally do rise.  What do to?

This morning, Finance Minister Bill Morneau stepped up to the plate with one small step in the right direction. Effective from early 2016, anyone buying a house valued at more than C$500,000 will have to put down a larger deposit. Right now you only need to put down 5 percent of the purchase price, but in the new year you'll have to put down 5 percent of the first 500K, and 10 percent of anything beyond that.

Those of us old enough to remember when couples would save for years in order to put down 20 percent or more may find these numbers outrageously skimpy, but it's better than nothing. Banks lending at these high ratios (in fact, anything above 80 percent loan-to-value) are already required to insure the mortgage, and by far the biggest insurance provider is government-owned CMHC. So even if Morneau's measure today doesn't actually slow the market, it may at least marginally reduce the burden on CMHC, and thus on the public purse, if and when things actually do blow up.

Bank of Canada Governor Stephen Poloz has been pleading with the government to do something like this, Back in October he said “Even in extreme conditions, when financial stability risks constrain monetary policy from achieving the inflation target over a reasonable time frame, a central bank would want to ensure that all macroprudential options were exhausted before trying to address those risks with monetary policy."  Tightening downpayment rules is just such a macroprudential option.

Should the Bank be leaving the job of reining in the housing market to the government?  Poloz clearly believes that low interest rates remain essential if the economy is to be kept from sliding back into recession, but this view appears to rest on two assumptions that look increasingly erroneous. First, Poloz evidently believes that the weak exchange rate that has resulted in part from low interest rates will boost non-oil exports; there's not much evidence of this. Second, he also seems to believe that a prolonged period of low interest rates will lead banks to increase lending for productive purposes, giving the economy a boost. So far that's not happening either: the banks are mainly lending into the housing sector, leading to the price overvaluation that has everyone from the IMF on down worried about a correction.

There's room for debate about why companies don't want to borrow and banks don't want to lend, at a time when Canada's main trading partner, the US, is moving smartly ahead. It surely must have something to do with the signals emanating from the Bank of Canada itself. If the Bank is so a'feared of the future that it wants to keep rates close to zero, why should businesses and lenders feel any different?

Time will tell if Morneau's baby step today makes any difference: with the Bank of Mom and Dad putting up so many down payments these days, best guess is that it won't.  However, more substantive controls are on the horizon. The main financial regulator in Canada, OSFI, announced today that it plans to tighten reserve requirements for banks' mortgage lending.  Regrettably, it's likely that any new rules won't be in place until 2017, by which time the market may well be even more egregiously overvalued than it is today.