Banks need to control their own lending and not rely on the government to do it for them.
That’s essentially what Finance Minister Jim Flaherty told Bloomberg News yesterday.
“The primary responsibility for prudence in lending practices rests with the financial institutions,” he said.
Just as importantly, individuals “need to take responsibility for what they do and exercise common sense in terms of taking on debt.”
It’s refreshing that sensibility is making headlines in Canada’s often emotional debt debate.
Banks are completely capable of underwriting prudently on their own. Moreover, banks by nature fear defaults. Mortgage defaults occur in plain view. They can’t be hidden and they are untolerated in Canada’s highly scrutinized and regulated mortgage market.
Imagine what would happen if, for example, BMO’s mortgage arrears were double other banks (e.g. 0.90% vs. the 0.45% industry average). There’d be investor outrage, a huge hit to BMO’s market cap, and major heat from regulators. It makes absolutely no difference if these defaults are insured or not; the government and investors demand that banks lend wisely.
Flaherty told Bloomberg: “Banks are responsible for their own business practices and what I find odd from time to time is when a bank executive asks me to tighten lending rules.”
Many find it just as odd that big bankers don’t want to do the right thing unless all the banks do it at once! Although, from the standpoint of preserving market share that’s understandable.
“It seems to me that’s the primary responsibility of the financial institutions and not the government,” says Flaherty.
Here’s more from Jim Flaherty on the potential for new mortgage restrictions in 2011:
“We continue to watch carefully.”
“We have a regulatory role and if we need to tighten the rules because the banks don’t — and it is necessary to do so — we would.”
“A lot of this demand is because of very low interest rates, so it’s not surprising that some people are taking advantage of that.”
“…people have bought more expensive houses than they need to have because they could afford to, because interest rates are low.”
“Part of it is rational in the sense that people can carry more debt when interest rates are very low.”
“Our concern is at the moment as interest rates go up—which they inevitably will—we want people to be able to afford their obligations.”
“We want to encourage thrift. We want to encourage people in the residential mortgage world to not buy more house than they can afford.“
Flaherty says he’s also concerned about “the home-equity loan market, which has grown significantly.”
“If we go back a generation, I think most of our parents viewed the house as something to be paid off. It was the first way that they built up equity. I think it would be preferable if we did more of that and less of buying as much house as one can possibly afford based on how much the bank will lend a person.”
“I find it just strange that I get some of the financial institutions telling me to mind my own business on regulatory matters — and then we have some worries about the level of consumer debt, and the banks are saying the government needs to move in and tighten standards.”
Flaherty won’t say whether any rule changes will be made in 2011, but he said he’ll carefully evaluate the economic implications. The most serious of these implications would be harmful effects on employment and job creation.
Our sense is that it’s better than 50/50 that some kind of rule changes are coming. There’s major political pressure out there. At the least, this might prompt token rule changes if nothing else.
On the other hand, patience is prudence when tinkering with a $1 trillion mortgage market. International Monetary Fund (IMF) Canadian Analyst, Charles Kramer, says: “At this point, the appropriate thing to do is wait and see how the credit cycle matures.” But he says we need to keep ready to curtail mortgage lending “a bit more if it doesn’t decelerate.”
It’s important to remember that rising rates will crimp affordability. That in turn will self-moderate housing and borrowing, and this will all happen without any government intervention whatsoever.
The concern is that adding new rules on top of a natural cyclical correction could cool housing too much. Kramer makes a judicious point about waiting (perhaps 2-4 quarters) before dishing out new lending restrictions.